Market Note – December 5, 2022

By Hightower Great Lakes on December 5, 2022

Fed Staying the Course

Fed Chair Jerome Powell spoke at the Brookings Institute on Wednesday, last week, and markets spun the Fed Chair’s comments into an equity and bond rally.

The reaction from markets was a bit of a head-scratcher, given that a slower pace of rate hikes and “higher for longer” policy had already been communicated.

Thursday, the day after Chair Powell’s speech, Core PCE continued to highlight inflation pressures, while Friday’s November Nonfarm Payrolls report highlighted 5.1% y/y wage growth. This wage growth represents an acceleration from the prior month, which was also revised upward.

The Fed is looking for indication that the labor market strength is slowing, which would reduce inflationary wage pressure and underscore a slowdown in demand. Until Core PCE meaningfully begins to trend toward their 2% goal, and until labor market tightness begins to ease, the Fed is expected to maintain their hawkish tightening policy.

A strong labor market and continued economic strength do support a soft-landing scenario, which the Fed is attempting to maneuver. This would equate to inflation around 2% and no significant spike in unemployment, nor sharp decline in economic output.

The Fed is continuing to be hawkish, and while parts of the economy continue to slow – particularly housing and some of the PMI data (e.g., new orders contracting in 5/6 recent months) – the labor market remains a very sticky contributor to persistent inflation.

In other words, we are slowing and should see progress on inflation in upcoming months. That being said, the Fed is still in aggressive mode on tightening, even if the pace is slower. Ultimately, rates will likely be higher for longer.

Labor Market Data Supports Persistent Inflation and Restrictive Fed

The new November payrolls and wage growth was better than anticipated, which led to a market selloff. While jobs added and higher wages is traditionally good news for the economy, a tight labor market adds conviction to the Fed’s tightening policy and “higher for longer” narrative.

Wages is a significant component to inflation, and the Fed does not want the economy caught in a “wage-price spiral,” where wage-margin pressure, as opposed to supply/demand dynamics, drives higher prices.

Hourly earnings increased +0.6% m/m in November vs. +0.3% expectation. October was revised higher to +0.5% m/m. 263,000 jobs were added in November, while the unemployment rate remained steady at 3.7%. Most of the jobs added are in leisure and hospitality industries, plus health care – driving the higher cost for services, which represents nearly 80% of the U.S. economy.

Chart 1: Core PCE and Wage Strength Persistent¹

The labor force participation rate remains stubbornly below pre-pandemic levels, which Chair Powell addressed by stating most of the 3.5 million fewer labor participants can be explained as “excess retirements.”

Powell also mentioned slower working-age growth, caused in part by lower net immigration and pandemic deaths, as labor supply continues to impact labor demand.

Inflation Retreating from Peak, but Sticky Components Remain

Despite pressure from wages, there’s been a slew of positive inflation data. Gasoline prices have continued to fall, and gas prices have retreated to pre-Russian invasion levels.²

Rents fell for the third straight month in November, now +4.7% year-to-date vs. +18% in 2021.³ The prices paid index, within the ISM manufacturing report, has fallen to a new cycle low, 43 – representing a significant, forward-looking contraction in manufacturing prices.

Chart 2: Labor Market Strength Continues as Manufacturing Prices Have Begun Falling⁴

PCE was the focus-report last week, since the Fed uses Core PCE as their preferred inflation indicator. PCE increased at a +4.1% annualized rate in November and Core PCE increased at a +2.7% annualized rate. Most categories of consumer goods, like vehicles, furniture, kitchenware and apparel saw a monthly decrease in prices. Notably, however, food, energy and service prices increased.

The Fed is looking for a material reversal in inflation trends, and while there are positive trends – particularly around manufacturing and goods prices – more progress is needed, and the Fed will continue to implement restrictive policy.

Market Yields Reverse, Greater Inversion

Treasuries across all maturities, save the 3-month, continued their weeks-long rally fueled by comments from Chair Powell indicating a likely lower 50 bps hike at the next FOMC meeting on December 14^th.

Two- and 10-year yields have dropped 31 and 60 bps respectively since November 10^th, when the lower-than-anticipated CPI report (7.7% v est. 7.9%) gave investors the belief that the Fed is making progress in its fight against inflation. During the same period, however, the 3-month bill yield has risen 12 bps, reaching 4.33% by Friday’s close.

The 2yr/10yr and 3M/10yr spreads have been inverted since July 5^th and November 8^th, respectively; despite being inverted for just less than a month, the latter spread is now further inverted than the former, sitting at -82 bps, the widest inversion on record, with data back to 1991.

Chart 3: 10-Year Treasury Yield Dips 49 bps Below Current Fed Target Rate⁵

OPEC Maintains Oil Output as Prices Fall

The OPEC+ cartel met over the weekend and ultimately decided to keep production levels unchanged. Oil prices have fallen, which is reflected in lower gasoline prices – now $3.41 vs. a June high above $5.⁶

The cartel opted to cut output by 2 million barrels per day in October, which drew sharp criticism, and vowed “consequences” by the Biden administration. Despite criticism, the administration has not continued to press that narrative, given the falling gasoline prices since the announced cut.

The OPEC meeting comes days after a group of G-7 nations and Australia agreed to a price cap on Russian oil. The price cap would allow the purchase of Russian oil, but only at a discounted $60 per barrel.

The goal is to maintain steady supply levels while limiting Russian revenues. Russia says it will not accept the price cap and is preparing a response.

Russia would still be able to sell its oil outside the price cap if using non-western ships, insurance and financing services (e.g., most Asian buyers). The EU is asking all 27-members to sign off and agree to the price cap.

The Week Ahead

Earnings –Tuesday: AZO. Thursday: AVGO, COST.

Economics – Monday: ISM Services PMI (November). Thursday: PPI (November), Michigan Sentiment (December).

Return for Selected Indices⁷

Click here to read last week’s Market Note (11/14).

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.

---

¹ Source: FactSet (chart). As of December 4, 2022.

² Source: Washington Post. As of November 30, 2022.

³ Source: Bloomberg. As of November 30, 2022.

⁴ Source: FactSet (chart). As of December 4, 2022.

⁵ Source: FactSet (chart). As of December 4, 2022.

⁶ Source: Washington Post. As of December 4, 2022.

⁷ Source: Bloomberg. As of December 4, 2022.