The equity markets have gotten off to a fairly strong start this week, but there’s little question that risk-off sentiment remains in control. The markets are digesting a lot of economic and earnings data, but the most watched event of the week will be the Fed meeting. While it’s almost certain that we’ll see the central bank keep the Fed Funds rate where it’s at, Powell’s forward-looking commentary will be watched closely. He’ll certainly say that inflation is still above target and the Fed stands to tighten further as conditions warrant, but the big question is whether or not the committee feels like higher rates on the long end of the curve are doing the work of tightening policy for them. The futures market is still pricing in a 30-40% chance of another rate hike by the end of Q2 2024. Any comments by Powell indicating that they’re planning on standing pat could be viewed bullishly by both the stock and bond markets.
For the second straight week, we’re seeing signs that the negative correlation between stocks and bonds is returning. This is going to be a critical piece for not just the return of Treasuries as a risk-off asset, but for the return of the flight to safety trade, in general. We’ve seen utilities and consumer staples outperform over the past few weeks. We’ve seen gold do well. We’ve seen bitcoin rally. All of these behaviors are indicative of risk-off conditions, but Treasuries have been the lone holdout. I think it’s probably less likely than not that Powell says something this week that will reestablish Treasuries as a risk-off asset, but it’s not outside the realm of possibility. If Powell says the Fed is essentially done raising rates, it could set the stage for a big Treasury rally. The yield curve is getting closer to flattening instead of being deeply inverted as it has for months. That could be the Treasury market starting to normalize again, a process that likely starts picking up steam through the remainder of 2023.
Friday’s jobs report is unlikely to produce a game-changer. The market has been waiting for months for the labor market to show signs of cracking. While we’ve seen minor uptrends in things, such as weekly jobless claims, we’ve yet to see anything that would indicate the jobs market is turning. October is expected to result in a modest jobs gain again and the employment cost index release earlier this week suggests that’s what we’ll get again. The ECI, which is closely watched by the Fed, slightly beat expectations, indicating that labor costs are still elevated and the jobs market is tight. The U.S. economy has unquestionably been stronger than expected for longer than expected, but a lot of the Fed’s monetary tightening decisions have yet to be felt. With long Treasury rates significantly higher over just the past couple of months, conditions will continue to get tighter for months. These impacts will likely begin showing up soon and it’s just a matter of time before the labor market cracks and accelerates the path towards recession.
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