SUMMARY: As Peter put it (HERE), the FOMC substantially reduced its pessimism toward the growth outlook – their median 2024 GDP forecast moved to 2.1% from 1.4% – and is assuming an above trend pace (>1.8%) for all years in the forecast. Yet the FOMC only reduced the 2025/2026 cut forecast mildly. Implicit in those forecasts is policy that is much less restrictive than their old forecasts. Hence the risk-on reaction. If their forecast comes to fruition (a GIANT if), it would favor steeper yield curves and stocks that benefit from an extension of the economic cycle. Some of those groups are Small caps, Cyclicals in general, and Deep Cyclicals now (see the DoD moves below). GARP remains our favorite factor profile given growth uncertainty.
To be fair, the framework that Powell laid out will only remain “risk-on” if the inflation increases seen in Jan/Feb prove to be mostly seasonal. Powell expressed confidence that seasonals influenced the inflation data. We will see when the March CPI data hits on April 10th. For now, there is not much to offset risk-on backdrop until the April 5th payroll report and especially the April 10th CPI.
Couple of Important Highlights: Powell directly addressed seasonal effects on the Jan/Feb inflation data, emphasizing the bumpy path of inflation. He didn’t dismiss the hot data but put equal emphasis on not extrapolating data. And you don’t get 2.6% core PCE for 2024, the new FOMC forecast, without assuming a seasonal give back of the Jab/Feb data.
Powell also directly addressed the labor market, arguing it doesn’t need to loosen if supply keeps growing. He said wage growth must continue declining (gradually). Gerard has argued wage growth could be an issue (HERE), but Powell didn’t seem concerned. Maybe we have a hawkish surprise on this point with Payroll report on April 5th.
Powell’s insistence that financial conditions are tight is also dovish, albeit a little odd. The Fed’s own financial conditions index doesn’t show a drag on growth, and this week’s housing data was more evidence of a rebound of the most interest rate sensitive sector (HERE). We disagree with leaning on the JOLTS data as proof of weakness (more on that HERE). But Powell’s insistence is dovish. Our call is for inflation to come down as economic growth stays around trend and wage growth slowly decelerates. That is why we forecast 2-2.5% real GDP and 3 cuts for 2024. That FCI is not nearly as restrictive as Powell claims increases the risk of wage growth/inflation getting stuck at too high of a level. That is a CLEAR medium term risk to our forecast and calls.
More in the full report below…
MARKET VIEWS: Following the dovish FOMC summary of economic projections (SEP) and dovish press conference (more on all that below), market internals were firmly risk-on. Cyclicals outperformed Defensives by +1.2%, a 95th percentile return. MS22RISK Index, our risk-on vs risk-off l-s swap, was up +1.34% l-s (also a 95th %tile move).
The rally extended to the most economically and interest rate-sensitive equities too, despite the FOMC signaling higher for longer in the dots. Companies with debt problems, MS22DEBT Index on bbg, were up over +2%. Profitable small caps were up +1.3%, and unprofitable small caps were up +2.5%. As Peter put it (HERE), the FOMC substantially reduced its pessimism on the near-term outlook with growth shifting to an above trend pace for all years in the forecast. Implicit in these forecasts is policy that is much less restrictive than under their old forecasts. Stronger growth and a longer business cycle benefit unprofitable companies and companies with debt problems, even if financing costs are higher.
The FOMC’s economic projections were net dovish – they kept three cuts penciled in for 2024 while raising the inflation and growth forecasts.
And Powell didn’t reverse tone during the presser. A couple of snippets we consider the most important here… Powell directly addressed seasonal effects on the Jan/Feb inflation data, emphasizing the bumpy path of inflation. He didn’t dismiss the hot data, but there was equal emphasis on not extrapolating the data. And you don’t get 2.6% core PCE for 2024 in the SEP without Jab/Feb having a season give back assumption. That was great for risk assets, and we are on to the March CPI print next month.
Powell also directly addressed the labor market, arguing it doesn’t need to loosen if supply keeps growing. He said wage growth has to continue declining (gradually). Gerard has argued wage growth could be an issue (HERE), but the trend is still lower for now and we’ll have to continue watching the data.
Powell’s insistence that financial conditions are tight is also dovish, albeit a little odd. The Fed’s own financial conditions index doesn’t show a drag on growth, and this week’s housing data was more evidence of a rebound in the most interest rate sensitive sector (HERE). We disagree with leaning on the JOLTS data as proof of weakness (more on that HERE). But his insistence is dovish. Our call is for inflation to come down as economic growth stays around trend and wage growth decelerates, so we’re not going to fight against Powell’s FCI take.
