Tag: Chicago Fed National Financial Conditions Index

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The real risk of a Fed rate cut

Key Points

  • ADP National Employment Report estimates that the private sector shed 32,000 jobs in November.
  • Traders are pricing in an 89% chance of a 25-basis-point rate cut by the Fed on December 10.
  • ISM Manufacturing and Services PMI shows inflation is not yet under control.
  • A rate cut will likely weaken the Dollar, increase demand for real assets, and drive up long-term yields.

The ADP National Employment report estimates that the economy lost 32,000 jobs in November, the 3-month moving average turning negative for the first time since the height of the pandemic in August 2020.

ADP Private Sector Jobs

Losses are heavily weighted toward small firms, which have taken a hit from tariffs, shedding 120,000 jobs in November, while mid-sized firms added 51,000 jobs and large firms 39,000.

ADP Private Sector Jobs

The Fed is expected to announce a 25-basis-point rate cut on December 10 in response to weak jobs data. Markets are pricing in an 89% probability of a cut, with the discount rate on 13-week T-Bills falling below the Fed’s current 3.75% to 4.00% target range for the fed funds rate.

3-Month T-Bill Discount Rate

Other parts of the economy remain resilient, with the ISM Services PMI increasing to 52.6% for November, well above the 48.6% breakeven level typical of past contractions.

ISM Services PMI

New orders also signal expansion, but the rate slowed to 52.9%.

ISM Services New Orders

Employment has improved over the past four months, but remains in a contraction.

ISM Services Employment

Most importantly, from the Fed’s perspective, 65.4% of enterprises reported increased prices, down from 70% in October but still reflecting strong inflationary pressures.

ISM Services Prices

The Manufacturing sector reported similar price rises in November, though the rate of increase is slowing.

ISM Manufacturing Prices

Financial Markets

The Chicago Fed National Financial Conditions Index edged higher to -0.522 for the week ending November 21.

Chicago Fed National Financial Conditions Index

Dynamic indicators, however, like Bitcoin below, continue to warn of a sharp contraction in financial market liquidity.

Bitcoin (BTC)

The secure overnight financing rate (SOFR) jumped to 4.12%, above the 4.0% rate the Fed charges on its standing repo facility (SRF), signaling that the Fed is struggling to control pricing in the $12 trillion repo market. Repo lending is primarily secured by US Treasury Bills and Notes, and a spike in the SOFR repo rate would trigger a sharp sell-off in the Treasury market.

Secured Overnight Financing Rate (SOFR) & Interest on Reserve Balance (IORB)

Rising long-term yields in Japan and Europe are sucking liquidity out of US financial markets. The Bank of Japan (BOJ) is also expected to hike its policy rate on December 18, with the 3-month Japanese Government Bill discount rate jumping to 0.633%, well above the current 0.50% policy rate.

Japanese Govt 3-Month Bill Discount Rate

A BOJ rate hike would likely trigger a sell-off in US financial markets as hedge funds unwind large carry trades funded in Japanese Yen.

The US Dollar Index broke support at 99 and is expected to fall sharply in December, taking a double hit from a Fed rate cut and a BOJ rate hike, which would narrow the current spread by an estimated 50 basis points.

Dollar Index

Treasury Markets

Long-term Treasury yields are softening in anticipation of a Fed rate cut, but could face a sell-off amid tightening liquidity.

10-Year Treasury Yield

Stocks

The S&P 500  also rallied in anticipation of a Fed rate cut, but again, the rally risks being undone by contracting liquidity.

S&P 500

Mag 7 technology stocks continue to show gains over the past 6 months, apart from Meta Platforms (META), with Alphabet (GOOGL) building an advantage in the competition to lead AI.

Magnificent 7 Technology Stocks

Small caps are also strengthening, with the Russell 2000 ETF (IWM) testing resistance at 250.

