(Source: Australian National Accounts: National Income, Expenditure and Product. Complete statistical tables available from the Australian Bureau of Statistics)

In cutting its cash rate for the second time during this easing cycle, Bullock called the move a “confident” cut. As the chart below demonstrates (Source: The Reserve Bank of Australia, Consumer Price Inflation – G1), Australia’s inflation has returned to pre-pandemic norms. Bullock described a broad-based slowing in price increases, leading to a forecast for “the underlying pulse of inflation around the midpoint of the 2 to 3 per cent range over the next year or so.” With that trend firmly in place, she concluded: “with inflation declining and the unemployment rate relatively low, we’re well positioned to deal with” the challenges presented by the U.S.’s trade war with the rest of the world.

(Full inflation data at Consumer Price Index, Australia)

Stable Inflation Enables Renewed Easing of Monetary Policy

The U.S.’s trade war threatens renewed inflation pressures through global supply chain disruptions. The RBA is monitoring these developments closely, forecasting “growth in our major trading partners slowing over the remainder of this year and next year.” At the same time, it has revised its domestic growth forecast expecting the economy to grow “a little more slowly,” and sees “global trade developments” as mostly deflationary—aside from inflationary supply shocks from the trade war. These factors underlie the RBA’s confidence in continuing the rate-cutting cycle.

The RBA has also been transparent about its easing bias. Bullock noted: “if we were just looking at where the domestic economy was at the moment, would we be looking at lowering rates or not, and as I said earlier with inflation in the band and also employment doing pretty well, we think there is a bit of scope to lower interest rates.” Even with labor market tightness, she added, “it does seem that inflation is continuing to come down notwithstanding a bit of tightness in the labour market.” Moreover, “inflation is right on target from a six-month annualised point of view.”

Looking ahead, the RBA sees conditional room for further easing: “I think if we continue to observe inflation coming down and staying down sustainably, then to the extent that we think there’s still restrictiveness in monetary policy—and we think there is a bit—then that would give us opportunities to lower the interest rate further.” However, Bullock acknowledged that renewed strength in consumer demand could change the equation: “If it looks like things pick up much more quickly than we thought they would… then all the cost pressures that the businesses are saying, well, they might be able to pass them on. That might be the risk on the upside, and the question there would be for us: are we still restrictive enough to keep that under control or do we need a bit more restrictiveness?”

Risks: A Fog of Unpredictability

Still, global and domestic risks remain. Bullock was frank about the external backdrop: “the situation we’re in is it’s not just uncertain, it’s actually unpredictable.” While the Federal Reserve has remained frozen—on high alert for stagflation—Australia is benefitting from a policy window (that may close in unpredictable ways).

Domestically, the RBA continues to monitor labor market imbalances. Bullock noted that “employment growth, the participation rate, vacancy rates, all these sorts of things are suggestive of the labour market still being quite tight.” On the other hand, consumption has not yet responded as expected to rising real incomes and falling rates: “We’ve been a little bit surprised that consumption hasn’t recovered as real incomes have started to recover. It’s just a bit softer than we thought it would be if you think about historical relationships. We thought it would have done better. So that’s the risk, that households for some reason are being much more cautious than they have been in the past and that that is a downside for the economy.”

The RBA has also shown intellectual flexibility in revisiting its assumptions: “we are open to the idea that we may be overestimating, or underestimating full employment, and I think that’s a healthy thing for us.”

Even amid these uncertainties, Australia’s anchored inflation and resilient labor conditions help reinforce the Australian dollar’s appeal as a mispriced asset in a volatile global landscape.

Trade Shocks: The Global Wildcard

Although Australia has a handle on its domestic picture, external shocks remain a major variable. Bullock acknowledged that the RBA, “just like everyone else, was completely blown out of the water by the scale and the scope” of the U.S.’s trade war. “So we really had to go back and have a much harder look. So there has been a lot of analysis done… and the Board does have to consider and factor much more of this into their thinking than was the case back before this all happened.”

