April 17, 2023
I'm back in action, following a week-long tour of colleges for my son.
We left off prior to Easter, heading into the March employment report.
As we discussed, the employment situation had already given signals of softening. The ISM services employment index for March was weaker than the prior reading. The ADP report for March showed the weakest job gains in more than two years. And the measure of "job openings" (JOLTS) had already contracted by nearly a million jobs — and that was before the effects of the banking fallout.
With that, the BLS job report for the month of March did indeed show slower job growth. The economy added 236k new jobs — quite a bit slower than the average monthly job additions of 334k over the prior six months.
Of course, this is of particular interest as the Fed has explicitly targeted the hot jobs market over the past year as a pain point for inflation (related to the leverage that workers have to negotiate higher wages). With the justification of oversupplied jobs, they have mechanically stepped interest rates higher, with the intent of job destruction and, therefore, demand destruction (and therefore, bringing inflation down).
So, again, the employment situation is now clearly softening. And we also learned last week that the inflation data continues to soften.
And remember, the Fed Funds rate is now ABOVE, their favored inflation gauge (core PCE). And historically, raising rates above the inflation rate has been the antidote to inflation.
Add to this, the shock in the banking system last month, should have signaled to the Fed that they've hit the intolerance level for interest rates.
So now, post-banking system shock, the already softening economic data will be exacerbated by a slowdown in bank lending. This, and the 475 basis points of Fed tightening still hasn't worked its way through the economy.
With this backdrop, the next Fed meeting is in two weeks. This tightening cycle should be over.
That said, the interest rate market is pricing in a near 90% chance of another quarter point hike. Given this market expectation, a "pause" by the Fed would be a positive surprise for stocks.
We have also entered Q1 earnings season, with a low expectations hurdle – expectations are for earnings contraction of 6.5%. Thus far, the big banks have posted big earnings beats, even AFTER adding to their respective war-chests of loan loss reserves.
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