Equity index returns increased during the holiday-shortened week, with the S&P 500 breaching 4,000 for the first time in two months. The possibility of the Fed slowing the pace of rate increases, along with some positive earnings reports from selected retail and tech stocks, spurred the market. Early in the week, news from China about a new round of lockdowns enforcing the zero-Covid policy and the ensuing civil unrest did little to rattle the general market.
On Wednesday, the minutes from the November 1 and 2 FOMC meetings were released. While most members supported the 75-basis-point rate hike in early November, the critical discussion focused on when the committee might slow the pace of future increases. Most of the FOMC participants of the survey thought a 50-basis point hike for the Fed funds rate at the December meeting was the most likely outcome. However, they also indicated the terminal rate would remain within the expected range.1 In previous tightening cycles dating back to the early 70s, the Fed funds rate increases terminated with real rates of return on Treasuries. (Real interest rate = nominal rate – rate of inflation.) The Taylor rule referred to on the Fed’s website, Monetary Policy and Principles and Practice, recommends the real interest rate should be 1.5 times the inflation rate. With the current rate of headline inflation running at close to 8 percent, Fed funds rate at 4 percent and Treasury yields under 4 percent, it appears the central bankers have more work ahead if inflation remains persistently higher from forces beyond their control. At a minimum, bond yields are likely to move higher.2
On Wednesday, the Census Bureau announced the October advance report of durable goods. New orders were up 1 percent, shipments were up 0.4 percent, unfilled orders were up 0.6 percent, inventories were up 0.2 percent, and capital goods nondefense new orders were up 1.3 percent. Considering inflation of 0.4% last month, the report reflects slowing conditions, which is common in a rising rate environment as demand slows.3 Initial unemployment claims for the week ending November 19 showed initial claims rising by 17,000 to 240,000. While climbing, the claims are within the recent range. Claims for all benefit programs decreased by 35,091 to 1,256,068.4
Also, on Wednesday, the S&P Global Flash US Composite PMI came in at 46.3 in November compared to 48.2 for October. The flash services reading was 46.1 versus the October reading of 47.8, the Manufacturing Output Index fell to 47.2 from 50.7 a month earlier, and the Manufacturing PMI decreased to 47.2 from 50.4. (A reading above 50 indicates expansions and a reading below 50 contractions.) The latest fall in output readings reflects steep downturns and is the second-fastest decline since May 2020.5 The University of Michigan’s November consumer sentiment survey revealed that consumers’ sentiments, views on current conditions, and expectations had fallen rapidly since the last readings. The index for Consumer Sentiment fell to 56.8 from 59.9, the Current Economic Conditions index dropped to 58.8 from 65.6, and the Index of Consumer Expectations fell to 55.6 from 56.2.6
We will continue to see choppy markets ahead as investors try to anticipate moves by the Fed, and as inflationary pressures impact consumer demand, we may see slowing economic activity in the coming months.
Sources:
1 https://www.federalreserve.gov/monetarypolicy/files/fomcminutes20221102.pdf
2 https://www.federalreserve.gov/monetarypolicy/policy-rules-and-how-policymakers-use-them.htm
3 https://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf
4 https://www.dol.gov/ui/data.pdf
5https://www.pmi.spglobal.com/Public/Home/PressRelease/d9ef5b8294e24a6f876372b65141b93
6 http://www.sca.isr.umich.edu/
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Warren Gerow is an independent investment wealth consultant to Sightline Wealth Management.
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