Hopes were dashed for a year-end Santa rally as a series of economic reports painted a mixed outlook for the economy. Markets rallied early in the week as November’s CPI report showed inflation shifting lower month-on-month, bringing some much need relief to inflation-weary consumers. However, the market’s momentum stalled on Wednesday as the Federal Reserve maintained its hawkish tone during its last FOMC meeting of the year, rattling nerves on Wall Street by raising its outlook for the peak Fed funds rate to 5.00-5.25% from 4.5-4.75% in September. Thursday’s economic reports added even more coal to investors’ stockings with retail sales dropping -0.60% as consumers failed to get in the holiday spirit. The report was a wakeup call to those betting on a soft landing now that the consumer appears to be buckling under the combination of inflation and tighter monetary conditions. Investors fear that a weaker consumer could tip the economy into recession, and traders elected to lock in profits from the autumn rally. For the week, the S&P 500 slipped -2.08%.
All Consumers Want for Christmas are Lower Prices
There’s just one thing consumers want for Christmas, relief from high prices. November’s CPI report provided some relief as consumer prices rose 0.10% month-to-month. That helped bring the trailing twelve month rise to 7.10%, down from October’s 7.80% rise and June’s 9.10% pandemic era peak. Core CPI rose 0.20% on the month and 6.00% on an annualized basis. The month-on-month decline was driven by a drop in energy, medical care services, and used cars. However, the report showed inflationary pressures remaining persistent in a number of categories. Food prices rose 0.50% for the month, up 10.60% from a year ago. Furthermore, prices for food are likely to remain elevated into 2023, especially for dry groceries and consumables. Walmart’s CEO weighed in on the stubborn and persistent inflation this week, noting the retailer continues to see mid double-digit inflation in this segment with few signs from suppliers that prices will come down soon. Shelter costs, which make up about one-third of the CPI weighting, have also proved particularly sticky. They were up 0.60% in November and are now up 7.10% on an annual basis. Although shelter costs are expected to moderate in 2023, they are still likely to remain elevated amid tight supply nationwide. Excluding food, goods inflation continued to ease during the month, falling -0.50%. However, services inflation remains persistent as consumer demand for experiences remains robust and the cost of labor remains high. In November, services inflation less energy was up 0.40%. Fed Chairman Jerome Powell recently highlighted services inflation as a key component to watch in determining future monetary policy moves.
Bah! Humbug! Higher Rates for Longer
The Federal Reserve showed few signs of easing up on its inflation fight, lifting its benchmark lending rate by 50 bps to a current target range of 4.25% to 4.50% – the highest level in 15 years. Wednesday’s hike was smaller than its previous hike of 75 bps and while the move was widely expected, markets were caught flat-footed by the Fed increasing its terminal rate (level at which it stops raising rates) to 5.00-5.25% in 2023 from September’s forecast of 4.5-4.75%. The higher rate should help the central bank tame persistent inflationary pressures, particularly on the services side which the Fed has become increasingly focused on in recent months. The Fed also noted in its dot plot of future expectations that it expects to keep interest rates higher for longer. The central bank now expects to keep rates elevated through next year, with no cuts expected until 2024. In 2024, Fed members are penciling in a full percentage point of rate cuts which should bring the benchmark rate to 4.10% by year-end. They expect to take another percentage point of cuts in 2025 to bring the rate down to 3.1%, before the benchmark settles into a long-run neutral level of 2.50%.
Final Thoughts
With just nine trading days left in 2022 and a light economic calendar ahead, there appears to be little to power a year-end Santa Rally for stocks as investors remain concerned that the Fed’s inflation fight will tip the economy into recession in 2023. On the one hand, the bond market indicates high conviction that an economic slowdown is in the cards with investors flocking to the safety of treasuries and pushing the 10-year treasury yield down to 3.49% from a peak of 4.25% in late October. Stock investors, on the other hand, have had mixed feelings on the economy and Fed, oscillating between concerns that a recession will result in lower corporate profits (bad for stocks) and hopes that a recession, while painful, will prompt the central bank to cut rates to boost economic growth (which is good for stocks). Depending on the week’s economic reports, the market has swung sharply between these two mindsets. The Fed does not want its policy undermined prematurely by a bull market and Powell reiterated this week that we still have a long way to go in order to tame inflation and the Fed intends to keep rates high for some time. In doing so the Fed is ultimately targeting the labor market, implicitly acknowledging that the strong labor market is the underlying fuel for inflation. Using their interest rate assumptions, the Fed now expects unemployment will rise to 4.6% by the end of 2023. With the national unemployment rate at 3.7% today, a 4.6% unemployment rate would imply needing nearly 1.7 million layoffs over the next year to reach this target. Given how strongly companies have been adding headcount, this hiring momentum not only needs to be blunted but it needs to be reversed. More and more it begins to look like a sharp economic downturn may be necessary to accomplish this, which ultimately didn’t leave markets feeling much of the Christmas spirit this week.
The Week Ahead
With the year drawing to a close, Week in Review is calling it a wrap. We’ll see you on the other side of 2023 with the latest nonfarm payrolls and ISM reports.
Happy Holidays from Probity Advisors, Inc.
‘Tis the season for holiday gatherings and celebrations, traditions, time with loved ones, and the general hustle and bustle that comes this time each year. It’s also a time for reflection and hopefully a time to count our blessings. For Probity, that means being grateful for the opportunity to celebrate the 50th work anniversary of our president and founder Buddy Ozanne this past year. It was wonderful to see so many familiar faces in person and to catch up with those of you who were able to join us in the Spring to mark the occasion of Buddy’s golden anniversary. Additionally, Probity Advisors, Inc. celebrated its 20th anniversary. As we reflect on these milestones, we are filled with gratitude to all of our clients, many of whom we have known and served for decades, for their trust and confidence in us.
We are also grateful for our associates and staff and are honored to note the incredible tenures of Christopher Sorrow and Adam Bronson who each celebrated their 20-year work anniversary this past year. Alissa Kaiser has been with Probity for 18 years, and Ana Avila has been with Probity for 14 years. Cinco Calfee Sorrow marked 11 years with the firm, and Whitney Magers celebrated a decade of service to our clients and to our firm in 2022.
Our continued mission is to provide advice and guidance that brings financial freedom to individuals — allowing them to enjoy the things they love without the burden of worrying about their financial security, enabling them to retire without the fear of insufficient savings, and helping them provide for their loved ones and leave a lasting legacy.
As mentioned above, this past year has continued to test investors’ resolve, and we welcome your visit to our offices anytime should you wish to speak with one of our advisors.
This holiday season and in the year ahead, we wish you and yours health, wealth, and happiness, and, most importantly, the time to enjoy them.