Stocks fell yesterday after a GDP release came in stronger than expected causing investors to fear the worst: higher interest rates for longer. The lily was gilded with a strong weekly unemployment figure rounding out the picture of a resilient economy.
‘Twas… the last trading day before Christmas, when all through the house, everything seemed to be stirring, missing still, was the silent mouse! As the year draws to a close and we all settle in to make merry over the coming days, one cannot help but to think back on the past year. No, I am not going to talk about loves lost and found… I would love to, but I, like you, keep thinking about market fortunes… some found, but most lost. In your introspection, you probably don’t have to look back too far to get a full picture of 2023, because everything is right in front of you… TODAY. How fitting that on the last trading day before the holiday that the Bureau of Economic Analysis will deliver its Personal Consumption Expenditures Deflator. That mouthful of words is more typically known as the PCE Deflator and it is the Fed’s favorite gauge of… you guessed it, inflation.
This morning’s report is expected to show that inflation moderated last month. The annual headline figure is expected to have slowed to +5.5% from +6.0%. That is nice, but the Fed likes to look at the Core deflator, which excludes food and energy. Those items are typically volatile, so economists like to ignore them in order to make forecasting more… um, accurate. That sounds silly given that food and energy were two of the main culprits in the pocketbook pain we have all experienced in the past year. Regardless, the Fed, with its grip on the throttles of the US economy, rely on that indicator to inform its policies, so we should pay attention to it. The Core number is expected to have pulled back to +4.6% from +5.0%. That number peaked last February just above +5.4%, so if those expectations are met in today’s release, it would represent progress. Of course, it should be noted that the Fed wants that numbers to be around +2.0% or well on its way there before it abandons its restrictive monetary policy. We started 2023 right around +5.0%, so any read below that represents at least some improvement. But if we look back to 2021, we can truly witness how inflation took hold of the economy rising from below the Fed’s +2.0% to that +5.0% where it is today. Check out the chart below to see just how crazy the ride has been.
It looks daunting, doesn’t it? The Fed thinks so as well, which is why it has not let up on its rate hiking or its hawkish rhetoric. The Fed, based on its most recent projections believes that the Core PCE will close out 2023 at +3.5%, still significantly higher than its target. It believes that inflation will persist largely due to the tight labor market. Higher wages which are a hallmark of a tight labor market are a big contributor to inflation. So, the Fed will continue to apply the brakes until the labor market, or the economy softens up enough to cause prices to moderate.
By “brakes” I am referring to, yes, higher interest rates. You know the principal cause of stock declines in the past year… and the cause for the weak earnings pain we are likely to get in the next 2 quarters. Ok, ok, we have plenty of time to think about that after the holidays. But for now, let’s just say that we started off the year worrying about inflation and interest rates, and we are closing out the year… still worrying about inflation and interest rates. Looking forward to next year’s holiday, will we be singing the same carol?
The Fed thinks so. It is expecting rates to be around 5% with inflation at a slightly better +3.5%. It projects that the unemployment rate will be 4.6%, only slightly higher than today’s 3.7%. So, that’s it, the final specter, The Ghost of Christmas Yet to Come, shows us a grim scene of higher interest rates, slower economic growth, and still high inflation. Wait a minute, we all know this story, and it ends on a positive note. One year is a long time in the market. Inflation, though high, is trending lower and many economists vehemently disagree with the Fed’s forecast. Yesterday’s upward revision of GDP is a positive sign that the economy is resilient. Along with the prior day’s stronger-than-expected Consumer Confidence number, the prospect of a so-called soft landing has, indeed gotten better. There is indeed a chance that inflation will recede without the economy falling into calamity. Let’s enjoy the holiday with that vision, looking forward to great prospects and possibilities in the year ahead. “May that be truly said of us, and all of us! And, so as Tiny Tim observed, God bless Us, Every One.”
YESTERDAY’S MARKETS
Stocks sold off yesterday on “good news is bad news” as the latest GDP revisions showed a resilient economy. The S&P500 fell by -1.45%, the Dow Jones Industrial Average traded lower by -1.05%, the Nasdaq Composite Index dropped by -2.18%, and the Russell 2000 Index declined by -1.29%. Bonds slipped and 10-year Treasury Note yields gained +1 basis point to 3.67%. Cryptos added +0.42% and Bitcoin gave up a scant -0.01%.
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