Listen to the Fed's

In February 2018, Jerome Powell took office as the 16th Chairman of The Federal Reserve. He had a goal to improve the Fed's communication with the investment marketplace. Starting in January 2019, he began holding press conferences following each of the eight committee meetings per year. Prior to this, the former Chairman would hold a press conference quarterly when the central bank's summary of economic projections was updated.

In June 2018, Jerome Powell stated, as reported by Yahoo!,

“As Chairman, I hope to foster a public conversation about what the Fed is doing to support a strong and resilient economy….And one practical step in doing so is to have a press conference like this after every one of our scheduled FOMC (Federal Open Market Committee) meetings…will give us more opportunities to explain our actions and to answer your questions,” adding that, “this change is only about improving communications.”

My wife regularly says that if you listen to someone long enough, they will tell you what they are thinking. One doesn't have to listen long to know what Jerome Powell is thinking. Since the beginning of 2022, he has been very clear with the committee's goal of reducing inflation to 2% by means of raising the Federal Reserve discount interest rate. There should be no question in anybody's mind when the Federal Reserve stops its rate hike policy.  

As a result, stock market investors, analysts, and commentators have become the uber focus of all economic reports related to inflation. A big boost for the market occurred on November 10 and 11 last year as the S&P 500, Dow Jones Industrial Average (DJIA), and NASDAQ had their best two-day performance in years, increasing 6.52%, 4.92%, and 9.37%, respectively. The news that incited investors was that the Consumer Price Index (CPI) had declined for the fourth consecutive month and possibly an indication that the Federal Reserve will slow its rate hike policy. In December, the Federal Reserve raised the Discount Rate by only 0.50% and the first time in 2022 to not increase the rate by 0.75%.

So far this year, investors appear mildly optimistic, with most of the year's gain incurred on January 6 when the major averages had another boost as the S&P 500, Dow Jones Industrial Average (DJIA), and NASDAQ had their best performance this year increasing 2.28%%, 2.13% and 2.56% respectfully. The day's gain recovered prior session losses to bring the averages back into positive territory for the year. The reason for the day's gain was attributed to signs inflation was abating.

As we have pointed out in previous Weekly Briefs in late 2022, there is solid evidence that many key sectors have slowed. You don't have to read economic reports to know that the residential housing market dramatically slowed in 2022 in both existing and new construction. This is a direct result of national mortgage rates jumping from 3% to over 7% in the first half of 2022 to end the year at 6.88% for a 30-year fixed rate. The slowdown in house sales has impacted many related industries from construction to movers. 

Energy and gasoline prices at the pump have come down from multi-decade high prices earlier in 2022, along with the sudden drop in natural gas prices due to warmer weather in Europe, with eight countries reporting their warmest New Year's Day ever (what a blessing that must be).  

Constant reports by the media about pending recession may have muted holiday retail sales. Forbes reported that according to Mastercard Spending Pulse, which tracks sales across all payment types, holiday retails sales increased by 7.6% from November 1 to Christmas Eve. In the article, they stated that,

“And shoppers were spending more in many categories – restaurant spending was up 15.1% compared to last year, clothing sales increased by 4.4%, in-store shopping was also up and saw an increase in sales of 6.8%, online sales increased 10.6%, while department stores only had a modest increase of 1% over 2021. Meanwhile, other categories didn't outperform last-year sales, such as electronics, which saw a decrease of 5.3%, and jewelry which saw a 5.4% sales decrease.”

It's clear the Federal Reserve is slowing its rate hike campaign with only a 0.5% rate hike in December as an indication they recognize the previous six rate hikes are having an impact on inflation. The question is, when will inflation slow to the Fed's target level to prompt the committee to stop rate hikes?

On January 5, Alan Blinder, in his Wall Street Journal commentary titled, “What if Inflation Suddenly Dropped and No One Noticed?” proposed that the Fed's target inflation rate may have already been met. Mr. Blinder, professor of economics and public affairs at Princeton, served as vice chairman of the Federal Reserve, 1994-96, states,

“Normally, focusing on 12-month inflation rates is the right thing to do, for two main reasons. First, it guards against hyperventilation over “blips” in the inflation data, whether up or down. Second, it obviates the need for seasonal adjustment since, for example, you are comparing prices in November 2022 with those in November 2021.”

