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Dear Fed - Market Participants Have Found Your Punchbowl

CAMS Weekly View from the Corner - Week ending 12/1/23


December 4, 2023


Back in the mid-1950’s the then sitting Federal Reserve Chairman William McChesney Martin offered the Fed is essentially in the position of being a chaperone to the economic/market party gathering.  With this, per Chairman Martin, it was the Fed’s responsibility to remove the party punchbowl just when the party was really heating up.

 

To current day our sitting Fed Chairman (Powell) and crew have been focused on removing the proverbial punchbowl which is known as tightening financial conditions.  The “punchbowl” essentially represents the backdrop of financial conditions of which the Fed plays a notable role in establishing hence William McChesney Martin’s metaphoric message.

 

Along this vein collective market participants have found the hidden punchbowl, seemingly added a few bottles of vodka to it and in so doing is lighting the party back up with a tremendous loosening of financial conditions of late, in particular in the previous 32 days.  This all while Chairman Powell has continued to offer this:

 

CHAIR POWELL:  “So it's, the fact is the Committee is not thinking about rate cuts right now at all. We're not talking about rate cuts, we're still very focused on the first question, which is; have we achieved a stance of monetary policy that's sufficiently restrictive to bring inflation down to 2 percent over time, sustainably? That is the question we're focusing on.”

Chairman Powell, Post FOMC Meeting Press Conference November 1, 2023

Transcript Link:  https://tinyurl.com/52bdbvny

 

The above is from the most recent Fed meeting press conference just 32 days ago beginning November.  Relative to market behaviors since then the above excerpt could have been from years ago. 

 

Below Powell offers prepared remarks just this past Friday at a Fireside Chat at Spelman College in Atlanta.  Does the message ring similar?

 

CHAIR POWELL:  “Inflation has declined to 3 percent over the 12 months ending October, but after factoring out energy and food prices, which tend to be volatile, what we call the “core” inflation is still 3.5 percent, well above our 2 percent objectiveIt would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate on when policy might ease.  We are prepared to tighten policy further if it becomes appropriate to do so.”

Fireside Chat at Spelman College, Atlanta, Georgia

December 1, 2023

 

According to collective market participants and their messaging via market executions over the previous 32 days Powell seemingly has not offered any of the above. 

 

This or said participants are tone deaf to his messaging in light of the endless streams of consistent behavior from the Fed in recent decades - think lower rates and print money – time and again – as in a one-trick pony rather than as true price inflation fighting entity when the environment calls for such.  In other words, based on their market behaviors it seems they view the Fed as a paper tiger.

  

PCE Price Inflation

 

The Fed’s favored price inflation measure is the Personal Consumption Expenditures:  Chain-type Price Index (PCE).  This measure was updated last Thursday reflecting much of the same storyline of recent time.  Progress but yet still well ahead of 2% target.  PCE came in at 3% increase rate, PCE less Food and Energy at 3.5% increase rate and PCE Services (Fed has been focused on Services price inflation as a notable concern) at 4.4% increased rate - all solidly above 2%.

 

In addition, last week the U.S. Bureau of Economic Analysis provided the second estimate for 3rd quarter Gross Domestic Product (GDP) which was revised higher to a now 5.2% annual growth rate.  Adding to our price inflation watch the GDP Price Index was also revised higher to 3.6% from the previously estimated 3.5%.  Yet again another price inflation metric updated to current day posting well north of the Fed’s 2% target.

 

Per Market Participants That Was Your Housing Crash

 

If by chance you have found yourself in recent times (months/years – this narrative has been around for a long while now) that the housing market was surely set to crash in light of runaway prices in recent years and was but a guarantee to fall dramatically lower; market participants in the previous 32 days have offered the “crash” has already occurred. 

 

Specifically, the Dow Jones Home Construction Index has rocketed higher over the previous 32 days.  While it had peaked in late June and trended consistently lower through the summer and early fall seasons all changed nearly in an instant from the post-Fed meeting press conference on November 1st  as it has launched higher to now a new all-time high point

 

Market crash?  To the contrary – per the forward messaging of this space participants are offering the housing market is set to trend onward and upward. 

 

An important side-note:  Realize market participants are always discounting the future and in so doing price assets today according to what they see (or think they see) as a future economic reality.  Price inflation – that’s done and over and so is the Fed – per the messaging and with this, relative to the housing market, it is launch time from here.  That is the messaging via price action - will it prove accurate?  Now there’s the billion dollar question.

 

Here’s the strange part in particular to housing and price inflation:  Said space has been one (of many to be accurate) stand-out areas of the economic structure that has experienced off-the-charts type price inflation.  To current day, via the most recently updated Consumer Price Index (CPI) Owners’ Equivalent Rent measure (which dominates the CPI construction for measuring housing price inflation) increased 6.8% compared to a year ago. 

 

For perspective, in this entire 21st century we had two occasions, 2002 and 2006 where this measure briefly touched a high point of 4.5% and dropped.  For further perspective, our current 6.8% reading is down from a peak of 8% - progress has been made but marginally when placed into context.  

 

With this though, per the aforementioned market participant messaging via the Dow Jones Home Construction Index all-time new high, this context and reality is of no significance because price inflation is done. 

 

To be clear when we offer price inflation and the Fed is done we are not exaggerating collective market participant’s messaging nor are we ourselves offering this as our stance/prediction but are merely sharing how this is unfolding via market participant behaviors relative to Fed comments and actual current price inflation reality.

 

Market Participants Dramatically Ease Financial Conditions


Above is a decade chart of the Financial Conditions Index published by the 7th District Bank of Chicago of the Federal Reserve System.  We can show the dramatic loosening in financial conditions in many different ways but this index offers the story in one fell swoop. 

 

Our red down arrow depicts the dramatic loosening of financial conditions over the previous month.  To place this into context, our red horizontal arrow highlights how far back we go to see the last time we have been this loose in overall financial conditions. 

 

Interestingly, this dates back to early spring season of 2022 which is also the timeframe when Powell and crew just started tightening financial conditions with their actions of raising interest rates etcetera.  Through this index market participants have taken overall financial conditions back to where they were when the Fed first began their price inflation fight in early 2022 – nearly two years ago.

 

This will be a very interesting storyline in coming weeks-to-months as it seems obvious the markets and the Fed are on opposite sides of this unfolding economic/price inflation backdrop and their respective forward looking views. 

 

Remember the time honored adage: Don’t Fight the Fed?  That’s long gone.


I wish you well…


Ken Reinhart


Director, Market Research & Portfolio Analysis

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