Did the Fed Just Take a Victory Lap?

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0:54Did the Fed just take a victory lap? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Darius Dale, founder of 42 Macro. Hey, Darius. Hey, Maggie. How are you? Happy holidays. How you doing? Yeah, I know. we're all feeling that spirit today. The Fed didn't just take a victory lap. It was the boom, mic drop, it sounds like, from Jay Powell and the gang. And it really sparked a huge rally across asset markets today. So if you're just catching up and have been away from screens, the Fed left rates unchanged but lowered its inflation forecast and indicated three-quarter point rate cuts next year.

1:33Bond yields, I mean, the market reaction was immediate. Bond yields dropped, 10-year rolling back to 4.03%. Stocks soared. S &P, and they're probably still settling up, but S &P up 1.3%. NASDAQ up 1.3%. Dow up 1.3%, above 37 ,000. The Russell, 2000, up 3.49%. percent, gold up, crypto up. Darius, what'd you make of it? What do you make of this move? Oh, it's to be expected. I mean, last we were on in the program, we were talking about how the asset markets are in the Goldilocks regime, and that was supported by fundamental evidence of a rising probability of a soft landing. And so in terms of today, you think about the Fed, a lot of investors were expecting, myself included, at least in terms of today, the Fed to come in and throw cold water on what had been a pretty remarkable easing of financial conditions that we've seen really since the beginning of November.

2:29But instead of coming dressed as the Grinch, Jay Powell came dressed as a mall Santa, as Oprah in a mall Santa outfit. It's like, you get a rate cut, you get a rate cut, you get a dot plot revision. And so in our opinion, this is good policy. This is appropriate policy. Now, I wouldn't call it a victory lap, But what they are doing is acknowledging a lot of the significant further progress we have observed in the data that points towards the direction of a soft landing. Something we talked about, you and I, Maggie, a couple weeks ago in terms of how to make money as an investor in terms of where we are in the economy.

3:04It's not about whether the economy soft lands or hard lands or no lands. It's about making money along the way in terms of the rising and falling probabilities of those outcomes. And this is something that our models picked up on at the beginning of November and have consistently gotten us incrementally bullish along the way across asset classes, stocks, bonds, and Bitcoin. Our models have basically said, hey, look, this is a great time to be fully invested. We've been the wards of that great time to be fully invested. And ultimately, that Goldilocks regime that we've been in for a while now is being driven by that fundamental data, that fundamental improvement.

3:38So it's interesting that you talked about the financial conditions, because I think that everyone really did expect, because to say that they were going to hold rates steady and that there would be easing, in and of itself, there are plenty of people in the market who are expecting that. We just had Jared on yesterday who's saying, I think they're going to be easing next year. It was the fact that they didn't try to walk it back or temper that at all. They had to know by going public with the plan to cut rates or acknowledge that rate cuts are coming, that would spark yet another leg of this rally.

4:16And they seem comfortable with that. What do you make of that? Does that make you feel that they are – or what do you think gives them the confidence to do that? Should we be scared they know something that we don't? Or is this a good news story? No, in my opinion, it's a great news story, Maggie. I think this is one of the feel-good stories of 2024, is the development of the U.S. economy. You know, you and I were talking about, you know, the resiliency of the economy going back 18 months ago in this program. And one of the things that sort of helped us understand that we'd have this transitory period of Goldilocks, even going back to January, was the immaculate disinflation that we've observed in the data.

4:54And that immaculate disinflation is coming from some immaculate forces in the labor market. So in terms of answering your question, Maggie, let's take it to the charts. Brian, if you throw up a slide. Wait, I love that. We ought to have like a sound effect that says, let's take it to the charts. Let's take it to the charts. Let's take it to the charts. So, Brian, throw up slide three where we show, it's a fairly complicated chart, but I'll be quick in terms of explaining it. Because to me, this is one of the most important charts in macro. I've been saying that for a full year now. It's certainly something that Powell alluded to in this press conference today in supporting the Bishda Plot revision.

