February 28, 2023
February US growth data disappoints for a second day with consumer confidence, Chicago PMI and Richmond Fed Index all missing expectations. A small decline in 12-month inflation expectations from the consumer confidence survey was the only bright spot. We also received hotter-than-expected CPIs out of France and Spain, which drove terminal ECB rate expectations 100bp beyond the current deposit rate. The ECB’s Lane said the tightening cycle will continue until the central bank is confident in reaching its 2% inflation target. Overnight reports note that rapidly falling freight rates have yet to impact prices because shipping companies use 1-2 year contracts.
Tomorrow, we receive more growth-related data with February ISM manufacturing expected to improve MoM but remain in contraction. Upcoming US inflation-related catalysts include Powell’s Senate testimony on March 7, the February Jobs Report on March 10 and February CPI on March 14.
US equities remain relatively resilient despite higher short-dated bond yields. Terminal rate expectations have risen nearly 60bp since the strong January payroll data in early February, while the S&P 500 (SPX) has pulled back ~4.5%. Last year, a rate backup of this magnitude would have generated at least twice as much downside. The disconnect between bond yields and equity performance in early February was linked to an emerging ‘no-landing’ scenario that followed stronger January growth data. The ‘no-landing’ theme is now facing a challenge with early February data surprising to the downside. Two days of disappointing growth data is unlikely to shift the prevailing near-term narrative, but more growth disappointments will. If sustained, higher-for-longer rates will generate a higher cost of capital, lower profit margins, lower corporate investment and demand destruction with lower rates of inflation. Achieving lower rates of inflation without the pain seems highly unlikely, and achieving a cyclical recovery without expanding money supply is even more unlikely. Year-over-year money supply growth in the US is usually in the low single digits. The cyclical boom that followed the pandemic was based on unprecedented money supply growth that reached a record of +27% in February 2021. US money supply growth is now in outright contraction, real wage growth is negative and floating rate debt is beginning to reset. We maintain a tactically bearish outlook for the S&P 500 (SPX), Nasdaq 100 (NDX) and especially the Russell 2000 (RTY) where companies are more exposed to floating rate debt.