However, for the past three years, almost nothing has been normal or close to long-term averages. As a result, almost every year over year, reports of economic activity will be significantly out of sync with longer-term averages. As an example, mortgage rates increased almost 200% in 180 days in 2022. Any year-over-year report of changing mortgage rates that starts with a data point of last year will differ significantly from the historical changing rates of the past 20 years. Since national mortgage rates appear to have peaked in December, it will take another twelve months before year-over-year changes in mortgage rates appear more stable. 

Referring to almost anything for the past one to three years may result in deceptive data that is not indicative of current trends. Mr. Blinder continues stating,

“As mentioned, the CPI inflation rate over the past 12 months has been an alarming 7.1%. But the U.S. economy got there by averaging an appalling 10.6% annualized inflation rate over the first seven months and a mere 2.5% over the last five. The PCE price index tells a similar story, though a somewhat less dramatic one. The 5.5% inflation rate over the past 12 months came from a 7.8% rate over the first seven months, followed by a 2.4% rate over the last five. Lest you think I'm performing numerical sleight-of-hand, the same phenomenon can and does operate in the opposite direction: Inflation can surprise you by leaping upward. It happened in 2021.”

He refers to the 27% increase in energy rates in the previous seven months, followed by an 11% drop in energy prices over the next five months, as a key contributor to the declining CPI. So, is the CPI really trending at the Fed's target rate near 2.5%? Not yet.

“Is today's true inflation rate a mere 2.5%, meaning that Jerome Powell and the Federal Reserve can relax? Not quite. Now for the catches, I promised earlier.

First, we've had this wonderfully low inflation rate for only five months. That's longer than one or two months, which is why I'm writing this article. But it's still too short a time to declare victory.

Second, if you concentrate instead on “core” inflation, which excludes food and energy prices, annual inflation over the past five months has run higher: a 4.7% annual rate for the CPI and 3.7% for the PCE. So, the Fed's fight against inflation isn't over.”

As we have pointed out in previous Weekly Briefs in late 2022, there is solid evidence that many key sectors have slowed. You don't have to read economic reports to know that the residential housing market dramatically slowed in 2022 in both existing and new construction. This is a direct result of national mortgage rates jumping from 3% to over 7% in the first half of 2022 to end the year at 6.88% for a 30-year fixed rate. The slowdown in house sales has impacted many related industries from construction to movers. 

Energy and gasoline prices at the pump have come down from multi-decade high prices earlier in 2022, along with the sudden drop in natural gas prices due to warmer weather in Europe, with eight countries reporting their warmest New Year's Day ever (what a blessing that must be).  

Constant reports by the media about pending recession may have muted holiday retail sales. Forbes reported that according to Mastercard Spending Pulse, which tracks sales across all payment types, holiday retails sales increased by 7.6% from November 1 to Christmas Eve. In the article, they stated that,

“And shoppers were spending more in many categories – restaurant spending was up 15.1% compared to last year, clothing sales increased by 4.4%, in-store shopping was also up and saw an increase in sales of 6.8%, online sales increased 10.6%, while department stores only had a modest increase of 1% over 2021. Meanwhile, other categories didn't outperform last-year sales, such as electronics, which saw a decrease of 5.3%, and jewelry which saw a 5.4% sales decrease.”

It's clear the Federal Reserve is slowing its rate hike campaign with only a 0.5% rate hike in December as an indication they recognize the previous six rate hikes are having an impact on inflation. The question is, when will inflation slow to the Fed's target level to prompt the committee to stop rate hikes?

On January 5, Alan Blinder, in his Wall Street Journal commentary titled, “What if Inflation Suddenly Dropped and No One Noticed?” proposed that the Fed's target inflation rate may have already been met. Mr. Blinder, professor of economics and public affairs at Princeton, served as vice chairman of the Federal Reserve, 1994-96, states,

“Normally, focusing on 12-month inflation rates is the right thing to do, for two main reasons. First, it guards against hyperventilation over “blips” in the inflation data, whether up or down. Second, it obviates the need for seasonal adjustment since, for example, you are comparing prices in November 2022 with those in November 2021.”