Russell 2000 Small Cap ETF (IWM)

Gold & Silver

Gold is retracing to test support at $4,200, with high prices taming investor enthusiasm for the present.

Spot Gold

Silver is consolidating in a narrow band above support at $58 per ounce. Respect of support would confirm our target of $62.

Spot Silver

Energy Metals

Energy metals are another prospective inflation hedge for investors.

The Sprott Uranium Miners ETF (URNM) broke resistance at 56, joining copper and lithium miners in an uptrend.

Sprott Uranium Miners ETF (URNM)

The Sprott Copper Miners ETF (COPP) broke resistance at 31.50, confirming a fresh advance.

Sprott Copper Miners ETF (COPP)

Sprott Lithium Miners ETF (LITP) is also in an uptrend since breaking resistance at 11.

Sprott Lithium Miners ETF (LITP)

Conclusion

Forced to choose between its two mandates, the Fed seems willing to prioritize maintaining full employment ahead of stable prices. Cutting rates while the unemployment rate is low (below 5.0%) may please President Trump, who wants to run the economy hot, but risks a sharp rebound in inflation.

High inflation would lower the debt-to-GDP ratio but would likely increase outflows from US Treasury markets and raise long-term interest rates as international bond investors demand a higher risk premium. It would also later necessitate a sharp increase in interest rates to get the genie back in the lamp.

Falling Bitcoin prices and rising secure overnight funding rates in the $12 billion repo market signal tight liquidity in financial markets. Unwinding carry trades may destabilize financial markets if the Bank of Japan hikes its policy rate on December 18 as expected. A Fed rate cut and a BOJ rate hike would narrow the current carry trade spread by an estimated 50 basis points, risking a sharp sell-off in several trillion dollars of US assets financed in Yen.

The danger is that the Fed may reintroduce QE to stabilize the repo market, as it did during the last Powell pivot in September 2019.

Demand for gold, silver, and energy metals — copper, lithium, and uranium — is likely to increase as concerns over inflation grow.

Acknowledgments

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US Bear Market & Extreme Pricing

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates whether the market is in a bull or bear phase, and the one on the right reflects the current stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive in relation to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high; however, we recommend exercising caution when adding new positions.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, signaling a bear market ahead. We have received updates for two of the three market indicators that were delayed by the US government shutdown, but are still waiting on an update for heavy truck sales (marked in orange below).

Bull-Bear Market Indicator

The Chicago Fed National Financial Conditions Index eased to -0.538 on November 14, indicating loose monetary conditions that support high stock prices.

Chicago Fed National Financial Conditions Index

However, a steep plunge in Bitcoin over the last few days warns of a liquidity contraction that will likely show up in financial conditions in the next few weeks.

Bitcoin (BTC)

Continued unemployment claims increased to almost 2 million, while the unemployment rate rose to 4.4%, both reflecting a slowly deteriorating labor market.

Continued Claims & Unemployment Rate

Of greater concern is the loss of 100 thousand jobs in cyclical sectors since February. A fall of 300 thousand from the February high would signal risk-off. Employment in manufacturing, construction, and transport and warehousing accounts for sizable job losses during a recession, which typically triggers an economic contraction.

Jobs in Cyclical Industries

Stock Pricing

Stock pricing decreased slightly to 98.15 percent, compared to a high of 98.66 percent in late October and an April low of 95.04 percent. The extreme pricing warns that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

The S&P 500 climbed to a record high of 3.28 times sales, compared to its long-term average of 1.8 times sales, an 82% premium.

S&P 500 Price-to-Sales

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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US Extreme Stock Pricing

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates whether the market is in a bull or bear phase, and the one on the right reflects the current stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive in relation to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high; however, we recommend exercising caution when adding new positions.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, signaling a potential bear market ahead. Updates to three market indicators (highlighted in orange below) are delayed because of the US government shutdown. The first BLS release of delayed data is scheduled for Thursday, November 20.