While the RBA braces for future trade war storms, the U.S. Federal Reserve is in the center of the storm. The Fed is bracing for staglfationary impacts from the trade war and, as a result, remains stuck with inaction even as current inflation falls further from the Fed’s policy rate. Australia, by contrast, enjoys the flexibility of acting on current data and trends.

Conclusion: A Value Currency with Upside

Australia is entering a policy sweet spot: inflation is within target, the labor market remains robust, and GDP growth is beginning to recover. The country’s policy flexibility and economic trajectory stand in contrast to that of the U.S., where a hawkish Fed is constrained by future inflation expectations and geopolitical risk.

From a currency trading perspective, the Australian dollar looks as a value currency—undervalued after years of economic drag and monetary tightening…even with concerns about Chinese growth.

The following weekly chart of Invesco CurrencyShares Australian Dollar Trust (FXA) (currency pair AUD/USD) shows 14-year pressure on the Australian dollar versus the U.S. dollar. assuming the pandemic lows hold, the time looks ripe for a sustained turnaround.

Be careful out there!

Full disclosure: long AUD/USD, long AUD/JPY

The post Inflation at Target and GDP Growth Recovery: A Comeback Case for the Australian Dollar appeared first on Inflation Watch.

For three months, the bond market has flagged stabilizing inflation starting with the Fed’s first rate cut of 50 basis points (bps). The stock market continued to rally along its uptrend lines. In parallel, the Federal Reserve signaled its second thoughts about its benigas n projections for inflation in the September Summary of Economic Projections. The stock market failed to listen and even Fed fund futures insisted on forcing the Fed into a December rate cut. The Fed delivered that rate cut with a major caveat in the December Summary of Economic Projections: hotter forecasts for inflation and economic growth and an incrementally hawkish expectation for future monetary policy rates. Accordingly, the Fed finally got the stock market’s attention as the market essentially plunged from euphoria to oversold in one day.

Long-term yields continued to increase the day of the Fed decision and the following day. The iShares 20+ Year Treasury Bond ETF (TLT) sliced right through presumed support and closed right at the low for the year set in April.

I took profits on my latest round of TLT put options last week. I will not chase TLT down here. Instead, I will wait to fade the next relief rally.

Instructive Projections

The Fed’s changes were significant but consistent with the Fed’s smoke signals and the declines in the long-term bond market.

• 2025 PCE inflation of 2.3-2.6% vs. the 2.1-2.2% September projection
• 2025 federal funds rate of 3.6-4.1% vs. the 3.1-3.6% September projection
• 2025 GDP 1.8-2.2% vs. the September projection of 1.8-2.2%

Fed Chair Jerome Powell’s commentary during the press conference was instructive. Powell left no question that the Fed sees higher inflation ahead: “these median projections are somewhat higher than in September consistent with the firmer inflation projection.” He acknowledged that under-estimating inflation this year was a partial driver of higher 2025 expectations: this year’s projections have “fallen apart as we’ve approached the end of the year”. Yet, Powell also laid the foundation and rationale for keeping a bias toward easing. He pointed reiterated that the labor market is no longer contributing to inflationary pressures and its accompanying cooling has gone far enough. Moreover, activity in the housing sector has been “weak”. Accordingly, Powell claimed that “cuts will certainly help to support economic activity and the labor market while we can still make progress on inflation because policy is still meaningfully restrictive.”

I remain skeptical. Is current policy really “meaningfully restrictive”? In his opening statement, Powell declared “with today’s action we have lowered our policy rate by a full percentage point from its peak and our policy stance is now significantly less restrictive. We can therefore be more cautious as we consider further adjustments to our policy rate.” This claim only weakly translates into “meaningfully restrictive.” Moreover, financial conditions are now almost as loose as they have ever been since the pandemic per the Chicago Fed’s Adjusted National Financial Conditions Index (ANFCI).

