Williams Pours Cold Water on The Doves: Dec. 15, 2023

Markets are sluggish as the New York Fed’s Williams poured cold water on rate cut expectations. Williams stated that the committee is not really talking about rate cuts. Marching at the beat of Williams while justifying hawks, flash PMI data from S&P Global reflected accelerating activity in the inflation-prone services sector this month. While cost pressures strengthened in services, the manufacturing sector did offset some of the acceleration amidst weak demand.

Services and Manufacturing Accelerate but in Different Directions

Even as the larger and more significant services sector is accelerating positively this month, the manufacturing segment is contracting even faster than last month. S&P Global’s Purchasing Managers’ Index for Services rose to 51.3 this month, well ahead of expectations of 50.6 and last month’s 50.8 reading. The index for manufacturing, meanwhile, dipped further below the expansion-contraction threshold of 50. The manufacturing figure arrived at 48.2, below projections of 49.3 and November’s 49.4 reading.

Servicers reported strong consumer demand with orders picking up at the fastest pace since July which contributed to rising cost pressures. The pickup in ordering was attributed to greater advertising expenses, looser financial conditions and adding additional revenue streams from existing customers. Service providers didn’t raise prices on consumers, though, as firms decided to trim margins to grow sales volumes. They did pick up their pace of hiring in response to robust customer traffic, with service sector job growth rising at the fastest pace since June even as wage pressures accelerated. Finally, purchasing managers reported an improved outlook for future months, with business confidence rising to the highest level since July.

Manufacturing conditions worsened, as consumer demand remained anemic with production and hiring falling as a result. Indeed, manufacturers reduced headcounts for the third consecutive month. Supplier delivery times improved due to reduced ordering and material availability. Against that backdrop, goods producers, in a surprising move, raised their prices to preserve margins.

Europe Entering Technical Recession

Across the Atlantic, economic conditions continue worsening in Europe against the backdrop of weak consumer demand, subdued hiring, elevated prices and lofty interest rates. The Services PMI arrived at 48.1 this month, much worse than expectations of 49 and November’s 48.7. On the manufacturing front, the sector’s PMI came in at 44.2, matching last month’s figure but missing estimates of 44.6. The absence of stronger data and an economic recovery point to the region entering a technical recession this quarter. 

Consumers Look for Value Amidst Cost Constraints

Consumers are continuing to trade down to lower-cost options but are increasing their discretionary spending. Meanwhile, the shortage of housing is helping homebuilders even as discounting is being used to entice buyers. Consider the following examples:

• Darden Restaurants reported weakness in its fine dining segment that includes Capital Grille and Ruth’s Chris Steak House but said strength in other chains drove a 2.8% year-over-year (y/y) increase in same-store sales. Its overall revenue of $2.73 billion was a 9.1% y/y increase and benefited from the company acquiring Ruth’s Chris and adding 45 new locations. The revenue, however, missed the consensus expectation of $2.74 billion. On a positive note, Darden’s earnings per share (EPS) of $1.84 benefited from the company increasing its prices. It beat the consensus expectation of $1.74 and climbed significantly from $1.52 in the year-ago quarter. Darden also increased its fiscal-year 2024 EPS guidance to $8.75 – $8.90. It previously said it expected an EPS of $8.55 to $8.85.
• Costco revenue of $57.8 billion met the analyst consensus expectation and was up from $54.44 billion in the year-ago quarter. The big-box discounter said same-store sales climbed 3.8% y/y while analysts expected a 4.3% increase. The company’s profit of $1.59 billion, or $3.58 a share, climbed y/y from $1.36 billion, or $3.07 a share, and beat the consensus expectation of $3.44. CFO Richard Galanti said foot traffic has been strong and customers have started buying discretionary items after previously refraining from doing so because of high interest rates and the resumption of student loan payment requirements.
• Lennar Corp. posted an adjusted EPS of $5.17, which exceeded the consensus estimate of $4.64 and increased 3% y/y. Its revenue of $10.97 billion also exceeded forecasts, with analysts expecting $10.34 billion. The company’s revenue climbed y/y from $10.17 billion. Stuart Miller, executive chairman and co-chief executive officer, said the company continues to benefit from industrywide production falling short of demand. 

Nasdaq Near All-Time High Amidst Awful Sectoral Performance

Markets are sluggish today with indices mixed, bond yields near the flat line and the dollar stronger. For equities, the Nasdaq Composite Index is leading as it looks to take out its all-time high of 16,764. It’s higher by 0.8%, hovering at 16,669 at the moment, roughly half a percent away. Meanwhile, the Dow Jones Industrial and S&P 500 indices are near the flatline. The small-cap Russell 2000 is today’s laggard, it’s down 0.3%. Sectoral breadth is awful, suggesting that the recent rally may have run its course. All sectors are down except for technology and consumer staples, they’re up 1% and 0.2%. The worst performing sectors on the session are real estate, energy and the defensive utilities and health care sectors, they’re all down between 1.3% and 1%. Bond yields aren’t moving much, with the 2- and 10-year Treasury maturities trading at 4.4% and 3.91%, with the former up 1 basis point (bp) while the latter is down 1 bp on the session. The dollar is moving higher on the back of NY Fed President Williams pointing to March being too early for a rate cut. The Dollar Index is up 52 bps to 102.48 as the greenback gains against the euro, pound sterling, yuan, yen and franc while it depreciates versus the Aussie and Canadian dollars. Crude oil is backtracking a bit of its recent progress, as Williams dampens optimism concerning U.S. monetary policy easing. The commodity is trading lower by 0.4%, or $0.26, to $71.32 per barrel (WTI) as market players dial back their risk appetites.

January’s CPI Will Not Be Friendly

John Williams is far from being a lone wolf in emphasizing that the Fed isn’t focusing its attention on future rate cuts. Our internal, real-time inflation indicators point to price increases accelerating this month and next month’s Consumer Price Index release likely climbing 0.4% m/m and 3.4% y/y, considerably hotter than the last two reports. Additionally, strong price increases in commodities and the loosest financial conditions since the start of the Fed’s tightening campaign point to considerable inflation in the coming weeks. With those points in mind, investors anticipating a March rate hike may be in no mood to marvel at the sight of daffodils pushing their shoots up through the frigid ground. Rather, a celebratory rate hike may occur not until households start dusting off their lawn mowers in May at the earliest. A readjustment trade is looming in markets.

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