From Dovish Raise to Hawkish Pause
By Crest Capital Advisors on June 16, 2023
Dow: 1.25% to 34,299.12
S&P 500: 2.58% to 4,409.59
Nasdaq: 3.25% to 13,689.57
Russell 2000: 0.52% to 1,875.71
10-Year Yield: 3.76%
Outperformers: Technology 4.44%, Materials 3.32%
Underperformers: Energy (0.71%)
US stocks were higher this week, with the S&P logging its fifth consecutive week of gains (the longest streak since October-November 2021). The Nasdaq Composite was up for the eighth straight week (the best since a 10-week streak into March 2019). Small-caps saw only slim gains compared to their outperformance in the two prior weeks.
The week’s big event was the June FOMC meeting, which voted on Wednesday to hold rates steady for the first time after a 10-meeting hiking campaign that brought 500 bp of tightening. But at the same time, the statement and press conference hinted at the possibility of more hikes ahead, should these be necessary. While the 50bp rise in the median 2023 forecast on the dot plot in June’s updated Summary of Economic Projections was more hawkish than expected, the meeting was largely consistent with the incoming consensus for the Fed to “pause” and give more time for the economic backdrop to evolve.
It was also a week thick with economic updates, bringing some support for the disinflation narrative. The May CPI report (which was released the day before the Fed decision) showed a cooler-than-expected headline increase, with the year-over-year change dropping to just 4.0% (the lowest since March 2021). While some core elements remained elevated (particularly used cars and shelter), analyst takes were relatively optimistic. May PPI also posted a larger-than-expected monthly decline on lower energy prices, with the core largely in line. Disinflation was also reflected in the prices paid/received data from the June NY and Philadelphia Fed manufacturing reports. There was also a big decline in year-ahead inflation expectations in the University of Michigan consumer sentiment report.
The disinflation and soft-landing themes were a notable part of the bullish narrative this week, which also benefitted from some continued “Fear of Missing Out” (FOMO) that has driven ~$40B in inflows to US equity funds over the past three weeks and caused many of the major investment banks to reassess their outlook for the stock market. Goldman Sachs was forced to raise its year-end S&P 500 target to 4,500 earlier in the week, with similar moves expected from more banks who have proved to be too pessimistic.
Confusing & Contradictory
So this is what a “hawkish skip” looks like. It looks like utter confusion. NO rate hike, and a dovish FOMC statement about buying time to collect more data…Contradicted by a sharp upgrade in the “dot plot” for year-end 2023, projecting a funds rate at 5.625%! That would mean two more 25 bp hikes and two more skips over the remaining four meetings. So why pause if you truly believe rates need to go even higher from here?!
In its quest to preserve its credibility, the Federal Reserve continues to come up with more and more ways to confuse and confound, thereby impugning their own credibility in its very attempt to maintain it. Fortunately for us as investors, the markets seem to be looking past the cheap ‘talk’, and instead is focused more on actions. And on that front, we finally got the “pause” we’ve all been waiting for, and that’s all that matters this week. Stocks and bonds cheered the move, with the former powering ahead to new YTD highs!
The Fed’s Summary of Economic projections (aka the ‘dot plot’) definitely stole the show this week. We highlighted the median economic forecast in pink in the chart below. Each dot represents the position of someone at the meeting. Looking ahead to 2025, it’s clear to us the Fed is clueless. Just look at that massive dispersion between points of view.
At this point, the only thing we can come up with is this move to signal two more hikes later in 2023 was a strategy to ensure that the stock market didn’t soar on the “pause” as every Wall Street strategist was telling investors always happens when the Fed moves to the sidelines. Considering Thursday’s upside price action, they may have missed the mark.
Or perhaps the mission was to disabuse the market of its belief over the entire intermeeting period that the first cut will come no later than January. But, while they raised the dot plot, at the same time the Fed has lowered its estimate of unemployment and inflation. That’s a three-way combination of realities which, in the Fed’s thought-mode, cannot coexist. Inflation is collapsing, and this week’s PPI is clearly signaling downright deflation. For all the Fed’s confusion, they did buy themselves the gift of time over which deflation will be so obvious they will have no choice but to pivot. No more rate hikes.
Inflation is falling faster than it rose. Isn’t this evidence of progress on the inflationary front?
The Money Supply, which typically leads inflation by about 16 months, has been in contractionary territory for months now, a condition we haven’t seen since the 1930s!
But What If We Take Them at Their Word?
As we’ve said before, we do not believe the Fed will raise rates again. We are clearly at a turning point in inflation and the economy, and yet there are definitely people at the Fed dedicated to lagging indicators. (Of which jobs data is one, as is looking at the last 12 months of inflation data) If we are to take the Fed at their word (to the extent the dot plot represents their word), then we’d argue they are on the precipice of making the same mistake they made prior to hiking rates…Being too late to react. Only in this instance the reaction function calls for no action…or perhaps even an easing of monetary policy conditions. In no way, shape, or form does it call for ongoing rate hikes from here.
