Market Snapshot
briefing.com
| Dow | 33678.57 | +748.56 | (2.27%) | | Nasdaq | 10589.68 | +284.52 | (2.76%) | | SP 500 | 3901.73 | +93.63 | (2.46%) | | 10-yr Note | +36/32 | 3.56 |
|
| | NYSE | Adv 2622 | Dec 424 | Vol 824 mln | | Nasdaq | Adv 3349 | Dec 1249 | Vol 5.1 bln |
Industry Watch
| Strong: Consumer Staples, Energy, Materials, Utilities, Industrials, Financials, Real Estate, Information Technology |
| | Weak: -- |
Moving the Market
-- Positive reaction to the better than feared December Employment Situation Report
-- Big pullback in Treasury yields from earlier highs
-- Broad buying interest pushing the S&P 500 past resistance at 3,850 followed by 3,900 in the final hour of trading
| Closing Summary
06-Jan-23 16:30 ET
Dow +700.53 at 33630.54, Nasdaq +264.05 at 10569.21, S&P +86.98 at 3895.08
[BRIEFING.COM] The stock market was able to close out the first week of 2023 on an upbeat note while also closing higher for the week overall. Today's session reflected a nice contrast to yesterday's retreat, which was fueled by Fed rate hike concerns. Today, the main indices all closed with a gain of at least 2.0%.
The upside bias was driven by the thinking that the Fed may be able to pause its rate hikes sooner than previously thought. To that end, investors turned their attention to the average hourly earnings number in the December Employment Situation Report following a spate of strong labor reports (JOLTS, ADP, and initial claims) earlier this week. The employment report reflected wage inflation moderating to 4.6% year-over-year in December versus a downwardly revised 4.8% in November.
The Treasury market responded positively to this indication, as did the stock market, at today's open; however, the initial move by the S&P 500 hit resistance at 3,850 and quickly got knocked back to 3,809.
Buyers in both the Treasury market and stock market latched onto a new rally catalyst in the form of the December ISM Non-Manufacturing Index, which was released at 10:00 a.m. ET and showed the first drop into contraction territory (i.e. a sub-50 reading) since May 2020. The downturn reflected a clear slowdown in economic activity that is a byproduct of rising interest rates and weakening demand.
The latter understanding fueled a sharp move lower in Treasury yields and a sharp move higher in stocks, helped by short covering activity and a sense that the Fed won't be able to take the target range for the fed funds rate much higher before it decides to hit the pause button.
Broad buying interest left all 11 S&P 500 sectors up at least 0.9% (health care). The heavily weighted information technology (+3.0%) and consumer discretionary (+2.4%) sectors were among the more influential leaders. The latter was partially boosted by Tesla (TSLA 113.06, +2.72, +2.5%), which logged a nice gain after trading down as much as 7.7% in the wake of a Wall Street Journal report that it has cut prices again in China for its Model Y and Model 3 vehicles.
The S&P 500 closed just shy of the 3,900 level while the Dow Jones Industrial Average jumped 700 points to 33,630.
The 2-yr note yield, sitting at 4.48% before the jobs data, fell to 4.40% after the 8:30 a.m. ET report, but subsequently dropped to 4.25% after the ISM Non-Manufacturing Index. It settled the session at 4.27%. The 10-yr note yield stair-stepped from 3.74% in front of the jobs report to 3.68%, then settled at 3.56%.
- S&P Midcap 400: +2.4% YTD
- Russell 2000: +1.8% YTD
- Dow Jones Industrial Average: +1.5% YTD
- S&P 500: +1.5% YTD
- Nasdaq Composite: +1.0% YTD
Reviewing today's economic data:
- Nonfarm payrolls increased by 223,000 in December (Briefing.com consensus 210,000) following a revised 256,000 increase in November (from 263,000)
- Nonfarm private payrolls increased by 220,000 (Briefing.com consensus 200,000) following a revised 202,000 increase in November (from 221,000)
- The unemployment rate fell to 3.5% in December from a revised 3.6% in November (from 3.7%)
- Average hourly earnings rose 0.3% (Briefing.com consensus 0.4%) after a revised 0.4% increase in November (from 0.6%)
- The average workweek fell to 34.3 hours in December from 34.4 hours in November
- The key takeaway for this market is that the report was better than feared, meaning it was not as strong as feared. Consequently, the initial response has been quite positive with some short-covering activity likely helping in the effort.
