This was a week when investors would have done well ignoring the economic calendar and instead focused on the summary of economic projections, more widely known as the “dot plot.” Released along with the minutes of the open market committee meeting on Wednesday, the dot plot showed a change in thinking from the committee. Investors had been speculating that the Fed had reached the peak of their tightening cycle and the FOMC release confirmed that. The dot plot released in September showed more than half of the committee expected an additional rate hike this year. The December chart indicated that no members anticipate any additional hikes this year. Moreover, the median view is that there will be 75 basis points of rate cuts in 2024. With that decidedly dovish statement, stock and bond markets continued their bullish run. The five-year Treasury note is trading below 4%, closing the week out at 3.92%, while the S&P 500 continues its parabolic rise, rallying more than 15% since the last week of October.
This morning’s employment report delivered a curveball to market participants who had been looking for continued economic moderation. That was not to be the case. The economy added 199,000 new jobs in November, up from the previous month and 14,000 more than the consensus had been expected. Average hourly earnings rose 4.0% year-over-year, as it did the prior month. But what really grabbed the investor’s attention was the downtick in the unemployment rate, which came in at 3.7%, 0.2% below the previous month. The large change in household employment, 747,000 new jobs reported, and the change in the size of the workforce, 532,000 new entrants, was responsible for the decline.
There were two news stories this week that made us double check the calendar to ensure that we hadn’t transported back sixteen years to pre-crisis 2007. The first had to do with the Federal Housing Finance Agency (FHFA) and the second was the proliferation of private credit.
The upward trajectory of stock prices continued this week despite what some observers called hawkish Fed minutes. We’re hesitant to side with that view simply because there was no deviation from the comments that Chairman Powell communicated at the post-meeting press conference. The committee remains vigilante against any signs that economic growth or inflation is reaccelerating and will raise the Fed Funds rate again if needed.
The October Consumer Price Index, at the headline level, was a welcome panacea for investors’ perception of inflation. Coming in at 3.2% year-over-year, CPI was universally greeted as good news and interest rates plunged across the curve. Looking beyond the headlines at some of the subcomponents raised suspicions that some of the data had been “fudged.” Specifically, the price of health insurance. For many, November is healthcare renewal season and it’s never cheaper to renew than it was the previous year. And certainly not 33.98% cheaper as measured by the BLS report due to a change in calculation methodology. That was one of the subcomponents that stuck out in Tuesday’s report. Nonetheless, the bigger picture is that inflation is falling, and the Fed can take solace in that fact. Moreover, that inflation report pretty much takes a rate hike at the December meeting off of the table as reflected in the Fed Futures market. Futures are now implying no further hikes and a rate cut of 25 basis points by next summer.
As we close out the year, investors seem to have concluded that the Federal Reserve has mostly accomplished their mission of containing inflation while simultaneously achieving an economic soft landing. We agree with the consensus. Year-over-year, the consumer price index was 3.1% in November, and we think that getting back to the Fed’s target of 2.0% will prove elusive for a few reasons. Principally, the changing workforce. The workforce is shrinking as the baby-boomers age out, and as it shrinks workers are finding they hold wage bargaining power, as evident by recent union gains and the rising minimum wages. To maintain profit margins, companies are forced to raise prices which creates the dreaded wage-price spiral. The Fed had hoped to avoid the occurrence by slowing the economy, but structural forces have prevented any slowing to date. Instead, the Fed is likely to need to raise their inflation speed limit to 3%.