With all the recent headlines surrounding the current state of the market, we are taking a deeper dive into key factors that we believe investors should keep an eye on, such as:
Stocks Soar Following Fed Chairman Powell’s ‘Less Hawkish’ Speech – Federal Reserve Chairman Jerome Powell gave a speech on Wednesday that sent stocks soaring. In comments delivered at an event at the Brookings Institution, Powell made comments that were ‘less hawkish’ than the Fed’s narrative on inflation and interest rates so far in 2022. We are intentionally using the phrase ‘less hawkish’ instead of ‘dovish’ here because the Fed Chairman certainly did not change his overall tone about the inflation fight. Powell said that “the time for moderating the pace of rate increases may come as soon as the December meeting,” but also that “wage growth remains well above levels that would be consistent with 2% inflation.” Powell still believes that the labor market is too strong, which signals that the Fed’s work in slowing price pressures is by no means done. Nevertheless, the equity markets seemed to take his comments as a strong signal that the December rate hike will come in at 50 basis points, which is a step down from the four consecutive 75 bp increases at previous meetings. The market also seemed pleased to hear Chairman Powell acknowledge that rate increases take time to work their way through the economy, which indicates the Fed’s sensitivity to going too far in monetary tightening. As we have written before, the market is looking for clues that the inflation and interest rate cycle are approaching their respective peaks. Powell’s speech offered one such clue.1
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Protests Sweep Through China as Growth Continues to Cool – China’s zero-Covid policies are causing problems for its economy and, in the latest twist, its citizens. Let’s start with economic activity – in November, activity in China’s manufacturing sector measured by the purchasing managers’ index fell to 48 from 49.2 in October, marking two consecutive months of contracting. The manufacturing sector is of greater importance in China than it is in the United States, given China’s export-driven focus. Another index that measures activity in the services and construction sector in China fell month-over-month in November, to a very weak 46.7. All told, China’s economy grew by 3% in the first three quarters of 2022, a far cry from the 6+% growth the investment community has come to expect from the world’s second-largest economy. The decline in economic activity began with the implosion of China’s Evergrande earlier in the year, the second-largest property developer in the country. Last week, the economic woes took on a new face with protests erupting in major Chinese cities, as citizens grow increasingly frustrated with rolling lockdowns and draconian measures designed to stamp out the virus. How China’s government responds, and whether zero-Covid remains a policy in force, will be a crucial story to watch as it relates to China’s economic growth – and by extension growth in the global economy – in the new year.3
Major Yield Curve Inversion – The yield curve’s inversion has gone from modest to significant in the last couple of weeks. The yield curve is often measured by the difference between the 2-year Treasury bond yield and the 10-year Treasury bond yield, and by that measure, the gap between the two reached 0.78% last week – the largest negative gap since late 1981. Our preferred look at the yield curve – the difference between the 3-month U.S. Treasury bond yield and the 10-year – has also turned negative, with the 3-month U.S. Treasury bond yielding 4.37% and the 10-year U.S. Treasury bond yielding 3.68%.4 As readers can see in the chart below, each time the 3-month/10-year yield curve inverted in the last 40+ years, a recession followed.5
U.S. Yield Curve (10-Year U.S. Treasury Minus 3-Month)
A recession may be nigh, but there is another very distinct possibility when it comes to the yield curve: investors may be pricing in a future with lower inflation, not an impending economic downturn. On one level, when longer-term Treasury bond yields are lower than short-term yields, it means investors think the fed-funds rate will be lower in the future than it is now – likely because the Fed will need to cut rates to revive a slowing economy. The market may be betting that inflation will be low enough next year to allow the Fed to take this action.
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Disclosure