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Weekly Update 05/03/2024: Fed Keeps Rates Unchanged

  • Employment growth tempered
  • JNJ unveils new talc litigation plan
  • Coke pushes price to boost topline
  • DuPont highlights material sector comeback
  • IBM raises dividend again
  • Apple unveils massive buyback and payout boost
  • Plenty of earnings summaries below

Institute of Supply Management

The ISM manufacturing number for April was released on Wednesday. It came in at 49.2, below the 50.0 threshold for determining expansion or contraction. After hitting 50.3 in March and reaching the expansion area for the first time in months, it was disappointing to see the gauge fall back into contraction. New orders also fell into contraction territory at 49.1, down from 51.4 in the prior month. Costs for materials and other inputs rose for the second consecutive month implying inflationary pressures remain in place with the gauge of prices reaching its highest level since June 2022. Seven industries contracted in April while nine reported expansion. One machinery manufacturer commented: “Market conditions have definitely softened. Thankfully, our backlog is strong and will get us through the year.” Meanwhile, a maker of electric equipment said: “There has been a lot of volatility in sales. On average, our sales look flat, but the volatility is concerning.”

Today, the ISM services component for last month was published. It also showed a result in the contraction territory coming in at 49.4 versus an estimate of 52.0 and the prior reading of 51.4. That marks a four year low for that index. Business activity fell to 50.9 versus 57.4 last month marking the lowest level since May 2020 during the early stages of the pandemic. It is rare that both the manufacturing and services indices slip below 50.0, but these are sentiment indicators. That means that these are based on point-in-time readings with no revisions at a later date. Impressions change from month-to-month and day-to-day so this may not be the beginning of a trend. But softening demand, dull future activity indicators and a neutral inventory level mixed with a surprise upside in the price index is not a favorable mix heading into the rest of 2024 and something the Fed will have to keep an eye on.

Federal Open Market Committee

On Wednesday, the FOMC decided unanimously to leave its benchmark federal funds rate unchanged, as expected, in the range of 5.25%-5.50%. This is the sixth consecutive meeting where the range has not changed. The key sentence in the statement: “In recent months, there has been a lack of further progress toward the Committee’s 2% inflation objective.” In other words, the battle against inflation, which the Fed began in earnest in March of 2022 has clearly stalled. Chances of a rate cut this year are diminishing with each monthly inflation report that is released. The FOMC does not expect to cut rates “until it has gained greater confidence that inflation is moving sustainably toward 2%.”

The Fed is also adjusting its balance sheet by changing the pace of quantitative tightening beginning June 1. They are lowering the cap on the amount of U.S. Treasury securities rolling off the balance sheet by more than half, down to $25 billion per month from $60 billion. On the margin, that translates to a loosening of monetary policy and may provide somewhat of a boost but is not likely to adjust the trajectory of the economy on its own or with the same effect as interest rate policy. Nevertheless, it bears watching because it can provide a boost or headwind to the economy through the actions of the Treasury.

The key takeaway from the meeting is that the bar to cut interest rates has gone up since the beginning of the year. Markets did breathe a sigh of relief when Powell said that current rates were “sufficiently restrictive.” In his opinion and assumedly those of the rest of the committee, there would need to be more evidence that higher rates were not bringing down inflation. The fact is, it is coming down, just maybe not at the pace they had hoped. Thus, it is quite unlikely that the Fed would raise rates again in the foreseeable future. As we have discussed, that would be a very negative move signaling that the Fed was still behind the inflation curve and bring into serious question its forecasting ability. Markets even briefly moved appreciably higher when Powell mentioned the unlikelihood of hikes, but reversed course and drifted lower by the end of the trading day Wednesday as his full comments were digested.

Policymakers were pleasantly surprised last fall when a string of benign inflation data points were released boosting the hopes that multiple rate cuts were on the horizon in 2024. As the first quarter unfolded and that data started to show persistent inflation and a still robust payroll environment, those hopes were derailed. While the first quarter of the year was one of the strongest since 2019 in terms of market returns, the month of April was decidedly negative as the “higher for longer” sentiment took root. As we have discussed during many client calls, this year is shaping up like the previous two in terms of being driven by what the Fed is going to do. For now, they are remaining patient. If the data picture continues to point to stubborn or resurgent price pressures, the discussion of rate hikes may have to be on the agenda at an upcoming meeting. Stay tuned.

