Stock futures pointed down sharply this morning, as release of the latest Personal Consumption Expenditures (or PCE) inflation data points to likely continuance of tough monetary policy from the Federal Reserve. Taking a look at the details, month to month, consumer spending in January expanded by 1.8%, versus economists’ expectation of 1.4% and the December showing of a 0.2% decline. Too, personal income advanced at a monthly pace of 0.6%, compared to expectations for a 1.2% increase, but stronger than the prior rate of 0.2%. Of particular importance was the release of the aforementioned Personal Consumption Expenditures (PCE) price index, which the Federal Reserve monitors closely. This index of inflation exhibited a month-to-month advance of 0.6%, greater than the previous month gain of 0.1%. Core PCE, exclusive of volatile food and energy prices, also stepped up 0.6%, on a monthly basis, a bit higher than the experts’ outlook (0.5%) and ahead of the 0.3% December pickup. Economists were anticipating 4.4% year-over-year growth in the core PCE, but the actual result was a swifter 5.4%, versus a revised 5.3% for the prior month.
The new data indicate that consumers remain able to spend. Unemployment is historically low, and wages are still rising, though at a more moderate rate. Inflationary pressures persist, but we expect goods and services price momentum to gradually slow ahead. Later this morning, investors will get readings on January new home sales, expected to show a limited increase, and the February consumer sentiment index, which may well come in about flat, remaining at a low level. In the following hours, several Fed officials are scheduled to speak on the economy and the central bank’s inflation-fighting strategy. Up to now, they have increasingly been turning more hawkish about interest rates. For this week, it looks as if the major market indexes will post losses.
Federal Reserve Chairman Jerome Powell is concerned that inflation is not receding as quickly as he would have liked. His attention is focused on the vibrant labor market, worried that an upward wage-price spiral could emerge in the coming months. At the same time, he is cognizant of the lag between the Fed’s short-term interest rate hikes and their effects on prices and the economy. We believe that most of the Fed’s heavy lifting has been done. The federal funds rate range is currently 4.50%-4.75%, compared to near zero at the start of 2022. Rates have not risen at such a resounding pace since the early 1980s. The consensus on Wall Street appears that the central bank will lift rates by one-quarter percentage point in both March and May, bringing them to 5.00%-5.25%. There is building speculation, however, that rates may ultimately rise to 5.25%-5.50% before summer; a pause in the Fed’s regimen seems likely after June. Meanwhile, the Fed’s balance sheet will continue to decline in size, as fewer maturing holdings of bonds are replaced. This policy will reduce liquidity in the economy, perhaps restricting lending and helping with the fight against inflation.
The domestic bond market has been fairly quick to react to the Fed’s ongoing rate strategy, as evidenced in higher short-term yields, and comparatively lower yields on longer-dated securities, characterized as “an inverted yield curve.” An inverted yield curve suggests that a recession is not far away. Stocks now appear to be following the bond market’s lead. Investors have become less enthusiastic about growth stocks and have turned more toward defensive equities that may hold up well during a recession.
So far, the U.S. economy has proven quite resilient, and a recession might possibly be avoided. Interest rate cuts do not seem likely until 2024. Until then, share prices will react to incoming economic data, corporate earnings, and Fed policy, not to mention any unforeseen serious global political or economic events. For now, we advise investors to maintain a significant weighting of defensive stocks in their portfolios, along with selective holdings of financially strong growth-oriented companies that may lead the market up once we get to the other side of the current interest rate increase cycle. – David M. Reimer
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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