All METARs know that the Federal Reserve has been raising the fed funds rate at the same time as gradually decreasing its bloated book of bonds in an effort to reduce inflation to its target of 2%. So far, the results are tepid. After months of rapid raises in the fed funds rate, the median CPI (which the Fed thinks can provide a better signal of the underlying inflation trend than either the all-items CPI or the CPI excluding food and energy (also known as core CPI) changed +0.5% in October 2022. The PCE excluding food and energy (the Fedās preferred inflation indicator) ticked down a fraction but was still 5%, way above the Fedās goal of 2%.
The Fed will announce its December change in the fed funds rate this coming week. The market expects + 0.5%.
Employment is strong and the ratio of jobs to applicants is 1.7. Wages are increasing fast (up 5%) but less than the inflation rate. The Labor Department will release its November reading for the consumer-price index Tuesday. The report will offer the Fed its last look at inflation before it announces its final interest-rate decision of the year on Wednesday.
Despite the Treasury yield curve indicating a future recession more strongly than in the past 30 years the markets are expecting a soft landing.
Investors Grow More Confident Fed Will Pull Off a Soft Landing
Mutual funds and hedge funds are putting money in stocks that would benefit from slowing inflation, falling rates
By Akane Otani, The Wall Street Journal, Dec. 11, 2022
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Mutual funds and hedge funds managing roughly $4.8 trillion in assets have been putting money into stocks that stand to benefit from inflation cooling, interest rates going down and the U.S. economy avoiding a recession.
The investors have larger-than-average positions in shares of industrial, materials and energy companies, Goldmanās analysis found. All three groups tend to be sensitive to changes in the economy, meaning investorsā bets should eventually pay off if the U.S. can avoid a deep and prolonged downturn, or a āhard landing.āā¦
Whether there winds up being a recession or not, many say they are in agreement on one thing: Markets are likely to remain volatile for some timeā¦[end quote]
While everyone hopes for a soft landing that will bring down inflation without a recession itās hard to put confidence in this.
Since the beginning of 2022 the SPX has followed a pattern of lower highs and lower lows. Last week fell back from the most recent high set on December 1, 2022.
The Fear & Greed Index fell to Neutral. The trade is neutral since the SPX, junk bonds and UST are bouncing around in a similar range. USD is falling since the market thinks the Fed will slow interest rate rises while the ECB and UK central bank are expected to raise more rapidly.
Copper, silver and gold are rising while oil is falling and natgas has stabilized in a broad channel.
The Treasury yield curve has fallen dramatically at the long end while rising at the short end, leading to a strongly inverted yield curve. There is a strong trend of falling long-term interest rates which may or may not stabilize. The 10-year TIPS yield is also falling.
The 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity spread is -0.74%, the deepest spread since December 2000 and a clear indicator of approaching recession.
The 10-year breakeven inflation rate is 2.26% so the market is showing confidence that the Fed will be able to control inflation. I am less confident than the market so I am buying TIPS instead of fixed income that is not inflation-adusted.
The METAR for next week is uncertain. The Fed will announce its raise of the Fed funds rate. If it is 0.5%, as the market expects, there will probably be a stock market rally. The Fed will emphasize, as it has many times before, that it will continue to tighten until inflation has been controlled for an extended period of time. The market wonāt listen as it hasnāt listened before ā but then it may face reality and drop. Will there be an end-of-year rally? Too soon to say.
Wendy