Episode 49

Will Santa Bring Inflation, Volatility, and Higher Rates?

By:

Director of Trading Education at Interactive Brokers

Andrew Wilkinson, Director of Trading Education, hosts IBKR’s December’s market and economic roundtable with Jose Torres, Senior Economist, and Steve Sosnick, Chief Strategist.

Summary – IBKR Podcasts Ep. 49

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Andrew Wilkinson 

Welcome everybody to today’s edition of IBKR Podcasts. I’m delighted to be joined in the studio here by my colleague Steve Sosnick. How are you, Steve? 

Steve Sosnick 

I’m great thanks. How are you, Andrew? 

Andrew Wilkinson 

Doing well, thank you and down in our West Palm Beach office, our resident economist Jose Torres. How are you, Jose? 

Jose Torres 

I’m doing great Andrew, thanks for having me. 

Andrew Wilkinson 

Very welcome. It’s always good to have you on the show. We’re going to start with you, Jose. Let’s have a little look at the Nonfarm Payrolls report from last Friday. What were the salient parts of that November report that grabbed your attention? 

Jose Torres 

It was a strong job number overall, but when you look under the hood there were some pockets of weakness. For example, in some of these cyclical areas like retail jobs and transportation we’re actually negative during the period. Also, there seems to be a continued discrepancy between the establishment survey and the household survey.  The establishment survey and the household survey are calculated differently. One is via payrolls, so it’s hard data, and the other one is with BLS economists calling households or going to visit households.  So, it’s hard data versus soft data, and the establishment survey shows that job gains were 260,000, but the household survey shows a loss of jobs.  Part of that could be that some folks have been forced to have multiple jobs to deal with generationally high inflation as well as higher interest rates. Speaking of inflation, the report was really negative on the inflationary side.  Labor force participation and wage growth are going the other way for three consecutive months. The labor force continues to contract, which is bad for inflation because employers have less workers to hire from; and then wage growth, of course they have to pay more to get employees into the door.  So, it’s an overall strong headline number, but some negativity when you go under the hood. 

Andrew Wilkinson 

I want to pick on two specific sectors. Manufacturing is the first one, and leisure and hospitality is the second.  I want you to talk to me a little bit about what’s actually going on under the hood here. For manufacturing, job gains released on Friday showed 19,000 manufacturing jobs created, which is down from a year-to-date average of 34,000 on a regular monthly basis. That’s at odds with what we saw a couple of days earlier in the ADP report, so tie that in with what’s happening also in the ISM manufacturing data.  And then leisure and hospitality – they continued to add employees. What does it tell us about consumers’ appetite for dining out and a willingness to pay increasingly higher food prices? 

Jose Torres 

Well, manufacturing is capital intensive and interest rate sensitive, so all the Fed rate hikes that we’ve experienced this year hit real estate and manufacturing first, so that explains some of the weakness. Some of the other weakness comes from the fact that in 2020 and 2021, pandemic lockdowns created a lot of demand for goods spending.  A lot of folks bought their microwaves, their refrigerators, their vehicles during that that time, and now spending trends have shifted to services. So, what’s weighing on manufacturing is that you have prices coming down because of declining demand.  Supply chain improvements are also making prices go down, and you also have commodity prices going down. It’s also weighing on the ISM. The ISM has employment contracting in November, while BLS has manufacturing employment increasing. All surveys do show manufacturing contracting. On the leisure and hospitality side, business has been booming. Folks continue to spend. Credit card debt is increasing a lot. Consumer sentiment is negative. However, when times are good, people in America spend to celebrate, and when times are bad or when folks are feeling bad, people spend to feel better.  So, that’s been an element of inflation that’s been very difficult for the Fed to cool down because the spending in the services remains so strong, and that also leads to labor demand in leisure and hospitality. 

Andrew Wilkinson 

OK, we’ll come back to you in a minute, Jose. I want to turn to Steve now. Steve, stocks soared last week following Chairman Powell’s revelation that the FOMC can perhaps relax its tightening to 50 basis point increments rather than 75 basis point increments. And they’re just headed for the moon. You interpreted the recent Powell speech somewhat differently than the equity market. Explain what stock traders chose to focus on and why. 

