The markets also needed to test themselves in a scenario of presumed economic weakness. They had not done so this year. And the scare was short-lived. The unemployment rate, the best postcard of the soft landing.
Rate cuts began in the G7. And doubly so. First it was the Bank of Canada’s turn with a quarter-point cut. The ECB followed in its footsteps with the same dose. Switzerland, in March, and Sweden were the pioneers in the G10. No. The Fed meets this Tuesday and Wednesday and will stay out of the fray. It simply does not have the inflation numbers from Canada. There, the core retail definition (its quarterly average) fell from 3.5% annualized in December to a sub-2% threshold in March and April. Nor does Jay Powell have the rush of Christine Lagarde in the Eurozone who simultaneously lowered rates and raised her inflation forecasts.
It is clear that the Fed must hold rates for longer until the rebelliousness of inflation, which has taken the opposite path to the Canadian one, subsides. Core inflation, which was hovering around 2% at the end of last year, accelerated to 3.5%. And the health of the economy does not urge an intervention either. Although this week the fears of a sudden cold were felt. And a sharp drop in long rates gave them momentary credence. The employment report, brimming with vigor on Friday, took care to close that window before it could be opened.
A drop in manufacturing output in May, the second in a row, according to the ISM report lit a yellow light on the activity dashboard. The collapse in new orders was the sharpest new data. The US slowed down towards the end of March and in April. Personal consumption contracted 0.1% real in April. The Atlanta Fed’s real-time forecast took note of the slowdown (with the same upfront exaggeration with which it recorded the rising tide earlier). If in mid-May it was forecasting 4.2% growth, by last Monday, following the ISM news, it had lowered it to 1.8%. The economy was finally showing signs of abrupt fatigue after so much hustle and bustle? Ten-year rates plunged 20 basis points from Monday to Wednesday. And they stood at 4.30% on the eve of the jobs report. What did they know that the rest of us didn’t? That there was conflicting information was relativized. The S&P Global PMI indicator showed a solid rebound in industrial production in May, not a decline. And the most important, services, grew according to both sources. OPEC’s easing of its production cut plan depressed the current price of crude oil and inflation expectations. And that explains, in part, the decline in long rates.
But it is not a dark cloud clouding the horizon; on the contrary. Nor does the fact that the U.S. trade deficit is increasing because April exports are growing, but imports are growing more, denote exhaustion. It is a sign of demand vitality. Nonetheless, the thorn of doubt was deeply embedded. The markets also needed to test themselves in a scenario of presumed economic weakness. They had not done so this year. And the scare was short-lived. The S&P 500 and the Nasdaq set records on Thursday. They liked the idea that the Fed would have to get serious about cutting rates. Not right away. Maybe in September. In other words, bringing forward the rate pruning may be an excellent footboard. After all, if the economy stumbles, it will get fixed. It will be enough for you to read the lines quoted above.
Unemployment rate, the best postcard of the soft landing
The fatigue thesis was short-lived. Until it was known that the labor market created 272 thousand new jobs in May, almost one hundred thousand more than in April and than expected. The point data is volatile. But the quarterly average of 249 thousand should be considered good. End of the discussion about cold or lukewarm. The unemployment rate climbed to 4% (strictly speaking, 3.96%), where it was a month before the rate hike -from zero- began in March 2022. It is the best postcard of the soft landing, with emphasis on softness (since the landing is not over yet). The labor market systematically adjusts searches and hires month by month, but operates at full occupancy increasing net jobs, real wages and the income pool.
The cooling thesis should be kept in our pockets until further notice. So much momentum forced the markets to take a step back. But no more than that. True, the rate cut will remain in the deep freeze. But what better for Wall Street than to have it available and not need it.
With a healthy economy, and 550 basis points of ammunition to spend in the glove box in a pinch, the bull market is not afraid of anyone. Although it will look askance at the first reading of May inflation. The Fed is its friend, but its patience should not be abused.