Kelly Evans: The case for "victory cuts"
The surface-level story is quite simple this morning: the jobs report came out, it was slightly stronger (especially on the wage front) than expected, so bond yields jumped and stocks are down again.
But there's a little more depth to what's going on in recent days and what seems to be ailing the stock market. We are not off to a great start; if stocks sell off again today, it'll be the fourth down day since January 1. The Stock Trader's Almanac warns the first five trading days are an omen for the rest of the year; even if some pooh-pooh the various "January indicators," the market undeniably has an echoes-of-2022 feel to it.
The problem is not so much that rates have backed up, with the 10-year yield going from sub-3.8% at the end of last month to 4.1% after the report crossed this morning. It's that rates have backed up without being matched by an increase in inflation expectations. In other words, real rates have increased. The best proxy for this, the 10-year TIPS yield, has shot up from 1.62% to 1.82% just over the past week.
That may not sound like a big deal, but real rates have been a key driver, or at least partner, of the stock market's sharp rally since late October. The 10-year TIPS yield, which had surged from 1.5% in late July to all the way above 2.5%, peaked on October 25th. The S&P bottomed two days later. Ever since, real rates almost fully retraced their late summer backup, while stocks hit near-record highs.
Until now, that is. Perhaps it's because of all the Fedspeak--plus the minutes released on Wednesday--pushing back on the market's hope and expectation of imminent and deep rate cuts this year. "What? You're telling me the market was wrong pricing in 11 cuts when the Fed had 3 in the Dot Plot?" joked one commentator on Twitter. Guest after guest on our show has also warned the Fed may not be as dovish as expected, and the stronger jobs report today is adding fuel to that narrative.
But here's the thing--maybe the market has it right, and the Fed is now making the error. Again, inflation expectations haven't moved up. On a five-year basis, the market is priced for 2.18% annual inflation, barely above target, and that's down from when we were at nearly 2.5% back in October. Perhaps the market is trying to tell the Fed how much cutting it needs to do to keep from overly restricting the economy.
But officials don't like to be told by the market. In fact, they typically interpret its signals the other way around. The first observation of the minutes from their December meeting noted that "Financial conditions eased...revers[ing] some of the tightening that occurred over the summer and much of the fall." The hawkish ensuing Fedspeak we've had suggests officials are more worried that this will "undo" their fight against inflation, rather than taking it as a positive development.
And this is where the case for "victory cuts," as Jefferies' David Zervos has coined them, comes in. The market is telling the Fed it can cut rates for a good reason; conquering inflation. If the Fed were to do so swiftly, it could perhaps preserve the expansion and truly earn the plaudits that are starting to come in.
Officials, however, appear more worried that doing so--cutting rates while the economy is still growing--will either confuse or scare the public, or undermine their inflation-fighting goals. But the market is demanding them, and giving a preview of the damage that too-tight monetary policy could do. And it would be far better for Fed officials to cut rates now, than to wait for a bigger slowing of the data that otherwise might have been avoided by doing so.
See you at 1 p.m!
Kelly
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