10/02/2023 Market Strategy
Take It To the Limit One More Time
Cooler heads prevailed over the weekend avoiding a government shutdown
Key Takeaways
- With the government shutdown averted (for now) the markets will turn their attention this week to this spate of economic data on offer, including the ISM surveys and nonfarm payrolls report.
- In our view the bond market appears to have a better grasp on the path that the Fed is taking to stem inflation than the stock market does. Equity markets appear to expect an end to the Fed’s cycle sooner than is likely to be realized.
- Last week’s economic data showed core inflation, as measured by the PCE deflator, moderating in August. The rise of just 0.1% from July to August in the core measure was lower than the 0.2% monthly rise forecast.
The agreement reached by Congress on Saturday avoided a government shutdown for now as cooler heads prevailed. The compromise arrived on Saturday by legislators will keep the government running until November 17 allowing time for further negotiation on Capitol Hill.
While government shutdowns have historically not often presented the hurdles for US markets that many market participants may have anticipated Moody’s rating agency recently expressed concerns that a shutdown this cycle might lead to its downgrading debt of the US based on concerns the rating agency has about political dysfunction in Congress and the size of the US current debt. That concern may well have served at least in part as an overhang of worry this time around that may have opened the door for the last minute agreement.
With government shutdown risk moved a month and a half down the road markets this week will likely focus on a brace of economic data that will provide updates on the economy tied to a diverse set of data covering manufacturing and services firms (the ISM surveys), and housing. The data flow culminates on Friday with the monthly jobs report, which will have key data on the change in nonfarm employment, hours worked, average hourly earnings, the unemployment rate, and the labor force participation rate. The week’s data will be the first indicators of economic activity for September, the final month of the third quarter.
Last week’s inflation data suggested that while the Federal Reserve has made considerable progress against untoward levels of inflation it still has more work to do before it can declare an end to the current rate hike cycle or even initiate an extended pause.
Thus far the resilience that the US economy has shown this year would suggest to us that a chance for a rate cut is not near. We persist with a view that the Fed might need to raise one more time this year and may have to raise at least one more time in the first half of next year should inflation remain sticky. We look for the potential for an extended pause in the latter part of the first half of next year with the possibility of a rate cut in the second half of 2024 if warranted.
Where are we now?
In our view the bond market would appear by its actions to have a better grasp on what (and how) the Fed is addressing inflation this cycle while the equity market appears to be offering resistance to taking the medicine the Fed has given thus far and may have to continue to dole out before the current rate hike cycle draws to a conclusion.
In some ways the current spate of weakness exhibited in the stock market (since the start of August through the end of September) feels like a lobbying effort by leveraged operators in the market directed towards the Fed looking to effect a policy change akin to the pivot that followed the selloff in the fourth quarter of 2018. (The Fed’s prior rate hike cycle ran from December 2015 through December 2018).
Ironically our experience over four decades in the markets tells us stock prices can actually rise during rate hike cycles that are in process and lead to normalized interest rates after periods of economic and market crisis that had led to interest rates bottoming.
We have been of the view for some time that “the end of free money” wrought by emergency monetary policy and turbo charged by fiscal policy is a good thing. A market environment where bond issuers pay for the privilege of borrowing money and bond buyers receive in exchange meaningful coupon levels can create the potential for an environment which discourages irrational exuberance across asset classes that can feed bubble creation and unreasonable levels of volatility driven by speculation.
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