February 23, 2023
Until last week, equity markets had been relatively resilient in the face of higher terminal rate expectations following the strong January Jobs Report.
A downward revision to Q4 GDP and upward revision to Q4 PCE inflation have investors cautious ahead of tomorrow’s core PCE print for January. Note that PCE is the last of the monthly inflation reports with expectations largely in place after hotter-than-expected January CPI and PPI reports. Meanwhile, US weekly jobless claims continue to signal tight labor market conditions after hitting a four week low this morning.
Yesterday’s release of Fed meeting minutes pressured equities on headlines stating ‘a few participants’ favored a 50bp hike. However, this shouldn’t surprise anyone given that recent speeches from Bullard, Mester and Kashkari seemed to suggest a preference for 50bp. The minutes also noted that ‘almost all’ participants favored a downshift to 25bp hikes and this week’s longer list of Fed speakers seem to endorse that path.
Press reports discuss the potential for a volatility spike based on the increased popularity of intraday option contracts called 0DTEs (Zero Days to Expiry). There’s also a focus on mortgage rates returning to highs from November and how the second half of last year produced the largest decline in home values since 2008.
Circling back to terminal rates, terminal Fed rate expectations had increased ~35bp through last Friday and the S&P 500 (SPX) was little changed. Six months ago, a rate backup of this magnitude would have resulted in ~10% pullback in the SPX. The relative resiliency in equity markets through last week was based on terminal rates only rising to match levels suggested in the most recent Fed dot plot at 5.25%. This week’s ~3% pullback in the SPX has resulted from terminal rates rising 10bp above Fed guidance. A perception that we’re nearing the end of the Fed’s tightening cycle may reduce the impact of higher rates on equity markets. Of course, that perception is dependent on a resumption in the disinflation trend. The most important near-term catalysts include: 1) US core PCE tomorrow; 2) Eurozone CPI next Thursday; 3) Powell’s Senate testimony on March 7; 4) US JOLTs job openings on March 8; 5) US Jobs Report March 10; 6) February US CPI on March 14.