Market Note – December 19, 2022

By Hightower Great Lakes on December 19, 2022

Bond Market Volatility

Bond markets responded with volatility after last week’s FOMC meeting. While the Fed’s 50 bps rate hike and higher rate expectations for 2023 led the short-end of the curve higher, the long-end of the curve fell. The market is clearly seeing a different path than the Fed is communicating.

Investing in fixed income continues to be attractive, and we prefer a barbell strategy. Positive real rates, slowing inflation and normal spreads support fixed income portfolios.

While the curve remains inverted, a barbell strategy offers benefits to reinvesting when shorter-duration bonds mature, plus the ability to capture higher yields on the long end.

Chart 1: Yield Curves Higher¹

Investors should continue to show adaptability. The fed funds futures indicate a 4.6% peak rate instead of the Fed’s 5.1% dot plot.

Fed vs. Inflation

We’ve now seen sequential month-over-month improvements in CPI (+0.1% m/m) and PPI (+0.3% m/m). Inflation has retreated from peak, but it remains very elevated. Despite the good news, which the market believed might support a Fed pause, the Fed continued to sound hawkish in their December FOMC meeting.

The Fed has continued to emphasize “higher for longer” policy and that they will “do what’s necessary” to lower inflation near 2%. The dot plot, which shows how each Fed policymaker anticipates rates, showed a median 5.1% expectation for peak fed funds rate in 2023 – 50 bps higher than their September dot plot (more hawkish).

No Fed members are projecting cuts. 5.1% was higher than expected and, especially after a tamer CPI inflation report, resulted in last week’s equity sell-off. It’s important to note that dot plots and Fed predictions are often inaccurate.

Chart 2: Fed Dot Plot and Fed Futures²

The Fed will continue to raise in 1H23; maybe 50 bps in Feb and 25 bps in March. The good news is that we continue to get closer to the end of rate hikes. The Fed also anticipates GDP to be 0.5% growth in 2023, down from 1.2% in September.

Muted GDP and recession expectations have resulted in the division between where the Fed is aiming to go versus what markets think is possible. This is indicated by the spread between the fed funds target and fed funds futures, and also the inverted yield curve.

It will be a challenge for the Fed to control the remaining economic inflation with monetary policy. The Fed cannot control the supply-side, and creating a sharp rise in unemployment in order to crush demand does not benefit anybody. Crushing labor won’t help food and energy prices. Crushing housing doesn’t help anybody, either.

The tight labor market can be better-resolved through fiscal policy – consider all the COVID and immigration policy pivots that have impacted labor participation the last few years. We believe the focus for 2023 will be less on inflation and more on employment and wages. 

Consumer Keeping Economy Strong

The Fed has been surprised by consumer strength and how demand continues to exceed supply in the labor market. Easing supply chains and lower input costs will support lower headline inflation figures – but a dichotomy is underscored by most service sectors continuing to have tight labor and rising prices.

Services represents 80% of the U.S. labor force. The Fed believes inflation will retreat, but there is still a “ways to go” for it to get near their 2% goal.

Chart 3: Leading Economic Indicators Slowing in Manufacturing, Expanding in Services3

The Fed spent most of the past decade-plus trying to spur inflation with easy monetary policy. Inflation was persistently below 2%. Now, given the unforeseen events and consequences since 2020, the Fed should view a retreat toward 3-3.5% inflation next year as an achievement. But it’s clear the Fed’s only goal will be reaching 2% – and this was reiterated last week.

As the Fed’s policy actions make their way through the economy on a 9-12 month lag, earnings are likely to come down amid an economic slowdown. This is consensus and, one could argue, because of a lot of bad news expectations are quite low, with the S&P 500 down 20% YTD and the Nasdaq down 30%.

It’s interesting to see that even though investors are cautious about a recession in 2023, there is currently a lot of momentum in the economy. Jobs and job openings remain strong, wages are higher and inflation is coming down – gasoline fell 13% last month, for example.

The most recent University of Michigan sentiment survey was positive, driven by lower gas prices and higher wage expectations. The Atlanta Fed’s GDPNow, which is a volatile GDP predictor, estimates +2.8% GDP in Q4.

In addition, there is a broad easing of conditions, with bond rates down well-below highs, mortgage rates down, wages up and credit spreads remaining normal. These dynamics put the economy in a better position to handle higher fed target rates.

Argentina Wins the World Cup

The World Cup ended in dramatic fashion on Sunday, with a 3-3 penalty shootout win by Argentina, defeating France. France was seeking back-to-back World Cups; despite Mbappé’s hat trick, Messi won his first World Cup trophy.

Argentina will receive $42 million as the winning team, while France will receive $30 million for second place. It’s estimated the 2022 World Cup will generate $7.5 billion for FIFA.

Qatar is seeking to reap their own benefits from hosting the World Cup, which Brookings Institute dives into on their podcast: “The Economics of the World Cup.”

The Week Ahead

Earnings – Tuesday: GIS, NKE, FDX. Wednesday: MU.

Economics – Monday: NAHB Housing Index (December). Tuesday: Building Permits and Housing Starts (November). Wednesday: Consumer Confidence (December). Friday: Core PCE (November).

Return for Selected Indices⁴

Click here to read last week’s Market Note (12/12).

Disclosures

OCIO is a group of investment professionals registered with Hightower Securities, LLC, member FINRA and SIPC, and with Hightower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through Hightower Securities, LLC; advisory services are offered through Hightower Advisors, LLC.

This is not an offer to buy or sell securities. No investment process is free of risk, and there is no guarantee that the investment process or the investment opportunities referenced herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. The investment opportunities referenced herein may not be suitable for all investors.

All data and information reference herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary, it does not constitute investment advice. OCIO and Hightower shall not in any way be liable for claims, and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only; the opinions expressed are solely those of OCIO and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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¹ Source: FactSet (chart). As of December 19, 2022.

² Source: Bloomberg (chart). As of December 16, 2022.

³ Source: FactSet (chart). As of December 19, 2022.

⁴ Source: Bloomberg. As of December 4, 2022.