- The ISM Non-Manufacturing Index for December dropped to 49.6% (Briefing.com consensus 55.0%) from 56.5% in November. The dividing line between expansion and contraction is 50.0%.
- The key takeaway from the report is that business activity for the non-manufacturing sector, which comprises the largest swath of U.S. economic activity, contracted for the first time since May 2020, reflecting a clear slowdown in economic activity that is a byproduct of rising interest rates and weakening demand.
- Factory orders declined 1.8% month-over-month in November (Briefing.com consensus -0.4%) following a downwardly revised 0.4% increase (from 1.0%) in October. Shipments of manufactured goods declined 0.6% month-over-month after increasing 0.2% in October.
- The key takeaway from the report is that it shows a clear slowdown in manufacturing activity with declines in new orders for both durable goods and nondurable goods. The 1.8% month-over-month decline in factory orders was the largest since April 2020.
Economic data on Monday is limited to November Consumer Credit (prior $27.0 billion) at 3:00 p.m. ET.
S&P 500 still at 3900 ahead of close
06-Jan-23 15:30 ET
Dow +743.52 at 33673.53, Nasdaq +288.79 at 10593.95, S&P +95.22 at 3903.32
[BRIEFING.COM] Things are little changed in the last half hour.
Every S&P 500 sector is up by at least 1.0% with information technology (+3.3%) sitting near the top of the leaderboard.
The U.S. Dollar Index is near its low for the day, down 1.1% to 103.88.
Economic data on Monday is limited to November Consumer Credit (prior $27.0 billion) at 3:00 p.m. ET.
S&P 500 touches 3900
06-Jan-23 15:00 ET
Dow +748.56 at 33678.57, Nasdaq +284.52 at 10589.68, S&P +93.63 at 3901.73
[BRIEFING.COM] The S&P 500 breached the 3,900 level recently after falling to 3,809 at this morning's low.
As the market continues to climb, Treasury yields grind lower. The 2-yr note yield is down 18 basis points to 4.27% and the 10-yr note yield is down 16 basis points to 3.56%.
Mega cap stocks extended their gains recently. The Vanguard Mega Cap Growth ETF (MGK) has trailed the S&P 500 by a slim margin for most of the session, but now it trades up 2.7% versus a 2.4% gain in the S&P 500.
Energy complex futures settled in mixed fashion. WTI crude oil futures rose 0.1% to $73.74/bbl and natural gas futures fell 1.2% to $3.39/mmbtu.
Gains continue; Costco leads S&P 500 higher after Dec. sales numbers impress
06-Jan-23 14:30 ET
Dow +670.25 at 33600.26, Nasdaq +260.11 at 10565.27, S&P +85.75 at 3893.85
[BRIEFING.COM] Gains have continued in the last 30 minutes, the S&P 500 (+2.25%) firmly situated in second place among the major averages.
S&P 500 constituents Costco (COST 481.87, +31.68, +7.04%), Lam Research (LRCX 444.50, +27.44, +6.58%), and First Solar (FSLR 154.36, +8.90, +6.12%) pepper the top of today's standings. COST moves higher following strong December sales growth, LRCX follows general strength in semiconductors, and FSLR caught a Wells Fargo upgrade to Overweight.
Meanwhile, Baxter Int'l (BAX 49.03, -3.54, -6.73%) slips to the bottom of the S&P after announcing the planned spin off its Renal Care and Acute Therapies global business units as well as exploring strategic alternatives for its BioPharma Solutions business prompting, in part, a Morgan Stanley downgrade to Equal Weight.
Gold flies after jobs data; weekly gold gains end above +2%
06-Jan-23 14:00 ET
Dow +577.04 at 33507.05, Nasdaq +217.45 at 10522.61, S&P +69.97 at 3878.07
[BRIEFING.COM] With about two hours to go on Friday afternoon the tech-heavy Nasdaq Composite (+2.11%) is atop the standings, now near session highs.
Gold futures settled $29.10 higher (+1.6%) to $1,869.70/oz, aided in part by this morning's jobs data as well as a dip in the dollar. The yellow metal ended the week higher by about +2.4%.
Meanwhile, the U.S. Dollar Index is down about -1% to $103.96.
