Talking Data: The Fed vs. the Markets

In the latest installment of Talking Data, Jim discusses the labor markets and the hopes for a Fed pivot.

  • What does the market think?
  • What does the Fed think?
  • What does it mean for markets?

Full Video Below:


Full Audio Below:

To subscribe and listen to past podcasts:
Below are some charts and commentary to augment the discussion above.

The chart below shows the divergence between what the Fed is communicating (blue) and what the market is pricing in (orange). The Fed is saying the terminal rate will be 5.00% – 5.25%. The market thinks it is closer to 4.86%.



This divergence will define the first part of 2023 trading.

So, why does the market think the Fed will do much less?

The latest Philadelphia Federal Reserve quarterly survey of professional forecasters shows the probability of a recession in the next year is the highest in the 50+ years this survey has been conducted.



A similar monthly survey conducted by Bloomberg of about 70 economists shows the probability of a recession is even higher at 63%.

This survey began in 2008, and the only time it was higher was when the US economy was actually in recession in 2020.



And before you conclude that the 63% of economists predicting a recession “doesn’t count,” note that the BofA’s December Global Fund Managers survey, in which 300 fund managers participated, had nearly an identical response at 68%.



Additionally, economists see the unemployment rate for year-end 2023 will now be 4.5% (October and November surveys). Note that in May (gold line), they had it at 3.6%.

This is a big rise, and such an increase only occurs in recessions.



So, what does the Fed see causing the fund’s rate to stay at 5.125% next year?

Start with the labor market.

The simple truth is the jobs market is not weakening. And the Fed is not changing unless it shows unmistakable signs of weakening.

Initial claims are not rising.



There are 1.7 open jobs for every unemployed person (bottom panel).



And year-over-year wage growth (orange, bottom panel) is holding around 5%.

Simply, if everyone gets 5% pay raises, they can “afford” 5% inflation. 5% inflation is unacceptable.



So, these are the battle lines. Who will win?

Wall Street has been losing to the Fed all year by insisting the Fed would “pause” then “pivot.”

Wall Street has been bearish on jobs. Instead, payrolls have beaten 11 of the last 12 months, including 8 in a row (rectangle).



The streak of eight straight payrolls beats should tell Wall Street something is amiss. They are getting the jobs market wrong.



Instead, they are doubling down that the jobs market is falling apart. Their latest rationalization is a big downward revision to Q2 2022 job growth. Even if true, these revisions are due in Feb 2024 (14 months). So, don’t hold your breath!


So, if the pattern continues that Wall Street is too pessimistic or too impatient on its pessimism and does not get its “pivot” because the economy does not immediately fall apart, what does it mean for markets?

Start with short rates, the 2-year yield. It has peaked at 4.72% on November 7.

The last five rate hike cycles ended with the 2-year yield above the terminal fed funds rate. So, if the Fed’s projection of a 5% funds rate is correct, history suggests the 2-year yield should be higher than this terminal rate, or at least 5.25%.



How about long rates (10-year yield)?

If the economy is not falling apart, the yield curve inversion will stall.

This should drag the 10-year yield higher (green). The yield curve (blue bottom panel), already at a 41-year extreme inversion, should not go much beyond -100 basis points if it even gets that extreme.



So, rates have yet to peak.

How about stocks? If rates are going higher, then the discount rates used in valuation are also going higher. Paying over 18x for next year’s earnings with higher discount rates looks awfully expensive.



Not to mention paying almost 17x for 2-year-out earnings (orange) or more than 15x for 3-year-out earnings (blue).

This is very expensive unless discount rates start falling because inflation is returning to 2% forever.



So here we are in 2022. Use all your skill to pick good stocks and hope they lose money and lead to a recession. Then you will be rewarded with higher stock prices as the Fed pivots.

Because if your stocks perform by delivering earnings and companies have to hire more people due to increased demand for their product, your reward is another wipeout in stock prices as the Fed never pivots.



This is what 15 years of QE, negative interest rates, forward guidance, and Fed puts have done. The market is all about liquidity. It is a junkie for liquidity. It is all that matters.

Or what was the most successful investing style between 2009 and 2021?

Buy broad-based equity ETFs and whine that the Fed is not doing enough to make you rich. Not only did everyone think this, most still believe this!


This idea that the economy weakens, the Fed pivots, and markets soar works with inflation around 2% forever, like from 2009 to 2020.

But if inflation is more than 2% going forward, the worst thing that can happen is the economy weakens enough for the Fed to pivot.


  • Zerohedge – (December 14, 2022) Ignore CPI And The FOMC: Why Michael Wilson Sees A Bloodbath Ahead In This Rerun Of 2008
    Wilson says that “the directional call for the S&P 500 seems pretty obvious for the next 3 months even if it’s still quite uncertain for the next 3 weeks” to which, however, one may simply counter that multiples may expand aggressively (frontrunning the next liquidity firehose) just as EPS collapse, keeping risk prices flat. In any case, the final word belongs to Wilson who writes that “with prices (mainly the ERP) not reflecting such risk, we do not recommend trying to pick up any remaining nickels this year.”