Halyard’s Weekly Wrap – 1/5/24 – Digging into the Details

The first week of the new year had been a quiet one until the employment report was released this morning.  The headline non-farm payrolls surprised to the upside, with 216,000 new jobs added to the workforce, and the unemployment rate falling to 3.7%.  At first glance the report was a solid one and the bond market immediately sold off.  However, digging into the details revealed that it was not as robust as the headline suggested.  Glaringly, household employment fell 683,000; the biggest drop since April 2020 when COVID crushed employment for much of the workforce.  It’s not unusual for the non-farm and the household reports to deviate, but an 899,000 deviation leads us to conclude that one or the other will be significantly revised.  Later this morning, the Institute for Supply Management (ISM) reported a sharp drop in their services employment survey.  Again, the drop was the sharpest since April 2020.  Investors seem to have interpreted the combined reports as offering a solid backdrop for the Fed’s plan to cut rates this year.

As always, the new year brings updated prognostications and 2024 is no exception.  The two most impactful to the bond market are an expectation of the termination of Quantitative Tightening (QT) and the direction of overnight Fed Funds.  The most recent dot plot tipped the hand of the Fed that they expect to cut the Fed Funds rate by 75-basis points this year.  From that, economists have begun to speculate when the first cut will occur.  The early consensus is the first cut will be 25 basis points at the June FOMC meeting followed by a 25-basis point cut every other meeting.  That seems like a fair guestimate, but there’s a lot that can happen between now and June that could change their thinking.  The rate cut scenario seems to be predicated on economic growth decelerating, but we would argue that if GDP growth stabilizes around 2% annualized, and the economy is able to generate 175,000 jobs a month, then the rate cut expectation could become moot.

Fed Fund futures are reflective of the 75-basis point cut expectation this year.  Looking out further, the futures are anticipating 175 basis points of cuts by February 2026

The other wild card this year is an end to quantitative tightening.  Currently the Federal Reserve allows up to $60 billion per month to mature and not be reinvested.  The Fed has hinted that they’ll conclude the program sometime in 2024 but haven’t given any specifics.  As with all policies, they need to be concerned about unintended consequences, especially since the forecast is for another large deficit this year.

Looking out to the first full work week of 2024, inflation data is going to be front-and-center.  CPI is to be released on Thursday and PPI comes next Friday.  Year-over-year core CPI is expected to be up 3.3%, up from the 3.1% outcome in November.  That’s going to contradict the Fed narrative that there’ll be 75 basis points of rate cuts in 2024.