Has The Fed Lost Respect?
Per usual, the Fed has been all over the place this week in prepared remarks. As a result, the markets have been up-and-down in trading this week.
Most interestingly, the Zoom call with Fed Governor Waller was hijacked on Thursday (more on that in a minute), which begs the question, has the Fed's policy of speaking out of both sides of their mouth finally caught up with them. It reminds me of the famous hit song by Aretha Franklin, "Respect." Otis Redding originally recorded this song in 1965, reaching as high as #35 on the US charts. Franklin's cover, however, is by far the most well-known version and it reached #1 on the US charts. Aretha's version add the "sock it to me" refrain and she played the piano on the original recording. Also added to the song is the "ree, ree, ree, ree" refrain, which is a reference to Franklin's nickname "Ree" (as in A-Ree-tha). Once Aretha's version hit the airwaves, Otis Redding told Jerry Wexler, producer of Aretha's version, "This girl has taken that song me. Ain't no longer my song. From now on, it belongs to her."
"What you want, baby, I got it
What you need, do you know I got it?
All I'm askin' is for a little respect when you get home
(Just a little bit) hey, baby
(Just a little bit) when you get home
(Just a little bit) mister
(Just a little bit)"
Here's what we've seen from the markets this week...
R.E.S.P.E.C.T. In addition to the back-and-forth from the Fed over, really the last two years, it's conceivable that the market and investors have lost respect for the Fed. Just this week alone, Fed Governor Bostic was hawkish on Wednesday and dovish on Thursday in his speaking appearances.
Perhaps in today's prepared remarks he'll be "owlish?" If that weren't enough, Fed Governor Waller's speech over Zoom that was scheduled for Thursday was cancelled when one attendee displayed pornographic images to all the viewers on the call. According to the Fed, the speech was cancelled due to "technical difficulties." Markets have been up-and-down this week, but not as tumultuous as you would expect given the Fed's back-and-forth. Lower unemployment claims helped ease concerns yesterday. Both Initial Claims and Continuing Claims were lower-than-expected and lower than the previous week.
This is providing hopes that the labor market is still on solid ground and that next week's Jobs Report will verify an economy that can handle the few rate hikes left. You see, since the consumer is two-thirds of GDP and employed consumers are likely to keep spending, a "soft landing" is certain within the realm of possibility. This idea is further supported by the latest GDP expectations for Q1 by the Federal Reserve of Atlanta. Their GDPNow estimate called for +2.3% for Q1, up from the original forecast of +0.7% in late January. Why the difference? Simply put, consumer spending. Consumer Spending was expected to contribute 1.2% to GDP and now is estimated at 2.5% of GDP.
Respect for the Data. What investors need to focus on now is the data and less on which way the Fed wind blows. In order to do that, we have to look at what we expect the Fed to do and move on.
Right now, the futures market is expecting 25 basis points at the March meeting, 25 basis points at the May meeting, and it's a toss-up between 25 bps or no hike in June. After that, the futures for the back half of 2023 expect zero hikes. But, doesn't Fed rate hiking cycles lead to recessions, you ask? Since 1955, Fed rate hiking cycles have led to 9 recessions (not including 2020, due to COVID anomaly). However, in 4 other instances, the hiking cycle did not lead to recession. While the 4 that did not end in recession do not seem to have much of a common denominator, the other 9 do seem to have something in common. With the exception of 1955-57 cycle, all of the other 8 cycles that led to recessions all began with a Fed funds rate equal to or greater than 1%. Where was the Fed Funds Rate last year when the Fed began this latest hiking cycle? It was the lowest ever (just above zero), going back to 1955. Also, in terms of how much the Fed increased rates during the cycle, this most recent cycle is only the 5th highest - with 1967, 1972, 1977, and 1980 being the highest. Even if we get three more hikes in 2023 and the Fed pauses, this cycle will only be the 4th highest. So, while it seems tough right now, things were worse in 1977 when the Fed raised rates more than 1000 basis points when the Fed Funds rate was already 4.66%!
The mortgage market has taken a step back the last couple of weeks as the Fed's hawkish language has caused mortgage rates to increase.
The 30-year mortgage rate peaked in November of last year at 7.08%. It had dropped to 6.09% by early February. At that point, we had seen a considerable uptick in mortgage applications. However, the FOMC minutes and multiple Fed speakers caused the 30-year rate to increase back up to 6.65%, with mortgage applications dropping as well. On the positive side, the overall housing market data has improved.
Existing Home Sales, a lagging indicator, seems to have flattened over the last 3 months, while New Home Sales and Pending Home Sales have picked up over the last few months. Pending Home Sales, a leading indicator, it at the highest level since August of last year. As we noted earlier, the consumer is still spending money. Vehicle Sales, while less than expected, were nearly 3 million in February, which is 16% higher than the low set in November of 2021. Redbook Sales were up 5.3% last week, even with the previous week. While the Manufacturing PMIs were lower than expected, there were still up higher in February than the previous month. The Services PMIs were higher than expected, but split compared to January's reading.
The key going forward is how does the consumer respond to further rate hikes and how well does the labor market hold up. If we get into a scenario where companies start massive layoffs and consumers slow or stop spending, recession is likely on the horizon. If companies continue hiring and/or avoid considerable layoffs, consumer will likely keep spending. The 2nd full week in March will bring February's Inflation numbers, which will provide some hint of how many more rate hikes we will have to endure. So far, the early market expectations are for a decline in the February CPI & PPI data. We shall see.
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