The market keeps trying to price in this idea that the Fed will raise a couple more .25 moves and then be done. After the rate pause, the assumption that is then being priced in is that by the end of 2023, the Fed will start to cut rates again to help stimulate the economy. This argument is being made by the same perma bulls that also say that the job market is strong, the economy is doing great, we are not headed into recession, and earnings and earnings growth justify a move up in stock prices. Let me start with the first assumption.
The Fed isn’t done raising rates. As long as the job market remains strong, which today’s ADP report showed once again, the Fed will not worry about their continuation of tightening until they hit their target. The strong job market poses the biggest threat to continued upward pressure on inflation. The ADP report was expected to show 150,000 jobs added for December. The report came in at 235,000 jobs. Much better than expected. Again, this is good for the economy, personal income, and spending…bad for inflation. We will get the BLS Non-Farm payroll number tomorrow. It is forecast to come in at 180k jobs and a 3.7% unemployment rate. This, again, will likely be treated by the markets as the good news is bad for stock prices. At least stock prices that are interest rate sensitive as these types of reports continue to give a reason for continued rate increases from the FOMC.
Neel Kashkari, the Minneapolis Fed President, said as much yesterday when he stated that the rates need to go up another 100 bps before he thinks we have done enough. Add to this that the Fed expects to keep rates that high for the remainder of 2023 and into 2024. This is not being predicted by the markets, at least not yet, which may be some of the reason for the downward pressure on stock prices today.
Layoffs are picking up steam, but not enough to impact the labor force. AMZN announced today that they will be laying off 18,000 workers. This, however, is around 1% of their total workforce and a drop in the bucket of the labor shortage that continues to put pressure on companies who are looking to hire new talent.
The second wrong assumption that is being made by the perma bulls of the market is the idea that the Fed will start to “normalize” interest rates by the end of 2023. What does that even mean? Normalize back to Zero Interest Rate Policy (ZIRP)? ZIRP may have been the norm for the last 12-15 years since the financial crisis of 08, but historically, ZIRP is not normal. If the economy is strong, labor and earnings are strong. The Fed does not need and shouldn’t cut rates. They should continue to lower their balance sheet through quantitative tightening and pause rate increases when they feel they have slowed demand enough to stop the inflation problem we are dealing with. If they cut rates again in the year, that goes against the idea that everything is ok. They will only cut rates this year and pivot if they have broken something. Let’s hope they don’t break anything.
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