April 8-12, 2024

Tactical Signal 9

Despite a momentary dip in market sentiment spurred by speculation about a potential rate cut, the economic landscape exhibited resilience, as evidenced by robust job reports and the overall health of the U.S. economy. Our tactical indicators remain soundly in a bullish position (100%) as the underlying fundamentals continued to display strength and stability, buoyed by encouraging indicators of employment and overall economic performance.

Reality bites when investors feel pinched by the Fed's preview to reduce rates, which differs from the movie premiere. After two FOMC meetings in 2024 with no Fed action to cut rates and better-than-expected economic growth, major averages eased sentiment on the idea of a likely rate cut. Long-term Treasuries widened by an average of 20 bps, resulting in another volatile session as U.S. Aggregate bond returns declined by 1.07%. Equity markets across all segments and market capitalizations declined, led by the S&P 500 falling by a modest 0.93%.

As the economy's strength continues to defy projections and surprise investors, the confidence in inflation moves toward the 2% target expected by the Federal Reserve wanes. Last week, key manufacturing and jobs reports came in much better than expected: ISM Mfg. Index rose to 50.3, Factory Orders rose by 1.4%, Redbook rose by 5.2%, Non-Farm Payrolls rose by 303k, Participation Rate rose by 62.7%, while Unemployment fell to 3.8%. Although the brief decline was in response to good news as bad news, the positive long-term fundamentals are good for the economy.

Investors must reconcile why the Fed needs to rush to cut rates if the overall economy is going strong, albeit with a lagging effect. Let's also not forget history. We have been in a zero-interest rate environment largely since the 2008 Financial Crisis, and prior to that, the Fed Funds rate was well over 5% in the late 1990s.

Looking ahead, as first-quarter corporate earnings gear up to confirm a strong economy, starting with banks this Friday, the outlook will be focused on inflation with less than four weeks to the next FOMC meeting: CPI and Core CPI will be released on Wednesday, P.P. and Core PPI will be released on Thursday, and Michigan's Inflation Expectations will be released on Friday.

"The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably down toward 2 percent. Of course, we are committed to both sides of our dual mandate, and an unexpected weakening in the labor market could also warrant a policy response. We will continue to make our decisions meeting by meeting."

Chair Powell's FOMC Press Conference, March 20, 2024.

Assessing the Fed – Lessons Learned or New Paradigm

Fed Chair Jerome PowellIn the realm of economic policy, where the Federal Reserve wields its Keynesian toolkit like a seasoned craftsman, a recent departure from convention has set eyes wide open on Wall Street. Chairman Jerome Powell's latest address, delivered post-Federal Open Market Committee (FOMC) meeting, wasn't your run-of-the-mill monetary policy sermon. No, it was more akin to a riveting academic debate, with Powell spotlighting an unexpected protagonist: "It is different this time."

Gathered at the esteemed Stanford Graduate School of Business, Powell's discourse veered into uncharted territory, hinting at a potential rendezvous with economic theory's less favored sibling. Could it be that the Fed's playbook needs an unconventional rewrite in the face of post-COVID inflation woes?

Traditionally, the Fed's dance with interest rates has been a delicate ballet aimed at steering aggregate demand, the cornerstone of demand-side economics. But despite unleashing a barrage of 11 rate hikes between 2022 and 2023, intended to apply the brakes on demand, the economy remains as buoyant as a helium-filled balloon at a parade. GDP growth struts along at a robust 3.4%, and unemployment lounges comfortably at 3.8%, leaving economists scratching their heads and their models gathering dust.

According to Powell, "So what is actually different this time, at the risk of making that statement, is that this inflation wasn't strictly just a question of demand overheating and the Fed coming in and having to suppress demand. That's been the more typical pattern perhaps on the back of a shock such as oil price shock, that kind of thing."

To their credit, Powell and his FOMC cohorts acknowledged the unexpected plot twist. This time around, it seems, the economic narrative has taken an unexpected turn, catching the Fed unprepared and leaving traditional economic theory in the dust – overheated demand and low-interest rates.

 "This episode actually also involved, as everyone will recall, the collapse of the supply side in a lot of ways. Supply chains stopped working. There were shortages of critical things like semiconductors, and it turned out that you couldn't make cars. In addition, there was a major labor force shock, so we lost several million people out of the labor market, causing a very severe labor shortage. So, it was a supply-side issue as well as overheated demand from the closing and then the reopening of the economy at a time when rates were low and fiscal policy was very supportive of demand," said Powell.

The market's anxious expectations of a rate reduction might have been premature. 

"So we had both of those things and therefore if those were the causes, what we needed to see was both the unwinding of the pandemic-related distortions to both supply and demand in the economy and the tight effects of monetary policy. So, today what we think we are seeing as inflation has come down sharply over the last year, is those two factors working together. They do work together, we think tight monetary policy weighing on demand that gives the supply side a better chance to recover," explained Powell.

Powell's narrative suggests that while demand may be frothy, the supply side of the equation is throwing the biggest curveballs. It's as if the economy decided to break free from its traditional narrative arc and pen its own script, leaving the Fed scrambling to rewrite the ending.

But as the curtain falls on Powell's performance, one can't help but wonder if a subplot has been overlooked. Could the Fed be missing a crucial clue in their quest to restore equilibrium? After all, in a world where intangible assets like software and A.I. are rewriting the rules of the game, perhaps it's time for the Fed to extend its approach.

As Bill Gates quipped, "the portion of the world's economy that doesn't fit the old model just keeps getting larger." Perhaps it's high time for the Fed to embrace the chaos and uncertainty of this new economic landscape, lest they find themselves playing a starring role in the next great recessionary drama.

Economic Reports April 8-12
Select Indices as of 4/5/24

Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.


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