By John Lau, CPA, CFP®, M.S.(Tax)
December 15, 2022 – CPI on Tuesday declined to 7.1% year-over-year – another sign of disinflation from the previous CPI reading at 7.7% (October) and 8.2% (September).
While the CPI report makes the idea of disinflation more concrete, 7.1% is still much too high and Tuesday’s report really doesn’t change the calculus on when the Fed pivots (that’ll depend on growth and when inflation falls further).
The Fed hiked interest by 50 basis points yesterday, while the 2023 median dot, which is the market’s proxy for the terminal rate (i.e. how high rates will go) rose to 5.125%. After yesterday’s rate hike, the Fed rate is currently at 4.375%, which means the Fed still intends to hike rates by an additional 75 bps before pausing.
2022 has been defined by the market largely ignoring hawkish Fed warnings, only to have the Fed get even more hawkish and cause a violent decline in stocks and bonds (early 2022, June 2022, August 2022, and September 2022). Yesterday set up perfectly for yet another episode as expectations for the terminal rate had fallen solidly below 5%, only to have the Fed come out and show a terminal rate above 5%.
However, while that was the most-obvious hawkish part of the FOMC decision, it wasn’t the only one. Many analysts had expected the Fed, in the statement, to either 1) Hedge or remove the phrase “ongoing increases” to the fed funds rate as a signal that Fed was nearly the end of the hiking campaign or 2) Soften the language around inflation slightly, noting recent declines in inflation indicators. The Fed did neither, keeping the statement almost identical to what was released in November.
So, the Fed ended 2022 as it started it, via clubbing the market over the head once again with its hawkish stick and clearly demonstrating that the declines in CPI and the growing number of anecdotal drops in inflation indicators are not enough, and that rates will continue to rise sharply despite these signs of progress.
Turning to Powell’s press conference, he reiterated the Fed’s commitment to bringing inflation down to 2.0% and notably said that he could not “confidently” say projections for the 2023 median dot (the terminal rate) would not need to rise further.
The remainder of this press conference was largely predictable — saying the Fed will be data dependent, they need more evidence inflation is falling, etc. But he was not as dovish in tone as the late-November speech, although the markets did rally late during his speech as Powell didn’t “pile on” to the hawkish FOMC statement.
The practical takeaway for us is that 1) A reasonable “ceiling” in the S&P 500 around 4,100 remains very much in place based on valuation constraints; 2) Inflation data is critically important because that will move the markets more than Fed commentary going forward, and we will be watching all of it for you, starting with the price indices in the Empire and Philly Fed indices today and the flash PMI tomorrow; 3) While upside remains limited, the market will remain vulnerable to downside risks (and a 10% or more sharp pullback) if inflation stats bounce back or growth suddenly falls off a cliff.
Bottom line, the set up as we start 2023 remains the same as the key event will be the transition from a Fed-policy dominated market to a growth-and-inflation-data dominated market, and we will be here to help you successfully navigate that transition.
From a tactical standpoint, given 1) Slowing growth, 2) Budding disinflation and 3) A still-hawkish Fed, we will remain cautious at these levels and continue to advocate for reducing volatility in portfolios via defensive sectors and take a defensive tilt in our tactical allocation approach.
As you may know, as of December 14, 2022, LFS Wealth Advisors has joined Robertson Stephens Wealth Management, LLC (“Robertson Stephens”). To learn more about Robertson Stephens and to read the press release, please click here.
John Lau
CPI Takeaway and What the Fed Decision Means
By John Lau, CPA, CFP®, M.S.(Tax)
December 15, 2022 – CPI on Tuesday declined to 7.1% year-over-year – another sign of disinflation from the previous CPI reading at 7.7% (October) and 8.2% (September).
While the CPI report makes the idea of disinflation more concrete, 7.1% is still much too high and Tuesday’s report really doesn’t change the calculus on when the Fed pivots (that’ll depend on growth and when inflation falls further).
The Fed hiked interest by 50 basis points yesterday, while the 2023 median dot, which is the market’s proxy for the terminal rate (i.e. how high rates will go) rose to 5.125%. After yesterday’s rate hike, the Fed rate is currently at 4.375%, which means the Fed still intends to hike rates by an additional 75 bps before pausing.
2022 has been defined by the market largely ignoring hawkish Fed warnings, only to have the Fed get even more hawkish and cause a violent decline in stocks and bonds (early 2022, June 2022, August 2022, and September 2022). Yesterday set up perfectly for yet another episode as expectations for the terminal rate had fallen solidly below 5%, only to have the Fed come out and show a terminal rate above 5%.
However, while that was the most-obvious hawkish part of the FOMC decision, it wasn’t the only one. Many analysts had expected the Fed, in the statement, to either 1) Hedge or remove the phrase “ongoing increases” to the fed funds rate as a signal that Fed was nearly the end of the hiking campaign or 2) Soften the language around inflation slightly, noting recent declines in inflation indicators. The Fed did neither, keeping the statement almost identical to what was released in November.
So, the Fed ended 2022 as it started it, via clubbing the market over the head once again with its hawkish stick and clearly demonstrating that the declines in CPI and the growing number of anecdotal drops in inflation indicators are not enough, and that rates will continue to rise sharply despite these signs of progress.
Turning to Powell’s press conference, he reiterated the Fed’s commitment to bringing inflation down to 2.0% and notably said that he could not “confidently” say projections for the 2023 median dot (the terminal rate) would not need to rise further.
The remainder of this press conference was largely predictable — saying the Fed will be data dependent, they need more evidence inflation is falling, etc. But he was not as dovish in tone as the late-November speech, although the markets did rally late during his speech as Powell didn’t “pile on” to the hawkish FOMC statement.
The practical takeaway for us is that 1) A reasonable “ceiling” in the S&P 500 around 4,100 remains very much in place based on valuation constraints; 2) Inflation data is critically important because that will move the markets more than Fed commentary going forward, and we will be watching all of it for you, starting with the price indices in the Empire and Philly Fed indices today and the flash PMI tomorrow; 3) While upside remains limited, the market will remain vulnerable to downside risks (and a 10% or more sharp pullback) if inflation stats bounce back or growth suddenly falls off a cliff.
Bottom line, the set up as we start 2023 remains the same as the key event will be the transition from a Fed-policy dominated market to a growth-and-inflation-data dominated market, and we will be here to help you successfully navigate that transition.
From a tactical standpoint, given 1) Slowing growth, 2) Budding disinflation and 3) A still-hawkish Fed, we will remain cautious at these levels and continue to advocate for reducing volatility in portfolios via defensive sectors and take a defensive tilt in our tactical allocation approach.
As you may know, as of December 14, 2022, LFS Wealth Advisors has joined Robertson Stephens Wealth Management, LLC (“Robertson Stephens”). To learn more about Robertson Stephens and to read the press release, please click here.
John Lau
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