2nd Powell pivot!

This week was the Federal Reserve’s final meeting of the year to discuss and decide their position on interest rates. While the market was already anticipating no additional hikes, what was more important was any guidance around future interest rate cuts. Since the last meeting in early November, the market has been pricing in cuts for next year, however, Chairman Powell has resisted any discussion of the matter. This changed this week when he admitted that cuts were likely coming in 2024. This was hailed as the second Powell pivot (the first one being in 2018).

• This is a significant development given the Fed’s reluctance to discuss cutting interest rates even as recently as 12 days ago
• Until now, the Fed has maintained a higher for longer narrative, which drove rates higher most of the year
• Risk assets rallied immediately on the change in tone, with previously lagging parts of the market leading the way (e.g. small caps, biotech)
• The US Dollar (USD) fell, leading to a rally in commodities and related companies, also a lagging part of the market
• Markets continue to price in a perfect soft landing, which is by no means a foregone conclusion
• The significance, however, is that the path forward for rates is now lower for the first time since early 2022
• Many Fed watchers noted that they seemed to have declared victory too early

Good inflation data, but too soon to declare victory?

Ahead of the Fed meeting, we received both CPI and PPI data, which showed inflation continued to moderate. While both came in around expectations, CPI Core (excluding food and energy) was at 4% year over year, while PPI showed a year over year reading of 2.5% for Core. PPI feeds into the Fed’s preferred inflation reading, the PCE deflator, which strengthens the case that inflation is heading toward the Fed’s target.

• While the inflation data is clearly showing deceleration, it is important to continue to pay attention
• When looking at the 1970’s, inflation receded before re-accelerating (chart below)
• While the current environment is certainly different, history does tend to rhyme
• This is primarily why some market participants felt that the Fed sounding the all-clear may have been somewhat premature

Strong retail sales

In November 2023, U.S. retail sales unexpectedly rose by 0.3% from October, indicating a stronger consumer spending pattern than anticipated. This rebound comes after a revised 0.2% decline in sales in October. The increase in retail sales was more pronounced (0.6%) when excluding auto and gas sales. This uptick suggests that despite elevated prices, consumers spent robustly in various sectors, including restaurants, furniture stores, and online retail. Clothing and accessories stores also saw increased sales, while electronics, appliance, and department stores experienced a decline. These figures are not adjusted for inflation.

• This is on the back of strong black Friday and cyber Monday data
• Consumption is 70% of the US economy, and the consumer remains resilient
• The strong jobs market is certainly an important factor in this dynamic
• As long as wages don’t accelerate, this continues to be a strong input towards a soft landing