Investors to the Fed: Open Your Gift!

Stocks opened mixed today, with the Nasdaq slightly higher but the Dow and S&P 500 a bit lower. The market could be forgiven for taking a breather, given the strong rally since October 27th. We’ve seen a lot of encouraging signs since then, such as a broadening of gains outside the Magnificent 7. Believe it or not, the stodgy Dow is up more than the S&P 500. In addition, bond yields and interest rates have fallen, taking some pressure off of investors.

The economy is clearly slowing, inflation is falling, and the Fed is getting exactly what it wants for Christmas.

At long last the labor market is beginning to cool off. Last month the number of unfilled job positions in the US fell to 8.7 million from 9.4 million. While still above historically normal levels, vacancies have been trending lower since the spring of 2022. And the ratio of unfilled positions to unemployed people has worked its way down to 1.3. The process of rebalancing supply & demand for labor has been mercifully gradual. So while the unemployment rate has ticked up to 3.9% from 3.4% this year, it’s clear that most employers have cut back on hiring rather than laying off workers.

Private research firm ISM says business activity within the service sector improved modestly last month. Hiring ticked up a bit and the pace of new business held steady. On the other hand, ISM reported continued contraction in the manufacturing sector, which has been challenged for the past year. Both surveys indicated lower cost inflation. And speaking of inflation, the New York Fed’s measure of retail price inflation has slowed to just 2.15%, which is essentially right on the Fed’s target.

Citigroup’s US Economic Surprise Index has fallen to 14 from 51 over the past month. This means that economic data are no longer coming in ahead of expectations. Clearly, momentum is slowing.

All of this should be good news for the Federal Reserve, whose dual mandate is to keep inflation in check while promoting full employment. But while the data show they’ve already won the battle, officials seem loathe to acknowledge it. The Fed’s narrative of sticky services inflation and an overheated job market is beginning to sound tired and out of touch.

Ritholtz CEO Josh Brown asks, “What is the data-driven reason” to keep short-term interest rates above 5% while inflation has slowed to 2-2.5%? Indeed, the stakes are high. The level of interest rates is clearly restrictive to growth and at some point the Fed will need to lower rates in order to keep the economy from falling into recession.