Page One
Last Updated: 06-Jan-23 09:01 ET | Archive
Market cheers less strong December employment situation
This week's labor data (JOLTS, ADP, and initial claims) has been on the strong side of things, raising concerns in the market's mind that the Fed will continue to raise rates and refrain from pivoting to a rate-cut cycle anytime soon.
Understandably, then, the air was thick in the futures market ahead of the release of the December Employment Situation Report at 8:30 a.m. ET. That air got a little less thick as the headlines hit, primarily because market participants spied a moderation in average hourly earnings growth to 4.6% year-over-year from 4.8% in November.
That is a key gauge for the Fed, so there was some quick thinking that it might persuade the Fed to take a softer approach to its next rate hike. Other elements of the report, though, namely the 3.5% unemployment rate that matches a 50-year low, are not going to persuade the Fed to pivot to a rate-cut cycle anytime soon. That will ultimately be the key takeaway from this report.
For now, though, the key takeaway for this market is that the report was better than feared, meaning it was not as strong as feared. Consequently, the initial response has been quite positive with some short-covering activity likely helping in the effort.
The S&P 500 futures, which were down four points just ahead of the release, are up 37 points and are trading 0.9% above fair value, the Nasdaq 100 futures, which were down 54 points just ahead of the release, are up 108 points and are trading 1.0% above fair value, and the Dow Jones Industrial Average futures, which were up five points just ahead of the release, are up 322 points and are trading 1.0% above fair value.
The 2-yr note yield, sitting at 4.48% in front of the report, has dropped to 4.39%, and the 10-yr note yield, sitting at 3.74% in front of the report, has dropped to 3.67%. The U.S. Dollar Index, up 0.5% before the release, is now up just 0.1%.
Other notable headlines from the Employment Situation Report are as follows:
- December nonfarm payrolls increased by 223,000 (Briefing.com consensus 210,000). The 3-month average for total nonfarm payrolls decreased to 247,000 from 263,000.
- November nonfarm payrolls revised to 256,000 from 263,000
- October nonfarm payrolls revised to 263,000 from 284,000
- December private sector payrolls increased by 220,000 (Briefing.com consensus 200,000)
- November private sector payrolls revised to 202,000 from 221,000
- October private sector payrolls revised to 219,000 from 248,000
- December unemployment rate was 3.5% (Briefing.com consensus 3.7%), versus a downwardly revised 3.6% (from 3.7%) in November
- Persons unemployed for 27 weeks or more accounted for 18.5% of the unemployed versus 20.3% in November
- The U6 unemployment rate, which accounts for unemployed and underemployed workers, was 6.5% versus 6.7% in November
- December average hourly earnings were up 0.3% (Briefing.com consensus 0.4%) versus a downwardly revised 0.4% (from 0.6%) in November
- Over the last 12 months, average hourly earnings have risen 4.6%, versus 4.8% for the 12 months ending in November
- The average workweek in December was 34.3 hours (Briefing.com consensus 34.4), versus 34.4 hours in November
- Manufacturing workweek was little changed at 40.1 hours
- Factory overtime declined 0.2 hour to 2.9 hours
- The labor force participation rate increased to 62.3% from 62.2% in November
- The employment-population ratio increased to 60.1% from 59.9% in November
In other developments, the House has held 11 votes for Speaker of the House and none have resulted in electing a Speaker of the House. The voting will continue today.
Also continuing at today's open will be weakness in Tesla (TSLA) and Southwest Airlines (LUV). The former has cut prices again China for its Model Y and Model 3 cars, according to The Wall Street Journal, and the latter has divulged that it expects to report a Q4 net loss driven by an estimated pre-tax negative impact in the range of $725-825 million related to its holiday flight cancellations. TSLA is down 6.5% and LUV is down 2.1%.
Those stocks will be outliers at the open, which should feature some broad-based buying interest as investors paradoxically cheer workers seeing a moderation in their wage growth and less strong (but not weak) hiring activity in December.
-- Patrick J. O'Hare, Briefing.com
Southwest Air to pay heavy price for late December meltdown, but shares fly higher anyway (LUV)
As Southwest Air's (LUV) debacle played out over the last ten days of 2022, leaving tens of thousands of passengers stranded for the holidays, it was difficult to pinpoint exactly how severe the financial impact would be for the company. That question was answered this morning, though, when LUV disclosed that it's anticipating a pre-tax negative impact of $725-$825 mln in Q4, resulting in the company taking a net loss for the quarter.
