David Rosenberg says the Fed will cut in December, Shoots Itself in the Foot

Key Concepts

• Nominal Neutral Rate: The interest rate that neither stimulates nor restricts economic growth.
• Dual Mandate (Federal Reserve): The Fed's objectives of maximum employment and stable prices.
• Unemployment Rate: A key indicator of labor market health, but its trend is more important than its absolute level.
• Income and Wealth Inequality: Structural issues impacting lower-income households.
• Purchasing Power: The ability of consumers to buy goods and services, which has been declining for lower-income groups.
• K-Shaped Economy: An economy where different segments experience vastly different outcomes, with some thriving while others struggle.
• Equity Wealth Effect: The impact of rising stock market values on consumer spending, particularly for higher-income individuals.
• Lagging Indicator: An economic statistic that changes after the economy has already begun to shift.
• FOMC (Federal Open Market Committee): The body within the Federal Reserve that sets monetary policy.
• "One and Done" Policy: A monetary policy approach where only a single rate cut is implemented.

Analysis of the Federal Reserve's Monetary Policy Stance

This discussion centers on the Federal Reserve's current monetary policy, with a strong argument that the Fed is behind the curve and should be cutting interest rates more aggressively.

1. The Nominal Neutral Rate and Fed's Position

• Main Topic: The appropriate level of interest rates relative to the neutral rate.
• Key Points:
  • The speaker believes the nominal neutral rate is no higher than 3%.
  • The Fed is currently almost 100 basis points (1%) above neutral.
  • This is concerning given the downward trend in underlying inflation and the unemployment rate.
• Supporting Evidence:
  • Underlying inflation has been "gradually to the downside."
  • The unemployment rate is "just a snake. Now to the second decimal place below four and a half percent."
  • The Fed's own projection for the full employment unemployment rate is 4.2%, and the current rate is already above that and trending higher.

2. The Fed's Dual Mandate and Unemployment Rate

• Main Topic: How the Fed's dual mandate is being interpreted and applied.
• Key Points:
  • While inflation is above the Fed's target, the unemployment rate is also a critical factor.
  • The Fed anticipates the unemployment rate to fall to 4.4% next year, which the speaker believes will be a "big surprise" as it's expected to rise.
  • The trend of the unemployment rate is more important than its absolute level.
• Supporting Evidence:
  • The unemployment rate is currently below 4.5% and trending upwards.
  • The speaker argues that "labor has been built up in the labor market" and the Fed should already be at neutral.
  • Historical data shows that most recessions since 1950 started with the unemployment rate at current levels.

3. Economic Pressures and Consumer Behavior

• Main Topic: The impact of economic conditions on different segments of the population and shifts in consumer behavior.
• Key Points:
  • There are "structural or secular problems related to... income and wealth inequality" that are undermining the "low end" of the economy.
  • The purchasing power of lower-income households has been on a "relentless downward trend."
  • A single rate cut is unlikely to significantly help lower-income individuals; they need more direct income support.
  • Pressures are now extending beyond the low end to the "middle end," evidenced by Wal-Mart gaining market share and high-end consumers shopping there.
  • This shift in consumer behavior indicates "reduced demand pressures" and should lead to lower inflation, barring new supply bottlenecks.
• Examples/Case Studies:
  • Wal-Mart: Its market share gains and attracting higher-end consumers are cited as evidence of economic strain across income levels.
  • High-end consumers parking Mercedes-Benz in Wal-Mart parking lots: A vivid illustration of the economic squeeze affecting even wealthier individuals.

4. The Fed's Policy Lag and Communication Strategy

• Main Topic: The Fed's perceived delay in policy action and the importance of clear communication.
• Key Points:
  • The speaker agrees with the assessment that the Fed is "behind the curve."
  • The key question is "by how much."
  • The Fed is expected to cut rates in December, with support from influential figures like Waller, Staley, and Williams (New York Fed President).
  • Powell's communication at the podium and the "ridiculous dot plots" are crucial.
  • The Fed should avoid a "one and done" approach, as markets price off the entire curve, not just the overnight rate.
  • Convincing markets of further rate cuts is essential for stimulating the economy.
• Supporting Evidence:
  • The Fed's current stance is seen as a self-inflicted wound if they signal a single cut.
  • Last year's communication strategy is cited as an example of the Fed "shooting themselves in the foot."

5. The U.S. Consumer and Economic Dichotomy

• Main Topic: The current state of the U.S. consumer and the divergence between income and spending.
• Key Points:
  • The U.S. consumer is "not so well."
  • Auto sales were down nearly 7% month-over-month, and chain store sales were weak.
  • The consumer picture is "on the soft side" and not contracting solely due to the "equity wealth effect on spending at the high end."
  • A significant dichotomy exists: real consumer spending has increased at over a 2% annual rate since April, while real disposable income has declined by 1% over the same period.
  • This divergence is causing the savings rate to fall rapidly.
  • The stock market is crucial for maintaining the economy, but it benefits a small segment (top 10% own 90% of the market).
  • While a recession in consumer spending might be avoided, there is a "recession in real household incomes" that started in April and is not receiving enough attention.
• Data/Statistics:
  • Auto sales down almost 7% month-over-month.
  • Real consumer spending up over 2% annual rate since April.
  • Real disposable income down 1% over the same period.
  • Top 10% own 90% of the stock market.

6. The Unemployment Rate as a Lagging Indicator

• Main Topic: The limitations of using the unemployment rate as a primary forward-looking economic indicator.
• Key Points:
  • The absolute level of the unemployment rate is less important than its change or trend.
  • The unemployment rate is a "classic lagging indicator."
  • Looking at the unemployment rate to predict future economic performance is like "looking in the rearview mirror."
• Supporting Evidence:
  • In past recessions, the unemployment rate reached much higher levels (e.g., 10%).
  • The trend of the unemployment rate increasing from cycle lows (3.5% to 4.5%) is a significant concern.
  • Most past recessions began when the unemployment rate was at current levels.

Conclusion/Synthesis

The central argument is that the Federal Reserve is currently maintaining an overly restrictive monetary policy, being nearly 100 basis points above the estimated nominal neutral rate of 3%. This stance is not justified by the current economic data, which shows a downward trend in underlying inflation and a rising unemployment rate, despite its current low level. The economy is exhibiting a "K-shaped" divergence, with lower and middle-income households facing declining purchasing power and income, while higher-income households are supported by wealth effects from the stock market. This economic strain is leading to shifts in consumer behavior, such as increased shopping at discount retailers by higher-income individuals, indicating reduced overall demand. The Fed's communication strategy is also highlighted as critical, with a warning against a "one and done" rate cut approach. The unemployment rate, while currently low, is a lagging indicator, and its upward trend, coupled with historical patterns, suggests a potential economic slowdown. Therefore, the Fed is urged to cut rates and signal further easing to effectively stimulate the economy and address the growing economic pressures.