If the markets are right, tomorrow’s Fed meeting policy statement will herald the second-to-last rate hike of the cycle, with a quarter-point move expected to be matched on March 22. However, Federal Reserve Chairman Jerome Powell likely has other ideas. . That’s why the S&P 500 fell from a six-week high on Monday, but markets firmed on Tuesday after the employment cost index showed weaker wage growth in the fourth quarter.
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Powell can explain why interest rates may need to rise a bit and stay there longer than investors are betting. Even so, Wall Street has doubled down on its belief that rate hikes are about to end. In fact, the odds of a quarter-point hike in March have risen from 98% on Monday to 82.5% today, according to the CME Group’s FedWatch page.
While the markets may turn out to be right, this week’s Fed meeting is about the Fed keeping options open. Powell has no interest in providing fodder for the S&P 500 to rise and Treasury yields to fall.
The big reveal will be how Powell characterizes the balance of risk. 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 probably isn’t ready to go just yet and will continue to say inflation risks are on the rise.
An even clearer S&P 500 rally signal would come if the Fed dropped its language that the policy committee anticipated “continued increases” in the Fed’s key interest rate. Most expect the language to stick.
Fed Meeting Minutes Fire Warning Shot
Minutes from the Fed’s meeting in mid-December highlighted policymakers’ concerns about an “unwarranted easing of financial conditions.” The rallying of financial markets could “complicate the Committee’s efforts to restore price stability,” according to the minutes.
This concern could be a priority for policymakers heading into this week’s Fed meeting. Indeed, the Chicago Fed’s indicator of domestic financial conditions through Jan. 20 showed they were easier than ever since rate hikes began last March.
Still, Powell’s press conference at 2:30 p.m. tomorrow after the Fed’s meeting wraps up will hardly be the final word on the rate hike outlook. Arguably, the series of labor market data released this week will have more impact on the markets than Powell.
Jobs, salary data is essential
On Tuesday morning, the Labor Department’s Employment Cost Index showed compensation costs rose 1% in the fourth quarter versus 1.1% expected. However, earnings rose 5.1% from a year ago, up slightly from the 5% growth in the third quarter.
Economists pay particular attention to the wage growth of private sector workers, excluding those in performance-based jobs, as a good indicator of underlying wage growth. In the fourth quarter, compensation in this category rose 0.9%, or an annualized rate of 3.6%. This measure excludes occupations in which pay is determined by commission, which may be more influenced by cyclical ups and downs.
The ECI report takes on added importance, with the Fed stressing the need for weaker wage growth to bring inflation back to the 2% target. Powell said a drop in wage growth to 3.5% would be sufficient.
With consumer spending and manufacturing both showing signs of weakness, January’s jobs report will provide more evidence on 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 expected to slow to 4.4% from 4.6% in December.
Setting up the S&P 500
In Tuesday’s stock action, the S&P 500 jumped 1.5% after the ECI report. Through Monday’s close, the S&P 500 had rebounded 12.3% from its October 12 bear market closing low, but remained 16.2% below its all-time high.
On Friday, the S&P 500 peaked around 4094, making a third run at 4100 since early December. This is the key level to watch for now.
Be sure to read IBD’s The Big Picture every day to stay in tune with the direction of the market and what it means for your trading decisions.
After the ECI data, the 10-year Treasury yield slipped to 3.52% from 3.55% on Monday.
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