A Clear Message From Confusing Data

For anybody involved in financial markets, numbers have a kind of sanctity. They are how we are judged -- profit and loss are all that matters in a dealing room. But they are also how we make sense of what has happened and make predictions as to what will happen. That is why economic data is important. They clarify things and give a sense of the direction in which the economy, and therefore the market is headed. With a whole host of reports coming this morning, the market was looking forward to some clarity. What it got instead was more confusion, or at least that is what it looked like at first glance.

The most important of this morning’s reports in an economic sense, the GDP number, was strong, showing an economy that grew by 2.9%, a little more than anticipated. The Fed’s rate hikes were expected to begin to bite in Q4, but the report indicates that there is still growth, meaning presumably that there is still inflationary pressure. That impression was reinforced by initial weekly jobless claims, which fell slightly, but contradicted by continuing claims, which climbed.

The actual inflation data, though, in the form of CPE, the Fed’s preferred measure of inflation, showed that that pressure is declining quite rapidly, with the index increasing by 3.2%, down from 4.8% in Q3. The ex-food and energy number showed a similar trend, at 3.9% compared to 4.7% for the previous quarter. Consumer Durable orders showed a strong gain, at least until transportation was stripped out. After that adjustment, orders were basically flat.

So, which is it? Does the data indicate that a recession is coming, or that the economy is proving remarkably resilient, absorbing a steep rise in interest rates in a way that suggests a so-called soft landing? The only honest answer to that question given the numbers we saw this morning is that it is still unclear. There were indications of both, which is presumably why S&P 500 futures reacted as they did, falling initially, then climbing.

As the dust settles, it looks like equity traders are focusing on the positive, with all the major indices looking like opening higher as I write this. But in light of moves in the bond market, even that makes no sense. Yields spiked after all that data, particularly in the 2-Year, clearly indicating that bond traders saw this morning’s information as making it less likely that the Fed will slow the rate of hikes at their next meeting, or pause soon as many had anticipated. Basically, is it as simple as stock investors thinking the numbers are positive while bond investors disagree? Not quite.

As I’m sure you are aware, the prospect of slowing, stopping, and maybe even reversing rate hikes over the next few months is what most people believe has underpinned the rally in stocks we have seen so far this year, so how can that be? How can stocks jump on data that suggests more rate hikes to come?

The only way that can happen is if the stock market has changed its focus. Instead of looking to the next Fed meeting, traders seem to be looking well beyond that, and assessing the chances of a major recession. Clearly, they think those chances are low. Bond traders, meanwhile, are looking more at the short-term impact of another 50 basis points on the Fed funds rate. So, as weird as it may seem in some ways, while the reactions would under normal circumstances be contradictory, they both are actually quite logical.

It is quite possible, likely even, that these numbers take away the prospect of a more dovish approach by the FOMC this time around. It is also possible, however, that the economy will take that in stride, just as it has the rate hikes we have seen so far. I suspect that when the economic history of this time is written, we will realize that the overheating we saw in the 18 months or so following the pandemic was worse than we thought, that reduced immigration has had much more of an impact than most imagine, and that those things combined to allow for drastic rate hikes being absorbed for much longer than they usually might be.

Whatever the reasons, though, the contradictory data we saw this morning actually sends quite a clear message: there is still a decent chance that inflation can be tamed without seriously harming the economy, and for that, we should all be thankful.

* In addition to contributing here, Martin Tillier works as Head of Research at the crypto platform SmartFI.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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