Bull-Bear Market Indicator

The Chicago Fed National Financial Conditions Index eased to -0.5349 on November 7, indicating loose monetary conditions that support high stock prices. However, a sharp decline in Bitcoin over the last few days warns of a contraction.

Chicago Fed National Financial Conditions Index

Stock Pricing

Stock pricing increased slightly to 98.37 percent, compared to a high of 98.66 percent in late October and an April low of 95.04 percent. The extreme pricing warns that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

A forward PE of 24.8 indicates the S&P 500 is trading at more than a 50 percent premium to its long-term average of 16.1 times projected earnings.

S&P 500 Forward PE

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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Record Lows and Highs spell trouble in the USA

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates whether the market is in a bull or bear phase, and the one on the right reflects the current stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we advise investors to exercise caution when adding new positions.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead. Updates to three market indicators (highlighted in orange below) are delayed because of the US government shutdown.

Bull-Bear Market Indicator

Another indicator, the University of Michigan index of current economic conditions, plunged to 52.3, the lowest reading since the series began in 1960. The low reading would typically signal a recession, but has not yet been confirmed by either tighter financial conditions or a fall in the S&P 500.

University of Michigan Current Economic Conditions

The Chicago Fed National Financial Conditions Index turned up to -0.515 but continues to signal loose monetary conditions, which support high stock prices.

Chicago Fed National Financial Conditions Index

The S&P 500 has not experienced a significant correction since April, and the 30-week Smoothed Momentum indicator continues to oscillate above zero.

S&P 500 30-Week Twiggs Momentum Smoothed

Stock Pricing

Stock pricing eased slightly, to 98.32 percent from a new high of 98.66 percent last week, and an April low of 95.04 percent. The extreme reading warns that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average of the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

The S&P 500 reached a new high of 3.28 times sales, compared to a long-term average of 1.80 times.

S&P 500 Price-to-Sales

Conclusion

A record-low current economic conditions index and a record-high price-to-sales ratio for the S&P 500 both warn of instability ahead. Stock prices are supported by loose monetary conditions, but cannot hide the underlying economic fragility.

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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US Stock Pricing at New High

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead. Updates to three market indicators (highlighted in orange below) are delayed because of the US government shutdown.

Bull-Bear Market Indicator

The Philadelphia Fed Coincident Economic Activity Index deserves mention in the absence of updates for some of our regular indicators. A decline below 2.5% typically only occurs several months ahead of a recession.

Coincident Economic Activity Index
The Chicago Fed National Financial Conditions Index continues to signal loose monetary conditions, supporting high stock prices.

Chicago Fed National Financial Conditions Index

However, a decline in bank reserves below $3.0 trillion warns that repo markets are tightening.

Commercial Bank Reserves

And Bitcoin continues to test support at 110K, warning of tighter liquidity.

Bitcoin (BTC)

Stock Pricing

Stock pricing increased to a new high of 98.66 percent, compared to an April low of 95.04 percent. The extreme reading warns that stocks are at risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

Robert Shiller’s CAPE index climbed above 40 for the first time ever outside of the Dotcom bubble. CAPE compares the S&P 500 index to a ten-year average of inflation-adjusted earnings.

S&P 500 CAPE

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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US Stock Pricing at Extreme

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead.

Bull-Bear Market Indicator

Updates to three market indicators (highlighted in orange) are delayed because of the US government shutdown.

The Chicago Fed National Index of Financial Conditions dropped to -0.559 on October 10, indicating a return to pandemic-era loose monetary conditions. NFCI values above zero indicate monetary tightening, while values below signal loose financial conditions.

Chicago Fed National Financial Conditions Index

Stock Pricing

Stock pricing increased to 98.45 percent, compared to a high of 98.56 percent two weeks ago, and an April low of 95.04 percent. The extreme reading warns that stocks are at long-term risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

Robert Shiller’s CAPE measure reached 39.20 this week, the highest ever recorded outside of the Dotcom bubble in 1999-2000.

