Powell’s speech could sway sentiment in either direction.
With the FOMC widely expected to increase the U.S. federal funds rate (FFR) by 25 basis points today, all eyes will be on Fed Chairman Jerome Powell’s 2:30 p.m. ET press conference. However, since investors often hear what they want to hear, his words should have little impact beyond the short term. As a result, it’s prudent to stay focused on the medium-term outlook, which continues to align with our technical and fundamental expectations.
For example, with the economic data supporting higher interest rates, the pivot narrative lacks fundamental merit. As evidence, the Dallas Fed’s Texas Service Sector Outlook Survey noted on Jan. 31:
“Labor market indicators pointed to stronger employment growth and steady workweeks. The employment index climbed five points from 5.3 to 10.5, while the part-time employment index rose three points to 1.2. The hours worked index improved from -1.8 to 0.9.”
In addition, we noted the strength in the manufacturing report on Jan. 31. We wrote:
“Labor market measures pointed to stronger employment growth and longer workweeks. The employment index climbed four points to 17.6, a reading significantly above its series average of 7.9. Thirty-one percent of firms noted net hiring, while 13 percent noted net layoffs. The hours worked index held fairly steady at 3.8.”
Likewise, The Conference Board released its Consumer Confidence Index on Jan. 31; and while the metric declined from 109.0 in December (an upward revision) to 107.1 in January, it has bounced off the lows from July 2022.
Please see below:
More importantly, the report stated:
“48.2% of consumers said jobs were ‘plentiful,’ up from 46.4%. 11.3% of consumers said jobs were ‘hard to get,’ down from 11.9%.”
Please see below:
To explain, the red line above tracks the U.S. U3 unemployment rate, while the gray line above tracks The Conference Board’s inverted (down means up) labor differential. For context, the latter is calculated by subtracting the jobs are ‘hard to get’ percentage from the jobs are ‘plentiful’ percentage. In a nutshell: a lower gray line means that Americans are confident about their employment prospects.
If you analyze the right side of the chart, you can see that the labor differential rose to 36.9% in January, its highest level since September. Thus, while the Fed needs to increase the U.S. unemployment rate to suppress wage inflation, the necessary demand destruction is not present.
Speaking of which, the U.S. Employment Cost Index (ECI) increased by 1.03% quarter-over-quarter (QoQ) on Jan. 31, slightly below the consensus estimate of 1.1%. But, the data is still profoundly hawkish from a historical perspective.
Please see below:
To explain, the red line above tracks the QoQ percentage change in the ECI. If you analyze the movement, you can see that a QoQ rise of 1% or more only occurred two times from 2001 until the pandemic began, though, there were also three others between 0.96% and 0.99% QoQ. In any event, QoQ increases of 1%+ are rare and highlight how wage inflation remains abundant.
In addition, with more earnings releases hitting the wire on Jan. 31, the pricing pressures remain. McDonald’s – the largest restaurant chain in the world – released its fourth-quarter earnings pre-market. CFO Ian Borden said during the Q4 conference call:
“In the U.S., we would say we're past the inflation peak and kind of heading on that downward slope. But certainly, we had high inflation, mid-teens in 2022 from a food and paper perspective. In 2023, we think our food and paper inflation is going to be kind of mid to high single digits. So still obviously very elevated from where it's been for a long time.”
He added:
“If you look at the full year in the U.S., we were up about 10% from an average pricing standpoint.”
So, while McDonald’s inflation has cooled from its peak, “mid to high single digits” still imply inflation of 5% to 9% in 2023. Moreover, the conjecture is profoundly hawkish because it shows that real businesses do not expect a 2% inflation rate anytime soon. Consequently, a higher FFR is needed to revert the cycle back to its pre-pandemic state.
As further evidence, Caterpillar – the world’s largest construction equipment manufacturer – released its fourth-quarter earnings on Jan. 31. CFO Andrew Bonfield said during the Q4 conference call:
“We currently expect to see a moderation of input costs inflation as the year progresses, and a corresponding moderation in price realization as we move through the year. Price, though, should still more than offset manufacturing costs for the year…..
“We still expect strong price in Q1. It will not be as big as Q4 for the simple reason we are lapping price increases that we put through at the beginning of 2022. So that will be coming down slightly, but we do expect price cost to be favorable for the first half of the year.”
Please see below:
To explain, Caterpillar recorded 20% revenue growth in Q4, but nearly 62% of that was a function of higher prices. This means the company raised its average selling price by more than 12%, and with “strong price in Q1” expected, we’re nowhere near the Fed’s 2% target or a level that would justify a dovish pivot.
Overall, risk assets remain elevated as the crowd underestimates the potential risks; and while it’s a fool’s errand to guess what Powell will or won’t say, please remember that the fundamentals lead the Fed, not the other way around. Therefore, with the medium-term outlooks bullish for the FFR, real yields and the USD Index, interest rates should have more upside before it’s all said and done.
Is FOMC day a ‘sell the news’ event, or will the crowd remain enthusiastic? Why are Americans so optimistic about their job prospects? And if the Fed pauses, why would corporations stop raising their prices?
Alex Demolitor
Precious Metals Strategist