Dear Investors,
Introduction
Inflation trends are moving in a favorable direction, but the change is likely to slow for the Fed to take its foot off the brake anytime soon.
While a pivot to rate cuts does not seem likely in the near term, central banks seem to be signaling a step down in the size of rate hikes, and in some cases, even a pause.
The U.S. Federal Reserve has slowed the pace of rate hikes from 75 basis points (bps) in November to 50 bps in December.
That follows the Bank of Canada stepping down from 75 bps in late October to 50 bps in December and saying it would consider “whether the policy interest rate needs to rise further.”
The central banks of Australia and Norway stepped down from 50 bps to 25 bps at their meetings back in October/November and repeating 25 bp hikes in December.
The central bank of one of the largest emerging-market economies, Brazil, along with the central bank for the largest emerging-market economy in Europe, Poland, both paused a few months ago, leaving rates unchanged at recent meetings.
Inflation signals remain noisy, clouding the picture
Even after a year of inflation rates not seen since the 1980s, prominent economists cannot agree on the seriousness of the challenge.
Needless to say, this lack of clarity complicates the policy response, as does the uncertain lag between policy action and economic outcomes.
Average hourly earnings grew 5.1%
As we turn to 2023, the story for the U.S. economy will likely shift focus from inflationary concerns to potential stresses in the broader economy and labor market.
To be sure, inflation is still high in relative historical terms, even if rates are slowing. And wage growth is proving too stubborn for a Fed keen on holding down inflation expectations.
Average hourly earnings grew 5.1% from a year earlier in November, according to the most recent jobs report, and the annualized gain over the prior three months (which is a better gauge of the near-term trend) was the fastest since January.
The Atlanta Federal Reserve bank’s wage growth tracker corroborated the trend, showing headline growth of 6.4% in November, with both job switchers and job stayers seeing gains, as shown in the chart above.
How long the federal funds rate could stay at its peak
Past cycles don’t necessarily provide clear guidance around how long the federal funds rate could stay at its peak.
The Fed has held it at the peak level for as little as three months, or as long as 18 months.
Notably, cycles in the high-inflation era of the early 1980s tended to be shorter, although yields started at very high levels.
The equal-weighted S&P 500 Index has outperformed its market capitalization-weighted peer by its largest margin since 2010
Charles Schwab makes valuable insights and take ahead great analysis, like this one.
With a hawkish Fed intending to keep rates higher for longer, the return of a higher risk-free rate has important implications for stock investors.
Not only are stock fundamentals coming back into play courtesy of higher rates and economic weakness, but the market’s leadership profile is decisively shifting.
Gone are the days when the market’s gains depended on the performance of just a handful of stocks (i.e., the “big five” or the “super seven”).
As shown in the chart above, the equal-weighted S&P 500 Index has outperformed its market capitalization-weighted peer by its largest margin since 2010.