I’m very surprised on how tight the labor markets remain and that is causing me to shift my expectations on the Fed’s rate path. Let’s review.
January’s strong jobs report might be an anomaly, but initial jobless claims and signs of increasing unemployment remain very low. Real economic data, such as production and GDP have been slightly on the soft side, but not terribly so. It looks like first quarter real GDP is coming in around 2%.
Sensitive commodity indexes have stabilized at a low level. The Bloomberg Commodity Index and all the rest are not plunging anymore. We had a slight uptick in the apartment list rental index for the month of February. There were quite a few declines in these rental figures last year, and the Case-Shiller Home Price Index came out last week for December and declined for the sixth time in a row, but the declines are not accelerating.
The M2 money supply, which I thought would decline even more, also stabilized in December. What does this all mean?
It means the Fed is going to hike rates again. The question now is 25 or 50 basis points, and it will depend quite a bit on a Friday’s employment report. Early expectation is 200,000 new jobs.
If Friday’s jobs data comes in hotter than expected, Fed hawks will be calling for a 50-basis points hike. I do not expect a pause in rate hikes until the jobs data is printing zero increases or a jobs decline. With timely initial claims showing tightness, the data is too strong for a pivot yet.
My read on the interest rate curve shows the market expects another four rate hikes of 25 basis points through the month of October. These four hikes could also be a 50-basis point hike and two more 25-basis point hikes.
I still think all these hikes are unnecessary. However, looking at the resilience of the economic data, it doesn’t look like the increase would be as damaging as I certainly feared in the fall when everything from commodity prices to home prices were plunging.
I’m now more sanguine about the Fed increasing rates since the economy seems to be withstanding these higher rates better than I anticipated.
On Behind the Markets last Friday, Jeremy Schwartz interviewed Warren Mosler, who believes higher interest rates are stimulating the economy with higher interest cost leading to very regressive income gains for those who have assets and are earning more income off their Treasury bonds.
There are winners and losers, but higher borrowing costs have historically been a more important restriction than the higher interest income earned. Mortgage rates increased 75 basis points over the last five weeks to over 7% again. There was a revival in housing activity in January, which is a real important sector. But that was when mortgage rates were back down to 6%. Now we are over 7% and that cannot be favorable to spending.
Interest income and interest costs are not directly a wash because firms will undertake less capital expenditures when hurdle rates on investments are increasing and too high. Yes, there is higher interest income but, if you have a checking or even savings account in the bank, your interest rates have gone up little. CD’s are a little bit better. You have fallen way behind inflation over the last two years on a fixed income portfolio. So, I disagree with these unorthodox views higher rates are stimulating.
The declining money supply we have over the last year represents a contraction of bank loans—which are assets for banks. An example: someone comes in for a $10,000 home improvement loan and the bank writes up $10,000 of deposits for them. If consumers (or firms) are now saying they cannot afford those higher borrowing costs, there are less loans and new deposits created in the system and lower M2 money supply. Consumer Confidence numbers came out last week and did not really express a bullish outlook on the economy—which is why loans and the money supply have fallen.
What does all this mean for the equity markets? The Fed is tighter because the economy is holding up and this gives us a better environment for earnings. A notable bear on Wall Street points to leading economic indicators suggesting consensus earnings are 20% too high. I take the opposite view that earnings estimates could even be conservative for the year given economic resilience and productivity gains that I see coming with more cost control. And we are selling at less than 18 times 220 price-to-earnings for the S&P 500. I believe 20 times earnings is a fair equilibrium multiple for the market—so we are not overvalued today.
Coming into 2023, I believed a Fed pause would warrant strong gains regardless of an economic or earnings slowdown. Today I am sticking with my calls for a robust equity market that brings gains of 10-15% for the year. All eyes now on jobs Friday!
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Professor Jeremy Siegel is a Senior Investment Strategy Advisor to WisdomTree Investments, Inc. and WisdomTree Asset Management, Inc. This material contains the current research and opinions of Professor Siegel, which are subject to change, and should not be considered or interpreted as a recommendation to participate in any particular trading strategy, or deemed to be an offer or sale of any investment product and it should not be relied on as such. The user of this information assumes the entire risk of any use made of the information provided herein. Unless expressly stated otherwise the opinions, interpretations or findings expressed herein do not necessarily represent the views of WisdomTree or any of its affiliates.