However, for the past three years, almost nothing has been normal or close to long-term averages. As a result, almost every year over year, reports of economic activity will be significantly out of sync with longer-term averages. As an example, mortgage rates increased almost 200% in 180 days in 2022. Any year-over-year report of changing mortgage rates that starts with a data point of last year will differ significantly from the historical changing rates of the past 20 years. Since national mortgage rates appear to have peaked in December, it will take another twelve months before year-over-year changes in mortgage rates appear more stable. 

Referring to almost anything for the past one to three years may result in deceptive data that is not indicative of current trends. Mr. Blinder continues stating,

“As mentioned, the CPI inflation rate over the past 12 months has been an alarming 7.1%. But the U.S. economy got there by averaging an appalling 10.6% annualized inflation rate over the first seven months and a mere 2.5% over the last five. The PCE price index tells a similar story, though a somewhat less dramatic one. The 5.5% inflation rate over the past 12 months came from a 7.8% rate over the first seven months, followed by a 2.4% rate over the last five. Lest you think I'm performing numerical sleight-of-hand, the same phenomenon can and does operate in the opposite direction: Inflation can surprise you by leaping upward. It happened in 2021.”

He refers to the 27% increase in energy rates in the previous seven months, followed by an 11% drop in energy prices over the next five months, as a key contributor to the declining CPI. So, is the CPI really trending at the Fed's target rate near 2.5%? Not yet.

“Is today's true inflation rate a mere 2.5%, meaning that Jerome Powell and the Federal Reserve can relax? Not quite. Now for the catches, I promised earlier.

First, we've had this wonderfully low inflation rate for only five months. That's longer than one or two months, which is why I'm writing this article. But it's still too short a time to declare victory.

Second, if you concentrate instead on “core” inflation, which excludes food and energy prices, annual inflation over the past five months has run higher: a 4.7% annual rate for the CPI and 3.7% for the PCE. So, the Fed's fight against inflation isn't over.”

As we have pointed out in previous Weekly Briefs in late 2022, there is solid evidence that many key sectors have slowed. You don't have to read economic reports to know that the residential housing market dramatically slowed in 2022 in both existing and new construction. This is a direct result of national mortgage rates jumping from 3% to over 7% in the first half of 2022 to end the year at 6.88% for a 30-year fixed rate. The slowdown in house sales has impacted many related industries from construction to movers. 

Energy and gasoline prices at the pump have come down from multi-decade high prices earlier in 2022, along with the sudden drop in natural gas prices due to warmer weather in Europe, with eight countries reporting their warmest New Year's Day ever (what a blessing that must be).  

Constant reports by the media about pending recession may have muted holiday retail sales. Forbes reported that according to Mastercard Spending Pulse, which tracks sales across all payment types, holiday retails sales increased by 7.6% from November 1 to Christmas Eve. In the article, they stated that,

“And shoppers were spending more in many categories – restaurant spending was up 15.1% compared to last year, clothing sales increased by 4.4%, in-store shopping was also up and saw an increase in sales of 6.8%, online sales increased 10.6%, while department stores only had a modest increase of 1% over 2021. Meanwhile, other categories didn't outperform last-year sales, such as electronics, which saw a decrease of 5.3%, and jewelry which saw a 5.4% sales decrease.”

It's clear the Federal Reserve is slowing its rate hike campaign with only a 0.5% rate hike in December as an indication they recognize the previous six rate hikes are having an impact on inflation. The question is, when will inflation slow to the Fed's target level to prompt the committee to stop rate hikes?

On January 5, Alan Blinder, in his Wall Street Journal commentary titled, “What if Inflation Suddenly Dropped and No One Noticed?” proposed that the Fed's target inflation rate may have already been met. Mr. Blinder, professor of economics and public affairs at Princeton, served as vice chairman of the Federal Reserve, 1994-96, states,

“Normally, focusing on 12-month inflation rates is the right thing to do, for two main reasons. First, it guards against hyperventilation over “blips” in the inflation data, whether up or down. Second, it obviates the need for seasonal adjustment since, for example, you are comparing prices in November 2022 with those in November 2021.”