- After registering back-to-back profitable quarters in Q2 and Q3, driven by robust leisure travel demand and an upswing in business travel, analysts were expecting healthy profits once again for Q4. However, those projected profits have vanished due to an estimated $400-$425 mln in lost revenue and travel reimbursement costs of up to $400 mln.
- Part of those reimbursement costs include an offer of 25,000 frequent-flier points for any traveler impacted by LUV's flight cancellations, which totaled a whopping 16,700 from December 21 - December 31.
- In the aftermath of this mess, LUV's antiquated crew scheduling system has fallen under the microscope. Essentially, the system became crippled and couldn't handle the surge in flight cancellations as the massive winter storm swept across most of the country.
- Likewise, CEO Bob Jordan is taking serious heat from multiple sides, including from regulators, politicians, the media, and, of course, from customers. Earlier this week, Bloomberg reported that LUV intends to keep Jordan, who now has the tall task of repairing both LUV's battered reputation, and the technology issues that instigated this disaster.
- While Jordan has pledged to identify and fix the problems that led to the avalanche of cancellations, details about what those remedies might include have been very limited. To be fair, the lack of a detailed plan of action may simply be due to the company's ongoing investigation into what happened. Nevertheless, restoring confidence -- for both customers and investors -- will be critical moving forward and assuring stakeholders that the problem is solved is key from a longer-term perspective.
Indeed, we don't believe that LUV's breakdown will have a permanent or lasting effect on its business. Perhaps some would-be customers will look to other airlines over the next couple of months as LUV's meltdown remains fresh in travelers' minds, but history suggests that the shelf-life for avoiding specific airlines over previous blunders or catastrophes is short-lived. On that note, the stock is trading higher and is outperforming its peers today as investors assess the financial damage that was already priced into the stock, and refocus on the healthy demand environment for airlines.
AutoZone as 2023 Investment Idea; favorable dynamics poised to continue throughout the year (AZO)
With inflation making headlines throughout 2022, consumers looked for areas in their budgets where savings could be realized. One such area was auto repairs, which saw an explosion in DIY during the pandemic and sustained this momentum throughout the past year. We see similar themes taking hold during 2023, making aftermarket auto parts retailer AutoZone (AZO), which has more exposure to the DIY market than its competitors O'Reilly Automotive (ORLY) and Advance Auto Parts (AAP), a solid Investment Idea for 2023.
- New and used auto prices are trending down from the elevated levels seen over the past year as supply chains normalize. However, new car prices are still setting records. According to Kelly Blue Book, the average new car sold during November reached nearly $49K. Meanwhile, in the used market, prices remain well above pre-pandemic levels. Used car retailer CarMax (KMX) reported average selling prices for used vehicles of over $28K in NovQ, a 1.9% jump yr/yr and a 37.8% leap compared to 2019.
- A physical presence is vital for an auto parts retailer, given the urgency surrounding vehicle breakdowns. A physical footprint also gives AZO a competitive advantage over e-commerce competitors like Amazon (AMZN) and eBay (EBAY), as it allows the company to offer hands-on services, such as help identifying correct parts.
- AZO has commented that its growth over the past two years resulted from capturing share from the broader market instead of its close competitors, underscoring the demand for physical locations. On that note, AZO boasts the most extensive physical presence, boasting over 6,100 domestic locations, dwarfing ORLY's 5,700 and AAP's 4,300.
- AZO also noted in early December that it is growing its market share, likely at the expense of AAP, which continues to experience difficulties with its private label portfolio. Also, AZO's aggressive pricing investments from 2021 allowed it to remain highly competitive in a marketplace where price and convenience trump differentiating services.
- Although AZO tends to cater more to DIY clients, with just around 29% of its FY22 (Aug) revs stemming from commercial sales, it is seeing healthy progress regarding its commercial acceleration strategy. Part of AZO's success branches from its focus on carrying more products closer to its customers, an approach AAP has started emphasizing more. This success is expected to continue for at least the near term, with AZO expecting its commercial business to drive Q2 (Feb) sales growth.
Risks are still present for AZO this year. The stock already climbed around 20% in 2022, paving the way for increased profit-taking activity on minor weak points in each quarter. Vehicles are also becoming more complex, making it more challenging for individuals to conduct repairs themselves. Consumers may also opt to delay certain repairs that are not vital to whether their car runs as prices remain elevated.
