Behold, a cut from an independent Fed

One of our long-term tropes has been that the current US administration would threaten the independence of the US central bank and other important institutions, like statistical agencies. A compromised central bank would allow higher inflation and possibly result in lower real growth. Compromised statistical agencies could hide those facts from global investors, causing them to systematically underprice risk, as the Dollar remains central to the global economic system.

But our job, as asset allocators, is to make decisions today (with an eye on the future, to be sure, but today) and to do so by recognising the signal within the exceptionally high-pitched noise. It is to assess and properly price the probability that:

1. Institutions will indeed be corroded.
2. That this will happen within our investment horizon.
3. That markets will price the corrosion as risk-negative events.

Which brings us back to the Fed. Following the Fed’s recent decision, we see the balance of probabilities move towards maintenance of a modicum of institutionalism. On the one hand, the Fed did indeed lower interest rates. It did so despite an uptick in their inflation and growth expectations.

This means that they are genuinely afraid of the slowdown in the labour market. It is not just the numbers, some of which are seasonal, but also the large downward revisions in the data, which are usually a signal of much broader weakness. As a reminder, last September’s unexpected double rate cut came after similar downward revisions of the labour data, and the Fed was again accused of being politicised prior to the election (following this move, the numbers were revised up and the Fed was generally acknowledged as having somewhat overreacted).

So how would an independent Fed go about it? It would probably unite in agreement as to what to do next, like most committees when it’s decision time (but the one anticipated dissent from the newly appointed Stephen Miran). Previous dissenters (Waller, Bowman) moved with consensus, possibly reflecting their wish to present unity and independence, a very positive sign). It would also continue to disagree as to what to do next, as economists do. Dispersion in opinions is exactly what we would be looking for to confirm independence.

Six members want no rate cuts, while nine want two rate cuts. Two want just one rate cut. There is one projection for a rate hike (!), and the inevitable projection for 5x more rate cuts (so 3 and 2 in the next two meetings!).

The problem may be that we ourselves are viewing things too much through a political lens, not that important institutions have necessarily lost their independence. If we simply ignored the political talk, there’s nothing from last week’s decision to suggest that the Fed is presently acting as anything other than independent.

But what about statistical agencies? Surely their loss of independence will be detrimental? A deterioration in data quality would cause higher risk premiums, higher inflation, lower real growth, and possibly dent the dollar’s might, not to mention risk the whole inflation-linked bond market? Do we even know how much inflation is? A great report from Goldman Sachs (11 September, “Data Unreliability”) may shed some light on the matter. The President indeed fired the head of the Bureau of Labour Statistics. It is also true that firings have caused a large part of the CPI data to be “imputed” (i.e. correlated with other data). Let’s start with that last one. It’s actually not as bad as it sounds. It simply means that there aren’t enough people to measure, say, the price of Greek yoghurt in New York. This being a universal good, it will, by and large, have universal pricing. This means that we can simply ask a store in Miami and we will get a very similar price. Imputation isn’t great, but in the era of modern supply chains, it doesn’t significantly degrade the data.

As to the statistics themselves, statisticians agree that agency heads don’t necessarily have the power to rig the numbers either way. The larger issue they are facing is the quality of the data itself. Lack of funding, as well as a dramatic drop in response rates, especially after the pandemic, has caused a lot of data volatility and more dramatic data revisions. Some cohorts are simply not answering questions. Those agencies employ career economists with no interest in fudging the data (and no way to hide it if they did). And even if public agencies did somehow manage to fudge swathes of statistics, private companies (Markit, ADP) do a good job at collecting data independently.  This being an entrepreneurial country, private vendors would even likely step up where public entities failed and bid to be paid by private investors. Whatever the case, it is very hard to see trillions of assets under management being left at the mercy of a few mismanaged statistical agencies.

What does this all mean for investors?

We don’t, for the foreseeable future, see a high risk from misleading data out of the US, or a significant structural inflation or market risk, for the moment, emanating from the loss of the Fed’s independence. Board member Lisa Cook’s firing has now failed in two courts. Even if the White House puts all its weight, it is more likely that the US central bank will simply be compelled to have a more open door to the Treasury, rather than necessarily being fully compromised. Having said that, both Stephen Miran (the new Fed member whose tenure ends in January) and Treasury Secretary Scott Bessent have alluded to the possibility of trying to control longer term borrowing costs, which could have a significant impact on demand for US Treasuries. But even then, it will not constitute proof of a compromised Fed.

What does this all mean for businesses?

First, the data can still be trusted, at least to the extent it always has. Inflation risks primarily stem from trade wars and supply chain disruptions, not from the Fed. The situation merits monitoring to be sure, but at its current path, it would lead only to a modest increase in inflation risks.

George Lagarias – Chief Economist

Market update

Global equity markets saw a broadly positive week, resulting in a +1.6% return in GBP terms. In the United States, the equities market delivered another record-setting week as it climbed +1.9% to a new high, following the Federal Reserve’s 0.25% interest rate cut on Wednesday (its first cut in 8 months). Large US technology shares rallied after the Fed’s move, and positive corporate news further boosted sentiment. In the United Kingdom, investor sentiment was supported by the Bank of England’s decision to hold interest rates at 4.0%. The BoE struck a cautious tone, indicating that while inflation is easing, any future rate cuts will be “gradual and careful.” The European equities market dipped early in the week amid caution before the Fed meeting and renewed US tariff threats on EU auto parts, but rebounded after the Fed’s cut - overall it saw an increase of +0.8% in GBP terms (yet a decrease of -0.1% in local). Within the emerging market equities market, Asian stocks led the way, driven by semiconductor shares, while Chinese shares lagged as investors took profit and reacted to weaker economic data - as a result, emerging market equities advanced overall by +1.8%.

The 10-year US Treasury yield rose +6 basis points over the week, as the Fed cut rates by a quarter-point. Fed Chair Jerome Powell indicated a “meeting-by-meeting” approach to further easing, tempering expectations of an aggressive cutting cycle and putting upward pressure on longer-term rates. UK gilt yields also increased by +4bps.

Early in the week, oil got a lift after the EU announced fresh sanctions on Russian oil exports, which raised supply concerns and prices increased by +0.7%. Gold rose by +1.8%, benefitting from the global shift toward easier monetary policy. The Fed’s rate cut, and the prospect of slower rate rises provided support to non-yielding assets like gold.

Macro news

The Federal Reserve cut its benchmark interest rate for the first time since December, by 0.25%. This move was widely expected by markets, which are also anticipating two more 0.25% rate cuts this year. The decision comes amidst signs of a weakening labour market and slowing economic activity.

The Bank of England is expected to keep its policy interest rate unchanged. This decision is influenced by persistent inflation figures: consumer inflation held steady at 3.8% in August, nearly doubling the Bank of England's 2% target. Core inflation, which excludes volatile items like energy and food, slowed to 3.6% in August from 3.8% in July. Services inflation, which the Bank of England watches closely, also slowed to 4.7% from 5.0%. The BoE is also being urged to slow its quantitative tightening program to help manage government borrowing costs.

UK labour market continues to show signs of cooling. Official figures show the jobs market cooled in July, with vacancies falling for the 37th consecutive month. The unemployment rate held steady at 4.7%. Average weekly earnings growth ticked up by 0.1% to 4.7% YoY, a figure considered too elevated to tame service inflation.