Sure, as one reporter in the Q&A pointed out, “we haven’t seen much change in mortgages, auto loan rates, or credit card rates.” Still, the conventional measures of financial conditions are about as good as can be in the post-pandemic era. Thus, the Fed is walking a fine line between the fear of restoking firmer than expected inflation and a labor market that is noticeably cooling. In the middle, the stock market is pricing in a perfect resolution to this dilemma even with the current plunge.

Powell’s Inflation Narrative Still Rests With the Pandemic

At several points during the Q&A portion of the conference call, Powell offered his version of inflation’s recent history, its origins and drivers. I was surprised to hear him claim that the economy is still dealing with pandemic-related disruptions that are propping up inflation. Perhaps this was a thinly veiled attempt to excuse this year’s under-appreciation of inflation’s stickiness. Powell also blamed technical factors for inflation’s stickiness: the way housing rents are calculated, lags in the data, and “temporary factors like fluctuations in used car prices.” As usual, I turned a skeptical ear toward this narrative because Powell, as he consistently does, absolved the Fed of any responsibility in aiding and abetting inflation’s stickiness by keeping rates too low for too long. I reviewed the case for why the Fed should have raised earlier in “Why Monetary Policy Was Late In Responding to the Pandemic-Era Inflation Surge“). At least this year’s experience and the learning response suggests the Fed will be more circumspect. Victory over inflation is not quite at hand yet.

The Fiscal Wildcard

Circumspection and caution should be keywords going into 2025 and beyond given the uncertainties in fiscal policy. A deepening tariff war and significant tax cuts threaten the Federal Reserve’s fragile dance with inflation-fighting. The mix of opinions within the Fed are telling. In describing how individual Fed members incorporated fiscal policy risks into their forecasts, Powell responded that some members chose to try to estimate fiscal impacts, some chose to leave out fiscal impacts, and others chose not to indicate whether they included fiscal policy. That is quite a mix! Powell made it sound like people stubbornly constructed their forecasts. Anyway, this inconsistency means that the reality of fiscal actions could drive inflation estimates even higher and cause even greater caution at the Fed.

King Dollar

The U.S. dollar (DXY) was the big post-Fed winner. Fresh strength in the U.S. dollar drove the Invesco CurrencyShares Euro Currency Trust (FXE) to a new 2-year low. This breakdown sets up FXE to eventually retest the lows from 2022. Accordingly, I am finally fully on the strong dollar bandwagon. I also expect the stock market to struggle to hit new all-time highs while the U.S. dollar makes new highs.

Is the Invesco CurrencyShares Euro Currency Trust (FXE) ready to resume a downtrend that started in earnest during the financial crisis?

YouTube video of the December 18th FOMC Press Conference

Be careful out there!

Full disclosure: long SPY put spread

The post The Federal Reserve’s “Hawkishness” Finally Gets the Stock Market’s Attention appeared first on Inflation Watch.

I am tempted to say financial markets have already done the Fed’s work. However, it is very likely that the minute the Federal Reserve even hints that rate cuts could be delayed until next year, the resulting tantrum in financial markets could be epic. The Fed is loathe to disappoint markets, and the message from the last meeting and subsequently from Jerome Powell has been to promise a rate cut sooner than later. Financial markets have persistently focused on any and all dovish twinges in Fed-related pronouncements. For example, from Powell’s testimony to Congress on March 6th (emphasis mine):

“We believe that our policy rate is likely at its peak for this tightening cycle. If the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economic outlook is uncertain, and ongoing progress toward our 2 percent inflation objective is not assured. Reducing policy restraint too soon or too much could result in a reversal of progress we have seen in inflation and ultimately require even tighter policy to get inflation back to 2 percent. At the same time, reducing policy restraint too late or too little could unduly weaken economic activity and employment.”

