A Pictorial of Fed Easing Pressures

Numerous market and economic indicators are suggesting the Fed should be continuing to ease interest rates. See the pictorial below.

While the Federal Reserve is waiting to see if the Trump Tariffs lead to problematic inflation, the traditional signs that it is time for the Fed to ease continue to multiply. What follows is a pictorial of economic relationships relative to the Federal Funds rate which are indicating the Fed normally would never have paused its easing cycle.

1. The Unemployment Rate has been Rising

During at least the last 40 years, the Fed has seldom been in tightening mode when the unemployment rate was rising (chart 1). Since 1985, the Fed has lowered the Funds rate 74% of the time during months when the unemployment rate rose. The unemployment rate (shown in red on the inverted right-side scale) bottomed in April 2023 at 3.4% and during the last two years has risen to 4.2%. It would not likely take much of a rise in the unemployment rate from here to bring considerable pressure on the Fed to start easing again.

2. Consumer Confidence has Collapsed

As demonstrated in chart 2, it’s highly irregular for the Fed not to be easing after consumer confidence just crashed close to post-war lows. Essentially, consumers are communicating they feel worse today about the economy than they did at the bottom of the 1990 recession, after the dotcom stock market collapse in the early-2000s, about as bad as they did at the worst of the 2020 pandemic recession, and worse than they did at any point during the 2008-09 Great Recession. If confidence remains this depressed, it will be unprecedented if the Fed doesn’t soon help by easing interest rates.

3. Employment Growth Grinding to a Halt

Annual nonfarm payroll employment growth just slowed to below 1.2% in April (chart 3). During the last 50 years, when the annual growth in job creation has become this sluggish, it has led to either an actual recession or at least a growth recession. At its current annual pace, job growth is less than it was when the Fed first began easing interest rates in 1989, 1995, 2000, 2007, and in 2019. How long can the Fed stand pat as job growth grinds to a halt?

4. Annual CPI inflation at a Recovery Low of only 2.3%

I know the Fed is worried about where inflation may be headed in the balance of this year as tariffs work through the economy. Perhaps the Fed will be proved correct and will be raising interest rates to fight tariff-related inflation pressures in the coming months. However, as shown in chart 4, if tariffs unexpectedly don’t cause much inflationary fallout, the Fed is likely to find itself behind the curve in terms of easing relative to diminishing inflationary pressures. The CPI annual inflation rate just declined to its lowest level of the recovery, and at least so far, shows no signs of becoming problematic. What inflation rate would force the Fed to give up worrying about an inflation ghost and ease? Should economic growth continue slowing, inflation may surprise and decline further than most anticipate, despite tariffs.

5. Job Openings no Longer Exceed Unemployment

In 2022, there were more than two job openings for every unemployed person (chart 5). Today, however, the number of job openings are about equal to the number of unemployed. This is yet another jobs market indicator suggesting the employment market is far weaker today than it has been at any point in this recovery. During the last 25 years, there has been a very close relationship between the ratio of job openings to the unemployed, and the Federal Funds rate. As shown in chart 5, typically when the openings/unemployment ratio has declined, so too has the Fed funds rate. Therefore, it is rather odd the Fed continues standing pat while this ratio regularly makes new recovery lows.

6. Real GDP growth sits near the 2% Stall Speed

Annual real GDP growth slowed to just 2.1% in the first quarter (chart 6). Historically, the 2% area has been considered the “stall speed” where recoveries often slip into a recession. Regardless, as shown in chart 6, since 1985, there has been a close relationship between real GDP growth and the Fed funds rate. When annual real GDP has neared the stall speed of 2%, the Fed has almost always been in easing mode.

7. US Leading Economic Indicator Flashing Red

The Federal Reserve of Chicago has developed a U.S. leading economic indicator based on dynamic factor analysis of 500 monthly measures of real economic activity – the Braves Butters Kelley Leading Index shown in chart 7. Since at least 1985, this leading index has closely traced movements in the Fed funds rate. Early this year, the index declined below zero for the first time since 2022. Since 1985, usually when this index was declining and was below zero, the Fed was easing interest rates. How long will the Fed be able to ignore leading indications about the health of the economy?

8. Fed Funds Usually Follows Crude Oil Prices

Although not a perfect relationship, as demonstrated in chart 8, the Fed funds rate has typically moved in line with crude oil prices. During the last 25 years, every major decline in the price of crude oil has been associated with either a zero Funds rate or a declining Funds rate. Since the Fed paused its easing campaign in mid-December, the price of crude oil has dropped by about 20% to more than a four-year low. And still, the Fed continues to stand pat!

9. Temporary Jobs Signal Economic Weakness

Traditionally, temporary jobs tend to rise during strong economic times and are the first to be cut as the economy slows. For the last 30 years, chart 9 overlays the level of temporary jobs with the Fed Funds rate. Clearly, the Funds rate has historically responded to the strength or weakness in temp jobs. Not only has the Funds rate normally peaked when temp jobs peak, but the Funds rate typically declines as temp jobs decline. Although temp jobs have flattened since late last year, they did decline substantially during the last couple years. Should temporary jobs start declining again, the Fed will likely face additional pressure to ease interest rates.

10. Investors Signaling Weak Growth, Not Inflation as the Primary Worry

Chart 10 overlays the trailing 1-year correlation between the weekly percent changes in the S&P 500 index and weekly changes in the 10-year U.S. Treasury yield (red line shown on an INVERTED right-side scale). This correlation has proved to be an excellent indicator as to whether investors are primarily worried about inflation (when the correlation is negative) or a recession (when the correlation is positive). As shown, during the last 30 years, there has been an extremely close relationship between this correlation and the Fed Funds rate. Currently, while the Fed remains concerned about inflation risk, the financial markets are clearly suggesting that recession, not inflation, is the real risk. The fact that investors fear a recession and show little concern about inflation stands in sharp contrast to the Fed’s contemporary obsession with inflation. Indeed, the current stock-bond yield correlation at about +0.2 suggests the Fed Funds rate should perhaps already be less than 3%.

Final Comments

As the Fed continues to “wait & see”, both the economy and the financial markets maintain pressure on the Fed to again ease interest rates. I don’t know whether inflation will worsen substantially in the months ahead due to tariffs (but my guess is inflation worries will likely prove greatly exaggerated) nor do I know how long the Fed can stand pat with interest rates. But, with the economy already regularly throwing off signs of stress, it probably won’t take much to convince the Fed it should soon again start easing.

Thanks for Taking a Peek! Jimp

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