5:28So draw your eyes to the middle panel of this chart where we show labor demand in the blue line and labor supply in the red line. And then the panel below that, we show the spread between labor demand and labor supply. And for those of you at home, labor demand is just the total household survey employment plus Joe's total job openings. And what we found is that that spread between labor demand and labor supply, which peaked at around 6 million back in early 2022, has gradually declined over the past several quarters to around 2.4 million. And the reason that's important is because it continues to take pressure off the labor market from the perspective of wages, that that spread tends to be quite positively correlated with wages.

6:07But the immaculate part of this is quite remarkable, Maggie. And I draw your eyes to the bottom panel of this chart where we show household survey employment in that blue line relative to Joel's total job openings. And for the first time in the history of these time series, we've seen a significant divergence in the direction of travel for these time series. We've seen slack get created consistently for almost two years now in the labor market coming from job openings. And none of the slack is coming from total employment. And in our opinion, that's obviously, this is how you get to a soft landing in terms of reducing the pressure, the upper pressure that we continue to experience on wages.

6:42And just a couple of things to highlight on that. Brian, if you throw slide four up, where we show Jolt's total job openings divided by total unemployed workers, the second panel and the third panel are actually the most important lines in this plot, are the private sector hires rate and the private sector crits rate. And what we find is that we're back to a trend level in both of those statistics. We're at 4.1 % in terms of the private sector hires rate. We're at 2.6 % in terms of the private sector quits rate. And the reason that's important and the punchline in this entire discussion, in my opinion, is on slide five, Brian, where we show the Latin FEDs wage growth tracker and the ADP median annual pay statistics for job changers in the blue line in both panels, for job stayers in the red lines of both panels.

7:23And so what we know is that, OK, now we are back to a normalized level of turnover in the labor market. And what we know is that people who change jobs tend to experience significantly faster wage growth. So investors should expect slower wage growth in the months ahead, all while we continue to see this sort of immaculate loosening of labor market conditions vis-a-vis that divergence between total employment and jolts. So we're getting a lot of really positive news. This is stuff we put in our macro scouting report every month for 42 macro clients. And so in my opinion, I think it's no surprise to see Chair Powell celebrate some of this stuff.

7:56I cannot confirm nor deny whether or not we meet with the Fed. So we'll keep moving. I think you dropped your breadcrumb for us, though. So there have been discussions about the labor market. There are some things about this economy that have been confounding. It is we had all that fiscal. That's something we haven't had before. There's a lot of talk about the lags. We've had war. We've had supply chains. We've had pandemics, all of this in the last few years. So being able to time out some of the impact of things hard ordinarily and then sort of maybe even harder against that backdrop. If we are, if the economy, is the Fed signaling rate cuts because the economy is going to be weakening into recession, which presumably have an impact on the labor market?

8:48Or are they suggesting something else is going on, maybe productivity that's strong enough to allow them to kind of land the plane, have inflation continue to get to their target without growth rolling over? It's the latter, Maggie. Great question, by the way. It's definitely the latter. One, we can derive that just from looking at their summary of economic projections. They're not calling for a significant slowdown on GDP growth, nor are they calling for significant uptick in unemployment rate. In my opinion, the number one thing that's happening that's really supporting rising expectations of a soft landing, not just amongst economists, but more importantly, being priced in asset markets, and appropriately so, is this big pickup that we've seen in productivity growth in recent quarters.

9:34You recall that, I want to say, the productivity growth came in right around 5 % on a quarter-for-quarter star basis, right around 2 % on a year-over-year basis in late October, and has since been revised higher. And the reason the bounce and productivity growth matters, it matters a lot for the future outlook for the economy for two reasons. Reason number one, Brian, if you throw up slide six, where we show our corporate profitability model relative to NIPA corporate profit growth, that's the blue line on the plot, and the shaded area curve is our corporate profitability model, that's just nominal gross domestic income minus the spread between the U of E rate of change of unit labor costs and productivity growth.

