As we started this year – I felt the market was getting ahead of itself. Not only was the tape approaching an overbought zone – it also assumed as many as six rate cuts (possibly seven) before the end of the year. What’s more – it also priced in that earnings per share (EPS) would grow 12% year on year. It felt like a contradiction. For e.g., either the economy was reeling and needed (emergency) rate cuts; or the economy is expanding strongly (supporting earnings growth)? Today Fed Chair Jay Powell pushed back on the former. Markets should not expect rate cuts as early as March… stocks didn’t like it.
Core PCE Softens – Giving the Fed Scope to Cut
If there’s one inflation indicator the Fed tracks more than any other – it’s Core PCE (personal consumption expenditures). The PCE price index looks at U.S. inflation by measuring changes in the cost of living for households. It tracks the prices of a basket of goods and services, each with different weightings, to reflect how much a typical household spends every month. Today we learned that Core PCE continues to soften – which is good news. Question is does this give the Fed further scope to cut rates sooner rather than later?
What Just Happened?
Only two weeks ago Fed Chair Powell said “the FOMC are not thinking about rate cuts”. And it was premature to conclude with confidence they are at a sufficiently restrictive level. Well forget all that. Powell performed one of the more remarkable pivots ever seen from the Fed. He pivoted 180 degrees from his sentiment barely 14 days ago. Powell is now talking three rate cuts next year and the Fed have essentially “won the battle” over inflation. My take is the Fed is now more concerned about the business cycle; i.e., recession. There is a reason the Fed will cut – and that is the risk of dislocation in the economy (i.e., recession)
Cautious… But Invested
It’s a brave person who is short the market. Probabilities suggest we are headed higher in the near-term. For example, previous episodes of Fed pausing suggests stocks typically gain. My sentiment today is best described as ‘cautious… but invested’. To that end, one should always be invested to some extent. And whilst it’s always unwise to be completely remiss of the risks — it would be an even greater mistake not to have some exposure to higher quality risk assets and fixed income (at current yields)
For a full list of posts from 2017…