Looking backward is no way to get to one’s destination. And yet the Fed’s myopic focus on backward looking data, simultaneously acknowledging long and variable lags and at the same time complaining that official inflation is still too high, has us thinking this is exactly what they are doing. Let’s consider…
- Real-time rents have already rolled over precipitously, yet official housing inflation remains high, thereby distorting core inflation higher than it should be (See last week’s CMD here).
- Money Supply (M2) is outright negative and at a level that hasn’t been seen in decades.
- Leading indicators have declined in excess of-8% over the past year. The economy has slowed significantly.
- ISM New Orders are in deep recessionary territory.
- Manufacturing PMIs are already in contraction and even Services is falling back towards neutral territory.
- Import/Export activity has slipped into negative territory after having surged upwards of 15-18% just over a year ago.
The Core inflation rate always lags the high frequency indicators. That’s a feature, not a bug! In short, the Fed is overstating the inflation risk as they focus an inflationary storm that has already passed.
If the Fed is not careful, “Higher for longer” will be to the business cycle downturn what “transitory” was to the inflation cycle upturn. There is a certain beautiful symmetry to appreciate if it weren’t inflicting terrible economic hardship and human misery upon millions.
Inflation Expectations
After being subjected to the Fed’s post-FOMC press conferences where Chairman Powell continues to sound a sour note about inflation because it is not yet back to their 2% target, we thought it might surprise many to learn the following. Paul Volcker, who presided over the Fed during the last inflation fighting era of the early 1980s, ended the inflation war when inflation was still higher than 2%. See the point? The Fed can end this inflation war, aka pivot, when the collective public believes inflation is broken.
And just like that, cue the University of Michigan survey of consumer sentiment released on Friday…
After last month’s rise in medium-term inflation expectations to its highest in 15 years, expectations from UMich’s survey were for a small pullback in preliminary June data. As it turns out, expectations were right in direction but the magnitude is off the charts as 1-year inflation expectations crashed from 4.2% to 3.3% (expected at 4.1%). Longer-term inflation expectations also slipped back from 15 year highs.
Consumer expectations for 1-year ahead inflation plunged from 4.2% to 3.3%. Thank falling energy/food prices. Gets to the fact that households experience headline inflation (which is falling & boosting real incomes). While the Fed focuses on core.
About Those Declining Earnings Expectations
With both CPI and PPI released this week, we are able to look at the most recent spread between the two indices which is potentially showing a positive sign for corporate profit margins. Consumers are still paying higher prices given the strength in the labor market and the producer price index for finished goods on a year-over-year basis is now negative. While the relationship is not perfect, this should bode well for margins and earnings if sales hold up. The chart below shows.
Economic Funnies
Crazy Stat(s) of the Week
Here is this week(s) crazy stats!
- A mountain of credit card debt is piling up as Americans turn to plastic to counter their dwindling purchasing power. According to the Federal Reserve Bank of New York, consumers now owe a record $988 billion on their cards, up 17% from a year earlier, or about $5,700 per person.
- The Fed Funds Rate is now over 1% higher than the US inflation rate. The last time monetary policy was this tight was back in October 2007.
Quote(s) of the Week
Editor’s Note: And the revisionist history begins…
“I see us having a non-recession recession…I just don’t see any sign in the underlying economy of the kind of demand destruction that is going to put unemployment back to levels we would really thing about as recessionary.”
-Scott Kleinman, Apollo Global Management Co-President
“We have cut our judgmental probability that the US economy will enter a recession in the next 12 months back to 25%, undoing our upward revision to 35% shortly after the SVB failure.”
-Goldman Sachs Chief Economist
Calendar of Events to Watch for the Week of June 19th
US Markets will be closed on Monday for the Juneteenth Holiday. Brokerage Conference schedules remain at its peak in between Q1/Q2 earnings here and Analyst/Investor Meetings remain relatively steady as well, with notable events from a number of influential companies on the calendar next week.
On the US Economic Calendar, we get data readings on Housing on Tuesday, Leading Indicators on Thursday, and wrap the week with Flash Services/Manufacturing PMI on Friday. We are also tracking a Federal Reserve speaking event from NY Fed President, John Williams, in New York on Tuesday. On Wednesday and Thursday, Fed Chair Powell will be giving his semi-annual testimony to Congress so we expect an outsized focus on monetary policy next week.
Monday 6/19 – US Markets will be closed in observance of the Juneteenth holiday.
Tuesday 6/20 – Housing Starts and Building Permits for the month of May will be released today. Economists are expecting a relatively in-line number for Housing Starts, up 0.7% month-over-month. NY Fed President John Williams is also on the calendar with a scheduled speaking engagement.
Wednesday 6/21 – No major US economic reports on the calendar today.
Thursday 6/22 – US Leading Indicators for May are expected to contract again at -0.40%. Looking overseas, Japan will release data on inflation via its measure of CPI. Economists are expecting an enviable 3.2% year-over-year rate. The weekly jobless claims data, released every Thursday, will continue to get extra scrutiny with so much Fed focus on labor market conditions.
Friday 6/23 – The preliminary Markit PMIs for June Manufacturing and Services are expected to show Manufacturing in contraction at 48.0 (in-line with last month’s reading) and Services still in expansion at 53.3 (but down a tick from last month’s 54.9).
Source: FactSet
