This morning, the attention of Wall Street is again on the Federal Reserve and whether its increasingly restrictive monetary policies are starting to effectively fight inflation. That is because at 8:30 A.M. (EST), the Labor Department reported that the Consumer Price Index (CPI) fell 0.1% in December. The core-CPI, which excludes the more volatile food and energy components, was up 0.3% last month. On a 12-month basis, the CPI and the core-CPI were up 6.5% and 5.7%, respectively. All the readings were indications that the Fed’s goal to slow demand to better match supply and ultimately put downward pressure on prices is working.
The more-benign CPI data, which is expected to be the most closely examined report by the Federal Reserve ahead of its early February Federal Open Market Committee (FOMC) meeting, come on the heels of last Friday’s December employment report that also showed some easing in inflationary pressures, with the average hourly wage falling on both a month-to-month and 12-month basis. The more-modest consumer price figures have many market pundits thinking that, while the Federal Reserve may not pivot on the interest-rate front in 2023, the pace of increases may be more measured as the central bank moves to push the federal funds rate above 5.00% before pausing later this year. The equity futures, which were higher heading into the CPI data, have been bouncing back and forth around the neutral line, as Wall Street tries to decipher what impact this report will have on the size of the Fed’s next interest-rate hike.
Later this morning, we may get some clarity on what Federal Reserve officials think the CPI data will have on its ongoing monetary policy tightening course. Both Richmond Fed President Tom Barkin and St. Louis Fed President James Bullard are scheduled to give speeches. To date, senior Federal Reserve senior officials have been steadfast in the stance that federal funds rate will need to go above 5.00% and stay at the level for an extended period to effectively fight inflation. That said, Federal Reserve Chairman Jerome Powell also has reiterated many times that the central bank will be data driven. Perhaps, this is the reason why Wall Street is not fully onboard that Federal Reserve will stay on the monetary policy course for as long as it is suggesting, especially if the economy were to continue to weaken. In recent weeks, contractions in both December manufacturing and nonmanufacturing suggest slower economic times may lie ahead.
Meantime, tomorrow marks the unofficial start to fourth-quarter earnings season, with the latest quarterly results from banking giant JPMorgan Chase (JPM) due before the start of the trading session stateside. The JPM results will kick off a busy stretch of quarterly reports from the nation’s biggest banks and financial institutions. The bank’s earnings release will provide some clues as to how big of an impact the Federal Reserve’s aggressive interest-rate increases had on both the U.S. economy and Corporate America during the final three months of 2022. The consensus expectation is that earnings for S&P 500 companies declined by a low-single-digit rate, which would mark the first retreat since the third-quarter of 2020 when the nation was in the midst of the COVID-19 pandemic and related shutdowns.
Our sense is that the upcoming fourth-quarter earnings season will be very much about what companies are saying about the first half of 2023 than results produced during the last three months. Indications are that GDP (gross domestic product) growth during the final quarter of 2022 was better than expected and that may lead to some positive surprises. However, the first six months of this year will likely reflect the impact of the most aggressive monetary policy tightening by the Federal Reserve in decades. With so much excess liquidity removed from the financial system in such a short period, the expectation is that many businesses and consumers will have to adjust their spending budgets to reflect the more stringent borrowing environment, especially if a recession is looming. That may hurt profits during the first two quarters of this year.
Given this backdrop, we think targeting high-quality companies that have a proven track record of delivering steady earnings growth and cash flows during more difficult economic times, while maintaining their dividends, may provide the best downside protection if a recession were to occur at some point this year. Keeping a healthy amount of one’s capital in cash would also allow investors to quickly adjust their portfolios if trading proves to be either more policy (i.e., Federal Reserve decisions) or earnings driven over the first few quarters of this year. We may get some more clarity on this over the next fortnight of trading, with heavy slate of earnings from Corporate America due in the next two weeks.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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