10:11And what we found is that corporate profitability bottomed the corporate a couple of quarters ago, and it's really kind of started to improve over the last couple of quarters. It's still cyclically depressed, but it's getting back towards more normalized levels, which implies corporations are, you know, there's a reduced need for corporations to shed costs on the labor front and or to pass on price increases to customers. Brian, if you put up slide seven in today's chart pack, where we show the spread between private sector average hourly earnings growth minus non-farm productivity. That spread, which is generally noise for most of the time, but however, whenever that spread rises substantially and it starts to eat away at corporate profitability, you tend to see higher rates of consumer price inflation as corporations pass on those price increases or that lack of productivity onto consumers.

11:00And the reality is we basically round tripped in terms of that blue line. We had a big spike up in terms of the spread between wage growth and productivity. And now we've had a sharp decline in terms of the spread between wage growth and productivity. And so what all this means is that there's a lot less pressure on corporate America to either fire people and or to pass on those price increases. So a lot of the slack that we're seeing created in the labor market, which in fact has been immaculate, can continue as long as this productivity level is sustained. And obviously, that's the hardest thing to forecast when it comes to forecasting macro economy.

11:36So we can't forecast that with any precision. No one can. But what we do know is that the trend rate of productivity is right around 1.7 percent. You can add 30 to 50 basis points, you know, just by hashtagging AI. And so you're talking about a level of productivity growth, if sustained somewhere to two, two and a half percent, would absolutely create a soft landing outcome in the U.S. economy. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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13:10Yeah, that's a really important distinction because when you're, you know, I mean, and it used to be that, that, you know, when when we'd see the Fed start to pivot, The thing that we've always talked about is, with anyone calling for that, is if they come on and say they're pivoting, watch out. Because if they're pivoting, it's probably for reasons that are negative, potentially, for stocks, at least, for corporate profits, for earnings, for job seekers. Do you agree, though, that it sounds like, or do you agree with the Fed forecast that we're not going to see a significant increase in unemployment?

13:49I don't know that I need to answer that question with a specific answer right now. What I will tell you is that we run a variety of models that give us a good look on whether we have a high probability or a low probability of a near-term recession, something that commences in the next three to six months. And those models, by and large, are saying there's a fairly low probability of a recession commencing in the economy. So for now, the markets are telling me that there's a low probability of recession, i.e. our global macro risk matrix, which is a very complicated and sophisticated system that allows us to be appropriately orienting our decision-making process with what's actually happening in markets, that is telling us that there's no recession on the horizon.

14:26And the actual qualitative research that we perform every day in our late-off morning note and every month in our macro scouting report are saying that a recession is a low-probability event. Now, that probability might start to rise at some point. But again, I don't think it's appropriate as an investor to pigeonhole yourself into the soft, hard, or no-landing camp. You can make money betting on a soft landing and then booking that trade and then eventually betting on a no landing or hard landing after that. And that, to me, is the number one thing that I see retail investors doing wrong right now.

14:55The institutional clients know that. When I have my daily pro-to-pro meetings with our institutional clients, they get that very much. Their job is to make money. The retail investor, they think their job is to be right about their forecast, and that's how they make money. And unfortunately, that's just not how the game works. Yeah. I think there may be some institutional people that are struggling with that too. You're right, Darius, but we've seen and heard from people who are kind of like still on that narrative. Now, it doesn't mean that they're trading the same thing they're talking, which is important, but there are plenty of people who believe that we are going to see inflation return.

15:31We are going to see the Fed's going to be wrong and that they're giving up the fight on inflation too soon. One of the things that Jay Powell said today, which was interesting, was that everyone's been wrong about the economy, including them, and that this is a time for everyone to be reflective because everyone got it wrong somewhere along the line. They are now, it seems, concerned about the lags of all of the tightening they've done and trying to get in front of that, worried maybe that there's there's going to be more pressure, downward pressure on the economy from their own policy. Do you have any thought about the timing of a rate cut?

