This robust growth resulted in the unemployment rate falling to 4.1%, below the expectation of 4.2%.
The quick takeaway from today’s data is simple – the Fed has zero reason to cut rates anytime soon…and frankly, shouldn’t have cut as much as it has so far.
As I write Friday morning, most of the headlines are focusing on the connection between this morning’s report and the Fed. That’s understandable – I just made that connection too; but frankly, such focus is misdirected.
The real driver of the bus these days is no longer the Fed. It’s the bond market…
And it’s not a fan of this morning’s report.
Let’s talk about what the bond market’s reaction is telling us, and what it could mean for stocks.
Why the surging 10-year Treasury yield is top dog, not the Fed
The Fed only controls short-term term rates. But the market controls longer-term rates (like the 10-year Treasury yield).
Your portfolio is far more influenced by the 10-year Treasury yield. Unfortunately, the 10-year Treasury yield is behaving like it has an axe to grind with this bull market.
Let’s back up to fill in some details…
Back in September, the Fed launched its first rate-cutting cycle since the Covid pandemic with a 50-basis-point cut. Since then, it has cut rates twice more, bringing the total amount of its cuts to 100 basis points.
Now, when the Fed cuts rates, we typically see a similar decline in bond yields. But that hasn’t happened since September.
Instead, for the first time ever, those 100 basis points of cuts from the Fed have resulted in an increase of 100 basis points in the 10-year Treasury yield.
For the first time ever, 100 basis points of cuts from the Fed have resulted in an increase of 100 basis points in the 10-year Treasury yield.
Source: ZeroHedge / Bloomberg
That fact that the 10-year Treasury yield is surging while the Fed is cutting tells us that the bond market believes the Fed has made a mistake.
Specifically, the bond market fears that the Fed’s loose rate policy has juiced an economy that needs no juice, therein opening the door to a resurgence of inflation. So, traders have been selling bonds in anticipation of higher yields to come.
At the same time, stocks have soared (until the last few weeks) because Wall Street was watching the Fed more than the bond market. It believed the Fed’s forecasts for rate cuts from the early fall while turning a blind eye to the climbing 10-year Treasury yield.
This has resulted in a huge divergence. As analyst Charles-Henry Monchau writes, “How much longer can this continue before the crocodile’s mouth snaps shut?”
Below, we look at that “crocodile’s mouth” with the S&P in green and the inverted 10-year Treasury yield in red.
Below, we look at a divergence between the S&P and the inverted 10-year Treasury yield with the S&P in green and the inverted 10-year Treasury yield in red.
Now, markets can remain out-of-whack for far longer than many investors anticipate; and this divergence doesn’t demand that stock prices fall. But that is exactly what’s happening as I write.
As of mid-afternoon, the 10-year Treasury yield has popped to more than 4.75% while stocks are rolling over. All three indexes are down more than 1%. And earlier today, the Nasdaq was off by more than 2%.
So, what’s at the core of this divergence between the bond market and the Fed, as well as this morning’s selloff?
Perspectives on inflation.
On one hand, we have Fed members who have (mostly) been saying that inflation is falling and in good shape. Sure, we’ve gotten the standard hedging refrain of “there’s more work to do,” but the overall message from most Fed members has been, “inflation is generally falling as we expect and want.”
Cut to the bond market and its dubious expression of “are you kidding me?”
Though core PCE inflation (the Fed’s favorite gauge of inflation) climbed only 0.1% in November, over the prior six months, its readings were:
May: 0.1%
June: 0.2%
July: 0.2%
August: 0.2%
September: 0.3%.
October: 0.3%.
This isn’t what “going according to plan” looks like.
Now, the question becomes, “which was the outlier – the six months of rising core PCE? Or the November reading of mild 0.1% PCE?”
If we go by the prediction marketplace Kalshi, the mild reading was the outlier, which means get ready for higher inflation
Kalshi is a regulated exchange that allows users to buy and sell contracts on the outcome of various events (similar to Polymarket). It predicted a big Trump win back in November when all the political pollsters were calling the presidential race a dead heat.
And as to why it deserves our consideration, here’s Fortune:
[Predictions] markets are both pure and efficient. They aggregate information persuading people to put real money on the line. They’re incentivized to be truthful.
“People don’t lie with money,” [Kalshi CEO, Tarek] Mansour said.
