January 23, 2023

Weekly Market
Update

The Fed Isn’t Satisfied and the Market Isn’t Listening

  • Last week, the S&P 500 shed -0.66%
  • The Dow Jones index -2.70%
  • The Nasdaq composite rose 0.55%, amid weaker-than-expected December Industrial Production and Retail Sales readings
  • The Fed looks poised to raise rates by another 25bps on February 1 into an already slowing economy with moderating inflation, and to message their continued resolve to fight inflation

3 Things to Know

A soft landing may not be coming

The recent rally in financial markets will only compel the Fed to step up its rhetoric and make it more likely to hold peak rates. Though the Fed’s next rate hikes are likely to be “only” 25 basis points, the cumulative power of its medicine is still pumping through the economy.

Policymakers are insufficiently patient with the present decline in inflation. Despite many data points showing inflation abating, the Fed’s focus on a “2%” rate of inflation is narrowing their field of vision.

More fiscal restraint in combination with an already slowing economy makes talk of a “soft landing” look far-fetched. While CGWI doesn’t expect US employment data to fall until later in the first quarter 2023, we do see the recent ISM, retail and housing data as being sufficient to presage a recession that can, for a time, further depress asset prices and weaken credit markets.

What does this mean for investors?

A recession is on its way. CGWI Office of the Chief Investment Strategist (OCIS) sees signs of it appearing with greater clarity month over month. Expect more market volatility in the US as well as market corrections to return before anticipating a lasting recovery.

Fed officials know that inflation measures lag movements in the real economy but have chosen to largely look at backward data to justify further action. It is becoming clear Fed policymakers are insufficiently patient with the present decline in inflation.

They’re now more narrowly focused on getting inflation, however defined, down to their “hard target” of 2%. A slowdown to the 2% pace is most likely to be hit only in 2024 after a drop in US employment.

Sadly, the loss of jobs and economic growth will have relatively little impact on inflation. Stimulus and supply disruptions of the past two years were the primary sources of inflation.

What does this mean for investors?

Our assessment is that inflation will decelerate and bottom at pre-Covid norms in years to come. While new or worsening supply shocks amid geopolitical conflicts remain the larger exogenous risks, inflation may remain more persistent in a few areas of the US economy.

The Fed wants a rise in unemployment

Fed Chairman Powell recently noted that shelter price measures will keep rising even as new rental agreements will show lower rents. He also noted how wage gains remain inconsistent with 2% inflation.

Other Fed policymakers appear likely to keep warning markets about the need to build up labor market “slack.” It appears clear the Fed wants a rise in unemployment, a clear sign of recession.

CGWI believes the housing downturn and surge in consumer goods inventories will result in US job losses in 2023, including services positions that support the goods sector. Wage gains are already decelerating and the total hours of work fell in the past two months.

US employment measures in January are particularly difficult to rely on because of seasonal adjustments typical at the start of every year.