Quite the mixed week with losses for U.S. equities offset by gains overseas. Haven’t seen that in a while!! There was also notable strength in energy and weakness in corporate bonds.
A lot of data to process this week, so let’s start with the economic updates. Probably the big kahuna report for the week was Friday’s unemployment/payroll numbers. Job growth came in a touch above expectations while the unemployment rate ticked higher.
Probably the most important statistic in the release, at least in terms of impacting Fed policy, was the wage data. The monthly numbers are volatile (dark blue line below), but the trend is towards modestly slower wage growth (dotted line).
This might argue for a less hawkish Fed in the months to come, but this is more than offset by a report earlier in the week. The number of unfilled job openings increased by a surprising amount in October.
So far the labor market remains tight despite the layoffs we are seeing at Twitter, Stripe, Lyft, etc.
Turning to the manufacturing sector, the broadest measure of activity is flirting with contraction. The ISM number fell to 50.2 in October. Anything below 50 would indicate a manufacturing recession.
An inflation statistic in the manufacturing report points towards deflation of all things. The prices paid component of the ISM report fell to 46.6 – anything below 50 indicates falling prices.
Manufacturing is about 11% of the U.S. economy, so the boarder implications of these two reports are somewhat limited, but it does point towards slowing growth and moderating inflationary pressures in this corner of the world.
Higher For Longer
With the data out of the way, the other main event of the week was the Fed meeting. A 75bps hike was widely expected, but would Chairman Powell hint at a slower pace of future rate hikes, or maybe an eventual pause?
They did move the Fed Funds rate higher by the expected 75bps. This marked the fourth consecutive three-quarter point move. As you can see below, there have only been a total of five 75bps hikes in the last 30 years.
The markets initially rallied based on the following comment in the press release:
“In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”
This was interpreted as saying the Fed was sensitive to hiking rates too far.
Well, the good feelings last about 15 minutes. During the press conference Chairman Powell then walked it all back. The key comment was:
"It’s very premature to think about or talk about pausing our rate hikes."
As soon as these words left his mouth equities swooned and bond yields spiked higher. There are three main takeaways from the meeting:
1) How fast to hike rates? On this question Powell conceded that dialing down the pace may “come as soon as the next meeting.” This probably means a half-point hike in rates next month
2) How far to hike rates? Here the Fed’s view has changed. Powell floated the idea that the Fed may have to hike more than originally thought. The market moved quickly to price in a peak Fed Funds rate over 5%, as you can see below.
3) How long to leave rates at a higher level? Basically, longer than people were thinking. Powell stressed the need to avoid the mistake of letting up too soon. He also said that the cost of doing too little was greater than the cost of doing too much in terms of rate hikes.
Now anyone who has been paying attention to the Fed the last few years (I sure hope you haven’t – there are far better things to do with your time!) probably remembers Yellen or Bernanke saying the exact opposite.
I’m paraphrasing, but basically they said: …it’s better for the Fed to keep rates low and take risks with inflation because 1) deflation is the bigger risk, and 2) the Fed knows how to battle inflation.
They are making this up as they go along, just like the rest of us. That’s not a criticism…economics and finance is hardly a science….but it does make you wonder what assumptions we all are making about 2023 that will ultimately prove to be bogus.
Charts We Found Interesting
1) The Atlanta Fed updated their estimate for 3rd quarter GDP growth this week. Surprisingly strong.
2) But if growth is projected to be so strong, why is the yield curve the most inverted it’s been since 1982? One side of this bet will be wrong next year.
3) Another trend that’s unlikely to repeat in 2023. I seriously doubt we will see all the world’s central banks tightening policy at the same time next year. Will we see one or two even cut rates?
4) Something else that’s unlikely to repeat next year – left tail returns for both stocks and bonds. But the $64 trillion question is which asset class reverts to the mean??
5) It’s been a tough run for FANGMAN investors.
6) Where the betting markets are ahead of next week’s election.
7) Walmart employs almost as many people as the Chinese military. Not quite sure what to make of that! Some staggering numbers regardless.
Have a good weekend.
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