S&P 500 CAPE

CAPE compares the S&P 500 index to a 10-year average of inflation-adjusted earnings.

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

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US Stock Pricing Remains Elevated

Bull/Bear Market Indicator
Stock Market Pricing Indicator

The gauge on the left indicates bull or bear market status, and the one on the right reflects stock market valuation levels. Stock market pricing indicates whether stocks are cheap or expensive relative to earnings, but it is a poor indicator of market timing. We do not recommend selling stocks because the market valuation is high. Still, we would advise investors to be circumspect about adding new positions without carefully investigating the underlying value.

Bull/Bear Market

The Bull/Bear indicator remains at 40%, warning of a bear market ahead.

Bull-Bear Market Indicator

Updates to three market indicators (highlighted in orange) are delayed because of the US government shutdown.
The University of Michigan consumer survey reports the 3-month average of current economic conditions declined to a low 61.0 points, warning of a recession.

University of Michigan: Current Economic Conditions

However, the S&P 500 remains elevated, and the Chicago Fed National Index of Financial Conditions was a low -0.546 on October 3, indicating a resilient economy with strong liquidity.

Chicago Fed National Financial Conditions Index

Stock Pricing

Stock pricing eased to 98.26 percent, compared to a high of 98.56 percent last week, and an April low of 95.04 percent. The extreme reading warns that stocks are at long-term risk of a significant drawdown.

Stock Market Value Indicator

We use z-scores to measure each indicator’s current position relative to its history, with the result expressed in standard deviations from the mean. We then calculate an average for the five readings and convert that to a percentile. The higher that stock market pricing is relative to its historical mean, the greater the risk of a sharp drawdown.

The S&P 500 rose to a new record of 3.33 times sales in September, compared to a long-term average of 1.8 times.

S&P 500 Price-to-Sales

Conclusion

The bull-bear indicator at 40% warns of a bear market ahead, while extreme pricing increases the long-term risk of a significant drawdown.

Acknowledgments

Notes

Posted on

Xi pulls the rug on Trump

Key Points

  • China increased export controls on critical materials where it has a dominant share of production, two weeks ahead of a scheduled face-to-face meeting between leader Xi Jinping and President Trump.
  • The US President has threatened retaliation, including 100% tariffs on Chinese imports.
  • The S&P 500 plunged on Friday, and gold recovered above $4,000 per ounce as investors fear an escalating trade war.

In an escalation of the ongoing trade war between the US and China, China expanded export controls over a range of critical materials just two weeks ahead of a face-to-face meeting scheduled between Chinese leader Xi Jinping and President Trump, at APEC, in South Korea.

BEIJING, Oct 9 (Reuters) – China dramatically expanded its rare earths export controls on Thursday, adding five new elements and extra scrutiny for semiconductor users as Beijing tightens control over the sector ahead of talks between Presidents Donald Trump and Xi Jinping. The world’s largest rare earths producer also added dozens of pieces of refining technology to its control list and announced rules that will require compliance from foreign rare earth producers who use Chinese materials.

In a Truth social post, President Trump said the Chinese move was a “real surprise” and questioned whether the scheduled meeting should proceed.

NEW YORK, Oct 10 (Reuters) – Stocks fell sharply on Friday, with the S&P 500 and Nasdaq suffering their biggest one-day percentage declines since April 10, while Treasury yields dropped and the U.S. dollar weakened as comments by President Donald Trump reignited worries over a U.S.-China trade war. After markets closed on Friday, Trump said he was raising tariffs on Chinese exports to the U.S. to 100% and imposing export controls on “any and all critical software” in a reprisal against recently announced export limits by China on rare earth minerals critical to tech and other manufacturing.

Stocks

The S&P 500 plunged through short-term support at 6700 on fears of an escalating trade war. A follow-through below 6500 would offer a target of 6350 for the correction.

