Investors Eagerly Await CPI Report and FOMC Meeting

Thoughts

• Equity markets have stalled following an impressive two-month rally, with the S&P 500® Index posting its worst week since September after a run of five gains in seven weeks. Volatility returned, with the VIX popping to 24 after breaking below 20 for the first time since August. Bond investors continue to act with the level of emotion generally observed in the equity market, with the 10-year Treasury yield falling to 3.43% last Wednesday before bouncing to 3.55%. The dollar continues to ease, with the 8% drop over the past three months representing the sharpest drop in a decade after hitting a 20-year high.
• Institutional investor sentiment is beginning to recover, with a Bloomberg survey of fund managers showing 71% expect a positive equity market next year, with average gain of 10%. In the 94-year history of the S&P 500, we have seen returns between 0-10% in only 13 years (14%). Reasons for optimism included peaking inflation and a recovery in the macro environment, with potential catalysts including a reopening in China and a ceasefire in Ukraine. Respondents’ optimism was cautious, however, with the largest threats identified as stubbornly high inflation and a strong recession. The survey reflected a continued shift away from the technology sector and other growth factors, preferring companies with more stable growth, resilient earnings, lower volatility, and higher dividend payouts.
• All eyes are on the CPI report on Tuesday and the FOMC meeting on Wednesday, the first time they’re back-to-back this year. While this week’s CPI reading is highly unlikely to materially shift the tone of the Fed meeting, investors would do well to buckle up and be patient. The market reaction to recent meetings has been negative, as Chair Powell has leaned hawkish in comments during his press conference. But remember that negative reactions tend to be somewhat temporary while positive reactions are typically more enduring.

News

• The highly anticipated Fed “pivot” awaits this Wednesday. The Fed Futures curve embeds a 75% chance of a 0.50% rate hike, roughly equal to a week ago. That would bring the top end of the Fed Funds target to 4.5%, which is less than 0.50% from the forecasted terminal rate, which is expected as of May. Fed officials will make changes to the “dot plot,” which is expected to show 1.00% of rate cuts in both 2024 and 2025, which would bring the median dot for 2025 to 2.9%. Given the continued strength of the labor market, Powell may see runway to continue his hawkish message to investors. Significant attention will be paid to any comments about easing the 2% inflation target.
• Investors are eagerly awaiting Tuesday’s reading on consumer price inflation, with elevated nervousness following the hotter-than-expected PPI reading last Thursday. Headline CPI is forecast to grow by 0.3% from October and 7.3% from a year ago, which would reflect modest easing from the 9.0% peak in June. Excluding the volatile food and energy categories, core CPI is expected at 6.1% from a year ago, down from September’s peak of 6.7%, but still among the highest readings in 40 years. Economists are split on how rapidly inflation will moderate in 2023, with the consensus expecting a decline to 3.4%. The 5-year breakeven rate (derived from the TIPS market) reflects an average of 2.3%, which is close to the long-term average and down from the peak of 3.6% in March.
• International markets have staged an impressive comeback, with the MSCI EAFE Index now outperforming the S&P 500 this year and the MSCI Emerging Market Index just slightly behind despite tremendous challenges facing global markets. Volatility remains elevated, largely due to energy uncertainty in Europe and China’s Covid lockdowns. Covid rates in China are surging, though recent comments and actions of officials reflect a softening of the zero Covid policy following a wave of protests. A top official over the weekend played down the current risk, saying fatality rates are similar to the flu.

What to Watch

• A busy week awaits, highlighted by the CPI report on Tuesday, and the FOMC meeting on Wednesday. Other notable data include the NFIB Small Business Index on Tuesday, retail sales and industrial production on Thursday, and PMI data on Friday.