Weekly Wisdom – November 3, 2022

By Hightower Great Lakes on November 3, 2022

Higher for Longer; Maybe a Slower Pace, but Certainly No Pause

As expected, the U.S. Federal Reserve raised the fed funds rate by 75 bps and is now at the target rate, at 3.75-4.00%, up from 0.0-0.25% at the beginning of the year.

The goal has been to slow demand in order to slow the pace of rising prices, allow supply chains to stabilize and loosen labor markets, while avoiding a recession or breaking financial systems in the process.

Fed Chair Powell stated that “ongoing increases will be appropriate,” while the Fed also continues to shrink their balance sheet. Their goal is to return inflation to 2% “over time.”

Simply put, the Fed wants 2% fed funds and will do whatever it needs to do to get there –  meaning rates are headed higher for longer. 

To this point, the Fed chair specifically noted that “how high” and “how long” are now much more important questions vs. “how fast,” considering the Fed has already achieved raising rates expeditiously, +375 bps year-to-date.

The peak rate is uncertain, and rate hikes will continue until it is sufficiently restrictive, bringing inflation to 2% over time.

Yield Curve Inversion and Predictions

The bond market has historically predicted periods of recession, particularly when specific parts of the curve become inverted.

These inversions tend to predict recessions with a lag of 6-12 months, but in this environment any timeline is possible, especially as the bond market is skewed by the Fed balance sheet runoff. 

The fast pace of rate hikes is reflected in the front-end of the curve in short-term rates. The 10-year Treasury rate is 4.08%, below the 3-month 4.12%.

In other words, you can earn a higher rate of return by holding a U.S. government bill for 3 months than holding a U.S. Treasury bond for 10 years.

Chart 1: Year-to-Date 3-month/ 10-Year Treasury Spread¹

Chart 2: 3-month/ 10-Year Treasury Spread (Complete History)²

Labor Tightness and Corporate Hiring Plans

Given the puts and takes in the macro environment, the one bright spot has been the labor market. It remains tight, and job openings increased during the month of September, with JOLTS at 10.7m – 1m more than consensus expected.

There are more job openings in September of this year than last year, despite the Fed’s best efforts to cool the labor market by slowing demand.

10.72 million job openings represent 1.9 jobs available per every available worker. The initial claims 4-week moving average remains below pre-pandemic levels, indicating that workers are keeping their jobs and finding new jobs.

And lastly, the unemployment rate is 3.5%, matching its lowest level in the last 50 years. These are all reasons the Fed doubled down on higher rates for longer.

They have the cover to do this because their dual mandate is job growth/strength vs inflation. Inflation has been winning out, with Core PCE at 4.9% y/y and core ECI at 5.2%

Chart 3: Elevated Job Openings; Recently Unemployed Figures Remain Low³

Chart 4: Q3 EPS Growth Broken Down by Sector⁴

Economic Activity and Inflation

ISM Manufacturing and Services both remain in expansionary territory, yet expansion is occurring at a slower pace than prior periods.

A handful of regional surveys indicate a further slowdown.

ISM surveys tend to be forward-indicators of economic activity, and the preliminary Q3 GDP report indicated an annualized +2.6% q/q growth – above the 2.31% q/q average across the seven years pre-pandemic.

Meanwhile, the Fed’s preferred inflation measure, Core PCE, has increased 5.1% y/y.

Chart 5: GDP Appears to Have Rebounded in Q3 as Inflation Stays Hot⁵

Click here to read last week’s Weekly Wisdom (10/26).

Disclosures

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¹ Source: FactSet (chart) (November 2, 2022).

² Source: FactSet (chart (November 2, 2022).

³ Source: FactSet (chart) (November 2, 2022).

⁴ Source: Credit Suisse Equity Research (November 2, 2022).

⁵ Source: FactSet (chart) (November 2, 2022).