Is the market coming to the realization that the overnight rate is going higher? In about 2 weeks monetary policy expectations have changed about 50 basis points. Will equities begin to reconciliate the inevitability? Most agree the rebound from the October lows was a result of the belief the Fed will pivot in June and the overnight rate will be lower in December than today.
The Federal Reserve had adamantly stated that this will not be the case, but the markets believed otherwise.
Changing topics, the discussion is beginning to increase as to how the proverbial inflationary goal posts are changing to reduce inflationary pressures.
About five months, there were in-depth discussions about the change as to how Owners’ Equivalent Rent (OER) was to be calculated. OER is a significant component of all inflationary indices. The government changed its methodology, and its new calculation is/was designed to reduce the rate of increase.
As also previously noted, late 2022 the BLS announced a change to the CPI, that the weightings in the index will now be based on single year’s spending pattern rather the previous two-year blend as such would lower inflation.
Because inflation was around 9% last year, the rate of downward change will be significantly more.
Last week, the Bureau of Labor and Statistics announced another change, this time in the index’s weighting for both housing and gasoline in the CPI, a change that will likely bring headline inflation down.
As noted above, the methodology to calculate OER was changed. Now the BLS changed the weighting of OER in the CPI index from 43% to 45%. Housing prices surged in 2022 but are now generally declining. As home prices fall, and because housing has an outsized weighting within in the CPI, the overall inflation reading should come down as well.
And then there is gasoline. The BLS lower gasoline’s weighting from 4% to 3.2% of the CPI. Gas prices are generally lower today than a year ago but is expected to rise which will also impact the CPI.
This is not the first time the BLS changed its CPI methodology. In 2002 the BLS adjusted the index weighting from a 10-year spending average to a two year average and the outcome was a slowdown in inflation growth, the intended outcome of today’s changes.
For cynics, one might conclude that if you don’t like the outcome based upon current metrics, change the metrics that will support your desired result or just move the goal posts.
Late Friday afternoon, Mohamed El-Erian, chief economic advisor at Allianz, reiterated the necessity for the Fed to move the inflation target to 3% or 4% to reflect today’s changed world as yesterday’s multipolarity and interdependency no longer exists. To reach a 2.0% inflation rate, the “economy would be crushed.” Changing the metrics would “considerably damage credibility.”
Commenting on Friday’s market activity, the NASDAQ slumped about 0.75% as Fed officials discussed the size of interest rate hikes needed to quell inflation. Fed fund futures have fully priced in quarter point interest rate increases at the Federal Reserve’s next two meetings while 50 basis point hikes are not out of the question.
Unlike the short end of the bond market, equities, specifically the NASDAQ is now just beginning to discount this inevitability.
Treasury markets were relatively quiet.
The economic calendar is comprised of revised 4Q GDP, several housing statistics, Minutes from the recent FOMC meeting, personal spending and income and a sentiment survey.
Last night the foreign markets were down. London was down 0.23%, Paris down 0.41% and Frankfurt down 0.47%. China was up 0.49%, Japan down 0.21% and Hang Seng down 1.71%.
Futures are off about 1% on geopolitical and monetary policy tensions. The 10-year is off 19/32 to yield 3.89%.
