Employment and Inflation Data Point to Cooling Economy and Inflation, Focus On r* Neutral Rate

Today’s PCE core index rose 0.1% for the month. The number would have been negative if it wasn’t for stubbornly high shelter costs which were up 0.4% for the fourth straight month (goods prices declined 0.4%, energy down 2.1%). Employment: Recurring applications for unemployment increased to 1.84 million for the week ending June 15. The highest level since 2021. These claims stats are “hard data” based on actual filings. Speaking of jobs data, a survey released this week indicates that 40% of companies posted fake job listings this year. Hiring managers do this for a variety of reasons. Tricking overworked employees into thinking help is on the way, making it appear the company is growing (when it isn’t), collecting resumes for future use, etc. Such revelations increase the skepticism on certain employment statistics based on “squishy” data such as surveys and internet postings. Futures markets continue to price in 2 rate cuts, most likely September and December. The 10-year Treasury initially rallied down to 4.25%, before an afternoon sell off drove it up to 4.40% (this may be due to traders focusing on the uncertain direction of future US fiscal policy after last night’s Presidential debate).

What goes up must come down? Once the Fed starts cutting rates, the focus will be on how deep the next round of cuts will be. Remember that this round of hiking started in March 2022 with a quarter point increase from a Fed Funds rate of near zero. The 10-year Treasury stood at about 2.10%. Both fixed and floating futures markets predict that we aren’t going back to those ultra-low interest rates. Predictions for the eventual “landing spot” involve estimates of the “r* rate” aka the “neutral rate” are coming into play. This is eventual Fed Funds rate that is neither stimulative nor restrictive to the economy. During the 2010s era of ultra-low rates, it was thought to be about 2.4%. Today, estimates range from 2.5% to as high as 3.75%. If it does turn out to be 3.75%, that would mean there are a total of only 6 to 8 rate cuts in the next cycle (as opposed to the 20 cuts it would take to get back down to near zero). And a SOFR index of about 3.50%-3.75% over which floating rate loans will be priced. Bond futures point to 5–10-year Treasuries bottoming out at about 3.50% (as opposed to extended periods of 1.50-3.00% treasuries during the last decade). Real estate cap rates and risk adjusted returns will of course be affected. A common refrain among analysts is, “The next 10 years won’t be like that last 10 years.” Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners.