January 2023
January was a peculiar month in that the New Year kicked off with a general feeling of malaise in terms of market sentiment stemming from what proved to be a disappointing holiday selling season. The stock market commenced the year trading at the December low as economic data continued to disappoint. The Fed, reacting to the string of weak Q4 economic reports and continued stubborn inflation readings, communicated that they would reduce the magnitude of rate hikes again from 50- to 25-basis points. In holding to their word, they did so at their February 1st meeting. Moreover, the committee members loosely suggested that the peak of the rate would reach 5% and not the 5.25% to 5.50% they communicated just 3 months earlier. That change in messaging succeeded in boosting investor concerns as witnessed in both stock prices and bond yields. The 30-year kicked off 2023 yielding 3.96%, only to close the month at 3.63%, as investors fretted that the economy was on the verge of recession and the Fed would be forced to cut rates later this year. Paradoxically, equity indices rallied for the same reason. The S&P 500 gained more than 6% for the month. While still more than 15% below the all-time high touched in December 2021, the index has rallied nearly 20% off of the 2022 low touched last October.
The fly in the ointment to the mid-2023 recession story is the employment situation. Despite an alarming number of layoff announcements, the unemployment rate, unemployment insurance, and the available job openings continue to signal a robust jobs market. Observers have cited the retirement of baby boomers and the general lack of desire to work as the cause, but there’s clearly a worker shortage in play. A recession typically results in a spike in unemployment. If the worker shortage narrative holds true, then perhaps the Fed will be able to engineer their much desired “soft landing.”
That view was confirmed on the first Friday of February when the BLS reported that 517,000 jobs were added to the economy in January. Certainly not the outcome expected of an economy teetering on the brink of recession. To counter Powell’s post- FOMC comments, Fed speakers reverted back to their hawkishness. The “jawboning” worked with the 2-year note rising 50 basis points from last week’s low yield. The 30-year yield also rose, but by about half of the 2-year move. The overnight/30-year spread remains inverted and is currently trading at about -80 basis points.
The January inflation data, released on February 14th, was more bad news for the bond market. The headline consumer price index rose 0.5% month-over-month which was a significant jump over the 0.1% recorded last month.
Given the employment backdrop, traders reversed their bet that Fed Funds would top out at 5.0% by early this summer, now betting that the overnight rate will touch 5.25% by this August.
But an analysis of the Fed Funds futures curve still shows that speculators believe that the Fed will quickly reverse course and cut rates by more than 100 basis point by the summer of 2024. That expectation jibes, loosely, with the Fed “dot plot”, their periodic guess as to where rates will be in the coming years. The majority of Fed members are expecting Fed Funds to average 4.25% in 2024. The Fed has a notoriously poor record of forecasting future rates and to understand why one only needs to look at the dispersion of expectations for 2024. For 2024 the high forecast is 5.6% and the low is 3.12%. For 2025, the dispersion is even greater, with a low of about 2.5% and a high above 5.5%. Looking past that forecast, our suspicion is that the Fed is going to need to keep rates higher for longer and the economy is going to need to adapt to that.
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