The Week in Review 2/21/23

"Economics is a very difficult subject. I've compared it to trying to learn how to repair a car when the engine is running." - Ben Bernanke

Good Morning,

Steady as she goes… volatility aside.

The S&P 500 and Dow Jones Industrial Average closed slightly lower for the week as investors digested quite a huge amount of economic news, along with comments from several Fed officials.

Month over month inflation data in the January Consumer Price Index (CPI) was not pleasing, but the report reflected continued deceleration on a year over year basis.

Services inflation, less energy services, was a notable exception, having accelerated to 7.2% year-over-year from 7.0% in December. On the heels of the CPI report, market participants received a much stronger than expected January retail sales report, higherthan-expected producer price data for January, and another remarkably low level of weekly initial jobless claims.

The positive economic news, along with accelerating services inflation, fueled concerns about the possibility of the Fed raising rates more than previously expected and keeping them higher for longer than previously expected.

On a related note, Fed officials made comments corroborating the market's concerns. Cleveland Fed President Mester (non-FOMC voter) said she advocated for a 50-basis point rate hike at the February 1 FOMC meeting, St. Louis Fed President Bullard (nonFOMC voter) said he wouldn't rule out supporting a 50-basis point rate hike at the March FOMC meeting, and Fed Governor Bowman (FOMC voter) said that rate hikes should continue until "a lot more progress" has been made on inflation.

Rate hike concerns were evident in Treasury market action last week, creating some headwinds due to valuation constraints and increased competition for stocks. The 2-yr note yield reached a high of 4.71% before settling up ten basis points to 4.61%. The 10-yr note yield reached a high of 3.92% before settling up nine basis points to 3.83%. Notably, the 1-yr T-bill yield hit 5.00% this week and settled at 5.06%.

The U.S. Dollar Index rose 0.2% for the week to 103.88.

Roughly half of the 11 S&P 500 sectors logged a gain last week led by consumer discretionary (+1.6%) and consumer staples (+0.9%). Meanwhile, the energy sector (-6.9%) was the worst performer by a wide margin amid falling oil prices. WTI crude oil futures fell 4.0% this week to $76.57/bbl.

The week began with participants willing to buy into weakness on Monday coming off last week's losses, which has been the case since the start of 2023. A quick dip right out of the gate had the S&P 500 slip below the 4,100 level before buyers stepped in and a rally effort took root, helped along by some short-covering activity and a fear of missing out on further gains.

There was no U.S. economic data of note on Monday, but participants received the NY Fed's Survey of Consumer Expectations. The survey showed that inflation expectations are mostly stable, but household income growth expectations have dropped.

After increasing each month since September of last year, the median expected growth in household income dropped by 1.3 percentage point to 3.3%. This is the largest onemonth drop in the nearly ten-year history of the series. The January reading, however, is only slightly below its 12-month trailing average of 3.5%, and the series remains well above its pre-pandemic levels.

January's decrease was more pronounced among respondents with no more than a high school education, respondents older than 60, and those with annual household incomes below $50k.

Tuesday's trade was mixed as investors digested the January Consumer Price Index (CPI).

CPI increased 0.5% month-over-month (consensus 0.5%) following last month's upwardly revised 0.1% increase (from -0.1%) and core-CPI, which excludes food and energy, increased 0.4% month-over-month (consensus 0.4%) on top of last month's upwardly revised 0.4% increase (from 0.3%). On a year-over-year basis, total CPI was up 6.4% -- the smallest 12-month increase since the period ending October 2021 -- and core-CPI was up 5.6% -- the smallest 12-month increase since December 2021.

The year-over-year levels were not as low as expected; and it didn't escape notice that services inflation, less energy services, accelerated to 7.2% year-over-year from 7.0% in December.

The stock market moved higher shortly after the open with investors seemingly still willing to buy on weakness before the early gains faded and the S&P 500 briefly slipped below the 4,100 level. The major indices were able to bounce somewhat, though, as Treasury yields back off their highs. The main indices ultimately closed the session well above their intraday lows.

The Treasury market was more resolute with its reaction to the CPI data. The 2-yr note yield, which stood at 4.50% just before the report, surged to 4.66% before settling the session at 4.63%. The 10-yr note yield, at 3.68% before the report, surged to 3.79% before settling the session at 3.76%.

The key takeaway from the report is that there has been a clear deceleration from the peak inflation; however, the inflation rates are not nearly low enough to suggest the Fed would even be thinking about cutting rates this year.

Market participants received a much stronger than expected January retail sales report ahead of Wednesday's open, which reflected continued strength in the economy, but left the market concerned that the Fed will raise rates more than expected. Total sales in January were up 3.0% month-over-month (consensus 1.7%) and sales, excluding autos, up 2.3% (consensus 0.8%).

Equities started the day in retreat mode, but true to 2023 form, investors stepped in to buy the early weakness. The main indices all closed the session at or near their best levels of the day. The rebound in the stock market, in spite of rising market rates, suggests perhaps that buyers were influenced more by the hopeful economic implications of the January retail sales data than its potentially adverse implications for monetary policy.

