By John Lau CPA, CFP®
February 6, 2023 – Markets rallied last week after the FOMC meeting and Fed Chair Powell’s press conference on Wednesday because Powell did nothing to refute the market’s belief that the Fed will stop raising rates after March and will cut rates two to three times by the end of the year. In addition, Powell’s “wishy washy” press conference performance only further emboldened those who think the Fed is bluffing on further rate hikes and on no rate cuts in 2023. In short, the market simply does not believe what the Fed is saying. It doesn’t when the Fed says the terminal rate will be 5.125% and it doesn’t believe the Fed when it says there won’t be any rate cuts this year. Powell did nothing last week to make the market believe the Fed, and because of that the market simply doesn’t believe them even more now—and that is why stocks rallied.
On Thursday (February 2), the ECB (European Central Bank) with the BOE (Bank of England) followed the Fed script and signaled they are near the end of their rate hiking cycles while the ECB’s Lagarde noted that disinflationary trends have taken hold. Both of the decisions were viewed as dovish and further fueled the rally underway in risk assets.
So, Was This a Bullish Gamechanger?
In my view – no, at least not from current levels. Powell didn’t tell us anything the market didn’t already assume, he just strengthened the market’s existing assumptions which are already mostly priced in. However, while that’s not enough to ignite material upside from here, it does seem to support the YTD rally so far.
Beyond the very short term, data remains the key. If growth rolls over hard or inflation bounces back (see more on data below), then markets will factor in more earnings losses or dial back these “less-hawkish” expectations. Both would be solidly negative for stocks. More broadly with the data, whether stocks extend the rally or pull back is still much more dependent on the outcome of a soft landing or hard landing. The most recent data implied hard landing, but it was ignored because of the Fed. That will only last so long.
Inflation data last week was mixed. According to the U.S. Employment Cost Index, there was more disinflation in wages, although only slightly (Employment Cost Index 1.0% vs (E) 1.1%, but other inflation metrics implied a bounce back in prices (Spanish CPI: 5.8% vs. (E) 4.9%; French CPI: 6.0%, up from 5.9%.)[1]
In short, it is still not clear that core inflation is consistently declining and the data hints a bounce back in core inflation could be coming. If that happens, central banks will have to get more hawkish, again.
Labor Market Data: employment data remains very robust. The Bureau of Labor Statistics reported total nonfarm payroll employment rose by 517,000 in January vs. (E) 188,000. And claims for unemployment insurance is at a current level of 183,000 down from 186,000 the preceding week and down from 222,000 one year ago[2].
In short, employment remains very robust, and while there is some evidence of an easing of wage pressures, it is faint and the labor market remains very tight.
Growth Data: The ISM[3] Manufacturing PMI[4] is currently at 47.4 vs. (E) 48.0, the lowest since 2009 (excluding 2020’s pandemic spike down). New Orders, the leading indicator in the report, dropped to 42.5 from 45.1. Both readings are the lowest since the Financial Crisis (if we ignore the pandemic spikes down). Prices, meanwhile, rose to 44.5 from 39.4 and that echoed other goods inflation readings that showed a bounce back in prices in Europe (Spanish CPI, French CPI, in inflation data above).
In short, manufacturing activity continued to slow in January, and while that is the minority of the economy, service activity has also been slowing. These are not the types of readings we would expect to see in a soft landing.
Here is the takeaway:
The biggest risk for markets over the medium term is if the Fed blinks too early like they did in the 1970’s. While Powell’s commentary is good in the short term, it also raises concerns about the Fed having to get hawkish again – like what happened in the 1970’s. So, risk is not eliminated just because Powell was not as hawkish as feared last week.
As I stated earlier, the key now is data: Inflation, especially core services inflation must come down, and quickly, to support the gains in stocks. Economic growth must stabilize, and a soft landing needs to become apparent to prevent a ’01-’03 style recession-based stock market decline. If that happens, then stocks can move higher throughout 2023, and we will get the clarity need to tilt offensive. If it does not, then this rally will not be sustainable.
[1] Investing.com
[2] YCharts, January 28, 2023
[3] Institute for Supply Management
[4] Purchasing Managers’ Index: A PMI index over 50 represents growth or expansion within the manufacturing sector of the economy compared with the prior month. A reading under 50 represents contraction, and a reading at 50 indicates an equal balance between manufacturers reporting advances and declines in their business.
