Capital markets perspective: Differing views
Capital markets perspective: Differing views
Capital markets perspective: Differing views
While there is still some ambiguity built in, markets and policymakers still seem to have a very different view of the future direction of the federal funds rate, that all-important interest rate upon which all sorts of things like mortgages, credit card rates and bank profitability rely for direction. That communication breakdown was brought home last week in a very real way when the Federal Reserve announced its latest decision on rates.
Here’s what happened: On Wednesday, the Fed surprised exactly no one when it left rates alone for a second consecutive meeting of the Fed’s rate setting committee. In the post-decision press conference, Fed Chair Jerome Powell pointed out a few things that markets had already guessed would serve as justifications for that inaction:
- Inflation is a little less awful than it was a year ago
- Supply chains had come a long way toward healing themselves
- The labor market seems to be stabilizing
Also on the list was a “tightening of financial conditions,” which is to say that equity markets have been selling off recently and interest rates have been rising of their own accord. Said a little differently, markets are starting to do some of the Fed’s heavy lifting all by themselves.
Okay, so far, so good: No surprises.
Here’s what caught my eye (and ear) on Wednesday: At some point about midway through the press conference, Powell used the phrase “we’re close to the end,” apparently referring to the idea that the eighteen-month tightening cycle that took the Federal Funds rate from effectively zero to its current range of 5.25% – 5.50% was close to over. Equity markets seemed to take that to heart and promptly piled on a few more points.
But what Powell seemed to be saying was that the market believes we’re close to the end, not necessarily that the Fed itself does (and, as Powell again went to great pains to point out, the Fed is still relying very much on economic data for its cues). So it’s quite possible that investors took Powell’s remark almost entirely out of context and rallied on a description of their own marginally suspect behavior rather than actual guidance regarding where Fed policy may tack from here. If so, that puts last week’s rally in something of a different light.
But another, much bigger potential miscommunication was also on display last week: Namely, a yawning disagreement between markets and the Fed regarding how long rates will need to stay restrictive to finally get the Fed comfortable that inflation has been tamed.
There were really very few changes in tone between this Fed week and the last one back in September. Still part of the Fed’s narrative are things like “getting inflation back to 2% will likely require a period of below-trend growth and a softening of labor market conditions,” and the notion that it takes a long and unknowable period of time for tighter Fed policy to impact the real economy. That became a segue to “data dependence” – the idea that only actual results from the economy itself will sway Fed policy, not simply financial market returns (or someone’s hunch about what “neutral rate” does or doesn’t mean).
And then there was this: When asked specifically about when the Fed might be comfortable cutting rates, Powell replied that at this point, it’s still safe to say that “the Committee is not thinking about cutting rates at all.” That’s not exactly new either – Powell has been very careful and consistent with that message for months. But here’s the problem: Based on fed fund futures data, market consensus holds that the Fed will be in a position to cut rates as soon as next May.1 If Powell’s familiar comments about data dependence and the Committee’s own proclivities are taken at face value, that doesn’t seem terribly likely unless a very deep recession develops very soon. Seems inevitable that someone will eventually be wrong here.
Which brings us to our final example of potential miscommunication: the labor market. Non-farm payrolls expanded by 150,000 in September, only the third time below 200,000 since the COVID pandemic ended and about 30,000 less than economists expected.2 At first blush that’s probably good news given Powell’s comments about needing to see more balance in the labor market before the Fed gets comfortable continuing its pause, let alone before it starts to think about cutting rates. But one nuance that may have been missed on the most powerful week-on-week rally for stocks so far this year is that Friday’s figure included a loss of around 33,000 striking autoworkers that will almost certainly return to payrolls next month, assuming the tentative deals struck between the union and the Big Three pass muster with the membership. Add those jobs back to Friday’s payrolls figure and you’re almost exactly spot-on with consensus, and the labor market is looking a little less balanced again.
