Perspective: Morning Commentary for January 31

January 31 – Stock futures traded mixed to weaker ahead of today’s anticipated statement from the Federal Reserve, while yesterday’s surprise rally in the commodity sector fell flat in overnight trading. The VIX is trading near 13 once again this morning, while the dollar index is trading near 103.3. Yields on 10-year Treasuries are trading at a two-week low near 4.00%, while yields on 2-year Treasuries are trading near 4.27%. Crude oil prices are modestly lower in early trade, while the grain and oilseed sector is mostly weaker as well.

The U.S. private sector created just 107K jobs in January, according to this morning’s ADP report. That’s down from analyst expectations of 145K jobs created. Furthermore, the December number was revised to 158K jobs created, down from the 164K originally reported. That raises questions about Friday’s big monthly employment report from the U.S. Department of Labor. The correlation between these two reports is not as strong as we’d like it to be, but it does raise some questions about whether we will reach the 170K overall non-farm job creations expected by analysts for January. These numbers are a central focus of traders on Wall Street for a couple of reasons. First, a weak job creation number tends to reflect weakness in the U.S. economy, but it also would suggest a quicker pivot by the Federal Reserve toward rate cuts, which Wall Street interprets as good for the economy.

Wage inflation is a related number that the Federal Reserve is monitoring relative to its efforts to bring overall inflation down to the 2% mandate. Today’s reported employment cost index rose 0.9% for the fourth quarter of 2023, which is down from the 1.1% rise that we saw in the third quarter. That’s still up 4.2% year-on-year, although that is a tick lower than the 4.3% reading that we saw for the third quarter. This data suggests that wage inflation is also trending lower, which is something that the Federal Reserve wants to see for gaining control of overall inflation. The question is, will the Fed see this as enough progress to pivot?

The Federal Open Market Committee concludes two days of meetings this afternoon with the release of its updated policy statement at 2 p.m. Eastern Time, followed by a press conference with Fed Chair Jerome Powell 30 minutes later. Wall Street wants a pivot to lower interest rates. It’s betting that the first cut will come in May, if not in March. The more dovish members of the FOMC are no doubt making an argument for such in today’s meeting. However, the more hawkish members are arguing that sticky wage inflation and rising housing prices are working against getting the overall inflation rate down to 2% as soon as they would like, suggesting that they should hold rates where they’re at for longer to make sure that it happens. They will also argue that the expectations of a pivot emerging out of the December meeting led to new highs for the stock market and a rise in consumer confidence, increasing spending for goods, services and housing, making it even more difficult to get down to the 2% level. They will argue that the above makes it even more critical that they communicate with more of a hawkish tone in both their printed statement and in the press conference if they want to continue to see progress on inflation data. Fed Chair Jerome Powell has a bent toward leaning toward dovish in public comments, which came out again in the press conference following the Fed’s December meeting. Will he allow that dovish bent to come out once again? In my opinion, he will work at sounding more hawkish - trying to focus on holding rates for longer until the data justifies a rate cut. But will he be successful in doing so? This is a pivotal day for Wall Street and for the Fed.

The broader commodity sector had a big money flow day on Tuesday, but the overnight follow-through was weak. The same issues are at play today as were in play yesterday as were in play a week ago. We’re still adequately supplied in most food and energy commodities, but we also still have slowly escalating geopolitical risks that create logistics challenges for global trade. Those logistics risks are lengthening trade routes while increasing costs. This is actually a greater problem for China, and its trade with Europe and the Eastern United States, than it is a direct problem for the United States. Yet, it’s a global market, and what impacts one part of the world impacts all of the world in one way or another. Speculative fund managers build large short positions in most commodities over the past year and a half on deflationary trend expectations. Prices fell notably over that period, reaching multi-year lows in many cases. End users are asking themselves if they’re willing to risk a possible short-covering rally that could be triggered by a geopolitical headline out of the Black Sea or Red Sea? Speculative fund managers with big profits in those short positions are asking the same thing. That’s going to give us periodic days like what we saw on Tuesday, when both come in to do some buying at these low price levels.