16:14Do they seem, if they're preemptive, are they likely to go sooner? I think the market's thinking March, right? Does that seem too soon? Yeah. So we were May prior to the meeting. I haven't checked it since the meeting. So May was the initial, not liftoff, what's the opposite of liftoff, lift down, or step down, whatever. Pivot. So let me answer your question. So this is good policy. They understand that monetary policy works with long and variable lags. And you and I have discussed on this program, you know, all since summer of last year, that the lags are longer and variable in this cycle. They're longer in the cycle because of the terming out of debt that we've done and also the expediency with which the Fed hiked the policy rate.

16:57So not only did consumers in the private sector, both households and corporates, not need to refinance anytime soon, they don't want to refinance anytime soon because of that widespread between what they're currently paying in debt service relative to what they would refinance into from a market rate perspective. So the Fed understands that these lags are longer and variable. So they understand that, hey, if we're actually getting the positive outcomes on inflation that we effectively want, then what is the purpose of allowing the policy rate to drift higher on a real basis and effectively tighten monetary policy further if we're actually getting this sort of soft landing outcome that, you know, if you're a fan of America, you should probably be betting on, right?

17:36You know, what's better than inflation returning comfortably back to target than, you know, without any significant hiccup in the labor market? That's a really positive outcome. Now, again, as an investor, Darius Dale, the founder and CEO of 42 Macro, is telling you it doesn't matter whether or not the economy soft lands. What matters is the progression of asset markets take to getting to the ultimate outcome. We could go into a hard landing very much in the second half of the year. But if the stock market runs up another 10, 15 percent between now and then, are you going to be able to live with yourself if you miss that gain?

18:08Are you going to be able to live with yourself if soft landing is still very much to consensus expectation three to four or five months from now? I'm not saying it will or won't be, but what I will tell you is that we have legitimate proven quantitative tools that will allow us to book gains on Goldilocks and rotate into something that's not Goldilocks in the future, in my opinion, at a better price point than a lot of folks who are just, you know, the economy must do this, therefore. Yeah, exactly. And that's been the issue. So I want to get to some questions because we've got a lot, obviously, given what's happened, because a lot of people are having to kind of reset now.

18:45Lena saying Darius has been right with his timing. And I wonder what he'll say about 2024. Any correction coming? I think you just answered that a little bit by saying you can't front run the connection, the correction that may or may not come at some point until, I mean, the Fed's data dependent. Sounds like we have to be too. Yeah, 100%. Brian, throw up slide eight, my favorite slide every morning that I refresh in terms of our research. So there's two things that are core to our research process in terms of helping orient our investment-making decisions and the recommendations that we make to our clients.

19:18One is our global macro risk matrix that helps us determine our top-down market regime. So what are the asset markets pricing in? Are they pricing it in too much or too little relative to the consensus narratives out there? That model has been telling us Goldilocks, Goldilocks, Goldilocks for a while now. This macro weather model, this is designed to incorporate qualitative information like what's happening with growth, inflation, fiscal policy, liquidity, all those things that we care about and we talk about on programs like these. We're systematically tracking these every single day. We refresh this model six times a week for 42 macro clients.

19:54And the key takeaway, there's several key takeaways. One, the current constellation of principal components of macro, whether you think about the rising trend in global liquidity or the rising trend in growth or the declining fiscal deficit, i.e. budget deficit widening, all those things, the current constellation of what's actually happening in the economy and in asset markets are telling you that you should expect better than normal returns for the stock market, the bond market, and Bitcoin over the next three months. That's based on the empirical analysis that we've done to determine those regimes.

20:26The dollar should be going down, which should be additive to global liquidity. And commodities are quite neutral right now. So what I'm trying to show in terms of demonstrating this process and answering the question is to tell investors, you don't have to live in perpetual fear of your ability and or inability. And I would argue, based on what Powell said today, which I agree with, your inability to forecast all these different dynamics in the economy because each of these are principal components and really important to determine the direction of asset markets. You can actually just now cast them and understand it better than everyone else and pivot when they change faster than everyone else, because most everyone in asset markets aren't looking at these things every single day and aren't able to react to these things when they change because they're too busy going down rabbit holes on hard landing or no landing or soft landing as opposed to just being Bayesian and reactive to the data.