However, for the past three years, almost nothing has been normal or close to long-term averages. As a result, almost every year over year, reports of economic activity will be significantly out of sync with longer-term averages. As an example, mortgage rates increased almost 200% in 180 days in 2022. Any year-over-year report of changing mortgage rates that starts with a data point of last year will differ significantly from the historical changing rates of the past 20 years. Since national mortgage rates appear to have peaked in December, it will take another twelve months before year-over-year changes in mortgage rates appear more stable. 

Referring to almost anything for the past one to three years may result in deceptive data that is not indicative of current trends. Mr. Blinder continues stating,

“As mentioned, the CPI inflation rate over the past 12 months has been an alarming 7.1%. But the U.S. economy got there by averaging an appalling 10.6% annualized inflation rate over the first seven months and a mere 2.5% over the last five. The PCE price index tells a similar story, though a somewhat less dramatic one. The 5.5% inflation rate over the past 12 months came from a 7.8% rate over the first seven months, followed by a 2.4% rate over the last five. Lest you think I'm performing numerical sleight-of-hand, the same phenomenon can and does operate in the opposite direction: Inflation can surprise you by leaping upward. It happened in 2021.”

He refers to the 27% increase in energy rates in the previous seven months, followed by an 11% drop in energy prices over the next five months, as a key contributor to the declining CPI. So, is the CPI really trending at the Fed's target rate near 2.5%? Not yet.

“Is today's true inflation rate a mere 2.5%, meaning that Jerome Powell and the Federal Reserve can relax? Not quite. Now for the catches, I promised earlier.

First, we've had this wonderfully low inflation rate for only five months. That's longer than one or two months, which is why I'm writing this article. But it's still too short a time to declare victory.

Second, if you concentrate instead on “core” inflation, which excludes food and energy prices, annual inflation over the past five months has run higher: a 4.7% annual rate for the CPI and 3.7% for the PCE. So, the Fed's fight against inflation isn't over.”

What Does This Mean to Me?

Investors are very focused on the Federal Reserve rate hike policy, and any economic data and any indication of slowing inflation will be received favorably. The largest single-day rallies in 2022 were directly the result of investors responding to favorable inflation and CPI reports. It is our opinion that many factors have been developing since the middle of 2022 that will slow inflation that has nothing to do with the Federal Reserve. Supply disruptions that depleted inventories substantially upset the supply and demand balance that created outsized price increases. One example is car prices. Manufacturers had to slow their production in 2020 and 2021 due to a shortage of computer chips and other key auto parts. Reduced supply created an imbalance of demand as suddenly, everyone needs a car. One friend as a car salesman said prices of Toyota Camry would jump $20K over MSRP by the middle of 2022. Now that manufacturers are catching up on orders and car lots are filling up, it's crickets at his dealership. One dealership in Houston was reported to have on-site over 400 Infinity SUV's. Any guess on the future price of Infinity SUV's in Houston?

It is possible that the Fed's inflation year-over-year target rate may be reached by the first half of 2023. Many of the issues of 2020 and 2021 that caused substantial price volatility in 2022 are nearly resolved, and the Federal Reserve rate hike policy has significantly slowed the lending industry to commercial and individual borrowers. 

Lastly, we can't forget about the Santa Claus “First Five Days Early Warning System” barometer. According to the Stock Trader's Almanac, 

“The first five trading days of January could predict the market's direction for the year. The last 47 up First Five Days were followed by full-year gains for an 83% accuracy ratio and a 14% average gain in all 47 years.”

All three major indices closed the first five trading days of 2023 in positive territory, with the S&P 500 +1.37%, Dow Jones + 1.12%, and NASDAQ +1.62%. It is a good sign the indices closed positively and, most notably, that NASDAQ posted the best return as technology was one of the worst-performing sectors in 2022.

Give us a call if you have any questions about this Brief or your accounts. 2022 was a tough year for all, and glad it's over. We maintain our favorable view of the U.S. economy and stock market. We welcome the opportunity to assist you as you pursue your financial and personal goals in 2023.