The Weekend Edition # 115 - Fed Preview

Welcome to another issue of the Weekend Edition.

Thank you to all who’ve read and welcome to all the new subscribers this week!

Here’s what we cover:

• Market Recap - The Rally Continues

• Macro - Preview of the last FOMC Meeting of 2023

• The Week Ahead - Economic & Earnings Calendars

• Closing Thoughts - Not much higher

Let’s dive in ⬇️

Market Recap - Dec 04 - Dec 08, 2023

This was certainly an interesting week with plenty of fireworks from across the globe.

We saw the US indices take turns rallying - with some profit-taking in the Magnificent Seven putting pressure on the Nasdaq while the Russell 2000 small-cap index played catch up. Much of the catch-up trade started with the short covering of small caps but, the rally did seem to broaden out to the equal-weighted S&P500 index.

According to Goldman Sachs, December favors the small-cap Russell 2000 Index:

We saw European equities rally as well, with the DAX hitting an all-time high, and the CAC and FTSE joining in on that rally. It would seem that the markets have confirmed a rate cut for the ECB by March-April 2024 and some suggest 250bps. I do think that's over the top but, my view is that the ECB will cut before the Fed does. ECB and the Bank of England have their meetings next week, on Thursday 14 Dec, the day after the Fed.

China saw no love after Moody's cut their outlook from Stable to Negative for mainland China, Hong Kong, Macau, and several of their banks. Finally, we got quite the drawdown on Japan as well, with 10Y JGB rates rising and the JPY strengthening significantly on comments made by Governor Ueda and Deputy Governor Himino. Traders started to price in a change in policy by this month's meeting on 19 Dec, which I doubt will happen. In fact, press reports the next day said: “Bank of Japan (BOJ) Governor Ueda's remark about exit from negative rate said to be taken out of context and not signal of imminent shift.”

Friday brought us a relatively strong labor report from the US and despite elevated yields, and a higher dollar, the market rallied once the initial sell-off was over. We did expect that any decline from this report would be an opportunity to buy the dip with the market firmly believing that the Fed's hiking cycle is over and rate cuts will come sooner than expected in December.

The CPI report will be released the day before the Fed's rate announcement and we're likely to see a slight deceleration at the headline level with gasoline prices declining in November. At the core level, however, the expectation is for a marginal increase.

- Headline consensus is 3.1% YoY (prior: 3.2%), and 0% MoM

- Consensus for Core Inflation is 4%; 0.3% MoM (prior: 0.2%)

If the CPI, FOMC, BoE, and ECB were not enough for next week, we also have triple witching Options Expiration on Friday, i.e, options expiration for indices, stocks, and futures.

Commodities

All anyone can talk about this week is Gold and Oil. Gold saw a sharp sudden spike reaching an all-time high of $2152.30/oz.

I can't say what exactly caused that sudden spike but, gold has been in favor because of the recession trade. As bonds price in lower growth, there are still those who are buying gold to hedge against an economic downturn and geopolitical tensions.

As for oil, it broke below $70/bbl on WTI and there doesn't seem to be much reprieve. There's news of the US reaching record levels of production that could ease the pressure on supplies. Moreover, there's speculation that if the OPEC+ countries don't abide by their quotas, Saudi Arabia may consider flooding the market as they have done previously. That would cause the price of oil to crash and force the other members to play ball.

Finally, China's demand continues to wane. China is in deflation with CPI numbers coming in at -0.5% YoY yesterday. This marks the sharpest decline in 3 years.

Some of the charts in the recap section have been sponsored by Koyfin. We have a special discount of 15% for MacroVisor readers for any new sign-ups to Koyfin. To take advantage of this promo please sign up here - Koyfin MacroVisor Discount

Macro - Preview of the last FOMC Meeting of 2023

What's happened since the last Fed meeting in September? 

• Financial conditions that had tightened significantly until the Fed's November meeting have since reversed. In fact, it's been the "largest easing in 40 years"

• CPI Inflation came in much lower than expected; PCE continues to decline smoothly, coming in lower than the Fed's year-end projections

• Inflation Expectations improved with the last reading this Friday declining to 3.1% from 4.5%

• The Unemployment Rate declined to 3.7% from 3.9% with this Friday's release

• ISMs and PMIs have shown marginal improvement

It would seem that the Fed's monetary policy is working, as far as inflation is concerned. We shouldn't be surprised if the Fed seems pleased with themselves where inflation is concerned. Achieving this level of inflation, without a sharp increase in unemployment and decrease in growth, seems like a victory.

The question is whether the Fed embraces the victory over inflation and declares an end to their hiking cycle. Something tells me, they won't. 

We've heard mixed views from Fed speakers over the last month, many of whom have expressed concerns about housing and services. They seem to think inflation risks are still skewed to the upside and the 2% target will only be achieved by the end of 2025.

But, I think what we need to take from all of that is Chair Powell's last speech on Dec 1, where he said:

Personally, I think he continues with this view - a hawkish hold.

Summary Of Economic Projections 

Where do we stand vs. the Fed's September projections?

I've marked up the Fed's September projections with the last readings we have on each of these indicators. The Real GDP is the last available annualized reading as of Sep 2023.

As you can see, the last readings are much better than the Fed's projections. This is likely the reason, we're not going to see a hike in December and unless something extremely drastic happens with inflation, we're not likely to see another hike during this cycle.

Everyone will be watching the Fed’s rate cut projections. Last September, what sparked a market sell-off was the Fed lowering rate cut projections to only 0.50% for 2024. Traders were pricing in 1%-1.25% and the Fed themselves had the number at.

Now given that financial conditions have tightened and inflation is now well within their year-end target, the question will be:

Will the Fed increase their rate cut projections?

I don’t see why they would have to. They’ve indicated that rate cuts are to begin after mid-2024 and if we go by that schedule, they have a meeting in March where they could change their projections. Holding the projections firm at this stage would allow them to keep that hawkish bias.

Assuming they don’t change the rate projections, a change to inflation and unemployment numbers could be just as telling. If the Fed lowers their inflation projections, that could signal additional cuts. And if unemployment projections are revised lower, that could possibly seal the deal on further cuts.

Unemployment remains low, but it’s a known phenomenon that the labor market tends to be strongest before a recession. And if the Fed is expecting substantially lower growth, that’s likely to be accompanied by higher unemployment. So this will still be something to monitor in the next few months.

The Week Ahead - Calendars

US Earnings Calendar

US Economic Calendar in Eastern Time (Source: Trading Economics)

Closing Thoughts - Not much higher

The major rally is probably behind us with Santa coming early this year. To be clear, we don’t expect a crash into the end of the year unless the Fed surprises us with a 25-bp hike. That’s almost a crazy notion at this point. but what we expect is a hawkish hold which may give the market another opportunity to buy the dip and cause equities to chop marginally higher into the end of the year.

It’s looking more likely that the SPX closes around the 4600 mark for the year. Last week showed us that a marginal increase in bond yields is not enough to deter the bullish sentiment at this stage, and it’s quite unlikely that yields spike unless the Fed does something drastic.

I would say that if the Fed decides to announce the end of the hiking cycle, the market view may change and equities may see a stronger rally into the end of the year.

Here’s wishing you safe investing.

Sincerely yours,

Ayesha Tariq, CFA

There’s always a story behind the numbers.

None of the above is Investment Advice. I may or may not have positions in any of the stocks or asset classes mentioned. I have no affiliation with any of the companies other than explicitly mentioned.