As your humble METAR weather reporter, I try to sift the data to separate signal from noise.
The two big data points last week were the Federal Reserve raising the fed funds rate by 0.25% and the stunning news that total nonfarm payroll employment rose by 517,000 in January.
The stock market celebrated as I predicted in last week’s Control Panel. At least two METARs pointed out that the “mungofitch 99 day rule” has been passed on the upside, a signal of a possible beginning of a durable bull market in stocks.
Let’s look a little deeper into what the data say.
“The [Federal Open Market] Committee decided to raise the target range for the federal funds rate to 4-1/2 to 4-3/4 percent. The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time…In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.”
Notice the plural in the ongoing increases of the fed funds rate. Notice the continued reductions of longer-term AAA debt securities held by the Fed. Notice the strong commitment to the 2% inflation target.
The markets simply don’t believe the Fed will do what it has stated repeatedly. Both the bond and stock markets would be priced lower if they did.
The great news from the employment report needs further analysis. There are two sections: the Establishment Survey (from employers) and the Household Survey (phoning households). The Establishment Survey counts employment whenever an employee is on the payroll, so workers with multiple part-time jobs can be counted more than once.
The reporters for both the N.Y. Times and Wall Street Journal simply reported the first line of the establishment survey from the Labor Department – wow, great! – but they didn’t dig any deeper into the data. Pretty darn lazy for professional reporters.
Further down in the fine print of the actual report is this notification:
"Effective with data for January 2023, updated population estimates were incorporated into the household survey. Population estimates for the household survey are developed by the U.S. Census Bureau…
The adjustments increased the estimated size of the civilian noninstitutional
population in December by 954,000, the civilian labor force by 871,000, employment by 810,000, and unemployment by 60,000."
Table C shows the effect of the introduction of new population estimates on the change in selected labor force measures between December 2022 and January 2023.
Dec.-Jan. change, as published 894
2023 population control effect 810
Dec.-Jan. change, after removing the population control effect 84
Yikes! Over 90% of the employment change reported in the Household Survey was actually a once-a-year adjustment due to Census numbers! The actual Dec.-Jan change, after removing the population control effect was only 84,000 new jobs!
That is a stunning difference! Nobody would get excited about adding only 84,000 jobs. Instead, the number is far lower than the expectation of over 150,000 new jobs.
This is how the WSJ spun the news.
Upbeat Economic Data Keep Investors on Edge About Fed
After a strong jobs report, traders are betting the Fed might raise interest rates two more times this year
By Akane Otani, The Wall Street Journal, Feb. 5, 2023
The U.S. labor market remains incredibly strong. Investors can’t decide if that is a good or bad thing.
At first glance, Friday’s jobs report seemed to have very little for money managers to dislike. The U.S. economy added a whopping 517,000 jobs in January, while the unemployment rate fell to its lowest level since 1969, according to Labor Department data…
Following the release of the report, traders increased bets that the Fed will raise interest rates two more times this year, instead of just once more, according to data from CME Group. Traders also bet the Fed will push interest rates higher than they had thought before the jobs report, according to FactSet, something that could ultimately put more pressure on markets…[end quote]
The Fed has been very clear. They will keep raising the fed funds rate until inflation has reached their target. Then they will hold the fed funds rate at that level for an extended period of time until they are sure that inflation will not reignite. They expect “pain” in the economy. They will not cave in even if a recession results.
The market’s expectation that the Fed will begin to drop the fed funds rate in 2023 is contrary to the Fed’s own “dot plots” of the fed funds rate.
The Fed will only cut rates if they are firmly convinced that inflation has met their target for the forseeable future AND if there is a severe recession. If inflation has met their target there is no reason to change the equilibrium and cut the fed funds rate. Doing so would only trigger the imbalances that caused the bubble in the first place, such as negative real yields.
The Control Panel shows that the stock indexes popped as predicted when the Fed slowed its fed funds rate raise to 0.25%. Stock market internals have been getting stronger.
The trade is risk-on as stocks and junk bonds rose relative to the 10 year Treasury bond and USD. The Fear and Greed Index is in Extreme Greed.
The USD, which has been falling for months, popped a little. Gold, which has been rising, fell suddenly. Copper has been falling for several weeks. Oil has been falling for a few weeks. Natgas has been falling since late December.
The Treasury yield curve may have bottomed after falling for several weeks. The 10 year Treasury seems to be in a stable channel of around 3.5%. This is still a negative real yield until inflation actually falls substantially.
The CPI-U index has dropped for the past couple of months, important for owners of TIPS and I-Bonds since that is used to calculate the interest.
The 10 year TIPS is currently yielding 2.22% less than the 10 Year Treasury. This has been gradually declining since April 2021 when the Fed began its anti-inflation actions.
The Conference Board Leading Economic Index® (LEI) for the U.S. decreased by 0.8 percent in December 2022 to 110.7 (2016=100), following a decline of 0.8 percent in November. The LEI is now down 3.8 percent over the six-month period between June and December 2022—a much steeper rate of decline than its 2.3 percent contraction over the previous six-month period (December 2021–June 2022).
Stocks are still richly valued. Even with the 2022 drop, the SPX Cyclically Adjusted P/E Ratio (CAPE Ratio) is about equal to the value in 1929, about double the historic median.
So…what is the data saying? Is this a good time to buy stocks? Is this a good time to extend the duration of bond holdings?
The stock market is betting on a soft landing or no recession. The top-line employment report appears to indicate a very strong job market but the top-line number is mostly an artifact of an annual adjustment. The actual number is weak but the market doesn’t recognize that. The Treasury yield curve and LEI signal recession.
The 99-day rule says that this is a good time to buy stocks. But that is based on the stock market, which could be blindsided when their over-optimistic assumptions turn out to be false.
I think the data are saying that there will be a recession and a better buying opportunity for stocks later. This may be a good opportunity to extend the duration of bonds since bond yields typically fall during recessions (raising the prices) and the Fed is working on suppressing long-term inflation.
The METAR for next week is sunny. But it could change fast if traders realize the gotchas hidden in the data.