Is the Fed Nailing the Soft Landing?

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0:54Is the Fed nailing the soft landing? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Peter Buchfar, the CIO of Bleakleaf Financial Group. Hi, Peter. It's great to have you back on. Hi, Maggie. Thanks for having me again. So we had the U.S. nonfarm payroll number out today, and we saw a mixed reaction. It's sort of interesting. After an early wobble, stocks had a positive response, the S &P 500 actually hitting a new high for the year here in the afternoon, while the Treasury market sold off, kind of rethinking those rate hikes. So if we just start off with the labor market, what, if anything new, did you learn from the numbers today?

1:32Well, it actually was a somewhat confusing jobs report because you had the establishment survey that when you include the revisions was slightly less than expected. And if you break down the job growth, most of it was in government, health care and leisure and hospitality. And you throw in the auto workers with the end of the UAW strike and there was very little job growth elsewhere. But the household survey, which flows into the unemployment rate, showed this very blockbuster type number, which I can't necessarily square up. I think the end result, though, when you take a step back, is if you average the six-month pace of job growth versus the 12-month versus the 2022 pace of job growth, both in the BLS report but also the ADP report, there's a clear slowdown in the pace of hiring.

2:24And we've seen that in other statistics. We've seen that in continuing claims, which is at the second highest level in a couple of years. You have the question in the conference board, consumer confidence number of jobs hard to get. That is the highest since March 2021. You have job openings at the lowest since March 2021. You have the employment component in both ISM and S &P Global's PMI, the job component of manufacturing below 50. You have the services employment barely above 50 in ISM and the lowest level since 2020 in the PMI. So there's a confluence of data that's pointing to a slowdown in the pace of labor growth.

3:14But at least today, the rise in yields was focused on the drop in the unemployment rate and that pickup in the household survey. because the market has gotten very excited on the hopes of rate cuts, even though the excitement is predicated on, yes, the good thing of moderating inflation, but also expectations of continued slowness and growth. And I think that today was sort of just a rejiggering of those expectations that Jay Powell may not just be so willing to just slashing and burning interest rates next year. because the data is not going to necessarily fall into exact place as the markets want it to be.

3:58Yeah, it's been the conundrum, isn't it? Because a lot of people have been coming on and just sort of looking at all those rate cuts baked in and just kind of trying to square it. The economy has been really tough to figure out, though, hasn't it? And it's been interesting this week, listening to the guests we've had on, most of them have really acknowledged that we've gotten that confirmation now that inflation is moving lower and that even if the timing is up in the air, there is this feeling that the Fed's next move is probably going to be lower. Let's just hear what some of the folks this week had to say, and then we'll talk on the other side.

4:36I've been around here a long time, and I've never seen it this bad. And people that I talk to, been around 40 or 50 years, have never, ever seen it this bad. If you look at what's happening in the real world, which is really where the chemical industry comes in, if you look at what's happening to housing and construction, it's awful. I think bonds are going to do well over the course of the next year because if inflation goes down to 2 % or even lower, we might even see a one-handle, then the Fed is going to have to cut in order to keep policy at the same level of tightness. The expectations are now for two rate cuts by June from the figures I was checking this morning.

5:24And yet that liquidity is going to favor investments in longer duration, higher volatility assets such as Bitcoin. And arguably, Bitcoin is one of the most sensitive of all risk assets to liquidity pressures because it doesn't have earnings to worry about. It doesn't have any cash flows to discount. I don't think that it really takes a lot to move the needle or for, let's say, Bitcoin in this crypto asset class to really see pretty significant gains. It doesn't have to be the same type of liquidity expansion that we saw coming out of COVID. But you'd actually need to see a ton of central bank liquidity for there to be big moves or sustain big moves in crypto.

6:07Now, just a reminder, those comments were before the payroll number. And many of them felt like the market was getting a little too aggressive in terms of pricing in. I think the speed of the rate cuts. But still looking out through the year, there was this feeling like we're kind of in a new regime for the Fed. I'm going to talk about a couple of interesting points that were brought up. But Peter, what are you expecting in terms of Fed policy? Well, I'm going to mention two things. Number one, let's just say the Fed does what the market has priced in and cuts about 125 basis points next year.

6:45The Fed funds rate is still going to be above 4%. That is a far cry from the zero we saw in the 15 years prior to 2022, give or take a few moments in 2018. So we're still going to have the cost of capital that is much higher than it was for that period of time. Number two, it is not so simple as inflation went up, inflation comes down, the Fed's job is over. because there's one thing to have inflation fall, but there's another thing to actually keep it down. Because Jay Powell remembers the 1970s when each time inflation fell, the Fed got complacent and inflation then re-accelerated. And it did it again and it did it again.

