Soft landing ?
As Fed officials remain in a no-speaking period ahead of the upcoming FOMC meeting on September 17 & 18, all eyes are on data reflecting the state of the US economy. Anticipation for Fed rate cuts, projected between 25 bps to 50 bps in the upcoming meeting, persists. Despite the recent US payroll data meeting expectations, the markets seem poised for increased volatility.
In the June edition of our newsletter, I delved into the rationale behind the Fed's decision to postpone the anticipated rate cuts until September due to positive economic activity and the necessity to monitor declining inflation. However, unexpected data in July, including the Sahm recession indicator triggered by US payroll figures, has sparked concerns of a sudden recession. The subsequent market volatility in late August led to significant declines in indices like Nasdaq, reminiscent of the cautionary tale "The Emperor's New Clothes". As we question our economic outlook, it begs the query: are we truly experiencing a downturn towards recession?
Well let's look at the Markets...The Treasury Market's yield curve un-inverted for the first time since 2022 last Friday on September 6th. This shift marked the first instance where the 10-year benchmark rate finished above its shorter counterpart, signaling a significant development in the market. The normalization of the yield curve from its previously inverted state, which had persisted for some time, is typically viewed as the final phase before an economic recession by market analysts.
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Moreover, a notable decline in the 2-year Treasury yield has led to the spread between the 2-year note and the Fed funds rate reaching its most negative level in recent history. Historically, when the spread between these two short-term rates has fallen below -1 percentage point, a recession has followed within a year after each occurrence.
These indicators underline the importance of monitoring market dynamics closely in the current economic landscape. While indicators and rule of thumbs are valuable for data awareness, it's crucial to recognize that signal detection algorithms have threshold levels tuned for accuracy based on past data. While they predict past events accurately, they may not forecast future events due to potentially different dynamics. Therefore, considering additional data points and signals is essential before declaring a recession is imminent.
At this point, a reminder on the decision-making process of Central banks like FED seems pertinent. In the June newsletter edition, the analogy was drawn between a 'thermostat' acting as a room temperature controller and Central Bank decisions based on data. This time, let's explore an analogy between an altimeter, crucial for pilots during take-off and landing, and the vital payrolls data published by the Bureau of Labor Statistics that the Fed will consider. Pilots rely on altimeter information obtained from pressure sensors to adjust levers for safe landings. In cases of sensor errors or failures, visual data becomes crucial. In scenarios of low visibility or adverse weather, the decision may even lead to aborting the landing for safety precautions.
So just as pilots gather alternative information during unexpected sensor readings, Fed officials would interpret the latest payrolls and wage growth data to assess the economy's trajectory. I would argue that the latest non-farm payrolls data on September 6, although showing less than expected job growth, has brought down the unemployment rate to 4.2%. With solid wage growth and strong consumer spending, as indicated by personal consumption expenditure growth figures, Fed officials are likely to focus on this labor payroll data. Despite the upcoming CPI report on September 11, the emphasis on labor suggests a more cautious 25 bps rate cut, rather than a 50 bps cut although market players in the bonds market anticipate faster rate cuts, indicating a perceived lag by the Fed in adjusting rates.
We are keeping a close eye on the upcoming Fed decision on Sep 17 and 18, anticipating market volatility regardless of a 25 bps or a 50-bps cut. The decision will impact investor sentiments, with a 25 bps cut potentially signaling concerns about the Fed and a 50 bps cut possibly causing worries about the economy's status. This volatility presents opportunities for investors to adjust their portfolios and consider asset allocation choices, like rotating to cyclical sectors away from technology stocks with higher valuations.
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Furthermore, the developments could lead to positive changes in US mortgage rates over the next 12 months, potentially enhancing affordability for households and boosting housing activity. However, commercial property may encounter challenges with refinancing due to rates remaining elevated compared to pre-pandemic levels.
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Looking at global economies, a significant portion of developed economies, as per the IMF's definition, are currently employing monetary easing measures. This trend suggests a preference for short-term, quick-fix solutions over more substantial, long-term strategies among economies grappling with escalating debt dynamics.
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Additionally, in the case of Turkey, recent positive indicators such as a decrease in the Current account deficit and unemployment rate are juxtaposed with the skepticism surrounding the Medium Term Plan. The plan's ambitious goals of achieving growth while curbing inflation simultaneously hint at potential challenges ahead, signaling a turbulent period for the Turkish economy. Buckle up for a potentially bumpy ride ahead!