Rate Cut Optimism to Be Tested, SEP, Powell: Dec. 13, 2023

Investors are building on recent gains this morning with this afternoon featuring two significant developments: The FOMC’s update on its economic projections as well as Chair Powell’s presentation shortly after, which may propel gains further or lead to a market reversal. Indeed, the market’s optimism regarding 5 rate cuts in 2024 may very well be tested this afternoon, with the committee perhaps only envisioning 2. In the meantime, however, lighter-than-expected wholesale inflation is supporting market sentiment.

Wholesale Inflation Cooler Than Anticipated

This morning’s Producer Price Index from the U.S. Bureau of Labor Statistics provided further evidence of slowing inflationary pressures in November. Both the headline and core PPI results were lower than expected for both month-over-month (m/m) and year-over-year (y/y) results. While headline and core were both flat m/m, they rose on a y/y basis. The headline index, furthermore, showed that wholesalers saw a sharp increase in the price of food but are catching a break with fuel costs and services.  

The m/m unchanged headline result fell below the analyst consensus expectation for a 0.1% m/m increase and the 0.9% y/y increase was lower than the estimate of 1%. In comparison, last month’s data came in at -0.4% m/m and 1.2% y/y. The headline number faced considerable pressure from chicken eggs, which recorded a 58.8% m/m price increase. Fresh fruits and melons, utility natural gas, electric power, and carbon steel experienced price gains as well. On a positive note, gasoline prices fell 4.1% m/m. Processed poultry, industrial chemicals, jet fuel, and liquefied petroleum gas prices also declined and along with gasoline prices contributed to the overall goods category number being flat m/m. Core figures came in at 0% m/m and 2%, lighter than projections calling for 0.1% and 2.2% and generally slower than October’s 0% and 2.3%. Core categories were helped by a 0.5% decline in transportation and warehousing services as well as a 0.2% drop in trade service costs. The other services category, on the other hand, rose 0.1% during the period.

Europe Edges Closer to Recession

Across the Atlantic, European economic prospects continue to deteriorate. This morning’s industrial production data was awful, dropping 0.7% m/m and 6.6% y/y in October, much worse than expectations of -0.3% and -4.6%. Weighing most on manufacturing activity were capital goods, intermediate goods and non-durable consumer goods with m/m declines of 1.4%, 0.6% and 0.6%. Energy and durable consumer goods offset some of the weakness though, with m/m gains of 1.1% and 0.2%. This data points to a second quarter of negative GDP for the region, a development which is synonymous with a technical recession.

Markets Await SEP and Powell

Markets are cautiously awaiting the 2:00 pm release of the FOMC’s Summary of Economic Projections (SEP) followed by Chair Powell’s presentation 30 minutes later. Asset prices are bullishly tilted at the moment with equity indices generally higher and bond yields lower but the dollar stronger. For equity indices, the Nasdaq Composite and S&P 500 are leading, with prices up 0.3% and 0.2%. The Dow Jones Industrial and Russell 2000 indices are both lower by 0.1%, meanwhile. Sector performance is broad based, with most sectors higher while materials, energy, consumer discretionary and industrials are lower by 0.1% to 0.8%. Utilities, real estate and technology are leading, with prices up 0.7%, 0.6% and 0.4%. In fixed-income land, the 2- and 10-year Treasury maturities are trading at 4.68% and 4.16%, with yields lower on the instruments by 4 and 5 basis points (bps). The dollar is stronger on the session, as it appreciates versus the pound sterling, franc, yuan and euro while it loses value relative to the yen and Aussie and Canadian dollars. The greenback’s index is up 3 bps to 103.84. In energy markets, crude oil is recovering from some of its recent battering on news that U.S. inventories declined by much more than expected last week. WTI crude is up 1%, or $0.69, to $69.37 per barrel.  

Powell Preps for Potential Hot Seat

With a little luck, Powell could extend his steak of making presentations without sparking market volatility. Yet, he may potentially experience another continuing and adversarial pattern—a trend of explaining why the Fed has a considerably more hawkish outlook than investors. Powell has recently emphasized that it’s too soon to talk about rate cuts as the Fed wants to ensure that inflation has been stymied in a sustainable manner before it begins to accommodate. Meanwhile, investors are anticipating five cuts to the fed funds rate next year. If today’s SEP, or dot plot, portrays expectations among policymakers for only two cuts next year, Powell will have to explain why the Fed believes extended monetary policy tightening is needed. Additionally, markets are likely to respond with increased volatility as corporate earnings expectations and equity valuations currently reflect a very dovish Fed in 2024. In contrast, a dot plot that is consistent with investors’ expectations and a quiet day for climate protestors could give Powell a break and cause equities to surge upward today. Given the strength and velocity of the rally, however, the former case is more likely as further upside in stocks is difficult to envision.

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