However, although shares may have become overextended, the stock has shown excellent support around its 200-day moving average, so waiting for a pullback toward those levels would reduce risk. Also, AZO and its peers have repeatedly mentioned how the current fleet of vehicles on the road continues to age, leading to increased breakdowns. Therefore, even though cars are becoming more complex, this concern may not be a meaningful challenge for some time. Meanwhile, consumers can delay certain repairs, but as ORLY has noted, little demand in the aftermarket auto parts industry is genuinely discretionary as repairs eventually need attention.
Lastly, AZO trades at an attractive forward P/E of ~18x, a discount relative to ORLY at ~23x. As always, with these longer-term ideas, we recommend utilizing a 20-25% stop loss.
Tesla steps on the accelerator with its price cuts in China, sending shares in reverse (TSLA)
The calendar may have flipped to 2023, but so far, the new year hasn't flipped the script for Tesla (TSLA), which saw its stock crash by 65% in 2022. Shares are under selling pressure once again after the Wall Street Journal reported that TSLA amped up its discounts for the Model 3 and Model Y in China, turbocharging mounting concerns about waning demand for its EVs. According to the article, the price cuts range from 6-13%, representing the steepest markdowns to date.
- Not coincidentally, the pricing action comes after TSLA's deliveries plunged by nearly 50% on a month/month basis in December to 55,800 vehicles. Macroeconomic headwinds, most notably including those associated with COVID-19, are clearly putting a dent in TSLA's sales in China, which account for nearly a quarter of its total sales.
- Perhaps more concerning, though, is that TSLA appears to be losing market share in China to a bevy of competitors such as BYD Co. (BYDDY), NIO (NIO), and Li Auto (LI).
- While TSLA's deliveries fell sharply in December, NIO and LI reported month/month delivery increases of 12% and 41%, respectively.
- Meanwhile, BYD is emerging as a viable threat to someday dethrone TSLA as the world's largest EV maker. In 2022, BYD delivered more than 910,000 vehicles, more than tripling the amount from 2011, as TSLA's delivery growth slipped to about 40% from nearly 100% in 2021. BYD's more economical price points are providing it with a key advantage over TSLA. For instance, the company's ATTO 3 SUV has a list price of about $45,000, compared to roughly $65,000 for TSLA's Model Y.
TSLA's struggles aren't limited to the Chinese market.
- Recall that the company doubled its discount on its Model 3 and Model Y vehicles in the U.S. late in December. The price cut was seen as a strategy to entice would-be buyers to make a purchase now, rather than waiting for the new tax credits to kick in for 2023.
- However, it's evident that the issue runs deeper than customers simply postponing their purchases. This was made clear when TSLA reported Q4 deliveries of 405,000, missing the ~418,000 consensus estimate -- even after that estimate had fallen in recent weeks.
- Rising competition in the U.S. is also playing a role in TSLA's slowdown, particularly from Ford (F) and General Motors (GM), but its troubles here are more macro-related at this point. Rising interest rates in particular are putting its vehicles out of reach for an increasing number of consumers.
The main takeaway is that TSLA is likely facing a combination of slowing topline growth and leaner automotive gross margin this year as it becomes more aggressive with its discounts. On the positive side, the stock has become much more compelling from a valuation standpoint with a forward P/E that's now south of 25x. Also, with the Cybertruck finally expected to roll out in mid-2023, the stock could have a meaningful and much-needed catalyst on the horizon.
World Wrestling getting a power kick as McMahon jumps back ring (WWE)
World Wrestling (WWE +22%) is wrestling up some nice gains after the company announced that Vince McMahon is jumping back in the ring. Not literally. He is the founder and controlling shareholder of WWE. He expects to assume the role of Executive Chairman and bring two people with him as board members. He wants unified decision making for the upcoming media rights negotiations and a parallel full review of strategic alternatives, which could mean a possible sale.
- So there is a lot to unpack here. Recall that McMahon "retired" in July 2022 following allegations of sexual misconduct that included non-disclosure agreement payments. He is 77 years old, so many investors figured he would remain retired. But this move tells us retirement was not suiting him well and that he apparently misses running his business.
