As I wrote last Friday, I think the Fed will cut 50 basis points tomorrow to get ahead of economic weakness. While there is no crisis evident yet, it is the right thing to do given how consistent business cycles unfold. In other words, a recession is coming, and the Fed should act early to mitigate it. Because Powell seems willing and able to defend it, I think the committee will go along with it.

But the gap between economic data and how much Fed cutting the bond market has priced-in (as shown through the 2-year yield) continues to widen. The bond market has priced in more weakness than is visible in economic data. See red circle in chart below:

Economic data released today, Retail Sales and Industrial Production, were positive. Headline Retail Sales beat expectations (+0.1% vs. -0.2% expected) showing that consumers are still spending. The prior month of 1.0% was revised up to 1.1%. The weakening labor market is only an economic problem insofar as it weakens spending, and that hasn’t really shown-up yet. Retail sales have grown 3.7% annualized over the last three months. The Retail Sales control group (subset that goes into PCE) has grown 6.3% annualized over the last three months. Industrial Production came in at +0.8% versus an expectation of +0.2%, although the prior month was revised down 0.3%. Put together, this month’s Industrial Production virtually erased last month’s decline that some pointed to as a possible start of a recession. These two data points are a continuation of the idea that a recession isn’t here yet.

Also, the Fed will release a new Summary of Economic Projections (SEP) tomorrow showing where each FOMC member thinks Fed Funds will be at the end of 2024, 2025, 2026, and longer term. It will undoubtedly not show as much easing as the bond market has priced in, which is not unusual, but an obvious point of comparison.

And with this backdrop, a 50 basis-point cut will likely cause some to think the Fed is ahead of the curve, not unlike October of 2007 after the Fed had cut 50 basis points on 9/18/2007; the first cut in that cycle. In a Wall Street Journal article on 10/8/2007, “Chance of a Fed Rate Cut Less Clear After Jobs Data”, writer Deborah Lynn Blumberg said,

“Investors now are split in two camps. On one side are those who maintain the Fed’s rate cut last month was too aggressive and who see no reason for further moves, given the improved jobs data [Payrolls were +110k and the Unemployment rate was 4.7% on 10/5/2007]. On the other side are those who say one month’s worth of better-looking jobs data won’t faze the Fed. They expect policy makers will have to cut again, given other signs of U.S. economic weakness.”

As we know now, the latter group were correct as the Fed further cut from 4.75% to 0.25% over the next year+, but the 2-year yield rose 37 basis points as traders briefly thought otherwise. It would be natural for bond market yields to rise somewhat to reassess how much Fed cutting is priced in, and for the “soft-landing” theme to take control of the narrative until another terrible economic data report comes along. No matter if the Fed cuts 25 or 50, don’t fall for the “soft-landing” narrative. These objections are part of the process in approaching a recession. The business cycle is bigger than the Fed, but interest rates may rise somewhat until that is more evident.