In the modern mainstream media era where everything is “breaking news”, please don’t assume I’m falling prey to this same use of hyperbole just to get eyeballs. There really is a LOT of news this week that could “possibly” change the outlook for stock and bond returns for the rest of 2023. I put possibly in quotes, because it’s also possible that all the major events this week come in line with current investor expectations and it’s a mild week for stocks and bonds. As the past few years have shown, it is not unusual to see wild swings in stock and bond prices when the prevailing narrative changes suddenly. With that, let’s review the list of upcoming events that could shape 2023.
The Federal Reserve
Fed Chairman Powell and the rest of the Federal Reserve board will begin a two-day meeting on Tuesday, with a rate announcement expected at 2pm on Wednesday. The consensus right now is for a 25-basis point hike this week, followed by hints of another hike in March. Obviously if the Fed paused rate hikes this week (or raised by more than 25 basis points) the market would react tremendously. There are free resources to see what odds Wall Street is currently placing that we will see a 25 point hike are by clicking here. The current reading north of 98% couldn’t be any stronger on what Wall Street expects this Wednesday.
At the top of the chart on that link, you can also click on future meetings to see where consensus lies. A quick look at the March meeting shows a greater than 84% probability of another 25-basis point hike during that meeting, whereas the May meeting probabilities right now show a very low probability of any further hikes after March. So, the current consensus is for a hike in February, March and then a pause.
This is where the market-moving news will emanate from, any signs from the Fed that perhaps this “hike-hike-pause” thesis is incorrect. The arguments for this thesis are straightforward: Inflation has been falling, and when looking at the expected year-over-year changes with key inflation variables like gas, car prices, and housing, the trend should continue into late Spring.
However, there are some who think the Fed will continue to hike beyond March…let’s discuss why. It’s clear that some of the Fed’s reputation has been tarnished recently with their “inflation is transitory” stance. They were slow to respond to growing inflation, and so some feel that the Fed will not stop raising until inflation is dead and buried. With their own stated goal of 2% inflation, there’s a long way to go before that level is reached and it’s highly unlikely we will get there by May. There’s also the issue that in the last few weeks we’ve continued to see strong economic data with GDP, durable goods orders and even housing showing signs of life. In addition, the stock market has responded with the S&P 500 up over 6% to start 2023. These strong economic reports and a rising stock market (which can spur animal spirits) could be disconcerting to Jay Powell and the Fed.
I wouldn’t be surprised to hear Jay take a more serious tone to a potential May hike. Remember when you were a kid, and your parents used your full name to scold you? “Derek Michael Amey it’s time to go to bed!” I think we may see Jay Powell take the same approach with investors and use a harsh tone to try and talk some of the enthusiasm out of the recent stock market rally.
Both the Fed and the ECB began raising rates in 2022, and they too will be meeting this week for the first time since December. During that last meeting in December, ECB President Madame Lagarde shocked many with her announcements. Remember, over the last few months the Fed has been sending signals that they are going to slow the pace of hikes as inflation comes down. Many were expecting the ECB to follow suit, but what they heard instead was comments about how they were going to raise 50-basis points per meeting for the foreseeable future. They then announced that the ECB would be starting QT (quantitative tightening) in March of 2023, when most of Wall Street was expecting just to hear what the framework of QT might look like. The DJIA lost over 750 points that day, with most of Wall Street pointing to the ECB’s actions and comments about future hikes, as the catalyst.
The ECB meets this Wednesday, just one day after the Fed meeting. Expectations are for a 50-basis point rate hike, but frankly given how shocked everyone was during the December meetings, anything could happen. Again, investors will pay close attention to Madame Lagarde’s words and try to see if she’s softened her tone following December’s rough meeting. A major shift in tone from Madame Lagarde in either direction could spark another major move in stocks and bonds.
If we imagine a world in which both the Fed meeting and the ECB meeting follow the prevailing script, and there’s no real market reaction, there’s still the matter of Friday’s job report that could create fireworks to end the week. We’ve seen a lot of layoffs coming from the tech sector, but so far those layoffs haven’t spread to the rest of the economy. The tech sector only employs around 3% of Americans, so while these jobs tend to be higher paying, this sector wouldn’t be able to shed a tremendous amount of jobs, all things equal.
The unemployment rate is traditionally believed to be a lagging indicator on Wall Street. The general idea is that employers will ride out a soft patch for some time before they have to take the dramatic step to lay people off. That generally means the economy is weak before we start to see job losses.
As with many things post-COVID though, the current economy does seem different. Job openings are still quite elevated, and employers know this. There’s a growing sense that employers might actually be hoarding employees. That is to say, since hiring is such a laborious task, they are loathe to let people go because if the recession is shallow or doesn’t even come, it will be tremendously difficult to go rehire. I’ll add if this is happening, and a recession never occurs or is in fact shallow, earnings will be under pressure. Employees have learned their worth since the recession hit, and those companies hoarding workers will be sacrificing profit margins to retain these folks.
Lastly, we come full circle to the Federal Reserve. We’re currently in an economic period where “good” news could actually be “bad” news. More Americans employed is good news for them and their families. However, the Fed is trying to slow inflation and slow wage growth, so if more Americans are getting hired this creates an issue for the Fed. If the employment picture remains strong, we may find that the Fed has to continue to raise rates for longer than the market currently expects.
As you can see this week is full of events that could shape the short-term trend of the markets, and I didn’t even mention the ISM report on manufacturing early in the week, or how over 100 companies in the S&P 500 report earnings this week. In a normal week, those two events would have a big impact. However, right now the market is focusing on inflation and economic growth and the three events mentioned above will provide a ton of information for Wall Street to digest, analyze and discuss.
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