Powell Stays on (His) Course

Are You Gonna Go My Way

Chairman Powell was certain that inflation would quickly revert to the Federal Reserve’s 2% inflation rate target until he wasn’t. The market was counting on Powell’s view to deliver three rate cuts this year, one-factor driving stock prices to record highs. Inflation data came in stronger than expected in January and February, but Powell did not alter his view. After the March inflation data remained elevated, the Fed Chair declared on April 16th that “progress had stalled” on inflation’s trajectory. This statement caused understandable investor trepidation going into the FOMC statement and press conference last Wednesday.

Those fears were validated when reading the Federal Open Market Committee (FOMC) statement that contained an added sentence stating that “there has been a lack of further progress toward the Committee’s 2 percent inflation objective.” When the Federal Open Market Committee (FOMC) adds something, it normally means the impact will last for a while. That was a warning for the upcoming press conference because it suggested that inflation will continue to show a lack of progress over the coming months.

Powell was far from pessimistic in front of the press; he was very clear when he declared, almost promising: “We will bring inflation down to 2%.” He repeatedly said that was his personal forecast, although he did qualify it by saying his confidence was lower after the last three inflation readings. 

His performance in front of the press raises more questions than it answers. The big uncertainty is whether his forecast matches the other 11 FOMC voters on the FOMC. The phrase “inflation remains elevated” has been in FOMC statements since November 2022. Therefore, if the remaining members were as confident as the Chairman that the economy is on track to reach the 2% target, why add that the last three months of elevated inflation represents a lack of progress? 

We will watch Fed speakers over the coming days to see if they agree with the Chairman or if he was simply expressing his personal views. If they push back, it will weigh further on investor sentiment and make Powell appear like a lone wolf, and that will weigh on stock prices.

Another 独狼 [Lone Wolf]  

The UBS analyst who stood out from the crowd in 2021 when he slapped a sell recommendation on the property developer Evergrande Group, a darling of the Chinese stock market a year before its default, has now turned bullish on Chinese real estate. Bullish is a relative term since he now expects a long bottoming out period, but he is an uber bull compared to other analysts, some who are saying China’s 20% drop in prices over three years is tiny compared to Hong Kong (70% drop in property prices in 1997) or Japan (15-year bear market in real estate). 

If John Lam, the head of China and Hong Kong property research at UBS, is correct that government stimulus puts a bottom in the property market, it carries significant consequences. 

Falling apartment prices have kept potential homeowners and investors from returning to the market, causing a 40% drop in sales, but new housing starts have dropped by 60%. Lam’s view is that the sharp decline in supply will hit an equilibrium with demand between January in the best case and December of 2025 as a worst-case scenario. If equity investors start to sense that the primary overhang on the Chinese economy is halting its freefall, there can be a strong recovery in stock prices. In fact, FXI, the large-cap Chinese ETF, is up 30% from its January lows, anticipating a recovery that could generate job growth. 

If an economic recovery takes hold, the negative aspect is that increased Chinese consumption and investment would raise the prices of commodities and be inflationary across global economies. China has been on the back burner for a while, but now it is important to watch once again.

When Bad is Good

The 175,000 increase in the April nonfarm payroll report came in far below its 240,000 forecast and far below March’s 315,000 increase. Average Hourly Earnings, which we discussed last week as the key data point to focus on in the report, fell significantly to 3.9% from 4.1% in March. Chairman Powell said during his press conference that inflation could go sideways, but the FOMC could still see a path to easing it if the labor market weekend. That comment caused the weaker data to spark a strong rally in the stock market.
The weaker employment outlook matches the weakness in other employment indicators we discussed in prior weeks, such as NFIB (small business) hiring intentions and the Jobs and Labor Turnover (JOLTS) hiring rate. The latter has fallen to its lowest level since the pandemic. The broad weakness in labor demand caused a big shift in expectations in the fixed-income market. The 10-year Treasury note dropped down to a 4.50% yield, and now traders are pricing in two rate cuts for December 2024 rather than just the one cut that was their forecast last week.

This shift increases the stakes over the tone the FOMC voters strike this week as they begin to speak publically after the May 1 meeting. Unless they talk the market back toward one rate cut, it is bullish for risk assets. Equity investors will remain optimistic as long as fixed-income investors continue to expect two rate cuts before year's end. 

What To Look for This Week

1. 05/06: FOMC voters Williams and Barkin are set to speak. Barkin has, so far, been clear that he wants to be patient before cutting rates, and his stance is crucial. If he doubles down on his view, it could be a significant indicator of Powell being out of alignment with the FOMC consensus This is a key aspect to watch for this week. 

2. 05/06 : The Fed surveys senior loan officers at banks every quarter, and the most recent report is released on Monday. Lending standards to consumers and businesses have been tight. The contraction in the availability of loans has been a factor behind small businesses pulling back on hiring. If the survey shows banks are continuing to be conservative in their lending practices, it does not bode well for the economy or stocks.

3. 05/08: Crude inventories have been rising, and crude has fallen on the news.. If the Department of Energy data Wednesday shows more inventory buildup, it reflects lower energy demand and a weaker economy, which are two negatives for stocks. The 10-year Treasury note auction is also this Wednesday.