7:36So I think that that is something that, while other Fed members may say, okay, inflation's down to two, let's just start cutting just so we don't have this rise in real rates, I think Jay Powell is going to be much more stubborn with this because he's focused on the end of his career. His term ends in probably, I think, February 2026. And the last thing he wants to see is after this come down in inflation is a reacceleration because he starts cutting interest rates just to satisfy the markets. Now, his job will get difficult in terms of this decision making if, and I do think when, the unemployment rate starts to tick north of 4 % and goes to 4.5 and maybe even 5 in an economic downturn, which I think is inevitable in a more pronounced fashion next year.

8:32That's going to be a very difficult thing for him to balance because he doesn't want to see, like I said, a reacceleration of inflation that the 1970s was basically all about. But like I said, even if he starts cutting, the Fed funds rate, the cost of capital is still going to be elevated. And I would not discount the possibility, which I think is more likely than not, that long-term interest rates actually rise when the Fed starts cutting short-term interest rates. And why would they do that? Because if they start to cut, it's going to be in response to a more accelerated slowdown in the economy, which implies that tax receipts are faltering.

9:17The budget deficit instead of$2 trillion could be$3 trillion. And as a percent of GDP is going to be potentially double digits, which means we're going to be flooded with supply. You have the risk of a much weaker dollar. They start to cut, which means you may start importing higher inflation. Maybe oil goes to$100 when they start to cut. That then leads to higher inflation at the same time. And foreigners that own a lot of U.S. Treasuries may not want to stick around for weakness in their dollar holdings. So all these could be reason for that. And we don't know what the Fed also is going to do with their balance sheet in terms of QT if they start to cut.

10:02because Jay Powell does not like to have such a big, fat balance sheet, even with a trillion dollars off its peak. So one of the Fed members alluded to the possibility of even continuing to shrink their balance sheet at the same time they cut interest rates. So I don't think that will necessarily happen. But if it does, that would be another reason why you can get a rise in long-term interest rates, even if they cut short-term interest rates. And that does not seem like that possibility is priced into the market at all. No, everyone just assumes, oh, the Fed's going to cut and rates are going to fall across the curve and it's just going to be so easy and everything will be fine.

10:39Yeah. Well, some people think the Fed has to cut not because of the economy, but because of these debt issues, because of interest payments, because they can't afford a recession. So even if they're worried about inflation, they're more worried about a deep recession for exactly the reasons that you talked about for ballooning the deficit. Let me let me put a pin in that, though, and ask you a question. What are the forces that would hold inflation above the Fed's target or put renewed upward pressure on inflation? We're seeing energy prices drop. Well, right now we have a lot of disinflation, whether it's energy and particularly gasoline prices.

11:16We're seeing that in goods. You listen to a lot of retail calls, particularly Walmart, who was interviewed on CNBC this week, that talked about deflation on the merchandise side. So all that stuff is coming together, which is all well and good right now. But stretching out over the next couple of years is, on the one hand, higher interest rates are hurting the demand side for things. But at the same time, it's also damaging the supply side of things. You take the rental market, which is 40 % of core CPI, about 30 % of headline. And we have an enormous amount of apartment units that are going to be finished in 2024 that are going to lead to further a cap on rental gains, and that will probably flow into 2025.

12:08But those are construction projects that were started basically a year ago. There is no new supply coming online, almost none, in terms of multifamily. So you're going to get a reacceleration in rents at some point in 2025, 2026. Let's take the trucking industry, for example, where we've seen a very sharp decline in trucking rates after the spike of 2020, 2021. Well, you have trucking companies going out of business left and right, yellow being the biggest. So you're seeing a rationalization of capacity, which will then eventually lead to a rise in trucking prices. So we're killing the supply side of the economy at the same time the Fed is trying to kill the demand side.

12:54And so you're setting the stage or you're sowing the seeds for reacceleration in inflation in the next couple of years, a.k.a. what's similar to what we saw in the 1970s. So, yeah, this is all great. Inflation is decelerating. But like I said earlier, there's one thing to have inflation come down. There's another thing to keep it down. 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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14:29What's your sense in terms, I know you're always listening to all the earnings calls and what companies are saying. We saw that huge rally in stocks in November. In fact, I think we have a question. I think it was from AJ. Yeah, why do you think the market's not selling off, even with the possibility of rate cuts not coming as soon as March? And do you think there's any possibility of another hike? I think today was the first day of where the stocks went up when the bond market took away some of the rate cuts. So it's just one day. I want to see if there's any follow-through next week. And Friday in December, seasonally, markets tend to trade higher.

