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Bloomberg macro strategist Simon White recently pointed out that the pressure on US soft economic data has risen to levels that previously prompted the Federal Reserve to cut interest rates. If monetary easing is sufficient in size and timing to curb the deterioration of hard data and recession risks, stocks will benefit.
President Trump's wait may be nearing its end, as he continually pressured the Federal Reserve during his second presidential term to cut interest rates, which Fed Chairman Jerome Powell had previously refused to do. But now, the Fed has reason to act - the downward pressure on soft data (i.e., surveys and market data) is increasing, a situation that has historically triggered an easing response.
This may sound good for the stock market, but usually “bad things” have already happened when the Fed cuts interest rates, and stocks are already in a downtrend. The current atypical exception is: while the Fed is considering cutting interest rates, the stock market is in an uptrend and hitting new highs. Whether stocks and credit face more weakness depends on whether the speed and strength of monetary easing can prevent the economic slowdown from evolving into a recession.
Both hard and soft data are essential for tracking the evolution of the economy, but investors are more focused on the Fed’s reaction to the data and its impact on assets.
Recessions often originate from the interaction between hard and soft data: most of the time they evolve independently, but at certain stages they become intertwined, forming a destructive negative feedback loop—soft data weakens first, and if it continues for too long, it will transmit to hard data through declining stock prices, reduced wealth effect, and dampened investment; the deterioration of hard data will then in turn affect soft data, forming a vicious cycle, usually ending in a recession.
The Fed can try to intervene before the negative feedback loop forms - the deterioration of soft data is often driven by sentiment, and monetary easing can reverse this trend. If we wait until cracks appear in the hard data before taking action, it will almost certainly be too late.
Therefore, if you want to predict Fed policy, you should focus on soft data rather than hard data. Current soft data indicates a warning: the chart below analyzes a large amount of soft and hard data, and if a certain threshold is exceeded, it is defined as “under pressure”. The results show that more than half of the soft data inputs are under pressure, while the hard data remains calm.
Since the 1980s, there has been a pattern: pressure on soft data must lead to a policy response. The chart below shows the periods of pressure on soft data, the date when the Fed first cuts interest rates, and the time when hard data begins to be disturbed - since the mid-1980s, almost every time soft data has been under pressure, it has been accompanied by interest rate cuts, suspension of increases, or extension of the suspension by the Fed (except for 2015/2016, when interest rates had just recovered from their lows after the global financial crisis).
In contrast, shocks to hard data are rare and only occur before and during recessions, at which time the Fed is usually in “stop-loss mode” (except for the post-pandemic cycle in 2022, when both soft and hard data were under pressure at the same time but there was no recession).
Although the probability of an economic recession in the US is currently low, which is in line with the calmness of hard data, recessions often happen suddenly. As shown in the previous chart, when hard data sounds the alarm, the Fed is usually powerless to help. There are at least two potential vulnerabilities to watch for in the economy:
For the stock market, the key lies in whether the potential slowdown indicated by the soft data will eventually turn into a recession, which largely depends on the timing and scope of monetary easing by the Fed. The market is currently fully betting on a “no recession” scenario, and if a recession occurs, stocks will fall significantly from their current levels.
If monetary policy fails to rescue (perhaps because the Fed is paying more attention to the inflation mission after tariffs have raised prices), the Trump administration may implement a de facto quantitative easing fiscal policy. Treasury Secretary Yellen is increasingly inclined towards short-term financing, and if short-term Treasury bond issuance increases, this will be beneficial for risk assets.
The market currently expects the Fed to cut interest rates next September, with a 20% probability of cutting interest rates in July - this is less likely when hard data is not disturbed. Overall interest rate pricing seems reasonable, but the potential outcomes facing stocks and credit are much wider.
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