Turkeys Fly, But Do They Land Softly?

Nov 22, 2022

By Ben Norris, CFA, Securities Research Analyst, Associate Vice President
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Turkeys rarely fly but when they do, they usually land softly. A soft landing is exactly what the Federal Reserve is hoping for as they seek to cool off the U.S. economy without causing a crash landing (recession). Prospects for a soft landing improved last week as the Producer Price Index (PPI) – a measure of inflation watched closely for its leading indicator status – came in lower than expected in October. Fed officials everywhere likely sighed in relief as evidence mounts that the worst of inflation may be behind us. Still, October PPI still saw wholesale prices increase 8% from a year prior. While this is a vast improvement from the 11.7% year-over-year increase seen in March, its still a high reading relative to history. Similarly, Core PPI, which removes the influence of food and energy costs, rose 5.4%. Stocks and bonds rallied on the news as the underlying data was particularly encouraging – much of the rise in prices could be attributed to increased prices of goods rather than services. The prices of services are generally stickier than prices of goods, which means they are of particular concern for the Fed.

Better-than-expected PPI comes after the Consumer Price Index (CPI) also came in lower than expected earlier this month after notching its highest reading in more than 40 years in June. While things are moving in the right direction, the Fed has been clear that they still have much work to do before achieving their eventual policy goals. For investors, this means they can expect another 0.50% interest rate increase at the Federal Open Market Committee’s December meeting. While many are hoping that the Fed will back off their policy-tightening campaign before pushing the U.S. economy into a recession, Fed officials have been quick to point out that much of the American economy remains strong and very non-recession like. Consumer activity, employment, and economic growth all argue against a near-term recession. This clears the way for the Fed to take their eventual rate target higher than previously thought. St. Louis Fed President James Bullard indicated last week that he sees rates peaking in the 5-5.25% range, which is higher than the latest “dot plot” of interest rate expectations from the Fed.

Stocks moved lower while rates moved higher following hawkish commentary from Bullard and others last week. Markets kicked off the week with a move lower as the number of major companies announcing layoffs continued to grow. In particular, major Technology companies are trimming their workforces to realize leaner cost structures into a potential economic downturn. The layoffs are surprising in some cases because they are occurring ahead of when many companies begin staffing up ahead of a busy holiday season. The S&P 500 (SPX) lost 0.9% Monday as stocks in the Real Estate, Consumer, and Financials sectors were punished. Tuesday brought the previously discussed PPI data that helped push markets into positive territory. SPX reversed the prior day’s move with a 0.9% gain and the losing sectors on Monday were the winners on Tuesday.

Wednesday saw stocks move lower once again. Big box retailer Target set the tone for the day after they forecast a weaker-than-expected holiday sales season. Inflation and mixed consumer activity were the primary reasons behind the soft commentary and the company indicated they would pursue a cost-cutting plan over the next several years. An unexpected detail in Target’s report was the effect that organized theft has had on the company’s results. Shoplifting is expected to have a $600 million impact on the company’s results in 2022, an increase of 50% from 2021. Target’s disappointing results set the tone for the day as investors worried that weakness could spread to other retailers. SPX lost 0.8% as the Consumer Discretionary sector shed 1.5%.

Thursday and Friday were generally uneventful as investors prepared for a slow, Thanksgiving-shortened week. More commentary from Fed officials suggested that rates would remain higher for longer. As a result, the yield on the 2-year Treasury rose to nearly 4.5% in Thursday trading. Jobless claims continue to impress with their stability – initial and continuing claims have remained near historic lows. All told, SPX dropped 0.3% by Thursday’s closing bell. Friday ended the week on a positive note with SPX gaining 0.5% – this was the fourth consecutive positive Friday for SPX reversing a trend of negative Friday finishes in the preceding four weeks. The general thought is that a rally to close the week is bullish because it indicates that investors are comfortable owning stocks into the weekend. Markets rallied despite hawkish comments from a Fed official that advocated for another 0.75% hike at the December policy meeting. Friday also brought existing home sales data, which showed that a combination of higher mortgage rates and lower inventory has been disastrous for the housing market. Existing home sales were down 5.9% in October and are down more than 28% versus a year ago. Housing hasn’t turned into an area of concern yet; many if not most homeowners locked in a low rate over the last several years, but first-time buyers are in a difficult position and an affordability crunch could mean that sales slow to a trickle. Those who are priced out of buying a house will be forced to continue renting, and higher rents will almost certainly follow. Inflation might not be completely in the rearview mirror.

Thanksgiving means that markets are closed on Thursday and will close early on Friday. Wednesday has a busy slate of economic data as a result. We would expect markets to remain quiet as investors spend time with their families and hopefully enjoying some well-cooked turkey.

Date Report Previous Consensus
Wednesday 11/23/2022 Durable Goods Orders (October) 0.4% 0.4%
Initial Jobless Claims 222,000 225,000
Continuing Jobless Claims 1.51M
U.S. Manufacturing PMI (November) 50.4 50.0
U.S. Services PMI (November) 47.8 48.0
U of Michigan Consumer Sentiment Index (November) 54.7 55.1
U of Michigan 5-year Inflation Expectations 3.0%
Thursday 11/24/2022 Thanksgiving
Friday 11/25/2022

 

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