15:12So I don't know what to make of it right now. But if the 10-year yield continues to go up, if Jay Powell next week talks down the possibility of what the bond market has priced in, you can be sure stocks will probably sell off. Because to me, the only reason why we've rallied in November is because the Fed is done and who doesn't want to miss the Fed is done route. Yeah. Presumably, we may have some catch up to right end of the year. Not everybody participated. In November, we saw some again, I know that you're a keen watcher across all sectors. We saw some broadening out, and some people took that as a good sign, at least as we head into New Year.

15:56You know, finally, the leadership broadened. Do you expect, what seems like it'll perform well into 24? Would you expect to see some of those other sectors catch up? Maybe tech doesn't push higher, and we have give back in tech, but maybe some backfilling from other sectors? or does it seem like the S &P broadly, stocks broadly, are at risk here of giving back some of those gains we saw in November? Well, it certainly would be nice to see the broadening continue since the rest of the market outside of the big names have been neglected to a point where the discrepancy is as wide as it's ever been.

16:38So it would be nice because a lot of these neglected stocks have already priced in probably a deep recession with many down 50, 60, 70 % from their highs. It gets tricky, though, in terms of what will lead us next year if the macro backdrop plays out as I think it will. I do think that the big names, and I know people like to call it the Magnificent Seven. To me, it's down to six because I think Tesla is sort of losing that allure like the other six are. And I'm referring more to the cult six. It's getting so overcrowded that to me, it's just the sustainability of it is in question. Because if it's all down because of AI, as great as this technology seems to be, monetizing it is just going to be – and making this foolproof type technology is going to take time.

17:39I mean, I just laugh. Like, they ran up Google$6 or$7 yesterday on their Gemini, their new iteration of AI. And then it comes out today that not only were they faking some of the ads for it and the demonstrations, but it was hallucinating like Microsoft's ChatGPT. It's like there's still time for this to develop. And the market cap increases that people are chasing in these names are truly astonishing. So I think what's more likely to happen is the rest of the market outperforms the bigger names. Now, whether that means that the rest of the market goes up and the bigger names go down or they both go down, the bigger names just go down more, I'm not sure.

18:25But I just think that this is like the tail end of this chase in these cult six. And I think if I'm right on the economy that it continues to slow, the business of those six are going to slow too, since all their customers are the remaining thousands of companies in the market. Yeah, I mean, it's a cap spend at the end of the day, right? I mean, you have to, you know, all of these other companies have to have capital expenditure to buy and deploy the AI. So it sounds like you're very concerned. Christopher just posted in the chat, Felix Zuloff thinks that first quarter next year brings big trouble, higher rates in S &P down to 3 ,500 after it just hit a new high today.

19:08Are you that kind of concerned? Or, you know, how are you thinking about the beginning of 24? Well, Felix is much better than me in terms of the timing of this. I do think that we're still in a bear market and until proven otherwise. And we haven't proven that otherwise. So I would not be surprised if we retested those lows. Now, when it happens, I have no idea. Again, Felix is much better at the cyclical measurements of his models that can more better time that. But I can't rule that out at all. I mean, the problem with the market putting aside the fundamentals is that when you have the valuations that we do, you don't have any room for error.

19:55And I think just people are still way too nonchalant with this higher interest rate environment. I mean, just if you look at high yield, investment grade and leveraged loans, and there's a whole other pool of debt out there. but just looking at those three slices of corporate bond land, you have about$700 billion that are coming due next year. You have about$1.1 trillion coming due in 2025. The impact of this higher rate world we're in, even if the Fed's cuts next year, still has a ways to go to play out. Even if the Fed cut 50 basis points or 100 basis points or 125 basis points next year, the resetting of this debt can still be double the rate at which the loan, the rate on the loan that's coming due.

20:44So there is a long runway still of this to play out on the economy. And people that are saying, oh, yeah, we're going to have a soft landing. Well, all they're doing is looking at where we are today. They're not focused to me on the trajectory of things coming our way, whether it's the debt maturities that I just mentioned, where the progression of the labor market that we're seeing, where the state of the consumer, that seems to be very fragile. If you're not a higher-end consumer where restaurants are packed, but Dollar General is saying business is still challenged, this still has time to play out.

21:24And I think that people have to appreciate that. You can't just look at how things are today and make the declaration that what kind of landing we're in. Yeah, it's interesting. And it reminds me when you say that David Rosenberg's contention is always that there is no landing. A soft landing is only a transition between a period of growth and the ultimate recession that's going to come. It's just the middle, the period that gets you there. But it's been so hard to time this, though, Peter, because so many people have been wrong about the economy and the resilience of the economy. Well, I think that, and I was wrong too, thinking that there would be more pronounced economic impact from a very sharp rise in interest rates in 2023.

