Employing Contrary Logic
Innova Asset Management
Construction of Multi-Asset SMA portfolios that are designed to work with investor behaviour, rather than against it.
Late last week, we saw an interesting confluence of two events: US jobs and employment data being released, and Federal Reserve Vice Chair Lael Brainard providing a surprisingly easy-to-interpret slate of Fed speak about their current trajectory.?
Prior to this interview, the most dominant narrative in markets was that the Fed would see a pause in interest rate hikes in September this year, based on the latest FOMC meeting minutes and comments from Atlanta Fed President Raphael Bostic. This narrative got thoroughly shaken by Brainard, coming out to directly say “right now, it’s very hard to see the case for a pause” and that “we’ve still got a lot of work to do to get inflation down to our 2% target”.?
US CPI YoY % Change?
Source: Bloomberg?
Brainard also noted that “we are starting from a position of strength – the economy has a lot of momentum”.?
US GDP Personal Consumption QoQ % Change?
Source: Bloomberg?
These statements may seem relatively inconsequential on their own, however it is worth noting that most appearances by Fed officials could be considered Kabuki theatre, the result of a decade-long campaign to better telegraph policy decisions following the 2013 “Taper Tantrum” episode.?
What we need to look for is what changes in rhetoric may have appeared in the direct context of upcoming employment figures. There were several which appeared in Brainard’s interview, with three which we will outline below:?
With the help of some highly capable (and cynical) commentators on US policy, we can translate those three statements into their intended message to markets:?
If we consider this logic, which seems contrary to what the market has accepted as the general narrative of “economic conditions strong = chance of rate hike pause”, then the latest US labour market figures are put into a different light.
Source: Bloomberg?
Some of those figures look vaguely disappointing if we consider the objective changes; non-farm payroll changes are slowing from last month, hourly earnings growth came in lower than expected, and the unemployment rate didn’t reduce.?
In light of the interpretation above however, this is in line with what the new Fed narrative wants to see – new hiring is slowing, wage price growth is not accelerating. Now we just need to start seeing core inflation decelerating consistently to hit all three targets.?
Does this mean that the Federal Reserve are sitting around a dark boardroom, rubbing their hands together at the thought of economic weakness and the job market not supporting as many working Americans as it can? Almost certainly not. Unfortunately, what the central bank narrative is now starting to recognise (in the US and likely globally) is that to bring down stratospheric inflation there must be some form of demand destruction (see: “the economy starts to falter”).?
If we employ some contrary ways of thinking to consider where the Fed will position – consequentially where market sentiment and direction will follow – strong figures for the economy and middling to strong inflation numbers will continue an aggressive tightening path, but a weakening fundamental view of the economy with weakening inflation impulse may give them pause for thought.?
As we have previously discussed, reading the tea leaves of Fed minutes for signs of absolute truth is risky business. Consider this more of a thought exercise in interpreting one of the strongest drivers of market sentiment at the moment, and a peripheral dynamic to be aware of in the near-term as we see the state of both the US and global economies, navigating the tight rope between soaring inflation and a faltering economic outlook.?