Steve Sosnick 

Stock traders are desperate for good news. We’ve been sort of baking into this market the idea that we would have this — I hate to use the term Santa Claus rally — but we’re in December and we’re here. Basically, a rally into the end of the year that would sort of salvage a good portion of what we’ve seen so far. And to justify this you need something. Remember, the markets have really been downgrading what they’ve been hoping for from the Fed or expecting from the Fed. We had the pivot.  That was squashed at Jackson Hole. We had the idea of peak rates. Well, no, they’re going to keep raising. We had the idea of a pause. Well, no, that’s not going to happen either. So, let’s seize upon the idea of slower rates. I put out something on Monday that described the market’s fixation with the second derivatives.  Since the first derivatives aren’t working — meaning the rate of inflation, or rate hikes are not to the markets favor — let’s focus now on the second derivative, the pace of the of the growth and inflation, or the pace of rate hikes. It’s basically whatever reed we can grasp onto to keep the positive momentum. 

Andrew Wilkinson 

And that commentary is available on tradersinsight.news. Let’s talk a little bit about volatility in the rearview mirror and the outlook for volatility. The Cboe Volatility Index is down today compared to its peaks in the in August. Is that the Fed pivot and what do you expect for volatility in the equity markets going forward? 

Steve Sosnick 

I think it’s way too early to write off volatility. Volatility is exacerbated by a restrictive monetary policy. An easy monetary policy dampens inflation – no dampens volatility, sorry. But the inverse is true as well, which is why we saw much more volatility in 2022 than we saw in the last couple of years. I think it’s premature to just say volatility is done. Lost in all the commentary about the slower pace of rate hikes is the fact that they’re going to continue quantitative tightening at the same pace there’s been, and possibly even faster. So, if you want to look at 2nd derivatives, guess what — that one’s unchanged.  But because the pace is so high, this is not good if you’re looking for stability.  It does beg the question, does volatility come back?  Remember also, VIX is constructed as the market’s best estimate of volatility over the coming 30 days.  With the exception of the Fed meeting mid-month, there’s not a lot to expect for volatility. The last two weeks of the year are historically dead in terms of movements or in terms of volume. Yes, you can get crazy moves in in a thin market, but for the most part that’s being priced in. When we look to VIX futures, they’re back sort of above 24-25-ish going into the beginning of the year, which is the market’s way of saying, “all right, we’ve got to get through December, but we’ll resume, you know. Stay tuned. We’ll resume everything in January.” 

Andrew Wilkinson 

Jose, we’ve got a big inflation report coming out this week. Besides CPI, what other related inflationary indicators are you keeping an eye on to gauge the development of inflationary pressure? 

Jose Torres 

I’m keeping an eye on commodity prices, natural gas, crude oil, lumber, copper, unemployment claims since a lot of the inflation pressure is coming from the labor market retail sales, the inflation Nowcasts from the Cleveland Fed, M2 money supply, the Fed’s balance sheet, air passenger levels, and the weekly Redbook Retail Sales Report.  And while inflation has eased up in the goods and commodity components, as I said earlier, services remain red hot due to the sizzling labor market. The Cleveland Fed now actually has the reading coming out next week for CPI about double the pace of the previous month, so that could spell some risks for the market going forward. 

Andrew Wilkinson 

Excellent Jose, thank you very much for joining me.  Steve, thank you and thanks to the audience for joining me. Do enjoy the holiday season and don’t forget to check us out at ibkrpodcasts.com or wherever you download your podcast from. Thanks everybody, bye for now.  

Related Links

https://www.dol.gov/ui/data.pdf

https://www.clevelandfed.org/indicators-and-data/inflation-nowcasting

https://www.tsa.gov/coronavirus/passenger-throughput

https://www.census.gov/retail/sales.html

https://www.federalreserve.gov/releases/h6/

https://www.federalreserve.gov/releases/h41/

https://www.tradersinsight.news/traders-insight/securities/macro/our-obsession-with-second-derivatives/

Disclosure: Interactive Brokers

The analysis in this material is provided for information only and is not and should not be construed as an offer to sell or the solicitation of an offer to buy any security. To the extent that this material discusses general market activity, industry or sector trends or other broad-based economic or political conditions, it should not be construed as research or investment advice. To the extent that it includes references to specific securities, commodities, currencies, or other instruments, those references do not constitute a recommendation by IBKR to buy, sell or hold such investments. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Interactive Brokers LLC, its affiliates, or its employees.

Any trading symbols displayed are for illustrative purposes only and are not intended to portray recommendations.

In accordance with EU regulation: The statements in this document shall not be considered as an objective or independent explanation of the matters. Please note that this document (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and (b) is not subject to any prohibition on dealing ahead of the dissemination or publication of investment research.

Disclosure: Futures Trading

Futures are not suitable for all investors. The amount you may lose may be greater than your initial investment. Before trading futures, please read the CFTC Risk Disclosure. A copy and additional information are available at ibkr.com.