21:16Yeah. So Timothy has a really interesting question. what are you looking at that's not obvious or that really gets your attention? So, I mean, we're in this period where everyone's going to have to reset, I think. I know you look across a million different indicators, but is there anything in the reaction today that you find interesting or a market that you think could be something to watch? What are you going to be most focused on? Is it still the labor market? What are you looking at? To me, it's inflation. Shout out to Jim Bianco, I think it was on Monday, who had a great discussion on inflation.

22:00Brian, if you throw up slide two in today's chart pack, where we show the dot plots for the Fed and the blue bars, the current year, one year forward is the second panel, two year forward, third panel, and so on and so forth. I focus your eyes on that second panel in terms of answering this specific question. Right now, that red line in the second panel is the December 2024 Fed funds rate. The blue bar in that panel is the one-year forward median dot plot estimate, which was revised lower today by 50 basis points. So right now, the market is effectively pricing in 75 basis points further of incremental rate cuts relative to what the Fed is already projecting.

22:36Now, the market may be right. The Fed may be eventually forced to kind of be dragged down to that level kicking and screaming. But to me, this is effectively saying soft landing is a very consensus, at least in the money markets right now. And so if we start to see adverse outcomes from an inflation standpoint, and I would argue we saw some adverse outcomes from an inflation standpoint in yesterday's report, that to me is the number one thing that could throw cold water on this Goldilocks regime, which is obviously a risk-on regime, and transition us to a risk-off regime, much like what we saw from August through October.

23:10I'll just give you a few statistics on that. So we track inflation impulses on a three-month annualized, six-month annualized, and year-over-year rate of change. But we tend to focus on the three-month annualized because that tends to line up with the direction of travel and asset markets. It may change in the future, but for now, three months seems to matter the most. If you look at the three-month annualized rates of change of super core CPI, that accelerated to 5.1%. That's obviously well above its pre-COVID trend. That's the highest print we've seen since November 2022. two, and median CPI accelerated to 4.9 % on a three-month annualized basis.

23:43That's the highest print we've seen since April. So there are underlying inflation measures, statistics, that are kind of bucking the trend of the general trend of disinflation that we're observing across the core PCE deflator, other measures of underlying inflation. Pretty much every inflation survey, whether you look at University of Michigan, Consumer Conference Board, New York Fed, all these inflation surveys are collapsing, but we're still seeing some evidence of sticky inflation. And so if we're looking ahead into next year, I try not to predict the predictors. To me, the predictor is the global macro risk matrix and the weather model telling me that it's a great time to take risk.

24:18I don't want to predict the predictors. But in answering the question, if I'm forced to predict the predictors, it's going to be sticky inflation data over the next one to two months that really throws cold water on this regime. And who knows? The market it could be 10 % higher by then. Yeah, that's the risk. We don't know when that comes in and what you've lost if you're on the sideline. But that's tricky for people. So this is when you have to think about your time frame and your risk appetite. And we'll flag it at the end. But remember, we're doing, depending on where you are on the risk spectrum, if you are thinking about crypto, and I see a couple of you commenting about that in the chat, we're doing a crypto live academy.

24:57The timing can be better tomorrow and Friday. And it's about sort of how to trade that market, what you need to understand about the dynamics. And so, you know, this will feed into it. If we're in a regime like this, how does that make that difference? So be sure to go to the website to figure out how to register for that. I think it's realvision.com forward slash get ready. It's free for everybody. If you're members, you'll automatically get access. If you're not, you just need to create a free account and you can go to it. So it's going to be a tricky time. I was laughing out loud. Mike Ray in the chat wrote, mortgage the house.