If the markets are right, tomorrow’s Fed meeting policy statement will announce the penultimate rate hike of the cycle with a quarter-point move expected to be matched on March 22. Federal Reserve Chairman Jerome Powell probably has other ideas. That’s why the S&P 500 bounced back from a six-week low on Monday, but markets rallied on Tuesday after the Employment Cost Index showed softer wage growth in the fourth quarter.
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Powell can make a case for why interest rates may need to go a bit higher and stay there for longer than investors are betting. Still, Wall Street doubled down on its belief that rate hikes are coming to an end. Indeed, odds of a quarter-point increase in March fell from 98% on Monday to 82.5% today, according to CME Groups FedWatch page.
While the markets may turn out to be right, this week’s Fed poll is about the Fed keeping options open. Powell has no interest in feeding the S&P 500 to move higher and Treasury yields to move lower.
The big story will be how Powell characterizes the risk balance. If he says they are now balanced between higher-than-expected inflation and lower inflation amid a weakening economy, the S&P 500 will shoot higher. But he is probably not willing to go there just yet and will continue to say that inflation risks are to the upside.
An even clearer S&P 500 rally signal would come if the Fed drops its language saying the policy committee expects “ongoing increases” in the Fed’s key interest rate. Most expect the language to remain.
Fed meeting minutes Fire warning shot
The minutes of the Fed meeting in mid-December highlighted policymakers’ concerns about an “unwarranted easing of financial conditions.” Recovery in the financial markets may “complicate the committee’s efforts to restore price stability,” the minutes state.
That concern may be top of mind for policymakers heading into this week’s Fed meeting. That’s because the Chicago Fed’s gauge of national financial conditions through Jan. 20 showed them to be easier than at any time since rate hikes began last March.
Still, Powell’s press conference at 14.30 tomorrow after the end of the Fed meeting is unlikely to be the last word on the prospects for interest rate increases. Undoubtedly, the volume of labor market data this week will have more of an impact on the markets than Powell.
Jobs, salary data is key
On Tuesday morning, the Labor Department’s Employment Cost Index showed that compensation costs rose 1% in the 4th quarter, compared to the 1.1% expected. However, compensation rose 5.1% from a year ago, a slight increase from the 5% growth in Q3.
Economists pay close attention to wage increases for private sector workers, excluding those in incentive-paid occupations, as a good indicator of underlying wage growth. In the 4th quarter, wages in this category rose by 0.9%, or 3.6% annually. This measure excludes occupations where pay is driven by commissions, which may be more affected by cyclical ups and downs.
The ECI report has added significance as the Fed emphasizes the need for lower wage growth to bring inflation back to the 2% target. Powell has said easing wage growth to 3.5% would be sufficient.
With both consumer spending and production showing signs of weakness, Friday’s January jobs report will provide more evidence of whether the economy’s last major source of strength is giving way. Analysts expect a solid gain of 185,000 jobs, but average hourly wage growth is seen slowing to 4.4% from 4.6% in December.
S&P 500 setup
In Tuesday’s stock market action, the S&P 500 rose 1.5% following the ECI report. Through Monday’s close, the S&P 500 was up 12.3% from its October 12 bear market closing low, but was still 16.2% below its all-time high.
On Friday, the S&P 500 rallied around 4094, making a third run to clear 4100 since the start of December. That’s the most important level you need to keep an eye on right now.
Be sure to read IBDs The big picture each day to stay in sync with market direction and what it means for your trading decisions.
Following the ECI data, the 10-year Treasury yield fell to 3.52% from 3.55% on Monday.
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