Inside Markets — The Fed Put

Friday’s Jobs Report was the fourth consecutive January where non-farm payrolls doubled consensus estimates.  This is due to a large seasonal adjustment in January to account for an expected increase in layoffs. Recent jobless claims data suggest a relatively low level of layoffs, but this may be in the process of changing (see above).  Friday’s report also saw a big increase in wages that may also be ‘one time’ in nature. The BLS survey was conducted during a week that included very bad weather patterns that resulted in a much shorter average workweek. The shorter workweek resulted in higher ‘average hourly earnings’ or wages.  Note the Q4 Employment Cost Index (ECI), which is a higher quality measure of wage growth, dropped to +0.9% from +1.1% in Q3.

We continue to look for a series of rate cuts beginning in June when YoY core PCE is likely to fall to 2.2%.  There’s a chance for this to happen earlier with rate cuts beginning in May.

Last week’s widely expected change in Fed guidance to a ‘neutral’ stance is important because it reestablishes the so called ‘Fed put.’  It’s the idea that the Fed is ready, willing and able to cut rates at the first sign of economic weakness.  For some, the Fed put established a psychological floor under equity markets. That may be true, but the floor is pretty low in our opinion.

Investors have added gross risk to their portfolios since November.  The addition of risk adds increased downside potential once equity volatility reaches elevated levels. In VIX terms, levels above 20-22 are generally considered elevated.  For now, the macro environment looks fairly benign (won’t last forever), which tends to compress volatility (VIX now 13.7) and expand valuations (SPX now ~20x forward EPS). VIX levels north of 20-22 will be our indicator to become more defensively positioned.