Isn’t it amazing how investors ignore the hawkish Federal Reserve (Fed) comments but fully embrace the dovish commentaries?
Fed’s Thomas Barkin’s words that suggested that the Fed could cut rates if recent progress in inflation continues sent the Nasdaq 100 to a fresh record for the 3rd consecutive day and the S&P 500 to a fresh YTD high and near an ATH record as well.
Yet all the other central bankers’ warnings that it could be too early to cut rates didn’t see the same enthusiastic reaction. But the trend is your friend, the doves are your friends, the hawks are not your friends and that’s – I guess - the magic ingredient to ensure a Santa rally.
Yet, there is no rational explanation to this asymmetric market reaction given that the latest US economic data points at ongoing strength, and the latter should be, in theory, supportive of the Fed hawks.
Investors are dreaming of aggressive rate cuts in an environment of strong economic growth, and that is not the right recipe for easing inflation and keeping it sufficiently low. The robust economic data and high earnings expectations are not compatible with a dovish Fed.
FedEx Rings the Alarm Bell.
The latest FedEx (NYSE:FDX) results didn’t enchant investors yesterday. The company, which serves as a gauge of economic activity, missed expectations due to declining airfreight and trucking volumes. The stock price fell 7% after the closing bell.
The selloff will likely send FedEx below its uptrending channel building since October – on the back of falling yields, but that negative correlation between the FedEx and the US 10-year yield is about to break, as FedEx, like most stocks, can’t continue to rise on the back of the falling yields: a further fall in yields implies a decent economic slowdown and that isn’t good for earnings, earnings expectations and hence the valuations.
Zooming out, the S&P stocks are now trading at nearly 20 times the 12-month earnings estimates, and the trailing 12-month EPS estimate is at a record. This is a valuable insight into the expectations regarding the overall earnings performance of the companies in the S&P 500, and the numbers don’t look like an economy that needs looser financial conditions.
Dollar Weakness
Released yesterday, the latest housing data in the US showed that housing starts jumped nearly 15% in November as the mortgage rates dipped from above 8% to below 7% thanks to a swift fall in US yields. That’s a good sign for economic health, but not necessarily for the future path of inflation. But the dollar didn’t react.
Another interesting place to see is the US deposits. The US deposits were around 80% at the peak of the pandemic and are now reverting toward the pre-pandemic norm of around 60%. The melting excess savings could slow down the US consumer spending, hence temper the economic growth and tame inflation, but Atlanta Fed’s GDPNow points to a 2.7% growth in the US GDP in Q4. Thursday’s official data will remind that the US economy grew more than 5% in Q3, a number that should raise questions regarding the dovish Fed optimism.
The Fed doves’ optimism is overdone given the strength of the underlying economic data, and the upside pressure on energy and shipping costs as the world’s leading energy and shipping companies have started avoiding Suez Canal due to Houthi attacks. The recent developments will start showing in the economic data in a few weeks and help investors assess the extent of global implications.
Inflation Falls!
As worries regarding the implications of developments in the Red Sea mount, latest inflation numbers from Europe and Britain give some respite.
Inflation in the Eurozone slowed to 2.4% in November and core inflation fell to 3.6% as expected.
In the UK, both headline and core inflation fell faster than expected in November. Headline CPI slipped below the 4% mark, as core inflation eased to 5.1%. Cable slipped below 1.27 as a kneejerk reaction to the softer-than-expected inflation figures.
Yet in absolute terms, core inflation in Britain is still more than twice the BoE’s 2% inflation target. And even though the pace of easing is more than welcome, the Bank of England (BoE) is still last in line to join the pivot party. Therefore, hawkish BoE expectations should limit the pound selloff if, of course, investors continue to divest from the US dollar on the back of softening Fed expectations.