Capital markets perspective: Game, set, match

Capital markets perspective: Game, set, match 


Ordinarily, after the Federal Reserve Board announces a decision on interest rates, stock and bond markets ping-pong back and forth while the post-decision press conference is on air. 

But this one, which came on the heels of a widely expected decision to leave rates alone on Wednesday afternoon, was stunning for its almost complete lack of highs and lows. Still, there were plenty of highlights, such as early in the press conference when Fed Chair Jerome Powell said that inflation data – including a very encouraging Consumer Price Index print released to the public on Wednesday morning1 – had not yet given the Federal Open Market Committee (FOMC) the greater confidence needed to begin cutting rates.2 That’s not exactly bullish. Then, a little less than halfway through, Powell said the Fed believes its policy is restrictive and is having the desired impact. Add to this the repositioning from “lack of progress on inflation” to “modest progress” (bullish) and the fact that the dot-plot was downgraded from two or three cuts in 2024 to just one (bearish): There were plenty of reasons to expect markets to react in real-time.

And yet equity markets barely moved during the entire time press conference. A calm in the wake of this kind of commentary is highly unusual – particularly when Fed policy is so critical to the market narrative. 

But from my perspective, maybe the most significant statement of all was a two-parter: Early on, Powell mentioned that if labor markets weaken more than expected, he and the committee were prepared to begin cutting rates. At the very end of the Q&A session, when asked to clarify what might qualify as “unexpected weakness in the labor market,” Powell responded that if the unemployment rate came in higher than forecast, it would catch his attention.

The Fed’s own staff economists now predict that unemployment will finish 2024 at 4.0% — a forecast published alongside Wednesday’s rate decision in the form of the Staff Economic Projections, which are updated during at the conclusion of every regular FOMC meeting in March, June, September and December.3 Less than a week before, the Bureau of Labor Statistics had reported that the U.S. unemployment rate had risen to exactly 4.0%. So any further increase in unemployment this month or next would technically qualify as “higher than forecast” and therefore put rate cuts squarely on the table, per Powell’s statement.

This is hardly just an academic exercise or a pedantic over-reliance on semantics: On Thursday, the day following the Fed’s decision and Powell’s perspective around 4.0% unemployment, weekly unemployment claims surged to 242,000 – still relatively low in an historical context, but also the highest level since last August and only a stone’s throw from the post-COVID recovery peak of 261,000.4

What should we take from all this? Maybe the market’s lack of reaction to the Fed’s alternating soft lobs and blistering aces during the post-decision press conference was somehow related to an intuitive understanding that the Fed has recognized the signs of a softer jobs market and is closer to cutting rates than it can admit in public. More likely, it’s some version of that sentiment combined with last week’s tangible evidence that inflation might indeed be well on its way to being beaten (thanks to Wednesday’s fortunately timed Consumer Price Index release).

Either way, it seems to me as if the watered-down action/reaction function that allowed markets to hold onto Wednesday’s early CPI-inspired gains with shocking passivity despite plenty of excuses to do otherwise is, at its root, related to hopes that the Fed will begin cutting sooner than the Bloomberg World Interest Rate Probability screens or Chicago Mercantile Exchange data (or the Fed’s own commentary) might suggest. And that should be good news, right? Well, not so fast: As we’ve tried to point out here and elsewhere, sometimes it’s only after the central bank starts cutting rates that markets become volatile and start to struggle. Need evidence? Look north and east: Earlier this month, both the Bank of Canada and the European Central bank became the first G-7 central banks to cut rates this cycle, and since then markets in both regions have underperformed the U.S. – where rates are still on hold – by wide margins.

Finally, here’s one entry in the “odds-and-ends” column: On Friday, the University of Michigan reported that consumer sentiment had taken an ugly leg down, with the “current conditions” component down nearly 10 points versus economists’ expectations.5 Particularly interesting was evidence that high-income consumers are starting to have concerns about stagnating incomes and the influence of higher prices on their household finances. If, as I suspect, we’re about to find out once and for all whether the Fed has truly stuck the “soft landing,” it’s consumers who will have the final say – and Friday’s disappointment probably isn’t what anyone wants to hear them chattering about.

What to watch this week

This is a fairly crowded week from a data perspective. We’ll get several looks at the state of the U.S. housing market, including Wednesday’s homebuilder sentiment survey from the National Association of Homebuilders, housing starts and permits from the Census Bureau (Thursday), and existing home sales (Friday). For more context, at least two homebuilders are also set to release earnings this week: Lennar on Monday and KB Homes on Tuesday. At this point in the cycle, housing is arguably even more critical to the economic narrative than usual: Demand for homes always carries a significant knock-on effect for other sources of consumer demand, making it a crucial piece of the puzzle if there is any case to be made for a pending improvement in consumer spending. But even more important at this point is the signal that housing demand may contain regarding the health of the labor market – which is of course a key lynchpin for the economy in general. For example, if affordability improves (via some combination lower mortgage rates and/or moderating home prices), it should spur transaction volumes. If it doesn’t, that’s a sure sign that something else isn’t working the way it should.

Speaking of the consumer, we’ll get an opportunity to see if last Friday’s results from the UofM’s consumer sentiment survey translated into less consumer activity on Tuesday when retail sales data for May is released. While the data are somewhat noisy, at least some softening has been evident in recent reports – particularly in categories that appear most attuned to the economic cycle, like furniture, autos and other discretionary items. Tune in on Tuesday to find out if this trend has continued into May.

We’ll also get our first two regional Fed manufacturing reports for June, Empire State on Monday and Philly Fed on Friday. These reports always make for interesting reading. While limited in scope (each survey is relevant only to manufacturing and only to businesses in their respective Fed regions), they provide fascinating insights into things like employment, prices, margins and other data points to help you paint a picture of the U.S. economy. Couple those reports with the preliminary Purchasing Managers’ Indices for June, due out on Friday, as well as the industrial production/capacity utilization release on Tuesday, and we should have more clarity into trends on the productive side of the economy by the end of this week.

Finally, the Conference Board will publish its Index of Leading Economic Indicators on Friday. I tend to de-emphasize LEI data when the economy is operating at a steady-state/between-the-peaks-and-valleys kind of tempo. But at inflection points – like where I believe we currently stand – it can be very interesting. Pay particular attention to the Conference Board’s “recession warning” tag, as well as the gap between leading and coincident indicators as a way to triangulate which direction the economy may break from here.  

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Tom Nun, CFA


Tom Nun, CFA, Portfolio Strategist at Empower, works alongside teams overseeing portfolio construction, advice solutions, portfolio management, and investment products and consulting.

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