December 2, 2022
After hearing from Jerome Powell on Wednesday, the markets were set for liftoff this morning, upon the catalyst of a weak jobs report.
Remember, in this world, bad news is good news (for stocks and the economy), as it builds the case for an end to this Fed tightening cycle.
The catalyst didn't happen. The November jobs report came in mostly on trend, but (a big but) the wage growth was hotter.
If we were to believe what the Fed has been selling, up to this week, we would expect such a report to embolden the Fed to follow through on their rhetoric, "to keep at it" (i.e. keep raising rates).
With that, after falling 85 basis points from the highs of just six weeks ago, with a hot wage number this morning, most would have expected the 10-year yield to rocket higher.
Indeed it had a bounce this morning. But by the end of the day, the 10-year yield completely reversed and closed at the lowest level since September 20. That's below 3.5%.
So, the market-determined interest rate (widely viewed to be the smart money) has returned to levels prior to the last 150 basis points of Fed tightening.
My view: The Fed has gone too far already. The 10-year yield is telling us the lag effect from the Fed action hasn't hit just yet. But it's coming. And Jerome Powell, in his discussion on Wednesday, definitely (finally) showed more humility about how this lag may play out.
When you take the Fed Funds rate from zero to 3.75% in eight months, and spike mortgage rates from 2.75% to near 8% that quickly, you're going to get damage, and a retrenchment in economic activity — and maybe even deflation.
We've seen the damage in the global financial system, with a near blow up in UK and European sovereign debt over the past several months. We've seen some retrenchment in the economy (U.S. and global manufacturing/PMIs back in contractionary territory).
We haven't seen falling prices yet in the stale government inflation data. But we may see it finally showing up, when we get the next inflation report, which will come on December 13th. Again, the 10-year yield may be giving us that message.
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