What is the Fed Waiting for? The Urgent Need for Action
Introduction:
In a recent opinion article for MarketWatch, the author highlights the pressing need for the Federal Reserve (Fed) to pay closer attention to its unemployment mandate. With the announcement of widespread layoffs, unemployment rates could potentially reach 5% or higher by October. Based on this, along with declining PCE inflation and plunging Treasury yields, the author argues that it is imperative for the Fed to take action and cut interest rates by 0.5% before the upcoming Jackson Hole hiatus in late August.
The Japanese Carry Trade and Stock Market Volatility:
One of the catalysts for the recent stock market gyrations is the Japanese carry trade. Japanese investors benefit from the appreciation of the U.S. dollar against the Japanese yen due to higher U.S. Treasury yields compared to equivalent interest rates in Japan. However, as recession fears intensified, U.S. Treasury yields collapsed, leading to the temporary unwinding of the Japanese carry trade. Consequently, the Nikkei 225 experienced a significant drop of 12.40% on Monday, only to rebound by 10.23% on Tuesday.
August Air Pockets and Market Volatility:
Complicating matters is the current month of August, known for its “air pockets” due to many Wall Street professionals and European traders being on vacation. As a result, the author anticipates that the market’s unpredictable up and down movements will persist until trading volume is exhausted.
Consumer Stress and the Struggling Bottom 20%:
The American consumer is under significant stress, as evidenced by McDonald’s recent announcement of its first quarterly sales decline since 2020, with same-store sales dropping by 1% in the second quarter. This decline is partially attributed to deflation, as other food suppliers, such as Lamb Weston, also reported disappointing sales. However, some relief can be found in the success of $5 meal deals introduced by McDonald’s, Burger King, and KFC. Additionally, major retailers like Target, Walmart, and Aldi have reduced prices on food and household staples, while Amazon, Walgreens, and Best Buy have announced price cuts on selected items. These efforts aim to alleviate the financial burden faced by the bottom 20% of consumers, who are struggling with inflation and trying to make ends meet.
Consumer Distress and the Fed’s Response:
Diageo’s recent warning about an “extraordinary environment” and its first decline in sales since 2020 further highlights consumer distress. As the maker of popular alcoholic beverages like Smirnoff vodka, Casamigos tequila, and Johnny Walker whisky, Diageo reported a 1.4% decline in annual sales and a 5% drop in unit sales, indicating widespread cutbacks in consumption. McDonald’s first sales decline in 13 quarters serves as a clear sign of consumer distress, which should hopefully prompt the Fed to cut key interest rates sooner rather than later.
The Role of Productivity in Economic Growth:
Despite erratic consumer spending, the U.S. economy can still grow thanks to productivity gains. The Labor Department’s report on Thursday revealed a 2.3% annual increase in productivity for the second quarter, surpassing economists’ expectations of 1.8%. This growth can be attributed, in part, to advancements in AI and better inventory management. As long as the rise in profits outpaces labor costs, productivity will continue to rise, providing a foundation for economic growth.
Global Chaos and Crude Oil Prices:
The world remains in a state of chaos, as demonstrated by the recent contested election in Venezuela. The Middle East also remains a volatile region, with Israel’s attack on a Hamas leader in Teheran and a Hezbollah commander in Beirut. Iranian Supreme Leader Ayatollah Ali Khamenei’s statement about seeking vengeance and Israel preparing for “severe punishment” further adds to the tension. Consequently, crude oil prices are expected to remain high as long as Iran and its proxies continue to pose a threat to Israel.
Concerns Amidst a Stronger Service Sector Survey:
Although the July ISM service sector survey showed stronger than expected results, it is concerning that eight service sectors are still contracting. The Institute of Supply Management reported an increase in its non-manufacturing service index to 51.4 in July, up from 48.8 in June. However, out of the 18 service industries surveyed, eight are experiencing a decline in activity. These sectors include Agriculture, Forestry, Fishing and Hunting; Real Estate, Rental and Leasing; Wholesale Trade; Retail Trade; Professional, Scientific and Technical Services; Information; Educational Services; and Other Services.
Conclusion:
Recession fears have materialized, and the Fed must take immediate action. The collapse in Treasury yields is a bullish sign, and the Fed cannot continue to resist market rates for much longer. Fortunately, the Fed is expected to cut key interest rates no later than September 18th, providing the U.S. economy with a much-needed boost. As August unfolds, market volatility is likely to persist, making it a long and hot month.
