The rebound on Wall Street dodged a bullet Friday, when stocks managed to avoid losses despite a jobs report which plainly argued for a hawkish Fed.
The robust NFP headline would’ve been enough to make the hawks’ case on its own, but wage growth running at twice the expected monthly pace was a material setback in the inflation fight, and the downtick in participation was insult to injury.
Nevertheless, US equities were flat, and finished the week with a decent gain despite falling in four of five sessions. The simplest of simple charts (below) says it all: Speculation around an imminent reduction in the pace of Fed hikes on the (still tenuous) notion that inflation has inflected is responsible for pretty much all of the recent gains.
US equities were up 1% this week. That was due entirely to Wednesday’s 3% rally, inspired by Jerome Powell’s Brookings address. The S&P rose 5.4% in November. Stocks rose 5.5% on November 10, following October’s cooler-than-expected CPI report.
On Thursday, I talked at length about the significance of Powell’s decision not to step on the two-month rebound in stocks, which was accompanied by relief for bonds and the worst month for the previously bulletproof dollar in a dozen years. Powell, it would seem, is now comfortable (or, at the least, not entirely uncomfortable) with markets trading the step-down in the pace of rate hikes bullishly as the Fed moves into the next (and perhaps final) phase of the tightening cycle.
For Goldman, the easing in financial conditions may ultimately be self-defeating. That’s according to the bank’s Kamakshya Trivedi, who noted that financial conditions have now retraced substantially all of the tightening seen since mid-year (figure below).
Consider that the recent FCI easing impulse put Goldman’s index back to levels reached on the day Nick Timiraos tipped the Fed’s intention to hike rates by 75bps at the June meeting, the first in what would end up being four consecutive three-quarter point moves.
“While this is perhaps unsurprising given the Fed’s stated plans to slow the pace of rate hikes, it is also likely unsustainable,” Trivedi said, of the unwind in FCI tightening. “While we agree in principle that the ultimate destination of the policy rate should matter more than the pace of hikes, setting a slower course tends to ease financial conditions by lowering rate vol and tilting the market to respond more to downside surprises.” That could be problematic if it holds going forward.
Trivedi went on to emphasize that Powell “did not express any apparent unease this week with the recent market moves.” That, in Goldman’s view, may make “it hard for the dollar to regain lost ground in the near-term.” At some point, the Fed will probably attempt to communicate the likelihood of a downshift to “regular” 25bps hikes starting in February, which could exacerbate the dynamic.
Powell is cognizant of the above. If it goes too far (say, in a Santa Claus rally), he could push back. “Ultimately, we think the recent market moves could prove self-defeating,” Goldman said late Friday. “Especially if the FCI impulse to 2023 growth turns more clearly positive.”
The Fomc is charged with balancing employment and inflation, and providing a stable banking system through regulation and other policies. Employment is good, maybe more than good, banking is stable except for crypto-hah, and inflation is too high. So they are raising rates and engaging in qt. The rest of the analysis is important but it often looks like naval gazing.
I believe that those who run money are historically offside from the market this year, badly positioned vis a vis their benchmarks. At year end, they will be judged on that performance and their year end bonuses, which usually represent a very large percentage of their annual compensation, may suffer considerably as a result. Traders, knowing this, have been bullying them into buying to keep up with the market, on every possible glimmer of good news, since the massive reversal day, Oct. 13, that started this rally. Sometimes, like with Powell’s speech, the glimmer is questionable at best. But the traders use it as a plausible trigger anyway and start buying, the shorts start covering and that sudden, unexpected stab higher forces the money managers to start buying, hating it all the while, but afraid of increasing their underperformance, if they don’t jump aboard.
If Powell is chill about the rally, perhaps he suspects it will come to a sudden halt with the end of the year. Certainly, I will be raising cash into year end, as that driver of this rally disappears. I suspect a much better buying opportunity this spring when we make a lower low.
I don’t think Powell was throwing the markets a bone this week, but actually may have managed a rare needle threading. He leaned hawkish, in service of the systemic risks he sees gathering (illiquidity) and perhaps as a reminder to the quant crews that their NIRP and ZIRP-based models are not likely coming back into vogue anytime soon, while also not freaking out the market with hard-landing or bust concerns on talks of higher than anticipated terminal rates for longer.
And as H has said, it seems only a matter of time until one of the maddeningly fluctuating data releases does Powell’s dirty work for him without him changing a thing. But the market is so frothy to front run a Fed pivot or China reopening, that any combo of spiky employment, spiky inflation or spiky Covid is likely to be just as good as another 75 bp hike in terms of FCI.