Fed Relying Too Much on Stable Labor Market for Their Lengthy Pause?

• Treasury yields are slightly higher this morning as more tariff talk has markets assessing the inflationary impact once again. With a light week of data, we’re subject to the turbulence created by these policy announcements, but the action is somewhat muted as a “been there done that” element enters into the trading calculus. Currently, the 10yr Treasury is yielding 4.57%, up 3bps on the day, while the 2yr is yielding 4.31% up 1bp on the day.

 

• The week is light on data and that leaves the stage for DC headlines as we await more substantive reports next week. One of the few reports of the week came this morning with Housing Starts and Permits for January. As expected, starts fell to 1.366 million annually, (down 9.8% from December) as the combination of high mortgage rates and high prices continue to weigh on residential activity. Single-family (1-4) starts fell 8.4% from December, so it wasn’t all about multi-family slowing. Meanwhile, building permits came in at 1.483 million annually, practically unchanged from December. As long as mortgage rates remain around 7% and home prices remain elevated, housing activity is likely to remain mediocre at best.

 

• Despite the dearth of data, we did get a notable Fed speaker on Monday offering his view on policy and the possibility of rate cuts. Fed Governor Christopher Waller, while speaking in Australia, emphasized the Fed would not wait until economic policy uncertainty relents before acting if the data called for that. What he was essentially saying is that the Fed won’t feel compelled to wait on the White House and Congress to get their fiscal policies in place, if they see a need to act. Waller referred to the Russia/Ukraine war erupting in February 2022, one month before they began hiking rates, and the following year with the SVB failure when some thought they would pause rate hikes, as examples of the Fed acting with uncertainties surrounding the decision.

 

• He also wasn’t too worried about the weak January Retail Sales Report. He saw it as a volatile report, with winter weather slowing sales, and not a harbinger of a more ominous slowing by the consumer. We shall see about that. Internet sales, not affected by weather, were also down and with confidence taking a dip and protest rallies gathering momentum the January pause in consumption could spill into February and March.

 

• He also mentioned the issue of lingering “residual seasonality” in early year inflation data that has tended to make the start of the year a hot one for inflation readings, only to see that heat turn cool as the year progresses. He expects we’ll see the same in 2025 which he allows may make the case for a rate cut later in the year, much like in 2024. He mentioned that with CPI/PPI data in hand the January core PCE (the Fed’s preferred inflation gauge) is looking close to a 0.25% MoM print. That would be substantially cooler than the 0.4% MoM core CPI print and with a hefty 0.50% monthly pop in last year rolling off the calculation, the yearly rate my dip from 2.8% to 2.6%.

 

• What went unmentioned was after that, base effects become much more challenging with 0.24%, 0.34%, 0.26% prints rolling off from last year. In fact, for much of the year, 2024 monthly gains were in that range so making any progress on the yearly rate will have to come from a real slowing in core PCE rates later this year. That’s hard to see right now with tariff talk, deportations, and tax cut proposals all the rage. So, color us skeptical of seeing anything close to a 2.0% YoY core rate in 2025.

 

• That doesn’t mean we don’t see a rate cut or two this year. Waller and much of the Fed remain convinced the labor market will give them the time to be overly patient in seeing more inflation improvement. We are not so sure of that. The January employment report was not robust and with the government sector likely to subtract from job growth in the months ahead, and a likely slowing in expansion plans from domestic firms, the labor market may be on thinner ice than is the current Fed thinking. They are, after all, pretty notorious for missing turns in the market. If the second quarter does start to seem some weakening, a few decent inflation reports may be all that are needed to revive the rate-cutting tendencies.

 

• In that regard, we will get the January FOMC Meeting Minutes later this afternoon to better judge the resolve of the Committee in waiting out better inflation numbers before returning to rate cuts. The two-days of Capitol Hill testimony of Chair Powell last week certainly didn’t hint at any relent from what seems to be a lengthy pause, but the minutes will provide a few more voices to chime in.

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After Soft Retail Sales and Waller Talk Futures Back to Seeing a Possible July Rate Cut

Source: CME

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Speaking of Retail Sales, some are Pointing to Weather as the Main Culprit for Soft Spending

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International Airfares YoY Percent Change – Should Help Lower Core PCE Estimate