The stock market still hasn’t completely accepted the likelihood of a recession forced by the Federal Reserve’s interest rate increases. And there’s still optimism about interest rate cuts in the second half of 2023. But I sense that the market consensus is moving on from the hopes for a soft landing–where higher interest rates slow the economy and whip inflation without causing a recession–to what Bloomberg today called a “growth recession.”
With all due apologies to T.S. Eliot, when it comes to stocks, April isn’t the cruelest month. That title goes, hands down, to September. Which my calendar says starts tomorrow. September is, on average, the worst-performing month for stocks
Today’s JOLTS report–Job Openings and Labor Turnover Survey–from the Department of Labor showed the number of available jobs climbing in July to 11.2 million. That’s up from a revised 11 million openings in June. Economists had expected a decline in the number of job openings to 10.4 million for the month. The surprising increase in job openings shows that the labor market continues to be extremely tight. The Federal Reserve has tagged labor market conditions as a key indicator that it is watching as it sets interest rates.
Financial markets are fixated on the risk from the Federal Reserve’s interest rate increases. But that means the markets are overlooking the risk posed by the Fed’s efforts to reduce the size of its balance sheet.
There’s no magic spell from the Federal Reserve that compels markets to believe Friday’s higher interest rates for longer speech from Fed chair Jerome Powell. I’d look for substantial pushback from investors and traders–and big money managers–who even on Friday were arguing that nothing had changed and that the Fed would still move to cut interest rates in the second half of 2022. I’m not sure that even a 75-basis-point increase in the benchmark interest rate at the Fed’s September 21 meeting would be enough to convince this group. While I think logic argues against it, I wouldn’t be surprised to see a bounce back from Fridays selling this week. I wouldn’t buy into such as move as a longer-term trend.
Well, that was short and direct. Especially for the Federal Reserve. In a speech of less than 10 minutes Fed chair Jerome Powell warned financial markets to expect that the central bank will keep raising interest rates and will then leave them at higher levels for some time in order to control inflation. Stocks dropped on Powell’s remarks with the S&P 500 down 2.80% at 3 p.m. New York time.
This week Fed presidents have set the table for Federal Reserve chair Jerome Powell’s Friday morning speech at the Jackson Hole central bankers’ conference. But it’s not clear that the financial markets are eating off the same menu.
Yesterday’s minutes from interest rate meetings at two of the Federal Reserve’s 12 regional banks show these banks favored a 100 basis-point increase in the Fed’s discount rate in July 14 votes at the two banks. (The discount rate is the rate that the Fed charges banks to borrow at the Fed’s discount window.) The votes came from the boards of the St. Louis and Minneapolis banks. At the July 27 meeting the Fed’s Open Market Committee voted unanimously for a 75-basis-point increase in the Fed’s benchmark interest rate. The committee also raised the discount rate by the same 75 basis points to 2.5%. For those of us trying to figure out what Fed chair Jerome Powell will say at his Friday speech at the Fed’s Jackson Hole central bankers conference, this is something of an indicator that there’s considerable sentiment at the Fed to keep aggressively raising interest rates.
Hedge funds are pouring millions into bets that Jerome Powells’ Federal Reserve will use its Jackson Hole central bankers’ confab this week to emphasize its strategy of higher interest rates until inflation is under control. Stocks haven’t liked the increase in yields today. As of 1 p.m. New York time, the Standard & Poor’s 500 was down 1.76% and the Dow Jones Industrial Average was off 1.53%. The NASDAQ Composite had dropped by 2.14%.
The Federal Reserve will do everything it can to talk the financial markets out of optimism about future interest rate increases.
The difference of opinion isn’t focused on the September 21 meeting. The market has pretty much decided that the central bank will raise interest rates by either 50 basis points or 75 basis points at that meeting. (The odds on the CME FedWatch tool as of Friday, August 19, were 59% for a 50-basis-point increase, and 41% for a 75 basis-point move. It’s a question of what comes after the September, November, and December Fed meetings. The market seems to have decided that the Federal Reserve will end this cycle of interest rate increases shortly after those meetings. The Fed, in recent remarks, has been trying to convince the market that the fight against inflation is likely to take longer than that. And that the market should expect further interest rate increases into 2023. This week’s central bankers conference in Jackson Hole provides a pulpit for the Fed to preach its message. And I’d expect Fed chair Jerome Powell to use his 10 a.m. Friday speech to say that the Fed isn’t thinking that its inflation fighting work is near done.
Ho, hum. Another day another big upside move in stocks. Because we all know that the inflation rate has peaked and is coming down. After all the headline CPI inflation number on Wednesday, August 10, told us so. In July all-items inflation ran at a year-to-year rate of just 8.5%, down from the 9.1% rate in June, and below the 8.7% rate economists were expecting.
Today, August 12, the Standard & Poor’s 500 index w up 1.73%, the Dow Jones Industrial Average was higher by 1.27%, and the NASDAQ Composite ended the day up 2.-5%. The NASDAQ `100 closed higher by 2.06%. The Russell 2000 small-cap index gained 2.09%.
Given, however, that the bulk of the lower-than-expected inflation rate in July resulted from a huge drop in gasoline prices, it’s important to take a look at where oil prices (and the price of gasoline at the pump) might be headed. In the short run there’s nothing so likely to derail this rally than a return to $4.00 a gallon PLUS gas prices.
It didn’t take long. The pixels were barely dry on yesterday’s CPI inflation report–headline inflation fell to a year-over-year rate of 8.5% in July from 9.1% in June–before members of the Federal Reserve warned that the stock market rally on the news was based on a misreading of the Fed’s likely reaction to the lower CPI inflation rate.
