The bond market has gotten ahead of the economic data
Happy New Year!
Economic data released in November (representing October) was uniformly negative and a major factor in how dovish the Fed was at their most recent 12/13 meeting. In the press conference, Jerome Powell said,
“Recent indicators suggest that growth of economic activity has slowed substantially from the outsized pace seen in the third quarter.”
ISM manufacturing and service surveys, non-farm payrolls, the unemployment rate, industrial production, and durable goods all missed expectations and fell from the prior month. The unemployment rate rose to a new recent high of 3.9%, which is 0.5% above its recent low and reminded economists of the Sahm rule which states that when the 3-month average of unemployment rises 0.5% from its recent low, the economy is in a recession. This has been true in each recession back to 1953, triggering an average of 3 months after a recession begins. The 3-month average of the unemployment rate is 0.3% above its recent low which is close, but the rule hasn’t triggered, and it will take a few more months to do so.
Since then, economic data has not been as bad. Non-farm payrolls beat expectations and recovered back to near 199k from 150k, the unemployment rate fell 0.2%, retail sales and industrial production reverted back to positive, and parts of the housing data (new home starts, existing home sales) showed strength. It isn’t that economic data has improved that much but it hasn’t been a continuation of what led to the dovish Fed. Meanwhile, interest rates have fallen unabated for two months because of weak economic data but just as much because of the Fed pivot which has a “once a business cycle” importance to traders and provided its own momentum. In other words, the bond market has gotten ahead of the economic data.
And so, as the Fed becomes more vocal after the holidays, unless the December economic data (released this month) is as negative as October’s, the Fed will likely continue to retract some of the December meeting’s dovish impression and it will dawn on the market that a March rate cut is not as certain as it is priced for now (76% chance.) I expect interest rates will bounce somewhat higher before they resume falling again.