3 reasons we think -2.5% decline is an over-reaction. "Higher for longer" is really "higher for longer DUE to higher GDP."

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We discuss: why the “hawkish” take by markets from FOMC ultimately reverses in the next few weeks.  There are 3 reasons, but the most important is the Fed funds YE 2024 is higher by +50bp because growth is raised by +40bp.  Wouldn’t it be worse if Fed raised GDP view but did not raise Fed funds?

Please click below to view today’s Macro Minute (Duration: 8:54).

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Since the FOMC rate decision (2 trading days), the S&P 500 is down -2.5% and down -4% for the month. The market’s viewed the September FOMC rate decision (and summary economic projections, or SEP) hawkishly. Stocks have been under pressure the entire month as US 10-yr yields relentlessly marched higher from 4.0% to nearly 4.5%. Unfortunately, our expectation for equities to gain post-FOMC did not materialize.

• For reasons we discuss below, we view the magnitude of the equity decline and commensurate surge in yields disproportionate to the FOMC rate decision and press conference. Understandably, this sounds like a tall order. After all, yields on the US treasuries surged to multidecade highs yesterday. So the fixed income market reacted strongly to the FOMC.
• The primary driver is the market’s takeaway for the Fed to stay “higher for longer” as the Fed’s SEP (summary economic projections) shows a median “dot plot” of 5.1% for YE 2024, versus 4.6% for the June SEP. In other words, in the past 3 months, the SEP shows the Fed FOMC now expects Fed funds to be +50bp higher with the passage of just 3 months.
• Fed Chair Powell made two clarifications to this rise in median YE 2024 dot plot.
  – First, he noted that the “SEP is not a plan that is negotiated or discussed…It’s an accumulation, really…what you see are the medians…from 19 people.”
  – Second, the driver for the higher YE 2024 FF is “what it reflects…is that economic activity has been stronger than we expected”
  – GDP 2024 median is now +1.5% versus 1.1%, or +40bp higher. So this makes sense.
• The “hawkish” take is the Fed has raised the bar for cuts. And the hawkish take is the market driving view. And that means inflation has to come down further and more consistently for the Fed to consider rate cuts. Powell made comments supporting this view:
  – “what people are saying is let’s see how the data come in—these good inflation readings that we’ve been seeing for the last three months, we want to see that it’s more than just three months, right?”
• The “dovish” take is simply, the SEP is merely the Fed’s guess of the future. And that incoming data will impact that path of that future. There is a military term called “WAG” (wild assed guess) and this is essentially what the SEP is. It is literally the Fed’s guess of the future.
  – And with GDP expected to be +40bp
  – Could the YE 2024 Fed funds have stayed at 4.6%?
  – Wouldn’t the market have been more negative if that was the case?
• Moreover, the Fed reiterated a “soft landing” is a primary objective and was declarative of that. But many only focused on an earlier exchange:
  – Q: would you call the soft landing now a baseline expectation?
  – A: MR. POWELL: No. No, I would not do that.
  – Powell likely misspoke or misheard, but that answer drove an immediate sell-off in equities.

BOTTOM LINE: Why is this -2.5% an over-reaction? 3 reasons

There are 3 reasons we believe equities over-reacted to the FOMC press conference.

• First, after re-listening and re-reading the transcript, the “higher for longer” message is not as hawkish given the rise in Fed funds by YE 2024 stems from higher growth. Think about that, wouldn’t it be less logical for the GDP forecast to go up, but the Fed doesn’t think Fed funds needs to adjust?
• There will be a circuit of Fed speakers over the next few weeks, and our take is the “higher for longer DUE to higher GDP” has a more dovish tone, in my view. A hawkish take would be if inflation persistence went up and therefore Fed funds needs to stay high. But the SEP does not have a rise in inflation.
• Second, we need to be mindful that the Fed’s SEP is merely a WAG of the future. And their prior forecasts have seen substantial error relative to what actually happened. As our chart below highlights, the only 3 CPI service categories with high inflation are:
  – housing (set to fall)
  – transportations services (set to fall)
  – “other” — an motley category, hence, called “other”
• Third, since 1930, a 4.5% US 10-year yield is not a P/E killer. In fact, the “sweet spot” for P/E is 3.5% to 5.5% yields which have seen an average P/E of ~20X. In fact, US yields below 3.5% are associated with lower P/E.
• Why does a US 10-year have the highest P/E? There are 3 reasons:
  – EPS: higher rates = higher nominal GDP growth
  – Margin: higher nominal GDP = higher profit margin
  – Future Value: high cost of capital = barriers to entry
• So these argue P/E today should be higher than P/E at the end of 2019 when Fed funds was 0% and US-10 year was 1.6%. Yet, P/E today is about the same as in 2019.
• Finally, we are exiting some seasonal weakness. And this, in our view, is supportive of stocks recapturing some of that decline.

