An Abundance of Caution

Our big concern from last week was a weakening in the macro data given that election years tends to see a tougher summer, and earnings are showing signs of slowing. Thursday and Friday brought us just that.

Thursday saw a weaker ISM Manufacturing PMI at 46.8% missing the estimate of 48.8%. Under the surface, new orders decelerates and employment saw a relatively sharp decline. All this, while prices paid actually went up. So yet again, a slowing economy with higher prices - stagflation.

The bigger issue was the data on Friday - the Employment Report - that saw the unemployment rate spike to 4.3%. Nonfarm payroll additions also missed expectations coming in at 114k vs. the consensus estimate of 175k.

The market sold off drastically, with the Nasdaq entering correction territory, so to speak. The Nasdaq 100 closed down -11.7% from it’s peak.

Bonds yields fell across the board, first pricing in a Fed cut, and then pricing in steeper cuts and weaker economy. The 10Y yield fell by the most since 2008.

As far as commodities were concerned, only Gold closed in the green with risk-off and geopolitical fears being priced in.

Macro - How many cuts?

The Fed meeting ended up being pretty much in line with what everyone expected - a dovish hold. Fed Chair Powell certainly put cuts on the table for September but, there wasn’t a sense of urgency about the deterioration in the macro data, particularly unemployment.

The next two days changed all that with a weaker ISM Manufacturing Report and the unemployment rate spiking to 4.3%.

Traders are going overboard with the cuts

The calls for cuts are now getting out of hand. Friday’s headlines read - JPM and Citi were pricing in 4-5 cuts for 2024. In an extreme case, this indicates a possible 50-bp cut in September and November with one 25-bp cut in December.

We don’t think this will be the case, or at least it shouldn’t be.

We continue to stick with the idea that “cutting too much, too soon” will be worse because of inflationary pressures. The Fed’s own projections show inflation remaining above the current trajectory, and there is a matter of base effects that are likely to show up in Q3 and Q4.

The Fed will likely do an insurance cut in September of 25bps, given that the unemployment rate is ticking up to claim a soft landing. However, the truth is, a gradual easing scenario would not make much of a difference if the economy really is headed for a recession, which we still don’t think it is. But from an optics perspective, the Fed would have achieved its goal.

What if inflation starts to accelerate again?

The Fed Funds Rate will still remain considerably high for a while even if the Fed starts to ease. We believe the easing cycle will be shallow to begin with and unless we see definite signs of a recession, the Fed will likely follow the path that they’ve laid out into 2026, with the minor adjustment of starting sooner.

As of now, we see the likelihood of two 25bp cuts in 2024.

Closing Thoughts - An Abundance of Caution

What we’re seeing is a corrective impulse with orderly selling - de-grossing and de-risking. We’re starting to see things go wrong, but we’re not at a stage where sentiment and positioning have turned negative. Retail and money managers still remain relatively bullish. We have warning signs, though:

• Somewhat disappointing earnings from the Mag 7
• Election uncertainty increasing
• Weaker macro data
• Geopolitical risks escalating

Add to that, seasonality is not our friend with lower summer liquidity.

What comes next is an abundance of caution since we don’t think that this drawdown is over as yet. With the market in risk-off mode, and apprehensive about a recession, we want to add some exposure to defensives as the market sells off. We want to take a pause here in cyclicals, as we don’t think it’s time to buy the dip just yet.

Other articles this week:

BoJ Preview

https://www.macrovisor.com/p/the-biggest-macro-event-of-the-week-is-the-bank-of-japan

None of the above is investment advice