- In terms of the media rights, its deals with Fox and USA expire next year with negotiations expected to begin later in 2023. McMahon's view is that his involvement will help the process because the media companies know they will have the support of the controlling shareholder.
- Initially, we thought investors may have concerns that McMahon's higher profile might cause the media companies to view the rights less favorably, but the stock reaction today says otherwise.
- In terms of the strategic alternatives, it would make sense to consider selling the company. Viewership has remained strong. Its SmackDown on Fox regularly attracts over 2 mln viewers and ranks number one in the coveted 18-49 demo among all Friday night broadcast programs.
- Also, interest in its Live Events has been recovering nicely since the pandemic. WrestleMania 39 is slated for April 1-2 at SoFi Stadium in Los Angeles. WWE has sold almost 100,000 tickets already. A sale of WWE to one of its media partners like Fox would make a lot of sense. And with its reasonable $3.7 bln market cap, it would be easily digestible for a bigger media company.
Like all WWE events, you never know what to expect. WWE will be an interesting name to watching in the coming months and quarters. With McMahon coming back into the picture, it is certain to be entertaining. We also have to commend McMahon for building WWE over the decades into the behemoth it has become. We think investors are excited to see him back in the mix and a potential sale would add a nice kicker.
Costco checks out plenty of buyers today on robust December comp growth (COST)
Shares of Costco (COST +7%) are seeing plenty of buyers today after the warehouse retailer posted vigorous total company comp growth, excluding the impacts of FX and gas prices, of +7.3% for December. The stock had pulled back yesterday as investors were nervous about the all-important holiday shopping season. However, given that consumer sentiment remains low, COST's December comps stand out positively, especially since the company was lapping decent comp growth of +11.5% in the year-ago period.
- As we saw during NovQ, big-ticket discretionary items are, unsurprisingly, experiencing pronounced softness as inflationary pressures squeeze consumer budgets. As a result, comps decelerated sequentially to +7.1% from +10.4%, with adjusted comp growth of just +5.3% in November. With same-store sales growth slowing, it is relieving to see COST break this trend during the holiday season.
- Still, it is critical to remember that the holiday shopping season is typically when consumers purchase big-ticket discretionary items, so comp growth may cool during January, which has occurred in each of the past two years.
- However, a slowdown from December to January would not indicate that certain tailwinds are not sustainable. Since the pandemic, at-home cooking has remained elevated, evidenced by robust demand at many grocers over the past two years, including Walmart (WMT), Kroger (KR), and competing warehouse retailer BJ's Wholesale (BJ). Therefore, it is beneficial that most of COST's revenue stems from its foods and sundries and fresh foods businesses, which totaled 51.7% of FY22 (Aug) sales.
- On a side note, BJ touched on the resilience of its grocery business in mid-November, noting that it has zero issues with this business and was optimistic it could continue gaining market share.
- Inflation may continue to pressure average transaction size, which contracted to +6.9% in NovQ from +10.0% in AugQ. However, COST has started to notice deflationary trends. Commodity costs, such as corn flour, sugar, and butter, have begun falling. Although traffic increased just 2.2% in the U.S. in NovQ versus a 5.2% jump in AugQ, likely due to plummeting gas prices nationwide, falling merchandise prices could reignite the allure of COST's discounted business model, boosting traffic over the next few quarters.
- It is also essential to call out COST's dedicated membership base, boasting steady renewal rates of around 90%. CFO Richard Galanti recently stated that raising its annual cost is only a matter of when, not if, providing a higher consistent stream of revenue in the near future.
Bottom line, COST's December sales report is encouraging, as it underscores consumers' desire to seek discounts even though they must pay an annual membership fee. As shares fill the gap after they sold off following disappointing NovQ earnings, perhaps the strong comp growth in December was the spark COST needed to realize plenty of upside potential.
The Big Picture
Last Updated: 06-Jan-23 14:50 ET | Archive
The market is fighting the Fed
Apparently, no one at the December 13-14 Federal Open Market Committee (FOMC) meeting thought it would be appropriate to begin reducing the federal funds rate target in 2023. That is a lot of "no ones" considering there were 19 forecasts provided at that meeting.
Call the market an interested observer of that meeting, the minutes from which were released this past week. You can also call the market an interested doubter of all those no ones.
