Good Monday AM,

I hope you had a fantastic weekend. There is no data today, but the selling has continued.

Bonds are just getting an old-fashioned whooping for the past few weeks. Tough to recommend locking but it is also tough to catch a falling knife.

I know there is a lot of talk about a soft landing and while we all hope that to be true, I came across the below slide and think it is one of the most important I have seen in a ling time. Tax receipts have fallen off a cliff and GDP tends to follow, as does a recession. My crystal ball broke about a year ago so I can’t tell you what will happen but this is alarming (as is the drop in retail sales in the second slide).

Despite the two graphs showing serious hardships on the horizon, the WSJ shared a piece where Goldman Sachs economists are penciling in US rate cuts beginning in the second quarter of 2024, followed by a gradual, quarterly pace of reductions. While the Federal Reserve will want to normalize interest rates once inflation is closer to target, policymakers won’t need to do this with urgency, the economists said. The Fed’s highest interest rates in 22 years have successfully helped calm price pressures but have yet to tip the US into a recession many economists once thought was inevitable.

In recent weeks, Wall Street economists have grown more optimistic that a soft landing is actually in the cards for the US economy. The most recent CPI report contained more signs that inflation is cooling, and that the Fed can let up on its hiking cycle. Meanwhile, the labor market still appears to be solid. So then the next question is: if the Fed gets into a place where it’s confident that the inflation shock is over, what does it do next?

As inflation falls, real short term rates move higher, and grow theoretically more constrictive.

This is the same reasoning as NY Fed President John Williams offered in a recent NYT interview with Jeanna Smialek. The expectation of cuts coming fairly soon is in keeping with what markets have been pricing in for a while, with the 3-month/2-year spread having stayed in inversion for most of the year.

Of course, in the beginning of the year, the inversion fit into a narrative of oncoming recession.

And of course, that’s always what people say, that inversions are recession signals. But more accurately, inversions are indicative of the market pricing in rate cuts. And of course rate cuts are usually associated with recessions. But the possibility that more and more people are raising is that we could just see rate cuts out of a desire to “normalize” policy, rather than rate cuts for recession fighting. If it happens, it would be the cherry on top of an ultimate soft landing.

Please remain safe and stay healthy!