22:08But what we've learned is that this process is going to be more drawn out. Because like I've said, the impact on one's debt doesn't happen all at once. It all depends on when your debt is coming due. And not only that, it's what business is not getting started or funded because of this higher cost of capital world. But this is going to be drawn out. This is going to be, and I've said this before on the show, more of a death by a thousand cuts rather than a major event like 08 or 07, 08 with Bear Stearns and Lehman. These were boom, boom, boom events. Yeah. This is going to be more drawn out, I believe.

22:52and that is one thing that I think we're learning. But there are people out there that think that because it hasn't happened yet means that it won't. So there's this sense of complacency that I think has been settling in where I'm of the belief, and I've learned my lesson from this year, that this is just a slow-moving blob, but it's still catching people in the blob. It's just taking more time for it to spread. Yeah, and if you listen to Paul Hodges, it really depends on where you sit in the economy, right? He's looking at the chemical area, more of the goods area. And, you know, from his extensive networks, you know, he said in that clip, it's the worst they've ever seen it.

23:35I mean, it's depression-like if you're in that part of the economy and supply chain. So it's hard to see. And Lizanne Saunders made this point with us a couple of months ago that it feels rolling, right? The goods and manufacturing sector have been terrible. Housing was terrible. Is it possible that because of the way it's moving through, that what was hard hit will start to stabilize and perhaps recover a little bit as maybe services then finally feel the recession? Can that make it more shallow and less painful and perhaps easier for policymakers to deal with if it's like that, Peter? Well, services are the biggest chunk of the economy.

24:18So you can, yes, have manufacturing stabilize. And I do think actually manufacturing is trying to stabilize around the world because inventories are more normalizing. A lot of retailers have been very disciplined in right-sizing their inventory levels because they learned a big lesson last year. So at some point, there's going to be a potential inventory rebuild. Now, I'm not sure the extent of that. We haven't seen it yet because end demand is still not there. But I do think maybe you've seen the bottom in manufacturing, but we could bounce along that bottom for a period of time. But you don't need manufacturing to weaken further from here to then eventually ensnare the service sector in a more broader downturn.

25:06And if you do, which then slows the broader economy, that will then delay any pickup in demand for goods, which will then delay any pickup in manufacturing. So yes, it's rolling, but that means that everyone eventually gets affected. Right. They're all getting caught in the down. It's just not - It doesn't mean that, okay, if you first get caught, you're going to start rebounding where other things are deteriorating. No, you're just getting caught first and maybe you experience the worst of it early on, but that doesn't mean you start to improve before the other things get bad. You are only going to improve when other things stop going down as well.

25:45We're going to take another quick break 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.

25:57Guy was pondering something, so I'll ask the question for you, Guy. As a Brit, I often wonder if the BOE will always follow the Fed's leader act differently. It's always been my assumption that they're aligned with policy decisions these days. There is a question, I'll broaden it out from the UK to include Europe. A lot of, quite a few of the people have been coming on in the last few weeks kind of pointing out it seems like Europe is a little ahead. They're feeling the recession. Do you think we're going to get a divergence globally here? Well, there is a group think when it comes to all these central bankers.

26:31So they all pretty much follow themselves. I mean, we're all, all these central banks are now at the end of the rate hiking cycle. all coincidentally, or maybe not, at the same time. And when they start cutting, yeah, maybe some will do it before others. But they'll all be a trend to do so pretty much all at once. But these central banks have been utterly embarrassed over the last bunch of years with the rise in inflation and the steps they've had to take to respond to it. And like I said at the beginning of this, they're not just going to easily give up this fight away by just slashing interest rates on an economic downturn.

27:16Because there used to be a time when positive real rates were normal of 200 to 300 basis points. So even if inflation slowed to 2 in the US, having a Fed funds rate of 4 % to 5 % used to be normal. It used to be on the low side, actually. But people are so accustomed to, oh, the Fed's just going to slash rates down to zero if inflation slows. No. I think Jay Powell's going to say, you know what? Let's normalize things. Let's have a real rate of 2 to 250 basis points for 4.5 % Fed funds. And that's going to be normal. But for the 15 years, again, prior to 2022, that was more abnormal. But adjusting to the new normal, which used to be the old normal, is still going to take time.

28:05What about Asia? A lot of people wondering what's happening with China. Some talk that maybe they are stimulating more than the market seems to think. Is China just going to be a weight for the global economy or can they contribute at all if they start to turn on the pumps? I think China is stepping up. Well, let's pick apart their economy. Manufacturing is going to be subject to the same trends as Europe and the US in terms of the demand for goods. The housing market, it does seem that China is really stepping up the containment of this. They're picking 50 of the top biggest developers, and they want these 50 to finish as many apartments that have already started that they can.