Wednesday gave us much economic data…

• Weekly MBA Mortgage Applications Index -7.7%; Prior -7.4%
• January Retail Sales 3.0% (consensus 1.7%); Prior -1.1%; January Retail Sales ex-auto 2.3% (consensus 0.8%); Prior was revised to -0.9% from -1.1%
  • o The key takeaway from the report is that consumers were spending freely on goods in January despite the ongoing inflation pressure; in fact, every single sales category showed a month-over-month increase, led by a 7.2% surge in sales at food services and drinking places.
• February Empire State Manufacturing -5.8 (consensus -19.0); Prior -32.9
• January Industrial Production 0.0% (consensus 0.5%); Prior was revised to -1.0% from -0.7%; January Capacity Utilization 78.3% (consensus 79.1%); Prior was revised to 78.4% from 78.8%
  • The key takeaway from the report is that the soft reading for January can be attributed entirely to a drop in the output of utilities. Otherwise, there was some welcome rebound strength in both mining and manufacturing output, the latter of which saw advances in durable, nondurable, and other manufacturing activity.
• December Business Inventories 0.3% (consensus 0.3%); Prior was revised to 0.3% from 0.4%
• February NAHB Housing Market Index 42 (consensus 37); Prior 35

The stock market started, and ended Thursday's session on a decidedly downbeat note.

The negative bias was in response to a higher-than-expected Producer Price Index (PPI) number for January, paired with another remarkably low level of weekly initial jobless claims, which fueled concerns that the Fed will not pause its rate hikes in the near future. The main indices sank shortly after the open, but there was a fairly strong recovery effort taking place throughout most of the session. The recovery coincided withbuyers stepping in when the S&P 500 breached the 4,100 level, along with Treasury yields backing down from their post-data release highs.

There was a sharp reversal in the last hour of trading that had the major indices close the session at or near their worst levels of the day, which took the S&P 500 below 4,100 again. The late afternoon plunge was precipitated by St. Louis Fed President James Bullard (not an FOMC voter) saying that he wouldn't rule out supporting a 50-basis point rate hike at the March FOMC meeting, adding that he advocated for a 50-basis point rate hike at the February 1 meeting, according to Bloomberg.

To be fair, the initial recovery effort happened after Cleveland Fed President Mester (not an FOMC voter) said earlier Friday that she, too, was advocating for a 50-basis point rate hike at the February 1 meeting. Nonetheless, the stock market used Mr. Bullard's position as an excuse to rein in some of its recovery enthusiasm.

Thursday was another big day of economic news…

• January Housing Starts 1.309 mln (consensus 1.355 mln); Prior was revised to 1.371 mln from 1.382 mln; January Building Permits 1.339 mln (consensus 1.350 mln); Prior was revised to 1.337 mln from 1.330 mln
  • The key takeaway from the report was the lack of growth in both single-family starts (-4.3%) and permits (-1.8%), which is a reflection of the adverse impact of rising interest rates and ongoing inflationpressures that are crimping builders' willingness to build new homes and buyers' willingness to purchase new homes due to affordability constraints.
• January PPI 0.7% (consensus 0.4%); Prior was revised to -0.2% from -0.5%; January Core PPI 0.5% (consensus 0.3%); Prior was revised to 0.3% from 0.1%
  • The key takeaway from the report for the market is that headline inflation was hotter than expected on a monthly basis. That could stoke worries about inflation pressures persisting at higher levels for longer than expected -- and the Fed keeping rates higher for longer -- even though there was improvement on a year-over-year basis.
• Weekly Initial Claims 194K (consensus 203K); Prior was revised to 195K from 196K; Weekly Continuing Claims 1.696 mln; Prior was revised to 1.680 mln from 1.688 mln
  • The key takeaway from the report is that the persistence of initial claims below 200,000 reflects a very tight labor market, and a reluctance on the part of most companies to cut their workforce, which will continue to drive worries at the Fed about tight labormarket conditions feeding into stickier wage-based inflation pressures.
• February Philadelphia Fed Index -24.3 (consensus -8.0); Prior -8.9

The stock market opened Friday decidedly weak, carrying over Thursday's downside momentum, as investors looked to take some money off the table after a big run recently and a long 3 day weekend approaching. Concerns about the Fed raising rates higher than expected for longer than expected also contributed to the early weakness.

The general tone started to shift, however, as market rates backed down from overnight highs. The 2-yr note yield, which hit 4.71% overnight, settled the session down two basis points to 4.61%. The 10-yr note yield, which hit 3.92% overnight, also fell two basis points today to 3.83%.

Ultimately, the main indices closed the session near their best levels of the day, which had the Dow Jones Industrial Average and Russell 2000 sporting slim gains. The S&P 500 and Nasdaq had their upside moves limited somewhat by downside pressure from the mega cap space.

Friday's economic data…

• January Import prices -0.2%; Prior was revised to -0.1% from 0.4%
• January Import Prices ex-oil 0.3%; Prior 0.4%
• January Export Prices 0.8%; Prior was revised to -3.2% from -2.6%
• January Export Prices ex-ag. 0.8%; Prior was revised to -3.3% from -2.7%
• January Leading Indicators -0.3% (consensus -0.3%); Prior was revised to -0.8% from -1.0%

Whew! A week full of things to chew on economically and little evidence that the Fed is close to pausing their relentless rate hikes.

Considering how aggressive the Fedspeak has been… we have to be impressed that the market has held on to most of our gains in 2023.

Have a wonderful holiday shortened week!

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