December 2, 2022

Don’t Fight the Fed

When I entered the asset management arm of my career, I was focused on the bond markets. The process of research and analysis that accompanies the bond market is different than that which covers the stock market. This is because when researching and analyzing a stock one focuses on the fundamentals of the that company, with bonds, the focus is on interest rates and the economic fundamentals are the best source to search for the right investment. Most of the time, bond yields tend to stay relatively lower to modest economic growth and inflation, which has been the case for the last 20 years. But now, as inflation has risen to the concern of the Fed, the impact has been to drive bond yields markedly higher and stocks markedly lower. This is what the Fed has wanted since beginning the fight to end inflation, are they winning?

 I bring this to light because after three days of the broad indexes working off some overbought conditions, Fed Chairman Powell then gave a speech that triggered a quick turnaround, leaving the broad indexes, in the black for the week. Why did this happen, and is the Fed’s work nearing the end? In my opinion, no. As a lifelong interest rate follower, there is long followed advice, if you think the Fed is wrong in being less aggressive with rate hikes, then you’re fighting with the Fed. The more reliable posture has always been, “don’t fight the Fed”. Why?

 This week revealed data showing a slight decrease in home prices. Also, GDP for the 3rd Quarter was revisited and remained modestly strong at 2.9%. The more positive news in the data was the GDP Price Index that came in at 4.3% further suggesting some deflation occurring in process. Consumer Spending showed slightly stronger data than the consensus of economists was expecting. Less welcome news was the data on national holdings of oil and gas which showed depleted inventory levels in need of resupplying. Although both fuels have been steady, they have also nonetheless remained historically high on average (Oil $80, Gas $7). Finally, today saw the release of monthly Employment data that showed stronger than expected Non-Farm Payroll Growth (263K), a steady, and low, Unemployment Rate (3.7%), Higher Average Hourly Earnings (5.1% vs 4.6% last month) and a slight decline in the overall Participation Rate (62.2% to 62.1%). By any measure, the Employment data showed a much stronger economic condition than suggested by Fed Chairman Powell. The economy is not weak, but slowing, inflation is still high, but peaking and until both conditions are realized to a measurable degree, the broad indexes will trade in a silo, waiting to break out.

 The humorous part of the narrative lately has been to talk about what the market wants rather than what the economics is telling us. The data this week undermines the arguments that recession is imminent. In my opinion, a recession is nonrandom, but not necessarily predictable. The reason for this is that prices in freely traded markets are determined by the economic principles of supply and demand.  Prices discount everything and as with the markets they impact, tend to travel in observable trends. The Fed is watching those trends, the market is watching those trends and this week, both got it wrong. But as behavior and history in the marketplace will tend to repeat itself, while the narratives will fail to embrace accountability, the Fed has always found it easy to change their mind. Therefore, in the meantime, in my opinion, best not to fight the Fed. 

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