It’s Difficult To Price In What the Fed Is Feeding Markets

MARKETS

US stocks snapped an early year run of negativity on Wednesday as markets digest fresh economic data suggesting progress is being made on achieving a soft landing this year.

But I am remiss not to suggest that the China reopening impulse is providing an early-year comfort blanket to global stock pickers. At the same time, European investors revel in a lower-than-expected inflation reading in France and a better-than-expected final Markit Composite PMI survey.

Still, US markets are reacting positively to the first macroeconomic data points of the new year, the first in a busy, if short, week for market participants. The ISM manufacturing index decreased slightly more than expected in December, while job openings fell by 54k to 10,458k in November from an upwardly revised October level.

Wednesday’s US data suggests that Main Street – and the Fed are progressing toward re-balancing the labour market and achieving a soft landing.

That said, the ISM manufacturing report does complicate the labour market picture as the employment component increased. Still, production, new orders, and supplier deliveries all decreased, as did the overall Index most graphically of an economy heading toward a recession.

The disconnect between the resilience of parts of the US economy in 2022 and the downdraft experienced by stocks has been a critical narrative of the past year. And whether this disconnect continues, the economy matches the market downdraft, or the US Stock Indexes rebound in the wake of an economic soft landing, are spinning a whirlwind of indecision.

The pervasive uncertainty and unpredictable market mood swings make for a highly challenging environment for Index based investors and incredibly difficult to trade comps.

FOMC MINUTES 

At the last FOMC meeting, Jerome Powell and his colleagues at the Fed leaned marginally more hawkish than expected in the economic projections that accompanied December’s 50bps rate hike.

Despite two consecutive downside surprises in the incoming inflation data, the median forecasts for price growth in 2023 were revised up to the dismay of the pivot camp as markets wanted a dovish outcome consistent with the benign monthly CPI prints.

Disheartened equities subsequently couched lower on the way to an abysmal December showing, which erased nearly half the animating rally seen during October and November.

Minutes from the Fed’s December gathering released on Wednesday seemed to validate the market’s hawkish interpretation as “Powell & The Gang,” which showed no let up in their hawkish resolve, despite the confab’s 50 bp rate hike that increased cumulative tightening to 425 bps. Even favourable inflation readings in October and November did little to dent their doggedness.

Still, the committee would “continue to make decisions meeting by meeting,” leaving the FOMC’s options open for the size of rate hikes at coming meetings, indicating they are 100 % in data dependant mode.

Our baseline view is that we have a balanced FED that is looking to slow the pace of hikes amid better news on inflation but is conscious of the risks of declaring victory too soon…and hence…is using the dots and guidance to signal a more protracted hiking cycle.

From a risk management perspective, however, it may be difficult for the market to price this nuance – in so far as the pace of hikes does matter a lot – even if offset with a higher terminal rate, especially as moving to a slower pace naturally ‘sets the tables’ for easier US financial conditions to persist.

While this broad strokes a significantly better growth outlook, thereby reducing the probability of a recession while nudging the odds up so slightly for the much hoped-for soft landing. Still, the positive growth impulse puts the downward trajectory of inflation at risk, given the labour market remains very tight.