WEEKLY: Didn't see that coming!
Week ended Dec 2, 2022
Investors were wrong-footed again, not by the Fed this time, but by the data. Before I dig into this deeper, let me give you the good news.
November was an excellent month for equity investors in the US, the second month running. Equally important, the bond market also had a good month for a change. Investors are looking at what just might turn out to be the first positive quarter for stocks in the US this year, assuming that we can avoid crumbling in December. The strong performance in equities wasn’t confined to the US though, as all of the global indices I track were positive in November. The star performer was emerging markets equities (MSCI EM index) which benefitted from a weaker U.S. Dollar. I’ll discuss markets more below, but let’s just say that November was solid if not spectacular - the way I like it - until things got a bit nutty on Wednesday afternoon, following Fed Chair Powell’s speech at the Brookings Institute (watch here, just over one hour including Q&A). The themes that were presented by Mr Powell were of course well telegraphed ahead of his actual speech, and – at least from my perspective – the presentation/Q&A offered no real new information. Mr Powell stuck closely to the Fed’s “house view”, the central theme being that the Fed would probably reduce the increments of increases in the Fed Funds rate going forward to better understand how inflation and the broader economy were reacting to tighter monetary policy. This approach certainly makes sense. Translating this into action steps, it meant that a 50bps increase in the Fed Funds rate is likely at the next FOMC meeting scheduled for Dec 13-14. Mr Powell stressed that
getting inflation under control was his number one priority,
the Fed would continue to focus on the economic data as far as determining future policy steps, and
wage inflation remained a key concern.
For some reason, investors interpreted these words as a dovish tilt, latching onto this narrative as equities took off like a rocket in the last 2.5 hours of Wednesday’s US trading session. Maybe this is just another case of FOMO gripping equity markets, and the adults in the room should instead focus on the bond market’s reaction. That’s the market I would trust more anyway. However, bonds also rallied Wednesday afternoon and into Thursday’s close, with yields falling around 20bps across the curve over this period. It all suddenly looked so positive as inflation was vanquished at no economic cost. What a lovely fantasy that turned out to be. No sooner had stocks stabilised on Thursday as many investors were scratching their heads asking “what just happened”, than the US jobs data for November was released Friday morning before the U.S. open. The US unemployment rate didn’t move (3.7%), but there were more jobs added than consensus expectations and wages were up 0.6% MoM (5.1% YoY). Overall, the report showed continued strength and resiliency in the US labour market and – more bothersome as far as the fight to reduce inflation – higher-than-expected wage increases (i.e. wage inflation). A price-wage spiral is just the scenario that Mr Powell and his Fed cohorts (and plenty of investors) fear, and this jobs report was a cold slap in the face in this respect. Both bonds and equities tanked on Friday morning following the release of the jobs report data, as the reality of inflation being conquered quickly and easily, opening the door for a Fed pivot, quickly melted away. The bond market is now more emphatically screaming “recession” than ever, as the inverted yield curve (2y-10y yield difference) steepened to its most negative level this cycle (–77bps end of week). What does this mean going forward? A far as I am concerned, nothing has really changed. The Fed’s challenge will continue to be to thread the eye of a needle by containing inflation without wrecking the US economy. It’s possible, but it’s not likely because it would take both precision and luck. The road ahead will be difficult and volatile, with the latter worsened by investors having visceral reactions to data suggesting one extreme or the other. Wednesday felt like an old-fashioned case of FOMO to me – a rally driven by momentum that “couldn’t be missed”.
What we need instead is a slow grind forward which is orderly and grounded in fundamentals, similar to what characterised much of October and November. What we do not need are emotional price gaps like we experienced on Wednesday afternoon. These sorts of moves do not inspire confidence, and ultimately undermine progress. The old adage “hope for the best and expect the worst” – or be defensive – still makes the most sense to me at this point, because the fight against inflation is far from over and the Fed will continue to tighten the screws because it is boxed in.
MARKETS THIS WEEK
November was a solid month for equity and bond investors, with stocks and US Treasuries racking up solid gains. In fact, all of the equity indices I track were positive in November, and most started December reasonably well aside from in the US, where investors got a bit ahead of their skis on Wednesday following Mr Powell’s presentation at Brookings. Below is a summary of the indices and asset classes I track for the past week and YtD, followed by the three themes that I think were the principal sentiment drivers in November.
The three key sentiment drivers in November were:
The US Dollar has finally moved off its peak levels, now down 8.4% since its peak in late September. Much of the decline came in November. The greenback’s weakness has improved some global market imbalances particularly related to emerging markets. A weaker US Dollar should also have a positive effect on revenues and operating margins of U.S. multinational companies. It is amazing how rapidly the Pound and Euro have bounced back off their lows, although I would attribute this much more to US Dollar weakness than confidence in the UK or Eurozone economies.
Oil prices have been under sharp pressure, less related to supply (which OPEC+ is trying to constrain) and more in anticipation of demand destruction as the global economy slows. WTI crude closed the week at $80.34/bbl, up for the week but down 6.9% in November and 24% since mid-year in spite of ongoing disruptions in the market related to sanctions on Russian oil.
Bitcoin continued to get slammed in November, having never really fully recovered from issues that began to surface in April. The sudden failure of FTX reverberated throughout the broader cryptocurrency market, causing prices of all cryptocurrencies and related infrastructure companies to plummet. BTC was down 16% in November and is down nearly 62% YtD. Former CEO of FTX Sam Bankman-Fried’s interview with Andrew Sorkin is here and is worth watching if you are interested in the FTX saga, which has weighted heavily on Bitcoin and the broader cryptocurrency market.
WHAT MATTERED THIS WEEK
Here are a few things with links that mattered this week (without commentary).
US JOLTS report here
PCE data in the BEA report for October here
Nov jobs report (US) for November from the BLS here
Below are some of the key data and economic releases and other events that matter for the weeks ahead.
Upcoming central bank meetings:
Federal Reserve – Dec 13th-14th
Bank of England – Dec 15th
ECB – Dec 15th
Bank of Japan – Dec 19th-20th
Corporate bonds (credit)
Safe haven and other assets