Market Players Dial Up Rate Cut Probabilities: Dec. 1, 2023

Shortly after Gooslebee talked turkey, Chair Powell took to the podium to emphasize that it is likely too soon to ease monetary policy. At the same time, he emphasized that even though the economy is creating jobs, the labor market is becoming more balanced. Investors are focusing on his positive commentary concerning the direction of inflation, however, with market players placing 57% odds of a cut at the Fed’s March meeting.

After today’s disappointing ISM data and other news of a slowing economy this week, investors were anticipating that Powell would provide dovish comments, but he mentioned it would be inappropriate to prematurely become more accommodative. His comments came shortly after a National Public Radio interview with Chicago Fed’s Austan Goolsbee, who explained that residual heat causes turkeys to continue cooking after being removed from the oven. As such, turkeys can be overcooked if left in the oven for too long. In a similar manner, the residual impact of monetary policy tightening can cause the economy to weaken even after the central bank becomes accommodative. That illustrates that there is a risk of the economy weakening excessively if the Fed doesn’t back off from its inflation battle.

Manufacturing Languishes

U.S. manufacturing continues to languish with the Institute of Supply Management (ISM) Purchasing Managers’ Index recording its thirteenth consecutive month of contraction in November. The manufacturing index’s result of 46.7 missed the market’s expectation for 47.6 and was well below the contraction-expansion threshold of 50. While the headline figure matched October’s figure, many survey respondents reported a dramatic slowing of economic conditions. Index components including new orders, production, employment, prices, backlogs and others all weakened in similar fashion.

Construction Spending Surprises

On the real estate and infrastructure front, construction spending grew faster than expected in October. The 0.6% month-over-month (m/m) growth rate was better than September’s 0.2% and projections calling for 0.4%. Investments in single-family housing, power facilities, manufacturer factories and educational institutions buoyed results, as the segments sported m/m gains of 1.1%,1%, 0.9% and 0.4%. The commercial, health care, lodging, transportation and apartment buildings areas weighed, however, with the sections declining 1.5%, 0.5%, 0.4%, 0.3% and 0.2%.

Oil Traders Doubt OPEC +’s Oil Production Limits

Powell spoke after oil prices maintained their recent declines, a result of traders’ skepticism about OPEC + members honoring new production cuts established yesterday by the cartel. Saudi Arabia pledged to extend its 1-million-barrel-per-day reduction for three months or until the end of March. Other oil producers agreed to cuts totaling approximately 900,000 barrels a day. Additionally, Brazil announced it would join production curtailment efforts. As traders drilled deeper into the agreement, however, they became increasingly skeptical that oil supply will trail demand based on the following reasons:

• The production quotas are voluntary
• Brazil said its production levels won’t be dictated by OPEC +
• Angola rejected the agreement
• U.S. oil inventories have increased by 20 million barrels year to date

Brent oil prices fell from approximately $84.50 a barrel before the meeting to roughly $81, while West Texas Intermediate crude (WTI) dropped from $79 a barrel to $76.

If implemented, the production cuts could hurt economic growth, stress consumers and delay rate cuts by supporting inflation. The resulting higher petroleum costs would be reflected in inflation gauges and manufacturers and servicers will eventually pass higher energy costs onto customers. Increased oil production could help support economic growth, support consumer spending and ease energy-related inflation pressures, resulting in the Fed cutting rates sooner rather than later.  

Market Players Don’t Believe Powell

Investors may be in a state in denial, with bond yields continuing to plunge following the stay-the-course restrictive policy comments from Powell today. Perhaps investors have dismissed his presentation with hopes that he is on the verge of becoming more dovish and will reflect such sentiment at the next Fed meeting on December 13. The December meeting will also feature the central bank’s update to its Summary of Economic Projections or dot-plot, which will quantify the number of cuts committee members expect in 2024. In the meantime, the next two weeks of economic data could potentially drive market volatility. Additional weak data is likely to fuel even more optimism for rate cuts early next year, while stronger-than-expected data may cause investors to rethink their outlook for monetary policy and corporate earnings.

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