Perspective: Morning Commentary for September 20

September 20 – It was a big day on Wall Street Thursday, with stock futures quietly consolidating overnight. Yet, the mood remains generally upbeat to close out the week. The VIX Is trading near 16 this morning, while the dollar index is trading near 100.7 after appearing to break through a triple bottom on the charts earlier this week. Yields on 10-year Treasuries are trading near 3.74%, while yields on 2-year Treasuries are trading near 3.61% as the yield curve continues to right itself following more than two years of inversion. Crude oil prices are modestly lower this morning following big recent gains. The grain and oilseed sector is again mixed, with wheat prices bouncing modestly overnight, while corn and soybean prices feel some early harvest pressure.

Fed fund futures are trading expectations this morning that we will see the Federal Open Market Committee cut another 25 basis points from its benchmark rate on November 7^th, but with expectations that we’ll see a total of 75 basis points come off current levels by the December meeting. That would suggest another 50-basis point move at one of the two remaining meetings this year. The aggressive cuts are not due to data showing us in an economic tailspin. Fed Chair Jerome Powell stated this week that the economy is doing fine. Rather, there’s a push to quickly restore the Fed’s benchmark rate to its “natural” level as quickly as possible now that it believes that its war with inflation is over. Powell won’t come out to specifically say that, remembering what happened after President George W. Bush gave his “Mission Accomplished” speech on the aircraft carrier USS Abraham Lincoln 21 years ago, but he has essentially said as much by his actions and recent comments. As such, much of Wall Street believes that there is no longer any need for rates to remain above their natural level, although nobody can really agree on what that natural level is in today’s economy.

The big 50-basis point cut will renew inflation risks, according to former Kansas City Fed President Thomas Hoenig. “They are gambling that they have inflation under control,” stated Hoenig. “They have turned their attention to maintaining employment, and that does inflate the risk of renewed inflation down the road.” I quote Hoenig here, because his comments match up well with my concern. I don’t believe that today’s fiscally stimulated economy fits the old academic models used by the Federal Reserve, and I believe that it is only a matter of time before the Fed has to turn on its printing presses again via quantitative easing in order to restrain the upside risks for mid- and longer-term borrowing costs due to Congress’ insatiable appetite for spending. You can argue about which party is most responsible, but the fact is that neither party has done much about our nation’s growing debt problem when it had the ability to do so. Why? Because getting elected means giving the people what they want, and our culture is one that wants what it wants now, and it will worry about how to pay for it later.

Reinflation will not immediately come back due to this rate cut, in my opinion. But I do believe that we will see it start to come back next year. The rate of inflation is coming down, except for portions of the service sector – most specially in the shelter and transportation services sector. The Fed has telegraphed that it will be aggressive in significantly cutting rates over the coming nine months to a year. Therefore, the consumer will likely delay purchases of durable goods and housing that require the use of credit. That could continue to keep things soft for a bit longer. The rate of inflation has come down, and will likely go down a bit more, but the effects of the inflation cycle we endured will not reverse, leading to a steady flow of labor union demands for higher wages – significantly higher wages – to “catchup.” Longshoremen on the East Coast and Gulf Coast are threatening to strike on October 1^st if they don’t get a new contract. They’re demanding a 77% pay raise over the coming six years, along with other job security measures. Other unions have already garnered substantial pay increases, although not as big as that request. It’s been estimated that a strike would cost the economy billions of dollars per day. Expect the costs of all goods and services coming into the country to see higher prices as wages go up. We’re all in favor of getting paid more, but my point is that all of these costs do get passed on to the consumer, whether it is wages of longshoremen, or of the person serving you food at your favorite local restaurant. Cutting interest rates puts more money into the pocket of consumers to stimulate consumption of goods and services, increasing demand, which results in higher prices, combined with higher wages for those providing those goods and services. Inflation will come back. It’s just a matter of timing, and whether a longshoreman strike delays it by providing a near-term drag on the economy.

Energy prices will take their cues from the above, while also monitoring geopolitical risks. Meanwhile, wheat prices are monitoring dryness in the Black Sea, Southern US Plains, & Argentina, while corn and soybean prices deal with early harvest pressure. There are some really good corn yields out there to offset some disappointing ones, while I’m hearing more disappointing soybean yields thus far than I am great ones.