Labor Market

The Employment Cost Index (ECI), tabulated by the Bureau of Labor Statistics, rose 1.2% in the first quarter of 2024, the most in a year, after rising 0.9% in the last quarter. Fed officials closely monitor the ECI because of the depth of data and the fact that it covers both wages and benefits while many other salary measures cover just pay. Wages and salaries rose 1.1% for the third consecutive quarter and were up 4.4% from a year ago boosted additionally by the effects of minimum-wage increases in about half of U.S. states at the start of the year. The report detailed that wages for service workers in the private sector rose 1.2% from the prior quarter, unadjusted for inflation. Goods-producing industries saw worker pay also rise 1.2%, the most in a year. Because the data is only tabulated on a quarterly basis, it is not as timely as other data points, but it is important, nonetheless.

U.S. job openings fell in March to the lowest level in three years according to the Jobs Openings and Labor Turnover Survey (JOLTS) released by the Bureau of Labor Statistics. Meanwhile, the number of people voluntarily leaving their positions, known as the quits rate, fell to 2.1%, the lowest since August 2020, suggesting a cooling in the labor market. Essentially, people are staying put in their jobs longer because they feel less confident that they can easily find a new job that may pay better or offer better benefits. Construction, finance and insurance were the industries which saw the highest contraction in openings. Conversely, state and local education jobs saw an increase in available positions. Overall, health care has the most available positions reflecting an aging population in need of caretakers. The ratio of openings to unemployed people fell to 1.3. That figure was 2-to-1 back in March 2022, and pre-pandemic it hovered around 1.2 so the trend has been getting closer to the historical norm. The bottom line is that declining job openings coupled with a higher reluctance to leave one’s current job should help moderate payroll inflation in the months ahead, but time will tell.

After weekly initial unemployment claims and continuing claims held steady for the weeks ending April 27 and April 20, respectively, the focus of the markets turned to the monthly employment report. The Labor Department released the nonfarm payroll report for April today which showed 175,000 jobs were created, the smallest gain in six months. The unemployment rate was 3.9%, slightly above the 3.8% from March. Average hourly earnings month-to-month rose 0.2% which was less than the 0.3% expected in a survey of economists by Bloomberg. April’s report is showing that the demand for workers is moderating as the headline number came in well below the consensus estimate which called for a gain of 240,000 jobs.

Does this fall into the category of “unexpected weakening” that Chairman Powell said would warrant a policy response? Probably not. But job figures are revised all the time. In fact, the last two months of payroll data was revised down by 22,000 after further review. Could this be the beginning of the slowing many traders and economists were expecting since the end of last year? Potentially. Health and private education (i.e., excluding public school teachers) accounted for over half of the entire gain in payrolls suggesting that the slowdown was even softer than the headline appears if only two sectors accounted for that great a percentage. The odds of an interest rate cut at the FOMC September meeting went from 40% just yesterday to 57% in this morning’s trading. The fact that average hourly earnings grew 3.9% over the past twelve months, matching the slowest pace since June 2021, is a more telling factor than the number of jobs gained or lost. The Fed’s biggest challenge now is inflation because a 3.9% unemployment rate still remains quite low historically speaking. With the participation rate—which measures the share of the population working or looking for work—holding steady at 62.7% for all workers and rising to 83.5% for those 25-54 (the prime working ages), that will help restrain wage growth.

Perhaps the biggest risk right now is to jump to some sort of be-all and end-all conclusion. A recession is not right around the corner because unemployment rose by 0.1%. Neither is inflation about to reignite because there were more warehousing job gains recorded. As is usually the case, the answer is a bit more nuanced and the path forward not as clear cut. Payroll figures have a notoriously poor track record for predicting recessions, and their seemingly constant revisions mean the most accurate data cannot be analyzed until months after the fact. Futures markets give a point-in-time estimate where traders put their money on the line, but, so far this year, they have been woefully incorrect in prognostication. From our viewpoint, knowing the general economic trends and gradual shifts in direction is important to the degree it influences our analysis of the individual names in client portfolios. Thankfully, we do not have to know exactly what GDP is going to be in the third quarter of this year or any other or what round number the Nasdaq composite is going to settle by year-end. Macroeconomic conditions serve as a backdrop to evaluating our ownership stakes in public companies. For more insight on these names, keep reading.

Company Events

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