Don’t Fight the Fed
You know the saying…maybe it’s overused and that’s probably the case. However, every day I think about how this whole monetary policy thing is one big experiment. The very notion of centralized entities manipulating entire economies at the stroke of a pen. Anyway, enough of that and onto the issues at hand.
Let’s review what happened last week. On Wednesday, the FOMC released minutes from its last meeting. Stock market reaction was positive if not tempered, with the Dow Jones, Nasdaq, and S&P500 all posting modest gains. The dollar index (DXY) also fell but failed to make a lower low on the daily chart. Nick Timiraos from WSJ has some of best immediate reactions to these data releases, and as you can see, he’s highlighted the part about a “substantial majority”. There are growing concerns among committee members over moving too hard, too fast, and guaranteeing a recession in 2023.
The U.S. dollar extended losses on Thursday after minutes from the Fed’s November meeting strengthened our view that the central bank would downshift and raise rates in smaller increments starting in December. DXY is finding support at the pink line, but the larger, untapped support is still lower in that 102-104 range. It seems likely for that area to be tested at some point for a solid weekly higher low to be set.
Weekly DXY chart:
The weak dollar has really helped stocks and particularly the Dow Jones Index (DJI) which closed the week above its August high and only down 7.5% from ATH. We weren’t wrong when we started calling for a #MidtermRally around then.
Weekly DJI chart:
The midterm rally will likely be capped once DXY starts to reverse, so we need to be aware of that. DJI is coming up to some resistance levels, and exposure to stocks should probably be gradually reduced from here on out. It’s been a great run!
Daily DJI chart:
Now! Let’s talk about this week. All the fun starts on Wed, Nov. 30, when Fed Chair Powell takes the stage at Brookings Institution. This comes right before the PCE release (Fed’s preferred inflation gauge) on Thursday. We know that a 50bps hike is pretty much baked in, according to the Fedwatch Tool.
If you want to know where to focus on that day, pay close attention to how much weight he puts on the PCE and upcoming readings in general. To date, he’s has taken a highly data-centric approach. Oftentimes really important comments come in Q&A session afterward as well.
Labour Market
I suspect there will be a lot of talk about the labour market. Chief analyst at Nordea, Niels Christensen stated, “As long as the Fed see a stronger labour market, they don’t have a big concern about tightening”. Meaning the Fed likely believes it has somewhat of a cushion.
Core PCE
Core PCE is expected to come in at +0.3%. vs. +0.5% in September & 5.0% vs. 5.1% YoY. However, inflation has remained stickier than expected to date, so an upside surprise shouldn’t shock anyone. Again, it remains to see how much emphasis Powell is going to give this print.
Remember when everyone got excited that June was peak inflation? Then we came back with stronger numbers, showing that it’s still persistent.
ISM Manufacturing PMI
This chart says it all. It’s been declining consistently, and another drop to 49.8 is expected from 50.2 previous. Factory activity is in decline, which means companies are preparing for lower forward demand…basically getting ready for a stormy 2023.
Labour Market
If indeed manufacturing PMI continues to contract, that means we likely see more layoffs soon, and an overall decline in the labour market. We see that in the projected NFP number, which is expected to barely tip the 200k mark (208k); down significantly from October. That would also be a 12-month low.
Unemployment, on the other hand, remains at historical lows. The Fed’s tightening has done little to counteract this, despite the record-breaking rate hikes. This inflationary factor remains quite intrenched.
Which is why the labour market conversation is going to be particularly interesting this time. Does Powell see it as a roadblock or a speed bump? How will this affect policy after December?
That’s all for today! I hope you enjoyed it.
