A trader reacts as the Fed rate announcement is displayed on the screen on the floor of the New York Stock Exchange (NYSE) in New York, USA, January 31, 2024.
Brendan McDermid | Reuters
The U.S. stock market is in a “very precarious” position as persistently strong employment and wage growth suggest the Federal Reserve’s interest rate hikes have not had the desired effect, according to Cole Smead, CEO of Smead Capital Management.
Nonfarm payrolls rose 353,000 in January, fresh data showed last week, well above the Dow Jones estimate of 185,000, while average hourly earnings rose 0.6% month over month, doubling consensus forecast. Unemployment is holding steady at a historically low 3.7%.
The figures come after Fed Chairman Jerome Powell said the central bank likely won’t cut rates in March as some market participants had expected.
Smead, who has so far correctly predicted the resilience of the American consumer in the face of monetary tightening, said Monday on CNBC’s “Squawk Box Europe” that “the real risk all along was how strong the economy was,” despite 500 basis points increase in interest rates. One basis point equals 0.01%.
“We know the Fed raised rates, we know it caused bank runs last spring, and we know it hurt the bond market. The long-term policy tools they used?” – said Smead.
“Wage growth is still very strong. The Fed has had no impact on wage growth, which we say continues to outpace inflation, and I view wage growth as a really good picture of continued inflation pressures.”
Inflation has slowed significantly from its pandemic-era peak of 9.1% in June 2022, but the U.S. Consumer Price Index rose 0.3% month over month in December, bringing the annual rate to 3. 4%, which is also higher than consensus estimates and higher than the Fed2 forecast. % target.
Smead argued that the fall in the consumer price index should be attributed to “luck” due to falling energy prices and other factors beyond the central bank’s control, rather than the Fed’s aggressive monetary tightening cycle.
If labor market conditions, consumer sentiment and household balance sheets remain strong, the Fed may have to keep interest rates higher for longer. Ultimately, this will mean that more and more listed companies will be forced to refinance at much higher levels than before, and so the stock market may not benefit from the strength of the economy.
Smead highlighted the period between 1964 and 1981 when the economy was “generally strong” but the stock market did not benefit proportionately due to ongoing inflationary pressures and tight monetary conditions, and suggested that markets may be entering a similar period .
Wall Street’s three main indexes on Friday completed their 13th winning week in the last 14, despite Powell’s warning of rate cuts as huge gains from US tech titans such as Meta gave additional optimism.
“The better question may be why is the stock market priced the way it is given economic strength and the Fed being forced to keep those rates high? This is a very dangerous thing for stocks,” Smead warned.
“And on top of that, the economic gains that we see in the economy have very little to do with the stock market, they don’t benefit the stock market. What did the stock market do last year? His grades went up. Does this have anything to do with the income growth associated with the economy? Not at all”.
Rate cuts should become ‘less urgent’
However, some strategists have stressed that the upside potential of the latest data means the Fed’s efforts to engineer a soft landing for the economy are starting to bear fruit and that a recession appears no longer in sight, which could limit the downside for the broader market .
Richard Flynn, managing director of Charles Schwab UK, said on Friday that until recently such a strong jobs report would “sound alarm bells in the market”, but that appears to be no longer the case.
“And while lower interest rates will certainly be welcomed, it is increasingly clear that markets and economies are coping well with the high-rate environment, so investors may feel the need to ease monetary policy is less pressing,” he said . in the note.
“[Friday’s] The numbers could be another factor delaying the Fed’s first rate cut later in the summer, but if the economy maintains a comfortable trajectory, that could be a good thing.”
This was echoed by Daniel Casali, chief investment strategist at Evelyn Partners, who said the bottom line is that investors are becoming “a little more confident that central banks can balance growth and inflation.”
“This favorable macroeconomic backdrop is relatively positive for stocks,” he wrote in a note.