Post-Fed Market Analysis and Outlook
By John Lau CPA, CFP®
February 6, 2023 – Markets rallied last week after the FOMC meeting and Fed Chair Powell’s press conference on Wednesday because Powell did nothing to refute the market’s belief that the Fed will stop raising rates after March and will cut rates two to three times by the end of the year. In addition, Powell’s “wishy washy” press conference performance only further emboldened those who think the Fed is bluffing on further rate hikes and on no rate cuts in 2023. In short, the market simply does not believe what the Fed is saying. It doesn’t when the Fed says the terminal rate will be 5.125% and it doesn’t believe the Fed when it says there won’t be any rate cuts this year. Powell did nothing last week to make the market believe the Fed, and because of that the market simply doesn’t believe them even more now—and that is why stocks rallied.
On Thursday (February 2), the ECB (European Central Bank) with the BOE (Bank of England) followed the Fed script and signaled they are near the end of their rate hiking cycles while the ECB’s Lagarde noted that disinflationary trends have taken hold. Both of the decisions were viewed as dovish and further fueled the rally underway in risk assets.
So, Was This a Bullish Gamechanger?
In my view – no, at least not from current levels. Powell didn’t tell us anything the market didn’t already assume, he just strengthened the market’s existing assumptions which are already mostly priced in. However, while that’s not enough to ignite material upside from here, it does seem to support the YTD rally so far.
Beyond the very short term, data remains the key. If growth rolls over hard or inflation bounces back (see more on data below), then markets will factor in more earnings losses or dial back these “less-hawkish” expectations. Both would be solidly negative for stocks. More broadly with the data, whether stocks extend the rally or pull back is still much more dependent on the outcome of a soft landing or hard landing. The most recent data implied hard landing, but it was ignored because of the Fed. That will only last so long.
Inflation data last week was mixed. According to the U.S. Employment Cost Index, there was more disinflation in wages, although only slightly (Employment Cost Index 1.0% vs (E) 1.1%, but other inflation metrics implied a bounce back in prices (Spanish CPI: 5.8% vs. (E) 4.9%; French CPI: 6.0%, up from 5.9%.)[1]
In short, it is still not clear that core inflation is consistently declining and the data hints a bounce back in core inflation could be coming. If that happens, central banks will have to get more hawkish, again.
Labor Market Data: employment data remains very robust. The Bureau of Labor Statistics reported total nonfarm payroll employment rose by 517,000 in January vs. (E) 188,000. And claims for unemployment insurance is at a current level of 183,000 down from 186,000 the preceding week and down from 222,000 one year ago[2].
In short, employment remains very robust, and while there is some evidence of an easing of wage pressures, it is faint and the labor market remains very tight.
Growth Data: The ISM[3] Manufacturing PMI[4] is currently at 47.4 vs. (E) 48.0, the lowest since 2009 (excluding 2020’s pandemic spike down). New Orders, the leading indicator in the report, dropped to 42.5 from 45.1. Both readings are the lowest since the Financial Crisis (if we ignore the pandemic spikes down). Prices, meanwhile, rose to 44.5 from 39.4 and that echoed other goods inflation readings that showed a bounce back in prices in Europe (Spanish CPI, French CPI, in inflation data above).
In short, manufacturing activity continued to slow in January, and while that is the minority of the economy, service activity has also been slowing. These are not the types of readings we would expect to see in a soft landing.
Here is the takeaway:
The biggest risk for markets over the medium term is if the Fed blinks too early like they did in the 1970’s. While Powell’s commentary is good in the short term, it also raises concerns about the Fed having to get hawkish again – like what happened in the 1970’s. So, risk is not eliminated just because Powell was not as hawkish as feared last week.
As I stated earlier, the key now is data: Inflation, especially core services inflation must come down, and quickly, to support the gains in stocks. Economic growth must stabilize, and a soft landing needs to become apparent to prevent a ’01-’03 style recession-based stock market decline. If that happens, then stocks can move higher throughout 2023, and we will get the clarity need to tilt offensive. If it does not, then this rally will not be sustainable.
[1] Investing.com
[2] YCharts, January 28, 2023
[3] Institute for Supply Management
[4] Purchasing Managers’ Index: A PMI index over 50 represents growth or expansion within the manufacturing sector of the economy compared with the prior month. A reading under 50 represents contraction, and a reading at 50 indicates an equal balance between manufacturers reporting advances and declines in their business.
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