Perspective: Morning Commentary for February 1

February 1 – Stock futures bounced this morning, taking back a potion of yesterday’s losses that came following the release of the Federal Reserve’s statement and press conference on Wednesday. They did so as they focused on today’s tech earnings reports. The VIX continues to trade near 14 this morning, while the dollar index firms to trade near 103.5, creating modest headwinds for the commodity sector. Yields on 10-year Treasuries are trading near 3.90% this morning, while yields on 2-year Treasuries are trading near 4.20%. Crude oil prices added some geopolitical risks back in this morning, pushing prices 1% higher, while grain and oilseed prices were mostly lower. The latter continues to suffer from soft demand relative to ample supplies amid a strong U.S. dollar.

First-time claims for unemployment benefits rose to 224K in the week ending January 27, up from 215K the previous week, and above analyst expectations of 214K. This raised the four-week moving average to 207.75K claims. Continuing claims for the week ending January 20 jumped by 70K to 1.898 million, while the four-week moving average rose by a smaller 7,500 to 1.841 million claims. This suggests an easing jobs market, which is negative for the economy, but positive for reducing wage inflation, which is the Federal Reserve’s goal. Another report released this morning showed that unit labor costs rose by an annualized rate of just 0.5% in the fourth quarter, down from analysts expectations of 2.1%, versus a contraction of 1.1% in the third quarter. The fourth quarter labor costs were influenced by a 3.2% rise in nonfarm productivity in the fourth quarter, up from expectations of 2.3%, but down from 4.9% the previous quarter.  

Things got wild on Wall Street for a time on Wednesday afternoon after the Federal Open Market Committee released its latest monetary policy statement, followed by Fed Chair Jerome Powell’s press conference 30 minutes later. There were two key changes in the policy statement focused on by traders. One was the removal of language that’s been in the statement that kept the door open for potentially higher rates if the data deemed necessary. That was seen as a dovish development. The second was insertion of a statement, “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward two percent.” That was the Fed’s attempt to show its hawkish side, per my comments yesterday. Powell tried to follow through with that theme in the press conference, because frankly, one of the greater challenges to the Fed reaching its 2% mandate is an economy thinking that the heavy lifting is already behind us, leading to strong consumer sentiment that fuels the purchase of goods, services, and homes.

Powell emphasized that “inflation is still too high, and the ongoing progress in bringing it down is not assured.” He clearly wanted to get that message across. He admitted that rates are likely at their peak for this current cycle, and that rate cuts are likely at some point this year if things continue on their current path. But he also stated that the FOMC had no rate cut proposal on the table for this week’s meeting, and that he didn’t expect one to be ready for the next meeting either. The market was quite volatile through the afternoon, first lowering rate cut expectations, and then pricing them in once again. It finished the day by giving a March rate cut roughly 50-50 odds, but then also by putting in roughly 50-50 odds of either a 25- or a 50-basis point rate cut in by the May meeting, with up to 150 basis points by December. That’s the type of cuts you get with a recession.

The data simply doesn’t show that type of need for a rate cut currently. The Fed frequently stated last year that one of its biggest worries was cutting too soon, resulting in a sharp rebound in inflation, similar to what happened four decades ago. The Fed can afford to be patient because the economy is showing few signs of an imminent recession, and it will likely continue to benefit from fiscal stimulus in this election year. All of this remains consistent with my view that we will likely see a rebound of inflation later this year which will cause fund managers to ask why they are holding big short positions in the commodity sector when they should be owning commodities in their portfolio instead. But that comes later. To be sure, Wednesday’s market action was also complicated by a collapse of share value for New York Community Bancorp after it cut its dividend in its earnings report, while also posting a surprise loss – all related to its absorption of assets of the failed Signature Bank. It’s been nearly a year since we had the big regional bank failure scare, but it reminded the markets that the risk remains with us. Wall Street assumes that more failures could speed up the Fed’s rate reduction cycle, if they were to occur in the days, weeks or months ahead. That remains a risk that will continue in the background which could rear its head at some point.