S&P 500

Financial Markets

Financial market conditions support high stock prices, with the Chicago Fed NFCI Index declining to -0.546 on October 3.

Chicago Fed National Financial Conditions Index

Bitcoin — our canary in the coal mine — retreated sharply to test support at 110K. Follow-through below 108K would warn of a significant contraction in financial market liquidity.

Bitcoin (BTC)

Treasury Markets

10-year Treasury yields are headed for another test of long-term support at 4.0%, shown on the weekly chart below.

10-Year Treasury Yield

Bond market guru Jim Bianco maintains that, with inflation “sticky” at 3.0%, a healthy yield curve would require the Fed to keep short-term rates 100 basis points higher at 4.0%, leaving little room for further cuts. He also warns that the 10-year should be another 100 basis points higher, at 5.0%.

The current trade war escalation will likely ensure the Fed cuts below 4.0%, raising the specter of a steep rise in inflation.

Consumers

The University of Michigan survey reports declining consumer sentiment in October, reaching lows not seen since the pandemic.

University of Michigan: Consumer Sentiment

Perceptions of current economic conditions are lower than when President Biden left office, leaving the GOP House majority at risk in the 2026 midterms.

University of Michigan: Current Economic Conditions

Consumer expectations have plunged to similar lows.

University of Michigan: Consumer Expectations

Expected price increases have moderated in recent months, but remain high at 4.6% p.a.

University of Michigan: 1-Year Inflation Expectations

Long-term expectations, likewise, are a high 3.7%, well above the Fed’s 2.0% target.

University of Michigan: 5-Year Inflation Expectations

Dollar & Gold

The US Dollar Index continues to test long-term support at 98, as shown in the weekly chart below. A breach would confirm our long-term target of 90.

Dollar Index

Gold retraced to test its new support level after reaching our target of $4,000 per ounce almost three months ahead of schedule. Escalating trade tensions with China sparked another rally, and follow-through above recent highs would signal a fresh advance, with a target of $4,250.

Spot Gold

Silver is more volatile, and tall shadows at $50 per ounce signal profit-taking and increase the likelihood of a correction.

Spot Silver

Energy

Nymex WTI Light Crude broke support at $60 per barrel in response to trade war fears.

Nymex WTI Crude

Crude prices below $60 per barrel squeeze shale producers’ margins and threaten US crude production as unproductive wells are closed. The Baker Hughes US oil rig count slipped to 418 from 422 last week.

Baker Hughes US Oil Rig Count

Base Metals

The Dow Jones Industrial Metals index ($BIM) fell sharply on the weekly chart below, warning of a correction in copper, aluminum, and other base metals, anticipating a fall in demand as the US-China trade war escalates.

Dow Jones Industrial Metals Index ($BIM)

Conclusion

Escalating geopolitical and trade tensions threaten to destabilize an already fragile global economy, with precarious fiscal debt levels and stubborn inflation. We anticipate low growth and high inflation and maintain our overweight position in gold and defensive stocks. We are underweight high-multiple technology stocks and avoid exposure to long-term bonds.

The US and China are caught in what is now known as a Thucydides trap. Ancient Greek historian Thucydides recorded the collision of an established hegemon, Athens, and a rising challenger, Sparta, and concluded that war was inevitable. Nowadays, with nuclear-armed adversaries, war seems unlikely. Instead, we will likely see a trade war with the two flexing their economic muscle to secure a dominant position in the global economic order. The US still has a strong military advantage, but China enjoys a similar advantage in industrial capacity. China presently has the upper hand because its leadership is more strategic, while President Trump is more transactional. However, the eventual outcome is uncertain, and we recommend a strong defensive posture to weather the fallout.

We expect increased fiscal spending, suppression of interest rates, and high inflation as the inevitable consequences of war.

The rise of gold and decline of US Treasuries as the global reserve asset will likely continue as tensions escalate in the decades ahead.

Acknowledgments

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