Will the Fed Be Data Dependent?

Stocks tried to rally in early trading, but then gave way. The Dow and S&P are down about .5%. Both indexes re-tested their mid-June lows and failed this week. That seems to set up for a run lower in order to price-in risk of recession. The bond market is mixed today with long-term Treasuries sagging and high-grade corporates rallying. There seems to be some indecision with bonds at the moment. Should they rally because enough risk has already been priced-in? Or should they continue selling off because rates throughout the economy may have further to go?

Commerce Dept. data show that consumer incomes and spending picked up a bit in August, and continue to look OK. Income growth slowed to a 3.9% y/y rate and spending growth decelerated slightly to 8.2%. That gap means that savings rates are falling. People are leaning on credit cards more these days. Obviously, inflation is taking a toll, and we can’t sustain spending at a significantly higher level than wage growth for a long time. The fix will be falling inflation, upon which we can count thanks to the Fed.

The Fed’s preferred inflation gauge, Core PCE, accelerated in August to 4.9% vs. an upwardly revised 4.7% in the prior month. Obviously It’s going the wrong direction; we need to see falling inflation if the Fed is to even consider pausing its interest rate hike schedule. The good news, however, is that Core PCE peaked back in February at 5.4% and the direction since then has mostly been lower.

I have complained a bit recently about the nonstop, repetitive parade of hawkish speeches & interviews by Fed officials. Yes, we know you are bent on raising interest rates aggressively, and are singularly focused on tamping down inflation. Enough already. But today brought some nuance to the message. A couple of Fed bank presidents—Thomas Barkin and Mary Daly—suggested in a rather soft way that the magnitude of future interest rate increases could be dependent on economic data. That is, the Fed may not bull-in-a-china-shop this thing right into recession. That’s encouraging…I think. Barkin acknowledged that inflationary pressures—in commodities & supply chains—are easing. Economic weakness in China and Europe is bringing down inflation overseas as well. Daly noted that the US economy and inflation are already slowing and future rate hikes will depend on how fast.