| Let's start with the obvious: having not signaled a cut in July, the Fed didn't deliver one. That's what we saw this week. But more importantly, the stage is now set for the Fed to make a wholesale shift the balance away from its inflation mandate toward the employment mandate. I think that will end up yielding a cut at every subsequent meeting until we get to a so-called neutral rate. Mind you, the Fed didn't telegraph anything of the sort in its press release Wednesday. Nor did Fed Chair Powell. But they changed the language to stress employment more — and that's a clue of where this headed. Former St. Louis Fed President Jim Bullard summed it up nicely on Bloomberg Surveillance this morning, dismissing increased speculation that the Fed would cut in 50 basis point increments. But he validated the concept that the fed funds rate is too high, with the goal being a return to a rate something like the 2.8% longer run target from the Fed's June summary of economic projections. It's wholly conceivable then that, even while the US economy is in no jeopardy of a recession, we see cuts at every meeting until we get to that level, with inflation remaining below 3%. What makes me conclude that? Most important is the last reading of the Fed's favorite inflation measure derived from the price level of personal consumption expenditures. That number, at 2.5% is low enough to green light rate cuts beginning in September. But I'm going to focus on inflation needing to be higher to reflect a robust, growing economy. If you look at core PCE inflation, the last time figures were as high as they are today for a subsequent 10-year stretch was from November 1988 to November 1998. That's one of the best runs in economic growth in recent memory. It suggests that the Fed's 2% target may simply be an arbitrary number that has no validity in the current global situation. It's a low figure that is an artifact of the high private debt and weak economic growth period that followed the bursting of the Internet bubble and the Great Financial Crisis. And so, to the degree the Fed wants to achieve a soft landing, 2.5% or 2.6% inflation might be good enough to begin cuts. My base case for the Fed now is quarter-percentage point cuts at every meeting from September until inflation and/or growth picks up. Now obviously I could be wrong. But I think a Fed that waits is a Fed that gets behind the curve and ends up cutting more, with the jeopardy of a hard landing much greater. The big question is why we even think this is a soft landing ride coming and not a hard landing one. I'll give you three answers. First, when you look at the data from jobless claims, it's telling us that people aren't losing jobs in droves and remaining unemployed. What sinks an economy is a spate of layoffs followed by the inability to find new employment. That's like an income shock to the economy that slows spending to the point where firms cut back on production and capital expenditure enough to trigger a recession. And remember, the big fluctuating variable in this is not personal consumption, which changes slowly. It's things like production and especially capital investment, something I'll come back to with AI later. The second answer I'll give you is from my colleague Simon White. His view: Excess liquidity, the difference between real money and economic growth, has remained persistently strong and has yet to turn down. That's powered a huge asset rally which has loosened financial conditions and defanged the Fed's rate hikes.
The result is that the yield curve inversion signal — when people are willing to accept lower yields for taking inflation and interest-rate risk for longer periods — that's used to predict recessions isn't telling you a recession is coming. It's merely telling you that the Fed is going to cut rates — which they are. The excess liquidity (something I attribute to massive deficits) will ensure that these are simply precautionary cuts preventing recession, not panicked ones after recession is inevitable. The last story is about the conflicting signals in the economy, best summarized by the earnings reports of Mastercard, Marriott and McDonald's. At McDonald's, sales fell for the first time since 2020.The CFO said "we don't expect that we're going to see a change in that environment over the next few quarters." Conclusion: some consumers are tapped out. They simply have to pull back. Meanwhile over at Marriott, a beneficiary of the post-pandemic wave of travel, they reduced their guidance "primarily as a result of a weaker operating environment in Greater China, as well as marginally softer expectations in the US and Canada." So while China is really weak, the US (and Canada) are only marginally so. But Mastercard saw shares rise the most in more than 20 months after profit beat estimates on strength in spending. I would summarize as follows: yes, overall consumer spending growth is declining but that slowing is happening some places more than others and it's actually not happening everywhere. To me that speaks to a slowing, not to a recession. And it is a slowdown that rate cuts can help prevent from becoming worse. | 
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