Jerome Powell Just Jinxed the Economy

We assume the wrathful gods were listening… and are already plotting to uncage the Furies…

For hubris they will not abide — especially from chairmen of the Federal Reserve.

Referring yesterday to the “remarkably positive set of economic circumstances” presently obtaining, Jerome Powell concluded:

“There’s no reason to think that this cycle can’t continue for quite some time, effectively indefinitely.”

When the great thunderbolt comes clapping down from Olympus we cannot say.

But our neck is craned against the sky… as we watch for signs.

Lo, we detect a disturbing cloud…

Should We Be Celebrating Today’s 3.9% Unemployment Rate?

The latest private sector employment numbers came out yesterday.

The nation’s employers added 230,000 jobs last month — trouncing the expected 179,000.

The Institute for Supply Management also revealed yesterday that the U.S. service sector attained near-record-level strength last month.

The president raised a gust of celebration:

“Blowout numbers on New Jobs and, separately, Services. Market up!”

Meantime, weekly jobless claims rest at 49-year lows… and wages are rising at the fastest clip in nine years.

All the while the (official) unemployment rate is a precious 3.9%.

Many economists believe it will slip to 3.8% after the Labor Department releases its September unemployment report tomorrow

A sub-4% unemployment rate is a rare bird.

Before appearing earlier this year, it last turned up in April 2000 — at the peak of the dot-com derangement.

But what came next?

The economy was in recession by March 2001 — less than one year later.

Perhaps today’s 3.9% unemployment is no cause for jubilation.

But we cite one isolated instance, comes your reply — you demand to see more.

And see more you will…

Prior to April 2000, unemployment last slipped below 4% in December 1969.

The economy was promptly sunk in recession… where it remained until November 1970.

An Overheating Economy?

We have still only offered two scraps of circumstantial evidence, you counter — the jury holds out yet.

Let us therefore call a certain Nicole Smith to the witness stand…

Ms. Smith is chief economist at Georgetown University’s Center on Education and the Workforce.

Her testimony reveals:

If we look historically at other times when the unemployment rate has fallen below 4%, it’s times where it was the boom phase just before recession or just after a major war period…

What we find is that the low unemployment rate is often associated with a boom phase just before a recession. It’s almost a precursor for a recession or a precursor for another slumping economy.

We bring forth Exhibit A in support thereof — a chart giving the history since 1950.

On each occasion the unemployment rate fell below 4%, it reveals, recession was hard upon us:

Chart 1

It is true, yes — recessions are not always occasioned by unemployment rates below 4%.

But the chart proves nonetheless:

On each occasion that the official unemployment rate sank beneath 4%… recession was soon on tap.

To remind, it is now perched at 3.9%… and may soon drop to 3.8%.

But why should recession rapidly follow peak employment?

Extremely low (once again, official) unemployment is associated with an “overheating” economy.

In the current context, explains Mark Zandi, chief economist at Moody’s Analytics:

This labor market is rip-roaring hot, and it is just going to get a lot hotter. The risk that this economy overheats is very high and this is just one more piece of evidence of that. 

The overheated economic engine, the Federal Reserve has historically concluded, requires a good cooling off.

That is, the Fed must increase interest rates to bring the business under control.

But instead of cooling off the engine… it often ends up throwing it into reverse.

As the following chart informs us,  rising interest rates preceded each recession since 1950:

Chart 2

Explains analyst Jesse Colombo, in Forbes:

Economic recessions, financial crises, and bear markets have occurred after virtually all Fed rate hike cycles, and there is no reason to believe that the current one will be an exception.

We must agree with his conclusion.

The Fed Prepares to Cross the “Neutral Rate”

The Federal Reserve has been increasing interest rates since December 2015.

It did so again just last week. December will likely bring another — the market odds presently stand at 78.5%.

Jerome Powell has insinuated that next year may see three additional rate hikes.

Meantime, we have recently discussed the “neutral rate” of interest.

Briefly, the neutral rate is the interest rate that neither stimulates the economy… nor restrains the economy.

Hence it is “neutral.”

But the neutral rate is elusive, shifting difficult to grasp… like the wind itself.

Powell believes the neutral rate is nowhere in sight.

Even if it were, he suggests he’s willing to drive right past it:

Interest rates are still accommodative, but we’re gradually moving to a place where they’ll be neutral… We may go past neutral. But we’re a long way from neutral at this point, probably.


We have noted in previous reckonings, evidence suggests a December rate hike could cross above the “neutral rate.”

And when the Federal Reserve’s target rate rises above the neutral rate, trouble is on tap — at least since the 1990s.

Once again, the evidence (the fed funds rate is in blue, the neutral rate in red):

Chart 3

Investors Are “All-in”

Yet another worrying portent drifts into view…

Data from research firm Topdown Charts reveal that investors have reduced their cash allocations to “rock-bottom” levels.

Like fools rushing into star-crossed love… investors are heaving themselves into stocks.

Callum Thomas, the firm’s founder:

It would be without recent historical precedent that cash allocations would drop further than where they are now. Basically where cash allocations are at this point is entirely consistent with the type of signs you see toward the end of a market cycle.

And finally:

“Long story short, U.S. investors are basically all-in. Good luck to them.”

The unemployment rate has dropped to fearfully low levels… The Federal Reserve may be sleepwalking into a bear trap… Investors are “all-in” on stocks.

Meantime, the economic expansion is the second-longest in history… and the bull market is nearly a decade old.

“The mills of the gods grind slowly,” said Greek philosopher Sextus Empiricus, “but they grind small.”

It is a lesson Jerome Powell may soon learn — good and hard.


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning