Financial News for the Week of February 9th, 2023

It was a very quiet week on the economic data calendar, giving investors a bit more time to digest last week’s blockbuster employment numbers in financial news. Since the jobs report, market pricing on the future path of the fed funds rate has firmed, with investors now anticipating two more 25 basis-point hikes by May, bringing the terminal rate to 5.25%. This aligns to FOMC’s last forecast outlined in the December Summary of Economic Projections. In contrast, markets differ from the Fed on the timing of rate cuts, with interest rate cuts priced in by financial markets for later this year, whereas the Fed doesn’t foresee that happening until 2024.

At an event on Tuesday, Fed Chair Powell did not pushback against the markets’ diverging view. Instead, he reiterated many of the same themes that he had emphasized in the press conference following last week’s interest rate announcement. The key message being that while the disinflationary process has begun, it remains very much in the early stages, and it will take “considerable time” before inflation returns to 2%. While financial markets initially rallied on the remarks, they later sold-off through the back-half of the week. At the time of writing, the S&P 500 is down 2%, while the 10-year Treasury edged higher by 15bps to 3.7% for the week.

When asked specifically about last week’s employment numbers, Powell said that it, “simply reaffirmed that the central bank has some way to go on raising rates” and that the strong numbers highlight that the adjustment process is unlikely to be linear. While there’s certainly validity to that argument, there’s also reason to believe that the January payrolls may be overstating the degree of strength in the labor market.

For starters, January was unseasonably warm across most of the U.S., which likely means there was a pull forward of economic activity. From that perspective, some of January’s gains may have been robbed from subsequent months – suggesting much weaker employment growth in the months ahead. Second, seasonal adjustment factors may have also played some role in biasing last month’s numbers higher.  January is historically a month where non-seasonally adjusted payrolls record a massive decline in absolute terms (Chart 1). While this remained true last month, it did so by the smallest amount since 1995. This likely translated to an outsized gain in the seasonally adjusted figures.

So, where does that leave us? It’s up for debate how much the January numbers are overstating the degree of underlying strength. But, at the end of the day, there is little doubt that the labor market remains incredibly tight. For now, Chair Powell seems content to not rattle expectations and watch how the data evolves in further financial news. You can’t argue the logic. Monetary policy acts with considerable lag, and the cumulative effect of all the tightening done over the past 11 months is not yet being felt. Even once rate hikes are finished, the real effective policy rate will continue to rise through this year as inflation continues to decline (Chart 2). With the FOMC now in the “fine tuning” stage of the tightening cycle, data dependence will be the name of the game. With that, the focus now shifts to next week’s inflation report. Stay tuned!

 

Thomas Feltmate, Director  | 416-944-5730