Hawks Die Hard Despite Lower Inflation
It has become apparent that last week's CPI surprise and this week's PPI surprise had many market actors unprepared. The Fed has access to all of the data points (and more) that we do, so I don't think they were surprised by the inflation print, but they were clearly surprised by the market's reaction to the upside. Hedge Funds and Institutional traders seemed to also be surprised by the market's movement.
Those with a recessionary view or a hawkish view toward rates are finding it hard to pivot and are willing to die on that particular hill. That leads us into this week's inspiration for market musings - 1988's 7th highest grossing movie "Die Hard." This movie is typically debated about this time of year as to whether or not it's truly a Christmas movie (it's definitely NOT, so feel free to debate me in the comments section). The movie cost $28 million to make, but was a surprise hit and grossed more than $141 million worldwide. The movie executives weren't really sure the film would pass muster at the box office as they were afraid to put Bruce Willis' picture on the movie poster (as shown). The original movie poster had just the Nakatomi Plaza, until the movie's initial success at the box office, then Willis' image was later added. There's so much great trivia about this movie:
Alan Rickman didn't even want to play Hans Gruber; he had literally just arrived in Hollywood 2 days prior to filming after an already successful career in TV and theater.
The fictional Nakatomi Plaza was actually the headquarters of the studio producing the film - 20th Century Studios - and much of the filming took place on empty floors of the building.
Many of the lines of dialogue were ad-libbed, such as "Hans...Bubby," as the script was constantly being re-written throughout filming. By the way, Rickman's response to that particular line is genuine.
When Sgt. Powell is circling the Nakatomi front drive, MaClane looks on saying, "Who's driving this car, Stevie Wonder?" At the same time, Argyle the limo driver is parked in the Nakatomi garage listening to Stevie Wonder's hit song "Skeletons".
Here's what we're seeing so far this week...
That's A Very Nice Suit. Last week, the October release of CPI showed a considerable decline in the year-over-year measure of inflation from 8.2% to 7.7%.
This week, it was followed up by a similar move in the year-over-year measure of the other inflation metric, PPI. The Producer Price Index dropped in October from 8.5% to 8.0%. Inflation has most definitely peaked and it's got the Fed all in a tizzy. Fed Governor Chris Waller (St. Louis) was quoted on Sunday as saying, “It was just one data point. The market seems to have gotten way out in front over this one CPI report. Everybody should just take a deep breath, calm down. We’ve got a ways to go.” In other words, according to the Fed, the data doesn't support our narrative, so now we've got to make markets believe more rate hikes are necessary. Just last week, both Harker (Philadelphia) and Logan (Dallas) from the Fed had hinted the Committee would have to start slowing their pace of rate increases.
Fed futures have consistently moved further away from a 75 basis point rate hike next month to a 50 basis point hike, since last week's inflation revelation. On top of that, bond interest rates are trying to tell us something, as well. Prior to the CPI release last week, the yield on the 10-year Treasury Bond has been steadily above 3.9% for the past month. On Thursday of last week, the yield dropped 28 basis points after the CPI release, and on Tuesday the yield dropped another 6 basis points following the PPI release. The yield on the 10-year is near two-month lows, which leaves Fed Chairman Powell with a conundrum. Can he keep the troops in line on the Committee for future rate hikes or will he be forced to negotiate like Hans Gruber with Josef Takagi, "That's a very nice suit, Mr. Takagi. It would be a shame to ruin it."
Yippee-ki-yay. Despite some good economic news this week and last week, some Fed members are intent on moving forward regardless of whether or not the data has changed.
While rising inflation and interest rates hurt consumers in Q1 and Q2 (i.e., the "technical" recession), consumers have emerged on the other side and are still spending. October Retail Sales came in higher than expected. September's number was 0.0% growth in Retail Sales, while October's number came in at +1.3% versus expected +1.0%. At the same time, Housing and Manufacturing are still struggling.
The latest NAHB Housing Market Index hit a level of 33 this week, which is just 3 points off the pandemic low of 30 in April of 2020. While there was some encouraging news in housing, as Weekly Mortgage Applications were up 2.7% this week - the first time that number has been positive in 9 consecutive weeks - the housing market is still languishing with all major metrics near multi-year lows. Manufacturing is mixed at best, with only 2 of the major regions showing positive expansion. If this is the case, why would St. Louis Fed President Bullard indicate this week that the Fed's rate policy hasn't been "restrictive" enough? At an economic development speech in Louisville today, Bullard stated, "To attain a sufficiently restrictive level, the policy rate will need to be increased further.” So is the Fed's intent to push us into a deeper recession than the one we experienced in early 2022? At this point I feel like John McClane against the group of hawkish Fed governors. In the famous exchange with Hans Gruber, who asks McClane, "Do you really think you have a change against us, Mr. Cowboy?" And John responds, "Yippee-ki-yay, _______________."
Welcome To The Party, Pal. Some other good news this week is that there are buyers out there in the equity markets.
As we noted last week, holiday sales are expected to be higher this year, with all indications from the Redbook & Retail Sales figures supporting that view, and GDP for the 4th quarter is expected to be +4.0%. This has buyers interested in equities. The latest number for the NAAIM (National Association of Active Investment Managers) shows equity exposure of 65%, which is a three-month high.
Long/Short managers have now allocated to the highest long leverage since August. In fact, Hedge Funds and CTAs are covering their short positions at the highest pace since January of 2021 and the COVID crash in 2020. On top of that, we have not seen an explosion of High Yield to Credit Spreads. Unlike previous recessions (and the 3 months of the COVID crash), spreads are very low by recessionary standards. This gives us some faith in equities here in the short term, especially with corporate buybacks in full swing going into year-end. When it comes to allocating some dry power to equities over the next few weeks, we would echo Mr. McClane...
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