Powell can insert all the standard caveats he wants. Markets read this statement as saying rate cuts are on their way!

A Nervous Bond Market

Yet, bond markets have been a little “nervous” all year. For example, the iShares 20+ Year Treasury Bond ETF (TLT) has trended downward (meaning higher bond yields) so far this year with lower highs and lower lows. From TradingView:

TLT is just a fresh low of the year away from finally catching the stock market’s attention again.

Copper, Lumber, and Oil – oh my!

The bond market has good reason for some jitters. Several commodities have sprung back to life this year. Copper miner Freeport-McMoRan Inc (FCX) is welcoming the upcoming Fed meeting with a 7+ month high. FCX is up 19.8% in less than two weeks. (FCX has been stuck in a trading range since the beginning of 2021).

Lumber bottomed out in early 2023. This month, lumber broke out above last summer’s high and is back to levels last seen in August, 2022.

Oil, everyone’s favorite non-core component of inflation, has been in “stealth” rally mode all year. The United States Oil Fund, LP (USO) looks ready to launch parabolically on the wings of rate cuts.

Where will these prices go with rate cuts? I vote higher.

The Golden Touch

Speaking of getting ready for rate cuts, gold, my favorite hedge enjoyed a spectacular (and overdue) breakout this month. SPDR Gold Shares (GLD) traded at an all-time high at its peak this month.

I like buying the dips in GLD going forward. The odds seem sufficiently high for the Fed to feel “forced” into easing into a sea of market liquidity.

Straining to See the Weakness in Labor Markets

So maybe the Fed can strain its economic gaze and find an excuse to do a “proactive” rate cut. The graph below shows the unemployment rate has likely bottomed out (left axis and blue line) Yet, it remains near historic lows. Initial unemployment claims have been trendless with a recent peak set last summer (right axis and green line). Finally, real GDP quarter-over-quarter growth has levitated in positive territory and for the last two years has defied overly persistent expectations for a recession (right axis and red line). From my perch, I see no excuse for a rate cut here, but perhaps I am not creative enough with the data.

Sources: U.S. Bureau of Labor Statistics, Unemployment Rate [UNRATE], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Employment and Training Administration, Initial Claims [ICSA], retrieved from FRED, Federal Reserve Bank of St. Louis; U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis.

The Stock Market’s Giddy Anticipation

The stock market’s giddy anticipation of rate cuts is poetic. The stock market has soared on loosening financial conditions and has been able to ignore just about any bad news the macro environment tries to toss out there. Recent successive all-time highs speak volumes to the buffer the Fed can enjoy if it so chooses to wait out the Presidential election before making changes to monetary policy.

Conclusion

With market breadth increasingly lagging the stock market’s ascension, I have been a skeptic about the overall rally for several weeks. The Federal Reserve is probably the last catalyst between now and the Presidential election that has a chance of validating my skepticism. If the Fed complies with the market’s giddiness, there is no telling how high the market could soar in coming months. If the Fed decides to wait things out, the stock market will lose a major contributor to the upward and higher fund. Then again, maybe the Fed pulls off a magical “hawkish rate cut” (one and done rate cut with a warning about the potential for inflation to rise from the ashes). The Fed could figure out just the right balance between disappointing the stock market and fueling ever increasing levels of speculation and higher commodity prices…

Be careful out there!

Full disclosure: long GLD

The post Financial Conditions Make A Monetary Roundtrip and Undercut the Need for Rate Cuts appeared first on Inflation Watch.

Monetary Policy Question and Answer with an AI

The following question and answer with the generative AI in NotebookLM is like a poor man’s substitute for the Fed’s official Q&A session. Each section of dialogue below starts with a quote from Fed Chair Jerome Powell, followed by my question, and then NotebookLM’s response. All quotes are verbatim with some caveats on NotebookLM’s response in curly brackets.