Key incoming data September

•  9/1 8:30am ET August Jobs Report Tame
•  9/1 10am ET August ISM Manufacturing Tame
•  9/6 10am ET August ISM Services Mixed
•  9/6 2pm ET Fed releases Beige Book Tame
•  9/8 9am ET Manheim Used Vehicle Index August Final Tame
•  9/8 2Q23 Fed Flow of Funds Report Tame
•   9/13 8:30am ET August CPI Mixed
•  9/14 8:30am ET August PPI Tame
•  9/15 8:30am ET September Empire Manufacturing Survey Tame
•  9/15 10am ET U. Mich. September prelim 1-yr inflation Tame
•  9/18 8:30am ET September New York Fed Business Activity Survey Tame
•  9/18 10am ET September NAHB Housing Market Index Tame
•  9/19 9am ET Manheim September Mid-Month Used Vehicle Value Index Mixed
•  9/20 2pm ET September FOMC rates decision Market saw Hawkish
•  9/21 8:30am ET September Philly Fed Business Outlook Survey Mixed
•  9/22 9:45am ET S&P Global PMI September Prelim
•  9/25 10:30am ET Dallas Fed September Manufacturing Activity Survey
•  9/26 9am ET July S&P CoreLogic CS home price
•  9/26 10am ET September Conference Board Consumer Confidence

Key incoming data August

• 8/1 10am ET July ISM Manufacturing Tame
• 8/1 10am ET JOLTS Job Openings Jun Tame
• 8/2 8:15am ADP National Employment Report Hot
• 8/3 10am ET July ISM Services Tame
• 8/4 8:30am ET July Jobs report Tame
• 8/7 11am ET Manheim Used Vehicle Index July Final Tame
• 8/10 8:30am ET July CPI Tame
• 8/11 8:30am ET July PPI Tame
• 8/11 10am ET U. Mich. July prelim 1-yr inflation Tame
• 8/11 Atlanta Fed Wage Tracker July Tame
• 8/15 8:30am ET Aug Empire Manufacturing SurveyMixed 
• 8/15 10am ET Aug NAHB Housing Market IndexTame
• 8/16 8:30am ET Aug New York Fed Business Activity SurveyNeutral
• 8/16 2pm ET FOMC MinutesMixed 
• 8/17 8:30am ET Aug Philly Fed Business Outlook Survey Positive
• 8/17 Manheim Aug Mid-Month Used Vehicle Value IndexTame
• 8/23 9:45am ET S&P Global PMI Aug PrelimWeak
• 8/25 10am ET Aug Final U Mich 1-yr inflationMixed
• 8/28 10:30am ET Dallas Fed Aug Manufacturing Activity Survey Tame
• 8/29 9am ET June S&P CoreLogic CS home price Tame
• 8/29 10am ET Aug Conference Board Consumer Confidence Tame
• 8/29 10 am ET Jul JOLTS Tame
• 8/31 8:30am ET July PCE Tame
• 9/1 8:30am ET August NFP jobs report
• 9/1 10am ET August ISM Manufacturing

Key incoming data July

• 7/3 10am ET June ISM Manufacturing Tame
• 7/6 8:15am ADP National Employment Report Hot
• 7/6 10am ET June ISM Services Tame
• 7/6 10 am ET May JOLTS Tame
• 7/7 8:30am ET June Jobs report Mixed
• 7/10 11am ET Manheim Used Vehicle Index June Final Tame
• 7/12 8:30am ET June CPI Tame
• 7/13 8:30am ET June PPI Tame
• 7/13 Atlanta Fed Wage Tracker June Tame
• 7/14 10am ET U. Mich. June prelim 1-yr inflation Mixed
• 7/17 8:30am July Empire Manufacturing Survey
• 7/18 8:30am July New York Fed Business Activity Survey
• 7/18 10am July NAHB Housing Market Index in-line
• 7/18 Manheim July Mid-Month Used Vehicle Value Index Tame
• 7/25 9am ET May S&P CoreLogic CS home price Tame
• 7/25 10am ET July Conference Board Consumer Confidence Tame
• 7/26 2pm ET July FOMC rates decision Tame
• 7/28 8:30am ET June PCE Tame
• 7/28 8:30am ET 2Q ECI Employment Cost Index Tame
• 7/28 10am ET July Final U Mich 1-yr inflation Tame

Key data from June

• 6/1 10am ET May ISM Manufacturing Tame
• 6/2 8:30am ET May Jobs report Tame
• 6/5 10am ET May ISM Services Tame
• 6/7 Manheim Used Vehicle Value Index May Tame
• 6/9 Atlanta Fed Wage Tracker April Tame
• 6/13 8:30am ET May CPI Tame
• 6/14 8:30am ET May PPI Tame
• 6/14 2pm ET April FOMC rates decision Tame
• 6/16 10am ET U. Mich. May prelim 1-yr inflation Tame
• 6/27 9am ET April S&P CoreLogic CS home price Tame
• 6/27 10am ET June Conference Board Consumer Confidence Tame
• 6/30 8:30am ET May PCE Tame
• 6/30 10am ET June Final U Mich 1-yr inflation Tame

Key data from May

• 5/1 10am ET April ISM Manufacturing (PMIs turn up) Positive inflection
• 5/2 10am ET Mar JOLTS Softer than consensus
• 5/3 10am ET April ISM Services Tame
• 5/3 2pm Fed May FOMC rates decision Dovish
• 5/5 8:30am ET April Jobs report Tame
• 5/5 Manheim Used Vehicle Value Index April Tame
• 5/8 2pm ET April 2023 Senior Loan Officer Opinion Survey Better than feared
• 5/10 8:30am ET April CPI Tame
• 5/11 8:30am ET April PPI Tame
• 5/12 10am ET U. Mich. April prelim 1-yr inflation Tame
• 5/12 Atlanta Fed Wage Tracker April Tame
• 5/24 2pm ET May FOMC minutes Dovish
• 5/26 8:30am ET PCE April Tame
• 5/26 10am ET U. Mich. April final 1-yr inflation Tame
• 5/31 10am ET JOLTS April job openings

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