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THE LAST MILE...INDEED!

In the last week or so the markets have absorbed the fact that a March rate cut is well off the table, and market prognosticators have begun reevaluating when the Fed might start the cycle of reducing the Fed Funds rate. But not so fast; we have entered the “last mile.” So, what is going on, and what framework should investors consider?

Inflation has been stickier than many had hoped, given the fairly rapid deceleration of the CPI Index, starting from the June 2022 reading of 1.3% and 9.1% over the previous 12 months. As I have mentioned in several posts, jobs and wages are the key tea leaves in deciphering the path of inflation. Wages have continued to outpace inflation and the jobs market has also remained strong. The January CPI showed inflation growing at 0.2% higher than the expected 2.9% and having the number start with a “3” also plays a psychological role in how people think about inflation. Viscerally, we are looking for inflation to move back towards 2%, so this acceleration will likely cause the Fed to pivot.

In thinking about the employment market, job creation increased by a significant 353,000 jobs in January, and this strongly outpaced the expected increase of 187,000. If jobs are growing at a faster clip than expected, it is reasonable to assume that wages will need to stay strong for employers to attract talent. The housing market has also shown very few signs of slowing down. Most economists that focus on the housing market and housing stock in the U.S. continue to cite a supply shortage which will likely keep a base under home optics for the foreseeable future.

This brings us to the current state of play in the markets. The likelihood of a rate cut in the coming months has continued to decline and there is increasing talk that the Fed might need to hike rates further to truly combat inflation. You will never hear us gloat about our view being right when we argue against the headlines, because our analysis could have been wrong had inflation declined to the Fed’s desired level. Ultimately, our view was tied to the unemployment rate and wages. That to us is the key; once we see employment slow and wage growth decline below the rate of inflation, we believe that will be the time that inflation pressures will start to subside, and the Fed can start considering the timing of a rate cut.

Within the markets, interest rates have increased with the 10-year moving above 4.2% in response to the heightened inflation concerns. At the same time, the economy has continued to roll along and equity valuations, particularly among growth stocks, are becoming a bit stretched. We have been recommending to our clients to consider rebalancing and we do not think that a recession is off the table. Watch wage growth and the employment market; we think this will be the path to guide us forward. 

This commentary has been prepared by Knights of Columbus Asset Advisors (“KoCAA”) for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions and information expressed herein reflect our judgment and are subject to change without notice. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations, and (6) changes in the policies of governments and/or regulatory authorities.

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