Stocks didn’t move much today after the Consumer Price Index for January showed enough inflation strength to bring Federal Reserve officials out in force to talk about a potential need to raise interest rates above current financial market expectations. But other indicators–the CME FedWatch Tool, most obviously–showed that investors and traders continue to reposition for more interest rate increases beyond the Fed’s May 3 meeting.
You’ll find it in the market for interest-rate options if you really dig through the data. Which Bloomberg has. On Tuesday, a trader amassed a large position in options that would make $135 million if the central bank keeps tightening until September and interest rates hit a peak of 6%.
Today I posted my two-hundred-and-thirty-fourth YouTube video: Why March 22 Is the Next Big Date Today’s topic is: Why March 22 Is the Next Big Date. March 22 is the date of the Fed’s next meeting. And it’s the first time we’ll get projections from the Fed on where interest rates will peak since the last Dot Plot in December. The market has been playing catch-up with the Fed since that December meeting. A hopeful market thought that the Fed was being too aggressive in their estimates of a peak of 5.00% to 5.10%, but the recent surge in jobs in January has made the market fall in line with the Fed’s expectations. As of February 7, the market had priced in a 25 basis point increase in March and May, with a peak hitting in June or July at 5.12% (nearly exactly the same as the Fed’s December projections). Just a week ago, the market was looking at a 4.9 peak in possibly May. The market has shifted to catch up with the Fed, but now we have to wait until March 22 to see if the Fed has moved the peak interest goalposts. In the meantime, I don’t expect the market to move much as we wait for the March 22 Fed meeting.
On the one hand, stock markets heard Federal Reserve Chair Jerome Powell reiterate his comments of last week that “disinflation” had become visible. On the other hand, bond markets and investors betting on the direction of the Fed Funds rate heard the Fed chairman tell the audience at the Washington Economics Club this morning, that the labor market remains extraordinarily strong, and if the jobs market doesn’t cool, the Federal Reserve will need to take its peak interest rate higher.
Do the huge January job gains mean that the Federal Reserve will raise interest rates to a higher peak? That was the worry today and it was enough to send the Standard & Poor’s 500 0.61% lower at the close and to knock a solid 1% off the NASDAQ Composite. The NASDAQ 100 fell 0.87% and the small-cap Russell 2000 lost 1.40%.
Was it accidental or intentional? We’ll find out on Tuesday when Fed chair Jerome Powell answers questions at the Economics Club in Washington. On Wednesday, February 1, in his post-Fed-meeting remarks, Powell came across as more dovish on inflation and interest rates than many Wall Street strategists and the financial markets had expected.
Today, Friday, February 3, the Bureau of Labor Statistics reported that the U.S. economy added a whopping 517,000 jobs in January. Economists had been expecting more along the lines f 50,000 jobs added in the month. The huge January surge took the headline unemployment rate to 3.4% The last time the unemployment rate was this low was May 1969. On the surface, the stronger, the much stronger, than expected job gain in January will put pressure on the Federal Reserve to continue raising interest rates. If the labor market is booming, it’s hard o see inflation coming down rapidly. But the real story here may be beneath the surface.
The Federal Reserve raised short-term interest rates Wednesday by 25 basis points, as expected. That brings the Fed’s benchmark interest rate to a range of 4.50% to 4.75%, the highest level since October 2007. After a pullback on the news and the Fed’s press release, the stock market advanced because in his press conference Fed chair Jerome Powell didn’t strongly push back on questions suggesting that the Fed sees inflation continuing to fall and that the central bank is nearing a pause in its interest rate increases. If you’re familiar with the way that financial markets torture the Fed’s frequently opaque language to support the current consensus, you won’t be surprised that today’s move up on stocks is based on a very minor shift in the Fed’s language.
With the Federal Reserve seemingly winding down its cycle of interest rate increases, a stronger dollar is no longer the big currency market story. Gold is. Gold is back. And for at least the next 3 to 6 months.
Here’s what I expect on Wednesday. The Federal Reserve’s Open Market Committee will announce a 25 basis point interest rate increase. In his post-meeting press conference Fed chair Jerome Powell will try to talk the financial markets out of their exuberance by stressing that the Fed doesn’t see a quick end to interest rate increases because at 5% inflation is still running way ahead of the Fed’s 2% target rate. And I expect that investors and traders will ignore Powell’s comments and bid stocks high because a pause in rate increases is just around the corner–maybe as early as March–and financial markets can look for the Fed to begin cutting interest rates in the second half of the year. To which I say, Bushwah! I would sell any post-meeting rally. March increasingly looks like the month where reality will whack the markets on its head.
I expect Federal Reserve to raise interest rates by 25 basis points on Wednesday, February 1. As of Friday, everybody from Elon Musk to my Amish egg guy thinks the Fed will raise rates by 25 basis points instead of the 50 basis points at the Fed’s December meeting. A 25 basis point move would, the consensus thinking goes, pave the way to a March end to this cycle of interest rate increases. And with a pause in effect, can a pivot to interest rate cuts by far behind? (I think this is very wishful thinking, but reality has never stopped a rally before.) On Friday, the CME FedWatch tool, which calculates the odds of a Fed move by looking at prices in the Fed Funds futures market, put the odds of a 25 basis point increase by 98.4%. No one, I repeat, no one was putting money on a 50 basis point move. The remaining 1.6% of the market was looking for the Fed to hold rates steady–in other words no interest rate increase. (I think even this tiny percentage might simply be an artifact of a few traders speculating on a big market reaction to a 25 basis point increase.)
So here’s what I think happens before and after the news.
The U.S. economy grew at a 2.9% annual rate in the December quarter of 2022. That brought growth for 2022 as a whole to 2.1%. Consumer spending was strong enough to offset slowdowns in housing and manufacturing. So good news. But growth in the quarter was still slower than the 3.2% growth rate in the third quarter
