After 24 years of studying data, there are very few things left that surprise me.  Just had to share this.

As today begins, so too does the 7^th meeting of the Federal Open Market Committee (FOMC) this year.  According to the markets, there is a 96% chance the FOMC will lower the Fed Funds target rate by 25 bps to a new range of 1.5% - 1.75%.  Unfortunately for us, there is nowhere near that amount of certainty about the future path of the target rate heading into the last FOMC meeting of the year.  Fortunately, we get a bunch of economic data this week, which should help lift the fog of uncertainty that surrounds that final December meeting.
 
The US economy is clearly in its third slowdown of this extended business cycle.  It is also in its second manufacturing recession in the last 3 years, as indicated by the contraction in the ISM manufacturing index.  The inversion of the US yield curve presents a scary proposition for 2020, in that, it typically signifies a high probability of recession within 12 months (on average) of its inversion date.  The chart below gives you a visual representation of this.  The chart shows the odds of entering a recession within the next 12 months, based on a probit model built by the New York Fed on the term structure of the US yield curve.  In simpler terms, it analyzes the 10 year-3 month spread and it has been very accurate in the past.


 
So are we heading for a US recession next year?  No one knows for sure, but I think there is one key sector of the economy that will decide that for us.  The chart below shows what percentage of 85 US economic indicators are currently negative.  As you can see, the current spike is entering territory that usually represents a higher risk of a US recession.  But, if you look at late 2015, we had a large amount of negative data weighing down the US economy (huge spike), including a manufacturing recession, BUT, we had no US recession.  Why?  I’m glad you asked!   What has been absent during all three slowdowns is labor market pressure (black spikes in the chart).  In my opinion, this will be the key determinant for whether we actually experience a meaningful recession next year or not.



 
This is the key chart for me moving forward, and luckily, we get fresh employment data on Friday.  If we see labor pressure start to spike, you need to plan on the path of the target rate to continue lower next year.  If the labor market stays favorable, this may be where the target rate settles for the foreseeable future.

On the eve of what looks like our first rate cut in a decade, I hear a lot of chatter on how this will benefit U.S. growth prospects via lower interest rates on loans and mortgages.  Well, being the curious fella I am, I decided to take a look at a couple things.

First, since consumers are big borrowers, and are typically more rate sensitive than businesses tend to be historically, I chose to look at how consumer confidence responded to interest rate cuts.  As you can see in the chart below, interstingly, not very well.



It would appear interest rate reductions actually have a negative effect on consumer confidence (red lines mark first cut).  There was one instance where several aggressive cuts by the Fed did not initially hurt consumer confidence and that was in 1998.  That was when we were in the throws of the Long Term Capital Management blow-up and the Russian debt crisis.  So what kept confidence rising?  My guess is we were in a stock market bubble that kept consumers' wealth rising rapidly, which in turn, kept consumers confident until the bubble popped, and the Fed began aggressive rate cuts in early 2000.

So, why is this important to bankers?   The next chart highlights the importance.  There is a strong correlation between consumer confidence and total loans and lease growth.  We need to watch what happens if/when the Fed actually cuts rates.  If the Fed needs to start a new easing cycle, and the stock market responds in a negative fashion, it is likely consumers will quickly become less confident, and thus a slowdown in loan and lease growth can be anticipated.  If the Fed is just going to cut rates once or twice, and stocks resume their bubbly advance, we could see a continuation of the current loan growth we are experiencing.



As always, there is no certainty in any of this.  However, those who ignore history are doomed to repeat it.