Labor Market Takes Center Stage on Fed Rate Path
U.S. stocks and bonds had a banner November as enthusiasm over a soft landing encouraged projections that the Federal Reserve will begin cutting rates in the first half of next year. The S&P 500 closed at its highest level of the year, and the 10-Year U.S. Treasury yield fell below 4.30% after breaching 5.00% in October. Treasury yields have in large part been responding to data showing further signs of labor market cooling. U.S. job openings fell to the lowest level since March 2021 with the number of available positions decreasing to 8.7 million from a downwardly revised 9.4 million in the prior month. The payrolls data on Friday is seen as critical in understanding the direction of the economy and will be a meaningful factor in how the Fed normalizes the policy rate.
Unfortunately for Fed Chair Powell, the risk-on exuberance we’ve witnessed goes against the Fed’s goal of tightening financial conditions and creates a potential scenario where the Fed must keep rates higher for longer, increasing the chance of a hard landing for the economy. In prepared remarks Powell delivered on Friday, he warned that “it would be premature to conclude with confidence that we have achieved a sufficiently restrictive stance, or to speculate when policy might ease.”
The rally in Bitcoin, which surpassed $44,000 for the first time in over a year, is another sign that a soft landing or “immaculate disinflation” environment has descended onto markets. This is further evidenced by the selloff in the U.S. Dollar, which has been falling for three weeks, and oil has fallen back towards $70, extending a six-week drop. Notably with oil, OPEC+ on Thursday attempted to coerce markets higher by announcing a new supply cutback of about 900,000 barrels a day. Markets however were left unimpressed and doubted the cartel’s ability to implement the “voluntary” production cuts and crude ended lower on the day.
Interestingly, even with the significant move higher in risk assets, cash continues to pour into money-market funds. Assets in money-market funds soared to a record high of $5.8 trillion in the last week of November. More than a trillion dollars have been added to money-market funds so far in 2023 driven by higher yields on the shortest end of the yield curve. Also notable has been the resiliency of high yield corporate bond spreads which have pushed towards the lowest levels of the year.
The fears heading into 2023 as the Fed battled to cool stubbornly high inflation were largely valid. Treasury yields soared on the premise that the Fed would have to keep the brakes on the economy longer than most had previously anticipated. It is the “long and variable lags” from the massive policy tightening that has yet to materialize. There has been a wide array of scenarios from imminent recession to a soft landing, all amidst a backdrop of the frenzy over burgeoning AI technology, a regional banking crisis, and a war in the Middle East. The soft landing hopes could quickly unravel if the labor data at the end of the week shows a sharper slowdown. The Atlanta Fed’s GDPNow shows fourth quarter growth has been revised down to 1.2% from 2.1% a week earlier. U.S. factory activity is shrinking, and the New York Fed’s latest household survey shows that a record-high share of consumers are saying that it is much harder to obtain credit. Higher rates are beginning to bite, and the durability of the asset rally rests on the Fed’s ability to respond to a rapidly shifting landscape.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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