Truth be told, I’m still a little skeptical that last week was really all about a resetting of Fed expectations anyway. Instead, here’s an alternative explanation: the U.S. Treasury’s quarterly refunding statement.3 Think of it this way: Imagine if your significant other told you in advance how much they were planning to put on the credit card over the next three months. Nice, right? That’s what the U.S. Treasury does for us taxpayers: It warns us how much it plans to borrow on our behalf three to six months ahead of time.
Ordinarily, that kind of data generates nominal interest. But this time around, it matters – a lot. That’s because a big part of the current narrative is that a sustained increase in government spending and a continued catch-up from this summer’s debt-issuance hiatus is threatening to create an imbalance between the supply of new treasury debt (high and rising) and demand for it (flat to falling). In fact, that idea became one of the more common explanations for the recent run-up in interest rates, which until last week had marched notably higher, even though the Fed is sitting on the sidelines. But when this quarter’s data were released, it looked less than originally supposed: Instead of an expected $850b-plus during the December quarter, it looks like the figure will be closer to $776b.4
Relief surrounding that revelation was probably one of the reasons that U.S. treasuries had one of their best weeks in a long time: 10-year yields fell by 0.26% and 2-year yields dropped by 0.16% as investors piled in. Because falling interest rates are usually a good thing for stocks, that could go a fair distance toward explaining all the green at the top of this report.
Meanwhile, the U.S. economy continues to lurch along. If I hadn’t burned all our space riffing on the Fed, I’d spend a few lines explaining how third-quarter employment costs came in a little hot (+1.1% for the third quarter instead of the 1.0% predicted5), or how consumer confidence weakened (even if slightly fewer people are worried about a pending recession than they were at the beginning of the summer).6 Also cut for space is a discussion of how mixed earnings trends have become (tractor company Caterpillar was clocked after issuing “underwhelming guidance,” while semiconductor company ON was punished for the same, even as Starbuck’s shot higher after telling everyone that they aren’t seeing any slowdown in demand from the caffeinated).
As it is, though, you’ll just have to take my word for it: Last quarter’s 4.9% GDP growth notwithstanding, trends feel a little squishier as we enter the final two months of 2023.
What to watch this week
After last week’s datapalooza, this week will be almost unnaturally quiet. In terms of planned releases, Monday’s senior loan officer’s survey – a questionnaire that Fed officials send to bankers every three months asking them how willing they are (or aren’t) to extend new loans – is probably the main event. Recent editions of the survey have pointed to declines in both the availability of credit as well as demand for new borrowing, and this week’s release promises more of the same. So far, the so-called “SLOOS” is perhaps the most tangible evidence that all this Fed tightening is reaching the real economy.
Second on the list (primarily because there are only two – yes, two – meaningful releases on this week’s calendar) is the mid-month read of consumer sentiment from the University of Michigan, due Friday. Consumer attitudes are souring, albeit slowly, as high interest costs begin to bite and inflation remains stubbornly implanted in consumers’ psyches. Look for that weakness to continue as multiple headwinds – including a drying up of COVID-era excess savings, renewed student loan obligations and an increasingly uncertain jobs outlook – start to register.
In the political sphere is a potential for increased rhetoric surrounding government shutdown. After Mike Johnson secured the speaker’s chair on October 25, attention immediately turned to resolving the budget impasse that threatened to shut down the government earlier this fall. The issue comes to a head again on November 17, and while the impact of a shutdown may or may not heavily influence markets, it nonetheless remains a risk worth monitoring.
Finally, an active speaking calendar for Federal Reserve officials, including two separate appearances by Chair Powell on both Wednesday and Thursday could sway the debate about the direction of Fed policy and the economy more broadly. Fed officials typically break a self-imposed silence following FOMC week, and the active calendar in the wake of last week’s pause on rates is par for the course. Within the half-dozen or so high-profile Fed speeches on tap for this week, we’ll be on the lookout for any hint that Fed officials are leaning toward a renewal of rate increases in December or that Fed economists are increasingly skeptical of the economy’s ability to land safely.
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