When the Fed and the market converged on the idea of 2 more rate cuts in 2025, I articulated that as a consequence I saw that as the least likely outcome- the one thing that would not happen.
As the "pause" has now been pretty much guaranteed the2-thngs we need to figure out are
How long it lasts
What happens next.
Let's start with how long it lasts.
Foe me looking back at the "pause" of the last 30-years is as good a guide as any
October 1987. The easing cycle lasted 17 weeks and then paused for 7 weeks
June 1989. The easing cycle (75 bp's) lasted 8 weeks and then paused for 12 weeks.
July 1995. The easing cycle (75 bp's) lasted 31 weeks and then paused for 60 weeks
Sept 1998. The easing cycle (75 bp's) lasted 8 weeks and then paused for 32 weeks
July 2019. The easing cycle (75 bp's) lasted 14 weeks and then paused for 18 weeks
Dec 2025. The easing cycle lasted 14 weeks (100 bp's) and has been place for 4 weeks next week
So, this time the 14-week easing cycle is consistent with the average of the 5 previous cycles before a pause (15.6 weeks) but was 100 bp's rather than the 75 bp's in the prior instances albeit we now know that a number of Fed policy makers did not want to cut in December
The average pause thereafter in the prior 5 instances has been close to 26 weeks and ranged from as little as 7 weeks in 1987 (heavily event driven ease due to stock market crash) and as much as 60 weeks (1995) when economic growth continued unabated despite the Fixed income bear market of 1994.
The 12- week pause in 1989 was undone by a housing/banking crisis while the 18-week pause in 2019 was undone by covid.
In 1989 and 2019 the deteriorating structural back drop saw a resumption of the easing cycle and subsequently much lower rates.
However, after the easing cycles of 1987 (stock market crash), 1995 (concerns that bear market in fixed income could cause a downturn- which it did not) and 1998 (Asia/Russia crises and LTCM failure the next move after the pause was actually to raise rates as the economy and employment remained resilient.
In 1987 we literally saw a 1/10th rise in unemployment to 6%, in 1995 3/10ths (5.4%) and in 1998 3/10ths. (4.6%).
This time around we did see a low to high move of 0.9% (now 0.7%) but stand at 4.1%- Below all three peaks of the other periods.
There can be a lot of question marks about the "bones" of the employment picture today but from the Fed's perspective it is 4.1% (very low) and we still have more than 1 job for every person unemployed.
The ease and pause are least like 1987 in terms of events (stock market crash) and employment deterioration, so it is interesting to note that the pauses in 1995 and 1998 were 60 weeks and 32 weeks respectively (average 46 weeks)
After the pause following the easing cycles of 1987, 1995 and 1998 the next Fed move was a hike.
So here is the "Rock and hard place for the Fed"
What are the criteria that could restart the easing cycle?
Sharp fall in inflation:
The last 6 core PCE numbers have averaged 0.2 (2.4% annualised) and there is a certainly a shot on base effects that we could see the YOY rate ease in the first 4 months of the year as we lose an average 0.4 a month.
However in the prior 2 years (2022 and 2021) it also averaged close to .4% a month both times....so we have clearly had a high base effect/seasonality for 3 years in a row. So, it is by no means clear that we can get a material drop here. (hence the pause)
Sharp economic downturn
Higher yields could clearly break things, but short-term yields are lower and, as yet, we have not even revisited the trend high in 5, 10 and 30-year yields- so likely we are not yet in "something breaks" territory
Sharp Stock market fall
That could certainly happen, and we have seen some weakness recently BUT we are coming off a 24% and 23% set of up years in the S&P .
The last time we effectively saw that was 1998-1999 when it rose 27% and 20% (also a total of 47%).
Yes, the market did fall in 2000 by over 10% and a further 13% in 2001 BUT the Fed did not ease until 3rd Jan 2001 .
At that stage we had to all effects seen the S&P drop into a bear market (high to low) with a fall of 19.25%. Why did they not move earlier? They saw the stock market move as one of irrational exuberance and the unemployment rate in December 2000 was just 1/ 10th off the lows at 3.9%.
So don't look for the Fed to independently react to the stock market unless and until the S&P closes in on 4,880
Housing market crash
In the absence of a surge in unemployment that is unlikely anytime soon. The buffer of the cheap fixed rate mortgages in 2021 means that a large increase in supply is unlikely anytime soon as consumers are protected by their "golden ticket"
The recent tragic developments in California (5th largest economy in the World after U.S. , China, Germany, Japan can only add to supply issues
Big importation of deflation from China
A high bar given the potential tariff dynamic coming.
Right now, the backdrops above are not what is standing out. What is?
Unemployment remains low.
Job openings (JOLTS) to total unemployed ratio has started to rise again.
Inflation remains sticky and inflation expectations are rising again
Economic growth remains buoyant with real GDP at 3.1% (Nominal at 5%) In Q3, 2024 and expected at 2.7% for Q4 (Atlanta Fed)
Existing home supply has started to dip again and is back to a very low 3.8 months by historic standards. Making up over 80% of housing activity this is a very important number. Thousands of homes lost in California just add to this at the margin.
Commodities are rising again with WTI up over 14% since December, Natural Gas over 80% since October and Copper nearly 8% in about 1 -1/2 weeks.
California also likely cause supply chain issues not just for housing and commodities but also potentially a whole host of materials and labor demand as the massive reconstruction takes place
This is a $150bn rebuild right now and that number likely gets bigger. This is both stimulative and inflationary.
We were already heading for the potential of renewed fiscal stimulus, further deregulation and tariffs (which already had the Fed on edge)
There is no way that this setup (absent things breaking) is going to let the Fed cut anytime soon. They will also not raise anytime soon given the fear of looking like they are reactionary/flip flopping.
This clearly suggests as do the charts that the long end of the curve will bear the brunt of this. There is little scope for the 2-year yield to head above the top of the Fed Funds band if they are pausing and/or easing. The market would have to seriously believe that the next Fed move will be up to sustain the 2-year yield above 4.5%
That is why levels of 5.75% on the longer end of the curve (10- year and 30-year) could easily be seen by end of Q1 as well as renewed steeper curves. I still expect the 2's 30's curve to move above 120 bp's this year.
For now, I think this still supports the USD and Gold to go higher and Long GOLD and short GBP is one of my favourite articulations of this.
While the Equity market is now responding to this we need to see if that continues but also need to recognise that any feedback loop from that (in terms of policy response and bond markets) is unlikely to be material unless and until we start to talk of a bear market (20% off the highs)
If and when all of the above starts to break things then we can step back, reassess and potentially construct a different picture but for now the Fed is done and between a rock and a hard place.
It will take time before they figure out what's next.
However, I cannot help but feel that they are (once again) totally miscalculating the picture here as they continue to preach the Gospel of more rate cuts this year.