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Trash Talk

Last week, several members of the Federal Reserve spoke, and what emerged was very conflicted. Normally, efforts are made to craft a consistent message, but the only thing they agreed on was that there will be no action at the April 30 - May 1 Federal Open Market Committee (FOMC) meeting. The harmony ended there, unfortunately. This is problematic because, without a stable consensus, a new Fed outlook can emerge and surprise the markets. Because the current view is for three rate cuts from the Federal Reserve this year, any change will be seen as negative for the markets. 

At their March meeting, there was a range of views across the FOMC participants regarding their year-end fed funds target. There is a split between the consensus 3 rate cut view and the other half who forecast two rate cuts or fewer. A split exists not only for the number of cuts but for the timing of those cuts.

Atlanta Fed President Raphael Bostic favors one rate cut in Q4, and Minneapolis Fed President Neel Kashkari mentioned the possibility of no rate cuts this year if inflation stays where it is. While it is bad enough that no principal message is coming out between central bankers, what’s worse is Kashkari sending confusing signals all by himself because he was in the 2-rate cut camp with steady inflation when he submitted his forecast on March 20.

Chairman Powell and two other voters expressed confidence in the baseline for three rate cuts for 2024, but even they were wavering. Powell seems more open to fewer cuts as he mentioned this week that the risk of cutting rates before there was solid evidence of hitting the Fed’s 2% inflation target “would be really quite disruptive.” 

President Austan Goolsbee of the Chicago Fed said if housing inflation doesn’t come down to 2% then overall inflation would probably not reach the Fed’s 2% target. The same day, Virginia Fed President Tom Barkin said he thinks inflation will hit the Fed’s 2% target, even “without shelter inflation returning to what is considered normal levels.”

With half of the FOMC voters speaking last week, this is what a consensus looks like?

The Consumer Price Index inflation reading this Wednesday, April 10, may help their views coalesce into a unified view. FOMC members go into a forced blackout period 14 days before their meetings. Perhaps they should have extended that rule to include last week—we all may have been better off. The markets seek stability, and this cross-talk from the FOMC is potentially very disruptive to markets that are showing signs of fragility.

Stock Sectors Spoke Succinctly: Stagflation

While the Fed was scattered, the stock market was speaking another language entirely as it bid up commodity stocks in relation to economically sensitive stocks. This is a vote for stagflation, which occurs when prices rise due to inflation and slow business activity down.

Oil stocks and materials stocks such as metals, chemicals, and paper companies were up. Meanwhile, bank stocks and consumer discretionary stocks (retail stores, hotels, restaurants, etc.) lagged.

When capital flows to commodity stocks, including gold miners, and away from stocks that move with the economy, it signals stagflation.

While investors have considered the current market environment closer to the 2000 tech bubble, the 2007 top exhibited stagflationary price action. While the S&P 500 index peaked in October 2007, materials and energy stocks rallied through June 2008.

Banks and Consumer Discretionary stocks have underperformed Energy and Materials for two months now. If the stock market is correctly forecasting the upcoming economic environment, the Fed will be in a bind because if interest rates must increase again to fight inflation, this will suppress weakening consumer demand even further.

Payrolls Hit Paydirt

Payrolls came in much stronger than expected, above any economist’s estimate, and there was no sign of wage inflation, an ideal situation for the Federal Reserve: increasing labor demand that doesn’t push salaries higher. It is important because the Fed has been concerned that higher wages would add to inflationary pressures. Labor force participation increased, meaning that the labor supply has increased, which is also good news for the Fed because more available workers keep a ceiling on wage gains. The improvement in the Conference Board Labor Differential (Jobs plentiful minus Jobs hard to get) is normally a strong indicator of a good payrolls number, and this time was no exception.  The March ADP employment report on Wednesday also registered the biggest hiring increase since July 2023.

This strong payroll report for March continues the theme of solid labor demand so far this year. It would seem logical for stock investors to welcome this. However, the is a hitch. The Fed’s dual mandate of maintaining price stability and maximum employment went out the window when inflation rapidly increased. They were focused on raising interest rates to contain inflation, even at the risk of causing a recession. Now that inflation has declined from 7% annual price increases, the market assumed there would be no more rate hikes. With employment heating up, the Fed could surprise the market with talk about rate hikes again, not to contain inflation but to contain growth before it spills over into higher inflation. Friday afternoon saw Michele Bowman talking about the potential for more rate hikes if progress on lowering inflation stalls. This is a first and potentially very significant if other FOMC members start to repeat this theme.  

What To Look for This Week

1. CPI should normally get the top slot in what to watch this week, but the world is on geopolitical pins and needles after Israel concluded that Iran could launch a missile or drone attack. That news, plus U.S. Secretary of State Anthony Blinken standing shoulder-to-shoulder last Thursday with Ukraine’s Foreign Minister Dmytro Kuleba declaring that Ukraine will become a member of NATO sooner than later, does not help relieve war concerns, either. When war headlines start to move the market, nothing else really matters, so expect big price swings if another front opens up in the Middle East.

2. Wednesday, April 10, the Consumer Price Index (CPI) is released at 8:30 am ET. A few hours later, the Cleveland Fed releases its Sticky-Price CPI, which is inflation for a specific group of goods and services whose prices move slowly. December and January Sticky-Price CPI were both at 4.6% annual inflation, and February fell to 4.4%. This gradual descent has created hesitation on the part of FOMC voters to cut rates. We will see whether CPI or Sticky-Price CPI pushes any of them to alter their rate-cut forecasts.

3. Earnings season starts this Friday with JP Morgan and Citibank as two of the major banks start the tone. This earnings season we will be on the lookout for how companies discuss their AI initiatives and whether investors continue to bid prices up on AI developments