Friday's Market Minute: Leading Market Indicators Match Up with Lagging Economic Data

The recent three-day profit taking sell-off has dampened the mood for bullish equity investors after a solid start to the year. Recession fears may be on the rise, but some investors are growing increasingly confident that the Fed might soon pause their rate hike campaign as headline inflation appears to have peaked. The lagged effects of the Fed’s actions are clearly showing up in prices and broad-based economic data. Wholesale price growth cooled off significantly in December, up 6.2% compared to a year earlier.

The year-over-year numbers rose far less than estimates and were down meaningfully from the revised 7.3% gain reported for November. Housing Starts and new Construction Permits declined again in December with negative revisions to November. Weak U.S. retail sales figures and signs of a steep decline in industrial production are yet other signs the economy is softening. As time passes, it is apparent that tight monetary policy deployed to bring down inflation is likely to slow the economy to below trend growth as lagged labor market conditions eventually weaken. 

The markets generally have a much better record in anticipating shifts in interest rates than actions taken by policy makers to either stimulate or cool the economy. Since the beginning of the year, the yield on two-year Treasuries has inverted by 25 basis points relative to the Federal funds rate. Based on this inversion, the bond market suggests the Fed is close to a pause as their main policy rate is closely correlated to two-year yields.

From the expected standpoint of other market based leading indicators, the dollar has demonstrated meaningful weakness since late September 2022, gold has risen, the yield on 10-year Treasuries has fallen nearly 90 basis points from a peak of 4.24% in late October, and emerging market equities have outperformed U.S. counterparts due to lower dollar-denominated external funding costs.

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