Perspective: Morning Commentary for April 12

April 12 – Stock futures are pulling back this morning, even as the dollar surges to fresh five-month highs amid a sinking euro on expectations of rate cuts from the European Central Bank. Yet, the commodity sector found good support overnight. The VIX is trading near 16 this morning, while the dollar index is trading near 105.9. Yields on 10-year Treasuries are trading near 4.53%, while yields on 2-year Treasuries are trading near 4.91%. Crude oil prices are more than 1% higher, while the grain and oilseed sector was modestly higher as well.

The Federal Reserve has a problem. It’s quite clear following the statements made after its March meeting that it wants to cut rates. It hinted at such all the way back in the December meeting. Fed Chair Jerome Powell was feeling the heat of lawmakers who were demanding rate cuts. Afterall, it’s an election year, and they want something good for their constituents. The Fed had frequently stated over the past couple of years that one mistake that it was determined not to make was to cut rates too soon, as it mistakenly did in 1980. Some of us remember well the pain of that mistake, and Fed members seemed to be well aware of the potential consequences as well. As such, they frequently repeated that they would rather error on the side of keeping rates higher for longer, rather than to pivot too soon. Yet, the pressure was mounting.

But members of the Federal Open Market Committee are human. They hear the criticisms. They feel the pressure. Perhaps they thought that the pressure would ease back in December if they would simply say, “yes, we’re ready to start talking about when to cut rates.” But here is the problem. It’s said to take 12 to 18 months for rate hikes to fully impact the economy. That’s why they paused the rate hikes – to give the economy time to adjust to the rate hikes already implemented. That would then allow them to better assess whether they had sufficiently raised rates. The problem was that they felt the pressure to cut rates in the midst of that waiting period. And, they failed to grasp that it takes 12 to 18 months for rate hikes to impact the economy, but it only takes the mention of possible rate cuts to stimulate the economy – something that the economy was not yet ready to handle. There was still too much stimulus left in the system yet, and the consumer’s desire to spend was still too strong. The statement of being ready to discuss rate cuts was perceived to be a pivot, even though no rate cuts have yet been implemented, and the stimulus was in place. The stock market hit new record highs, Treasury yields fell, triggering renewed demand for housing and consumer spending as sentiment surged. The perceived pivot took place at a time when energy prices were near more than two year lows. A rise in consumer buying coupled with rising geopolitical risks in the Middle East and the Black Sea pushed energy prices to five-month highs, adding more fuel to the reinflation pressures.

Now, what does the Fed do? It may have made it impossible to cut rates this year, unless it closes its eyes and does it anyway to ease the political pressure. But cutting rates – even once – will add to the stimulus effect. The economy is doing well without the cuts. Cutting now will juice it further, possibly necessitating the Fed to do the unthinkable – raise rates again. Sound like a repeat of 1980? I am in no way forecasting rates as high as the Fed had to push them in 1980. Different circumstances were in play at that time. But a legitimate rate cut at this point would probably be in indicator that the economy has suddenly taken a downturn. Meanwhile, the Fed must find a way to get a handle on this inflation problem before it gets out of hand, as it did in 1980, requiring then Fed Chair Volker to take drastic measures. The Fed had its opportunity to moderate its dovish tone at the March meeting, but it instead added to the problem with more talk of cuts. It just created an even greater challenge for itself in a year when anything it does will appear to be political, even if it’s trying not to be political. And this time it must do so following statements from the European Central Bank that it fully intends to cut rates soon, sending our dollar surging higher as the euro falls.

USDA’s monthly WASDE report seemed tame enough on face value, but there were some surprises in it. The most notable surprise was its failure to cut its Brazil corn and soybean production estimates, even though they stand near a record difference from those from Brazil’s CONAB. Perhaps USDA is tired of needing to constantly upgrade previous year’s production estimates when Brazil always seems to have soybeans left over at the end of the year, despite higher than expected demand. In fact, it has added 6 million metric tons to last year’s crop over the past half year as it became obvious that Brazil’s supplies exceed what it should have had with the originally estimated 156 mmt crop for last year. Now it has last year’s crop at 162 mmt. It likely doesn’t want to end up having to revise this year’s crop higher as well, just as it has had to do for past years. Regardless, it didn’t provide much for the bulls in yesterday’s report. Look for USDA’s U.S. corn ending stocks to continue to slip lower due to solid demand, but also look for USDA to raise its domestic soybean crush estimate in future months as well. As for wheat, the Black Sea is controlling the narrative currently with cheap prices, but that will all change rapidly if its production is challenged in an otherwise snug global situation.