Don't You Forget About Me
Fed Chairman Powell wanted to make sure markets didn't forget him this week as he seemingly pulled the rug out from investor's hopes of a "soft pivot."
Markets jumped 1% as whispers of a slow-down in the pace of rate hikes just before the Fed's announcement on Wednesday, only to have cold water poured on the excitement by the Fed Chairman in his post-announcement press conference. This week's title song, "Don't You (Forget About Me)" was written by songwriters Keith Forsey and Steve Schiff specifically for "The Breakfast Club" movie that premiered in 1985. The song was performed by Simple Minds and was the only hit from the movie's soundtrack, but it was a good one, topping at #1 on the Billboard charts. A bit of trivia about the song - Simple Minds originally turned down the chance to record the song. They didn't want to record a song they didn't write and they weren't crazy about the lyrics "vanity...insecurity." However, the film's director, the uniquely plugged in John Hughes, arranged a screening of the film for the band members of Simple Minds and...simply changed their minds (I know it's cheesy, but I had to do it). The rest, as they say, is history.
"Won't you come see about me?
I'll be alone, dancing, you know it, baby
Tell me your troubles and doubts
Give them everything, inside and out and
Love's strange, so real in the dark
Think of the tender things that we were working on
Slow change may pull us apart
When the light gets into your heart, baby
Don't you forget about me
Don't, don't, don't, don't
Don't you forget about me"
Here's what we're seeing so far this week...
Don't You Forget About Me. The Fed announced their expected rate decision of a 75 basis point hike on Wednesday, which was largely priced in. However, the official statement indicated a slower pace to rate hikes and market participants were calling it a "soft pivot."
And yet, 30 minutes later, Powell doused those hopes with cold water in his press conference by stating "pausing is not something we're thinking about." Was the Fed laying a trap for equity markets this week or is Powell so determined to get financial conditions back under the Fed's control? Powell on Wednesday was reminiscent of the rebellious John Bender in "The Breakfast Club." He reiterated in his press conference, "If we under-tighten, risk is inflation entrenched." Before Wednesday, equities had rallied 10% off of the October 13th lows - clearly something Mr. Powell wasn't about to allow.
Since Wednesday's press conference, Fed Futures have now shifted over the last 30 days from a 42% probability of a 25 basis point rate hike in December to a split probability of 50 or 75 basis point hike next month. That is quite a move and one the Fed seems willing to undertake, as Powell stated yesterday that there is "significant uncertainty" around a Fed hiking end-point. In fact, there are now Fed Funds Futures indicating a 45% probability of a 75 basis point rate hike in March of 2023, when previously it was expected the Fed would end rate hikes in February of next year. Thanks Mr. Powell – if your actions push us into recession, we're unlikely to forget about you!
I'll Be Alone, Dancing, You Know It, Baby. There weren't many ringing the alarm bells on inflation in early 2021 like I was that inflation was going to be a problem and was anything but "transitory." There aren't many now willing to say that inflation has peaked.
While I'm not 100% percent there, I'm about 95% sure inflation has peaked. Next week we get the CPI print for October (we'll have to wait an additional week on PPI). As of today, the market is expecting another drop in inflation on a year-over-year basis. If so, it would be the 4th consecutive month of declines. There are movements in some inputs to PPI & CPI that we think back up the market's expectations for lower inflation.
First, gas prices in October (national average) declined about half of 1%. Commodity prices were relatively stable. The Baltic Dry Index, costs of transporting raw materials, declined 17% in October. In addition, the National Rent Index fell 0.7% for the 2nd consecutive month and was the largest monthly decline in the history of the index. And, just in case you're thinking that it was a geographical phenomenon, the rent index fell in 89 of the 100 largest cities in October. Unit Labor Costs declined from +8.9% in Q2 to +3.5% in Q3 and were lower than expected.
What does all this mean? Well, October saw the S&P 500 Index rise 8.1% on a total return basis, which is the best month of 2022, so far. And, we enter the November to April stretch, which is historically the best 6-month stretch for equities in a Mid-term year since 1945. So, if the goal is to fight inflation, why does the Fed need to keep raising rates through March of next year? We will have to ask Mr. Powell that question. As Principal Vernon said in the movie, "Don't mess with the bull, young man, you'll get the horns." So, what's my role in all this, you ask? Just consider me the lowly Janitor, Carl, who's here to tell you, "By the way, that clock's 20 minutes fast."
Tell Me Your Troubles And Doubts. While things may be shaping up for a potential rally in equities, the economic picture is not all roses.
However, we don't need Mr. Powell to tell us that. The Housing Market is still reeling with the 30-year Mortgage Rate at 6.95%. The Housing Affordability Index, while improved over the past couple of months, is still at 5-year lows. Some green shoots have come up in the form of Mortgage Applications. Applications have been down for the past 6 consecutive weeks, but were just slightly down this week, which may indicate that investors are adjusting to higher rates. The Redbook Sales showed some life after dropping in early October. On a year-over-year basis, sales were up 9.7% last week.
The Jobs Report came out this morning and could be problematic for the "soft-pivot" crowd. The ADP Private Payrolls report on Wednesday showed 239,000 jobs added, which was higher than expected and higher than September. This morning's government report showed 261,000 jobs added, which was much more than expected. In addition, September's report was revised higher by 52,000 jobs. Many were equities to decline with a strong jobs report, as it would mean the Fed has more room to continue hiking rates. Yet, equities seem to be handling the number in-stride so far this morning. As I noted last week, the SKEW Index is still at 5-year lows and pointing to no out-sized returns for the S&P 500 Index, so any major moves would likely be temporary in nature. Either way, investors should treat the Fed how the Fed treated investors last year. All we heard from Mr. Powell was inflation was "transitory." So investors that are looking 6-9 months into the future should respond to Mr. Powell as Brian "the Brain" did in at the movie's conclusion:
"Dear Mr. Vernon,
We accept the fact that we had to sacrifice
a whole Saturday in detention for whatever
it was we did wrong. But we think you're
crazy to make us write an essay telling
you who we think we are. You see us as
you want to see us - in the simplest terms,
in the most convenient definitions. But what
we found out is that each one of us is a
brain, and an athlete, and a basket case, a
princess, and a criminal. Does that answer
The Breakfast Club"
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