If the markets are alright, tomorrow’s Fed meeting policy statement will announce the next-to-last rate hike in the cycle, with a quarter-point move expected to take place on March 22nd. However, it is possible that Federal Reserve Chairman Jerome Powell will have other ideas. That’s why the S&P 500 pulled back from a six-week high on Monday, but markets stabilized on Tuesday after the Employment Cost Index showed weak wage growth in the fourth quarter.
Powell may argue why interest rates need to go up a bit and stay there longer than investors are betting. However, Wall Street doubled down on its belief that the rate hike is about to end. In fact, the odds of a quarter-point increase in March dropped from 98% on Monday to 82.5% today, according to CME Group. FedWatch page.
While the markets may be right, this week’s Fed meeting is all about keeping the Fed’s options open. Powell has no interest in providing fodder for the S&P 500 to rise and Treasury yields to fall.
The biggest factor will be how Powell characterizes the balance of risk. If he says it’s now balancing higher-than-expected inflation and lower inflation amid a weakening economy, the S&P 500 will rally. But he’s probably not ready to go there just yet and will continue to say that inflation risks are to the upside.
A clearer bullish signal for the S&P 500 would emerge if the Fed drops its language that the Policy Committee expects “continued increases” in the Fed’s key interest rate. Most people expect language to stay.
A gunshot warning shot minutes away from the Fed meeting
Minutes of the Fed’s mid-December meeting highlighted policymakers’ concerns about “undue easing in financial conditions.” The minutes said that the recovery of financial markets may “complicate the committee’s efforts to restore price stability.”
This concern may be a top priority for policymakers at this week’s Federal Reserve meeting. That’s because the Chicago Fed’s measure of national financial conditions through January 20 showed that they were easier than at any time since they began raising interest rates last March.
However, Powell’s press conference at 2:30pm tomorrow after the Fed meeting ends will not be the last word on rate hike expectations. Arguably, the batch of labor market data released this week will have a bigger impact on the markets than Powell’s.
Jobs and wage data are basic
On Tuesday morning, the Labor Department’s Employment Cost Index showed compensation costs rising 1% in the fourth quarter versus the expected 1.1%. However, compensation increased 5.1% from a year ago, up slightly from the 5% growth in the third quarter.
Economists pay close attention to wage growth for private sector workers, excluding those in paid occupations, as a good indicator of underlying wage growth. In the fourth quarter, wages in this category increased 0.9%, or an annualized pace of 3.6%. This measure excludes occupations for which the pay is commission-driven, which may be more affected by periodic highs and lows.
The importance of the ECI report has increased as the Fed emphasized the need for lower wage growth to bring inflation back to the 2% target. Powell said easing wage growth to 3.5% would be enough.
With both consumer spending and manufacturing showing signs of weakness, Friday’s January jobs report will provide more evidence of whether the last major source of strength for the economy has faded. Analysts expect strong gains from 185,000 jobs, but average hourly earnings growth is expected to ease to 4.4% from 4.6% in December.
S&P 500 setup
In stock market action on Tuesday, the S&P 500 jumped 1.5% after the ECI report. During Monday’s close, the S&P 500 rose 12.3% from the bear market’s closing low of Oct. 12, but remained 16.2% below its all-time high.
On Friday, the S&P 500 peaked around 4,094, posting a third run at the clearing of 4,100 since the beginning of December. This is the key level to watch right now.
Be sure to read IBD’s The Big Picture Every day to stay in sync with the market trend and what it means for your trading decisions.
Following the ECI data, the 10-year Treasury yield fell to 3.52% from 3.55% on Monday.
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