The Dot Plot Thickens
Federal Reserve Chair Jerome Powell’s hawkish comments in Senate testimony Tuesday sent stocks into a tailspin. He continued his two-day appearance on Capitol Hill on Wednesday, in the House.
Powell’s market-crushing rhetorical performances make me nostalgic for his curmudgeonly predecessor Alan Greenspan, who was famously cryptic. If I had my druthers, Powell would simply utter five words in his testimony today: “Our work is not done.” And then go home.
Another source of investor anxiety is the next policy-making meeting of the Federal Open Market Committee (FOMC), scheduled for March 21-22. The FOMC is expected to hike interest rates by another 0.25%.
The FOMC also is scheduled at this meeting to unveil a new series of inflation and economic growth forecasts, as well as a new “dot plot.”
Connecting the dots…
The Fed has been trying to become more predictable in the years since it initiated extraordinary monetary easing to help stimulate the economy after the Great Recession of 2007-2009.
To that end, the U.S. central bank developed the dot plot, a chart published four times per year (once per quarter in March, June, September, and December) after an FOMC meeting. The dot plot shows the projections of each of the Fed’s 16 members for the level of future interest rates.
The chart includes consensus from the previous Fed meeting, a critical ingredient in analyzing the anticipated direction and slope of interest rates.
The dot plot summarizes the FOMC members’ best projections for the path of the federal funds rate over the next three years. Each dot represents the view of a Fed policy maker for the fed fund rate’s target range at the end of each year depicted.
The following tweet aptly demonstrates why stocks cratered on March 7:
Powell told the House Wednesday that Fed officials will closely parse several economic indicators ahead of their March meeting. “Those will be important and we’ll scrutinize them,” he said. “We’re not on a preset path. We will be guided by the incoming data and the evolving outlook.”
The Bureau of Labor Statistics (BLS) reported Wednesday in its Job Openings and Labor Turnover Survey (JOLTS) that the U.S. labor market is cooling off, although it’s still too hot for the Fed’s taste.
As part of its monthly JOLTS, the BLS reported that the number of job openings in the U.S. dropped to 10.8 million in January, a dip from the upwardly revised 11.23 million in December but still higher than the 10.6 million openings that analysts had been predicting. Persistent strength in the jobs market puts pressure on the Fed to remain hawkish for longer.
Powell’s stern testimony combined with the surprising JOLTS data roiled the major equity indices on Wednesday, which reversed sharp intraday declines to eventually close as follows:
- DJIA: -0.18%
- S&P 500: +0.14%
- NASDAQ: +0.40
- Russell 2000: +0.04%
Of course, like most prognosticators, the Fed reserves the right to change its mind based on any unanticipated squiggle in economic indicators. A drop in inflation levels could send the Fed back into its cave, where it would wait for more robust news to forge ahead with more rate increases.
My expectation is that the FOMC also will boost rates at its May meeting, but rate hikes beyond this will largely hinge on both inflation and labor data.
The effects of Fed tightening tend to lag. Inflation has proven “stickier” than expected, but it’s on a path to moderate in the coming months, especially in the goods, housing and rental sectors.
The worrisome inflation flashpoints are wages and services. That said, it’s likely that the Fed will pause its rate-hiking cycle in mid-2023, a turning point that would boost investor sentiment.
Crucial economic reports are scheduled in the coming days, including the nonfarm jobs report on Friday, March 10 and the consumer price index (CPI) report on Tuesday, March 14. CPI inflation for the month of February is expected to show moderation.
Analysts have been pessimistic about corporate earnings lately. For the fourth quarter of 2022, the S&P 500 posted a year-over-year earnings decline of -4.6%. We could see a strong stock market rally later this year, if three conditions are met: inflation eases, the Fed pauses its rate hiking cycle, and downward revisions to corporate earnings hit a bottom.
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John Persinos is the editorial director of Investing Daily.