In case you needed a reminder of just how much the stock market relishes the Fed put, all you had to do was look at the performance of the stock market this past week. Saddled with uncertainty about tariff actions and a slate of relatively weak economic data here and abroad, the S&P 500 was up 4.6% for the week as of this writing.
Every sector was up, with gains ranging from 1.0% (communication services) to 9.2% (materials) in a move that put short sellers in a choke hold and drew sidelined money back into the market, fearful of missing out on further gains. Even more remarkable is that this week's gain came in just four sessions. The S&P 500 closed down 0.3% on Monday.
And what was it that got the stock market running like it did?
First, there was a nagging sense that it was due for a bounce from a short-term oversold condition, yet the real catalyst was a tacit acknowledgment from Fed Chair Powell on Tuesday that the Fed is finding reason to lower the fed funds rate sooner rather than later.
Once again, the fed funds futures market and the Treasury market were instrumental in opening the Fed's eyes. Both have been aggressive in pricing in future rate cuts, because they see a weaker economic environment unfolding.
The Employment Situation Report for May was the latest data point to corroborate the forward-looking nature of the fed funds futures market and Treasury market.
Not Good Enough
To be clear, the May employment report wasn't bad. Nonfarm payrolls increased by 75,000 positions, average hourly earnings increased 0.2%, and the unemployment rate remained at a near 50-year low of 3.6%.
The sticking point is that the employment report wasn't unquestionably good. That is important because employment is a lagging indicator, and the fading three-month moving average for nonfarm payrolls is suggesting that hiring activity has slowed and will likely translate into slower growth overall for the U.S. economy.
One could make a case that the slow hiring activity in May was the result of employers not being able to find enough qualified workers in a tight labor market.
We suspect that remains true in some industries, but that argument breaks down in the aggregate since it was not supported by a larger-than-expected increase in average hourly earnings. On the contrary, average hourly earnings increased just 0.2% m/m (Briefing.com consensus +0.3%), leaving the yr/yr increase at 3.1% versus 3.2% in April.
Preemptive not Reactive
The Fed had previously said that it will be patient in changing the target range for the fed funds rate from its current level of 2.25-2.50%, wanting to wait and see how incoming data unfolded.
That is the Fed's prerogative, yet the fed funds futures market and Treasury market are using instant messaging to communicate to the Fed that there is no time to waste, partly because the market sees a loss of momentum in many economic indicators and partly because the market sees a growth impediment in the tariff/trade mess involving China and Mexico -- and perhaps other countries before the capricious policy tweets are all said and done.
In brief, these markets are begging the Fed to be preemptive and not reactive.
The scope of their angst has resulted in three rate cuts before the end of the year being priced into the fed funds futures market, the ongoing inversion of the 10-yr - 3-mo spread, and the sharp drop in the 2-yr note yield, which went as low as 1.77% after the May employment report.
Separately, with an increasing number of Fed officials calling attention to the low inflation rates, and highlighting their concerns about inflation expectations weakening, there has been an equally stunning drop in yields at the back end of the yield curve, which is more inflation sensitive.
The yield on the 10-yr note sits at just 2.08%, which is its lowest level since 2017 and down 60 basis points from where it started the year.
The Treasury market, for one, is giving the Fed the high sign to cut rates, and to do it soon.
What It All Means
"Soon" is unlikely to be at the June 18-19 FOMC meeting, which precedes the purported meeting between President Trump and President Xi at the G-20 meeting.
The July 30-31 FOMC meeting is rounding into form as the most likely time for a rate cut. According to the CME FedWatch Tool, the fed funds futures market is pricing in an 89.5% probability of a rate cut then, up from 68.3% before the release of the May employment report.
As stated above, the latter wasn't bad. Accordingly, Friday's rally in the stock market wasn't a case of seeing bad news as good news.
It was a case of seeing less-good news for a lagging indicator compelling the Fed to be a more constructive leading indicator for the U.S. economy via a rate cut that happens sooner rather than later, and which the fed funds futures market and Treasury market have effectively forced the Fed to make.
(Editor's Note: The next installment of The Big Picture will be posted the week of June 17)