Fed Put

Macro Perspectives

• US stocks kicked off the shortened trading week on a lower note on Monday, pausing after last week's strong gains that drove Wall Street to record highs.

• The Dow Jones declined by 162 points, the S&P 500 and the Nasdaq 100 each lost 0.3%.

• In corporate news, Intel's shares dropped 1.7% after reports that China introduced guidelines to phase out US microprocessors from Intel in government PCs and servers.

• Microsoft also declined 1.4% due to concerns about the impact of the new guidelines on Windows operating systems.

• United Airlines' stock fell 3.4% following a Reuters report of increased scrutiny by the U.S.

Let's revisit Jerome Powell's comments last week on the employment situation.

The Fed has a mandate from Congress to achieve price stability AND maximum employment. They've recently started acknowledging that the pursuit of the former (at this stage), might create a problem with the latter (job losses). And that's because of this chart ...

The chart above shows the current level of the Fed Funds rate in purple (where the Fed has set the short-term benchmark rate), alongside the most recent inflation reading in orange (January PCE). 

The difference is the "real" interest rate (Fed Funds rate minus inflation) - that real interest rate is at historically high levels. So the Fed continues to put downward pressure on inflation and on economic activity - with the Fed keeping rates steady, as inflation has been falling the real rate has been rising, which means the Fed has been getting tighter and tighter (i.e. more downward pressure on inflation and the economy).

On a related note, the Atlanta Fed's Q1 GDP projection has been adjusted down by over one percentage point over the past few weeks (the green line in the chart below). Additionally, from the most recent jobs report, the unemployment rate ticked up in February.

So, what did Jerome Powell say last week about the employment situation? He said, "unexpected weakening in the labor market could warrant a policy response."

So that's a condition to start rate cuts. They are monitoring "very, very carefully" ... for "cracks."

What's another condition? The continued trend of falling inflation, to satisfy the Fed's need for "confidence" that the stair step toward 2% remains intact. With that, we get another inflation report this Friday (February PCE).

What's another condition? Any stress bubbling up in money markets as they try to navigate the end of quantitative tightening, and the level of reserves to be left in the banking system. As Powell admitted, the last time they tried this (2018-2019), they triggered a liquidity shock, and returned to easing.

So, the Fed has a 300 basis points of restrictive cushion, should inflation remain sticky at current levels. But the longer the duration of restrictive policy, the more likely the employment situation deteriorates, which triggers Fed action.

This is looking like the return of the Fed put.