Powell: “We are committed to achieving a stance of monetary policy that is sufficiently restrictive to bring inflation sustainably down to 2 percent over time, and to keeping policy restrictive until we are confident that inflation is on a path to that objective.”

Me: “Does Powell express any confidence that inflation is on the path to meeting its objective of 2%?”

NotebookLM: “No, Powell does not express any confidence that inflation is on the path to meeting its objective of 2%. He says that the Fed will continue to raise rates until inflation is under control, and that the two conditions that would lead the Fed to stop raising rates are (1) if inflation is on a path to the Fed’s 2% target and (2) if the labor market is continuing to broadly cool off and achieve a 4% unemployment rate. He does not say that either of these conditions are likely or happening now.” {That second condition is not directly stated in the transcript. NotebookLM must have picked this up from an external commentary. A more accurate characterization would be to drop the specific, quantified unemployment target}.

Powell: “We are attentive to recent data showing the resilience of economic growth and demand for labor. Evidence of growth persistently above potential, or that tightness in the labor market is no longer easing, could put further progress on inflation at risk and could warrant further tightening of monetary policy.”

Me: “What evidence does Powell cite to demonstrate that recent data show the resilience of economic growth and demand for labor?”

NotebookLM: “Powell cites the following evidence to demonstrate that recent data show the resilience of economic growth and demand for labor:

• GDP growth: Powell cites the strong third quarter GDP figures as evidence that the economy is continuing to expand at a strong pace.
• Employment: Powell notes that the labor market remains very strong, with job openings and labor demand still clearly remaining very strong.
• Inflation: Powell acknowledges that inflation is still high, but he argues that the recent data show that inflation is beginning to moderate.”

Powell: “As for the Committee, we are committed to achieving a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2 percent over time. And we’re not confident yet that we have achieved such a stance.”

Me: “Does the lack of confidence in achieving a sufficiently restrictive monetary policy leave open the possibility for future rate hikes?”

NotebookLM: “Yes, the lack of confidence in achieving a sufficiently restrictive monetary policy leaves open the possibility for future rate hikes.” {The rest of the response provided an incoherent timeline of Fed action}

Powell: “…the way we’re going to be going into these future meetings is to be just determining the extent of any additional further policy tightening that may be appropriate to return inflation to 2 percent over time” (Powell later reemphasized “it’s fair to say that’s the question we’re asking is, should we hike more”)

Me: This statement suggests that the Federal Reserve has a bias toward hiking rates again. What do you think? Explain your reasoning.

NotebookLM: “Yes, Powell’s statement suggests that the Federal Reserve has a bias toward hiking rates again...However, it is important to note that Powell also said that the Fed will “be humble” in its approach to raising rates, and that it will “listen carefully” to the data. This suggests that the Fed is not committed to a specific path for rate hikes, and that it will be willing to adjust its plans if necessary.” {Rest of answer repeated incoherent timeline even after I asked for a different explanation}

Powell: “the Committee is not thinking about rate cuts right now at all. We’re not talking about rate cuts, we’re still very focused on the first question, which is; have we achieved a stance of monetary policy that’s sufficiently restrictive to bring inflation down to 2 percent over time, sustainably? That is the question we’re focusing on. The next question, as you know, will be for how long will we remain restrictive?”

Me: “How would you assess the odds of a rate cut anytime soon based on this comment and the rest of the transcript?”

NotebookLM: “The odds of a rate cut in the near future are low.

• Powell said that the Committee is not thinking about rate cuts right now at all.
• The Committee is focused on bringing inflation down to 2 percent sustainably.
• The Committee will consider a rate cut if inflation comes down and remains low for an extended period of time.

However, it is important to note that the Committee is also considering other factors, such as the strength of the economy and the labor market. If the economy slows down or the labor market weakens, the Committee may be more likely to consider a rate cut.”

