Markets Seem to Be Pricing in a Looming Economic Crisis

So, the eagle has landed and did it ever. 

The expectations coming in were for June consumer prices to have cooled from the already rather cool pace of May. Bond markets had bet on it, as had equity markets. The Bureau of Labor Statistics released its data for July CPI at 08:30 a.m. ET on Thursday morning. The results were even more disinflationary (or deflationary, for a number of metrics) than expected. On a month-over-month basis, headline CPI printed at -0.1% coming off of a flat month for May. Expectations had been for positive 0.1%. Headline CPI landed at growth of 3% year over year, down from 3.3% growth for May and below the consensus view for 3.1%.

At the core, CPI crossed the tape at monthly growth of 0.1% for June, down from the 0.2% pace of growth for May and below expectations for another 0.2% print. The annual print at the core showed growth of 3.3%, which was a tick below the 3.4% growth experienced in May and below the expectation for another 3.4% print for June. Core CPI has decelerated for three consecutive months now on both a month-over-month and year-over-year basis.

Hot or Not?

On a month-over-month basis, there were more components of the CPI that were cold than hot, and what was cold was really cold. Ex-the core, eating out is still a problem. The cost of eating out was up 0.4% in July after growth of 0.4% in May. Eating at home was warmer than the headline print. Preparing your own food cost 0.2% more in June than it did in May.

Energy prices largely collapsed in June, with gasoline down 3.8% from May, after May had been down 3.6% from April. Fuel oil was down 2.4% in June from May, after being down 0.4% in May from April. Even electricity prices were down 0.7% and have not printed in a state of monthly growth since March.

Once we get to core items, used vehicles were down 1.5% as new car prices dropped 0.2%. New cars have not printed in a state of price expansion since December 2023. Shelter was up 0.2% from May, which was the smallest monthly increase for this category since the cows came home. Even transportation, which had been a thorn in the side of a lot of folks, sported a second consecutive monthly decrease of 0.5%.

Fed Funds Futures

Jerome Powell sure did seem a bit more confident than he probably should have on Wednesday. Certainly more confident than he seemed on Tuesday, didn't he? In the wake of this release, the U.S. dollar index spiked, treasury yields collapsed, gold, silver and bitcoin all popped and equity index futures moved higher, but stocks then opened lower as profit takers took to the streets.

Fed funds futures trading in Chicago moved toward showing much more confidence in the idea of the FOMC reducing short-term interest rates ahead of the national election. The likelihood of the FOMC standing pat on July 31, 2024 is still almost assured but has moved down to 91% from 95%. The probability for a 25-basis point rate cut on September 18, 2024 has increased to about 81% after peaking just after the release at roughly 85%. This is up from the low 70s on Wednesday.

Beyond that, these futures markets are pricing in a 51% probability for 50 basis points' worth of cuts by November 7, 2024 (after the election) and a 90% chance for those 50 basis points' worth of cuts by December 18, 2024. This market is now pricing in a 70% probability for 175 basis points' worth of rate cuts by July 2025.

What Is Being Accounted For?

Are financial markets pricing in the likelihood for an economic crisis by late 2024/early 2025? Maybe. Perhaps even probably. Why either of these guys want to be president next year, I can't figure it out. The next president will inherit an economy in decline and a fiscal catastrophe that has not quite manifested itself just yet.

Are financial markets pricing in the deregulation and lower taxes that might be associated with a Republican sweep of the executive and legislative branches of government in November? Possibly, but I don't think so, as the probability for a contracting economy is the more likely of the two outcomes and that would not explain the rapid drop in expected short-term rates.

My View

This release almost assured that the Fed gets started on reducing short-term interest rates in September. Is this a problem from the point of monitoring the Fed's independence from the current administration. That is a problematic conclusion that some will draw if this comes to pass. That said, CPI has been coming in quickly for a few months now and the economy has been showing signs of potentially doing more than merely cracking. I would prefer no changes in policy from here into November, but if trying to arrest economic decay rather than merely reacting to consumer level inflation that on an annual basis is still not close to reaching the Fed's 2% target.

My fear is that inflation continues to slow into August and then, due to base effects if nothing else, re-ignites into the Autumn creating a stagflationary environment. I have written on this and spoke of this in the media. I am not talking about 1970s style stagflation. Someone always wants to fight when I express this view. Nonetheless, this could be an uncomfortable Q3 and Q4 of 2024 and early 2025.

Whether it will be a mistake or not, I don't truly know, but all of this reinforces the probability of the Fed's move into a trajectory toward easier monetary policy as they continue to try to draw down their balance sheet. That means a weaker dollar, relative to reserve currency peers as the green back had become overvalued in recent months. To me, that means: stay long the precious metals, stay long short-dated treasuries (for now) that one may have used as cash equivalents, and be ready to respect trends when and if trends change. 

We are not at the end of the cycle; we are not even at the beginning of the cycle. This doesn't mean that AI/mega-cap tech is cooked. This doesn't mean that it's time yet to move a portion of one's equity exposure into bond proxies.

At the time of publication, Guilfoyle was long gold, silver and tresuries.