Kalshi did its own research and found that in surveys, economists got inflation rates right only 2 out of 10 times. But prediction markets got it right 6 out of 7 times.
So, what are predictions traders betting saying about inflation’s path in 2025?
4.0%.
Graphic showing that the predictions website Kalshi believes inflation will hit 4% in 2025
Source: Kalshi
We’ve been concerned about this here in the Digest. Let’s rewind to mid-November when we featured the below analysis from Louis Navellier’s favorite economist, Ed Yardeni:
If the Fed continues to lower the federal funds rate, monetary policy will most likely stimulate an economy that doesn’t need to be stimulated.
The result could be rebounds in both price and asset inflation rates.
This possibility of higher-than-expected inflation has our hypergrowth expert Luke Lango paying attention
To be clear, Luke remains bullish on stocks in 2025. He believes that the S&P will enjoy its third consecutive year of 20%-plus gains. But he’s open-eyed about the growing risk of reinflation.
Let’s jump to yesterday’s issue of Hypergrowth Investing:
Recently, inflation has stagnated.
While it declined pretty steadily from 9% in June 2022 to 2.5% in September 2024, it has actually been rising over the past few months.
In October, the inflation rate rose from 2.5% to 2.6%. In November, it rose from 2.6% to 2.8%. And real-time estimates suggest that it will rise again to 2.9% in December.
Luke highlights two recent sources of near-term reinflation:
Oil prices, which have been on an upswing over the past month, jumping from $67 to nearly $77 per barrel (by the way, oil is popping today as news of U.S. sanctions on Russian oil breaks)
A strengthening economy, which led to a record-strong holiday shopping season, and likely, some unwanted inflation pressures
But the real inflationary wildcard that expands across 2025 is Trump and his economic agenda.
Back to Luke:
It looks like some form of tariffs are coming – potentially weighty ones.
Tariffs could increase costs. Hefty tariffs could significantly increase costs. That would mean more reinflation.
Indeed, after Trump instituted a variety of tariffs during his first term in 2018, the U.S. inflation rate rose about 100 basis points in a matter of months.
If something similar happens this time around, then we’d be looking at an inflation rate of nearly 4% by late 2025.
That 4% figure should look familiar. It’s what we just saw is Kalshi’s prediction for inflation in 2025.
Do you believe the Fed will be cutting rates if inflation begins climbing toward 4% this year?
Ordinarily, I would make a joke about how absurd that would be, but then again, I think it’s absurd that the Fed has cut rates 100 basis points since September given today’s economic/inflationary backdrop.
As we stand today, the dynamic is shifting. It feels as though it’s becoming less about “getting rate cuts” and more about “avoiding rate hikes.”
Back to Luke:
An inflation rate [at 4%] wouldn’t just mean no more rate cuts from the Fed. It may actually mean more rate hikes.
This economy cannot stand any more rate hikes…
The U.S. housing market is frozen solid, with home sales last year falling to their lowest level since 1995. What happens if mortgage rates spike even higher? …
[Meanwhile], since financing rates are sky-high, the auto market is frozen solid, too. If those rates keep rising, car sales will collapse.
Not to mention, consumers have also maxed out their credit cards. Total credit card balances in the U.S. hit nearly $1.2 trillion in the third quarter of 2024 – another record high.
Point being: The current debt-saddled U.S. consumer cannot handle higher interest rates. But if inflation meaningfully reaccelerates in 2025, higher interest rates is exactly what we will get.
Before you grow too bearish
Luke isn’t calling for the above scenario to play out. So, let’s balance that bearish hypothetical with his baseline case for this year:
AI-driven productivity gains and increased domestic energy creation should keep inflation on a downward path to 2% in 2025.
We will likely see tariffs enacted, though not as expansive as has been promised.
The net result should be lower inflation, lower interest rates, and higher stocks.
We’re crossing fingers that Luke’s forecast is correct.
In any case, let’s end with two takeaways:
One, if you’re not watching the bond market equally as much as the Fed – if not more – we recommend you make that shift. It’s providing us better clues about what’s happening in our financial markets.
Two, if you haven’t done so already, create an investment plan that outlines what you’ll do if inflation and the 10-year Treasury yield continue not playing nice. They’re driving the bus today.
We’ll keep you updated on all this here in the Digest.