I selected quotes that I thought were most likely to produce some insight into the market’s excitement over the prospects for monetary policy. So just to be thorough, I asked NotebookLM one last question: “Is there anything in this transcript that even hints at the possibility for easier monetary policy in the near future? What about prospects for an end to rate hikes? Explain your reasoning only using content from this transcript.”

NotebookLM concluded: “There is no indication in this transcript that the Fed is considering easier monetary policy or an end to rate hikes.” Its explanation was a repeat response to my previous question.

The Persistent Longing for Easier Monetary Policy

With just two months left in the year and earnings season nearing an end, eyes and prognostications turn to 2024. Year-to-date performance remains positive but the market’s three most dangerous months of the year stained market sentiment. Thus, the persistent longing for easier monetary policy is taking on a new urgency. A recent example came from Goldman Sachs (GS) in predicting a strong year for IPOs in 2024. The main reason for the optimism? Rate cuts! From the Yahoo Finance article “The ‘real IPO reopening’ is coming in 2024: Goldman Sachs“:

“Bruun’s case for IPOs to reemerge stems from a core stance repeated throughout Goldman’s 2024 outlook roundtable on Tuesday: The Federal Reserve will cut rates in 2024. And history says that’s usually an opportune time for the IPO market.

‘When expectation moves such that people are anticipating rate declines and are starting to see rates come down, that’s usually when IPOs open up,’ Bruun said.”

This kind of persistent longing for easier monetary policy is likely to pervade financial markets as the assumption of an end to rate hikes takes deeper root in market sentiment and psychology. If rate hikes have ended then, logically, rate cuts must be imminent.

Still, the Fed will also persist in doing what it can to prevent the market from getting ahead of the Fed’s desire to keep driving inflation to its 2% target. I fully expect Fed jawboning in coming weeks and months to do its best to work against the notion that easier monetary policy is on its way soon. Currently, Fed fund futures do not anticipate any more rate hikes, and the first rate cut comes in June. Both projections are the exact same as they were before the November 1st meeting. Thus this lack of change still has me scratching my head about a renewed excitement over the prospects for monetary policy. From the CME FedWatchTool (the blue boxes indicate the market’s projection for the most likely target for the Fed’s interest rate range the given meeting date in the first column):

The S&P 500

Finally, here is a close-up of the daily trading action in the S&P for perspective on the scale of the market’s recent excitement. Market breadth over this time period went parabolic. (image from TradingView.com)

The post Why the Excitement? A Q&A on Monetary Policy with Generative AI appeared first on Inflation Watch.

As rates have risen, inflation expectations have declined sharply. Bullard offered the following chart to demonstrate the effectiveness of the Fed’s rush to front-load rate hikes.

Some people look at these expectations and conclude the Fed can stop before getting into the “sufficiently restrictive” zone. Some people might even conclude that Fed should start cutting rates. Most of those folks are probably focused on the stock market’s performance. Bullard instead is looking at the actual performance in the economy. GDP growth was unexpectedly strong in the second half of 2022. Even more importantly, the labor market remains very strong in aggregate as it glides through unprecedented territory. At least since 1980, the U.S. economy has never experienced such a wide gap between available jobs to the high side and available workers to the low side.

As long as this gap persists at such a magnitude, the Fed can feel comfortable about lifting rates into restrictive territory.

The Fed can declare partial victory since inflation expectations are back to previous norms. However, as Bullard noted consistently with the Fed’s messaging for months, “inflation remains too high.” If the Fed prematurely declares victory, the tightness of the labor market could become a source for reigniting inflation pressures, both real and expected.

Bullard’s words can generate out-sized market impacts. On this day, the market took Bullard’s caution pretty well. Bullard is still hawkish, but at least he is conceding some form of victory. The S&P 500’s (SPY) 1.2% loss is well within the volatility the index has experienced since it broke down below its 50-day moving average (DMA) in mid-December.

Be careful out there!

Full disclosure: no positions

The post Bullard Ready to Declare Partial Victory Over Inflation appeared first on Inflation Watch.