The bond market is sending Fed officials a clear signal: Hike now at your own peril.
It's the same message Fed officials have selectively chosen to ignore all year. If you’re still keeping score, the Fed pivoted hawkish in December, dovish in March, hawkish in May, dovish in June, and hawkish in August. That’s right, 5 policy pivots in 7 months.
Here's the much discussed passage from Fed head Janet Yellen's prepared remarks in Jackson Hole:
"Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives. Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months. Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee's outlook."
Investors clearly believe Yellen's hawkish rhetoric. Fed Funds futures on September and December hike probabilities just popped back up to 42% and 64%, respectively. Note: Before hawkish comments from Fischer and Yellen, those probabilities were 32% and 57%, respectively on Thursday.
All eyes are on Friday's Jobs report. As Yellen's speech clearly indicates, the Fed is closely watching for strength in non-farm payrolls to justify future rate rises ("in light of the continued solid performance of the labor market... the case for an increase in the federal funds rate has strengthened in recent months.").
And though largely ignored by the media last week, remember, second quarter GDP was revised down to 1.1% from 1.2%, on Friday, Consumer Confidence hit a four-month low and 90% of the Housing market (see Existing Home Sales) slowed to -1.6% year-over-year. So clearly, one of the few things the Fed has left to trumpet is relative strength in the labor market.
Even that premise is faulty. As we've shown many times before (see chart below), non-farm payrolls put in their year-over-year rate of change peak in February 2015 and have been declining ever since. As Hedgeye CEO Keith McCullough points out in today's Early Look, "it’s now mathematically impossible for labor to accelerate in Q3."
Why does this matter?
The 10s/2s yield spread continues its crash to year-to-date lows this morning as the market fears Fed tightening into an economic slowdown.
In other words, U.S. #GrowthSlowing. This is the call that's driven asset prices all year. So, whether or not the Fed hikes rates into a slowdown or turns dovish on a Jobs Report bomb and the stock market pops doesn't really matter (outside of risk managing any short-term investor hyperventilation). Our favorite macro positions continue to crush the performance of the S&P 500 year-to-date (see below) as investors continue to price in economic reality.
What it all means...
Investors have become disillusioned by supposed Fed omnipotence. That's being price into markets daily.