Hold the Rate Cut
According to the CME FedWatch Tool, there will most likely be a rate cut by the end of the year. We would venture to say that the market also doesn't believe the Fed's terminal rate will go beyond a target range of 5.00-5.25%. The prevailing view at the moment is that the peak will be in the 4.75-5.00% range.
Notably, we heard Kansas City Fed President George (non-FOMC voter) say this week that she sees rates reaching 5.00% and staying there "well into 2024." Atlanta Fed President Bostic (non-FOMC voter) said he has 5.00-5.25% for his projection and holding there "well into 2024."
St. Louis Fed President Bullard (non-FOMC voter) acknowledged that, "While the policy rate is not yet in a zone that may be considered sufficiently restrictive, it is getting closer." Note: he didn't say anything about a possible rate cut in 2023.
And then there was Minneapolis Fed President Kashkari. He is a 2023 FOMC voter, so that distinction alone gives his viewpoint some added weight in the policy outlook. He said that he sees the Fed pausing its rate hikes at 5.40% before cautioning that rates could be taken potentially much higher from wherever the Fed pauses if there is slow progress in lowering inflation after the Fed pauses.
None of these no ones gave the market any reason to think that a pivot to a rate-cut cycle is going to happen anytime soon. The market, seemingly bothered at times by their stubbornness, didn't give up its own fight to prove these no ones wrong.
We know this looking at the behavior of the Treasury market throughout the week and particularly on Friday following the release of the December Employment Situation Report and the December ISM Non-Manufacturing Index.
A Step in the Pause Direction?
Briefly, the December jobs report was not weak. It just wasn't as strong as feared. The focal point in that respect was average hourly earnings, which decelerated to 4.6% year-over-year from a downwardly revised 4.8% in November.
The market responded favorably to this deceleration because it knows the Fed is worried about wage inflation keeping aggregate inflation persistently high. Therefore, the downshift in average hourly earnings growth from November was seen as a step in the right direction for tempering the Fed's hawkish mindset.
The December ISM Non-Manufacturing Index, released 90 minutes after the jobs report, solidified that thinking as it registered the first contraction reading (49.6%) since May 2020. The dividing line between expansion and contraction is 50.0%.
The 2-yr note yield, sitting at 4.48% in front of the release of the December employment report, fell to 4.40% in its wake, but subsequently dropped as low as 4.25% after the ISM Non-Manufacturing Index. The 10-yr note yield, meanwhile, stair-stepped from 3.74% to 3.68% to 3.56%.
That rally -- and the one that ensued in the stock market -- was catalyzed by the thinking that the Fed won't be able to take the target range for the fed funds rate much higher before it decides to hit the pause button.
A pause is still a long way from a rate cut, yet a pause beats another rate hike any day for a market that got broadsided in 2022 by a series of aggressive rate hikes.
What It All Means
In effect, what we have is a market that is intent on fighting the Fed even though it has been trained not to fight the Fed. At this juncture, though, the market feels like it has a fight worth fighting because the Fed sucker punched everyone with its prior view that inflation would be transitory.
The market wanted the Fed to start fighting inflation sooner, but all it did was shadow box. Now, the Fed is in the fight, and it is hammering home rate hikes left and right to try to bring inflation back down to its 2.0% target, showing little regard it seems for the long and variable lags of its prior punches.
Hence, when the non-manufacturing sector, which accounts for the largest swath of U.S. economic activity, falls into a state of contraction, it puts the market in a fighting mood, counter punching the Fed with trades that imply the Fed is on course to make a policy mistake.
The market is fighting in a way that it hopes convinces the Fed to go to a neutral corner soon. That is the connection from the inverted yield curve and the steep drop in the 2-yr note yield in particular following the December Employment Report and December ISM Non-Manufacturing Index.
Perhaps the Fed will respect the fight in the market. Then again, the minutes from the last FOMC meeting carried this observation:
"Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability."
The market definitely has a fight on its hands to begin 2023 and the Fed does, too. The latter is fighting inflation and the former is fighting the Fed to stand down soon, fearing that economic conditions are going to deteriorate sharply in coming months.
The reaction function in the market, then, will be acute around every major economic release, because each release will be interpreted in terms of what it means for the path of monetary policy. That should translate into a lot of roller-coaster action for a market that knows it typically doesn't pay to fight the Fed but isn't going to go down without a fight when it fears a policy mistake is in the making.
-- Patrick J. O'Hare, Briefing.com
|
