There are decades when nothing happens, and there are weeks when decades happen, Vladimir Lenin has been quoted as saying. The coming week may not pack in 10 years’ worth of market and economic news, but it is certainly shaping up as the most eventful one for investors so far this year.
The Federal Open Market Committee winds up its two-day meeting on Wednesday, and while it’s all but certain that no interest-rate actions will be taken, we will be looking for clarification about the wide gap between the much bigger expectations for rate cuts from the market and the smaller ones the panel projects.
Crucial data on the state of the labor market are also on tap, and the Treasury will outline its borrowing plans, which has big implications beyond the bond market. And corporate earnings reporting season reaches a crescendo, featuring five of the technology megacap companies.
The FOMC meeting takes center stage amid all these happenings, especially Federal Reserve Chairman Jerome Powell’s news conference on Wednesday afternoon. The panel won’t produce new projections from those released in December, which showed a median expectation of three cuts of one-quarter percentage point each by year end from the current federal-funds target range of 5.25% to 5.5%.
But fed-funds futures project five and as many as six cuts by December, according to the CME FedWatch site. March futures put slightly less than 50-50 odds of an initial cut that month but then see quarter-point cuts every FOMC meeting thereafter, beginning on May Day. At Friday’s settlement, December futures implied a 4.085% fed-funds rate, compared with a 4.6% median from the most recent FOMC Summary of Economic Projections.
Those rate-cut expectations ironically come while the stock market hovers near record highs and economic data continue to surprise to the upside.
In essence, investors want it all, observes Vincent Reinhart, chief economist and macro strategist at Dreyfus-Mellon and former secretary and economist at the FOMC. The market’s pricing of up to six rate cuts implies economic distress, but the hope is for cuts without distress, which is internally inconsistent, he told Barron’s.
The primary case for the Fed to lower its policy rate is marked deceleration in inflation. The monetary authorities’ preferred measure, the core personal-consumption expenditures index, which excludes food and energy, has slowed to about a 2% annual rate measured over the past three- and six-month intervals, in line with their target. On a year-over-year basis, core PCE sported a “two handle,” in trader parlance, at 2.9% in December, down from its peak 5.5%.
Reinhart cautions that it’s too early for the Fed to take a victory lap on inflation. Most of the improvement has come from an easing of supply-side constraints that bedeviled the economy during and after Covid. But those dreaded supply-chain woes could return, based on an uptick in the New York Fed’s index of those pressures. The low water level in the Panama Canal and Houthi attacks on commercial vessels in the Red Sea are delaying shipments and pushing up costs.
At the same time, the economy continues to grow above trend. Fourth-quarter gross domestic product handily beat economists’ projections, showing a 3.3% real (inflation adjusted) annual rate of growth, which followed the previous quarter’s 4.9% blowout results.
Tom Porcelli, chief U.S. economist at PGIM Fixed Income, avers that the easing in inflation means the real fed-funds rate represents very tight policy. The “neutral” policy rate would be around 4%, though nobody can accurately tell what the elusive level is that neither boosts nor retards growth. But a bit of humility is called for, he adds in an interview, with no “Mission Accomplished” declarations.
The FOMC won’t have January jobs data, due the following Friday. The consensus among economists is another solid rise of 175,000 in nonfarm payrolls, down from December’s surprisingly strong 216,000, with a possible uptick of one-tenth in the jobless rate, to 3.8%. Pay is also a focus, and the Fed’s preferred measure, the Employment Cost Index, is out on Wednesday. The expectation: a 1% rise in the quarter. And the December Job Openings and Labor Turnover Survey should show further easing in openings.
The Treasury will outline its borrowing needs on Monday and the breakdown in its bill, note, and bond offerings on Wednesday. As I noted a few weeks ago, Uncle Sam’s decision to trim its offerings of longer-dated securities helped to kick off the big bond and stock rallies of late 2023. For now, corporations have been rushing to market to borrow at narrow spreads over risk-free government securities, with $168 billion issued in the month through Thursday, almost $10 billion above the total for January 2023.
These favorable borrowing terms, along with major averages ending the week at or near records, indicate easy financial conditions, which are a spur to growth. And while the fed-funds rate is a comfortable margin above inflation, it remains a half percentage point below the growth in nominal GDP of 5.8% last year, as measured in current dollars, notes Joseph Carson, former chief economist at AllianceBernstein, on his blog. There has never been a recession when the fed-funds rate was below nominal GDP over the past five decades, all of which have been quite eventful.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
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