Stocks Stabilize on Improved U.S. Inflation Outlook

What you need to know…

The S&P 500 Index ($SPX) (SPY) Friday closed up +0.59%, the Dow Jones Industrials Index ($DOWI) (DIA) closed +0.53%, and the Nasdaq 100 Index ($IUXX) (QQQ) closed up +0.27%.

Stocks saw support Friday after the decline in the PCE deflator improved the U.S. inflation outlook, which was dovish for Fed policy. The markets are currently discounting a 100% chance of a +25 bp rate hike at the next FOMC meeting on Jan 31-Feb 1, and about a one-third chance of a +50 bp rate hike at that meeting.  The markets are discounting a peak funds rate of 4.91% in May-June 2023, which would represent a further +58 bp rate hike from the current average effective federal funds rate of 4.33%.

On the negative side for stocks, the 10-year T-note yield Friday rose by +6.9 bp to 3.747%.

The stock market saw support after Congress Friday gave final approval to the $1.7 trillion funding bill and sent it to President Biden’s desk for his signature, thus averting a government shutdown on Saturday.  The bill included $47 billion of security funds for Ukraine and electoral reforms to support U.S. democracy.  The bill also bans downloading the TikTok app to government phones due to information security concerns.  The bill had some bipartisan support in the Senate, but House passage was mostly on party lines.

The good news is that the U.S. government is now funded until the end of the fiscal year on September 30, 2023, which eliminates the threat of a government shutdown until then.  However, the markets still have the debt ceiling to worry about, which could prompt the more serious threat of a Treasury default.  The Bipartisan Policy Center projects that the current debt limit will be hit sometime in the first half of 2023, but that emergency measures will stave off the x-date and a Treasury default risk until Q3-2023. Republicans take over control of the House when the new session begins on January 3, but Democrats will remain in control of the Senate.

U.S. stocks were undercut this week by the explosion of the Covid pandemic in China, with the potential for new variants to develop and affect the rest of the world.  Also, the Chinese economy is taking a sharp hit, with negative consequences for the global economy and supply chain.

Bloomberg reported Friday that the minutes from an internal meeting of China’s National Health Commission held on Wednesday showed that nearly 37 million people may have contracted Covid on a single day earlier this week and that a mind-bending 18% of the population (248 million people) likely contracted Covid just in the first 20 days of December.  The commission estimates that more than half of the residents in the Sichuan province and the capital of Beijing may have been infected.  China, several weeks ago, abruptly dropped its Covid zero policy due to public protests.  Covid cases are reportedly deluging China’s hospitals and crematoriums. 

Feb WTI crude oil prices rallied +2.67% Friday after Russia said it might cut production by 500,000-700,000 bpd in response to Europe’s partial oil embargo on Russian oil imports.  Russia has threatened to retaliate for the European oil embargo and price cap and may be trying to at least talk oil prices higher.  However, the embargo is having a significant impact, as Bloomberg reports that total oil shipments from Russia in mid-December fell by -54%.

Gasoline prices Friday rallied sharply on reports that as much as one-third of Texas Gulf Coast refinery capacity was shut down due to the cold snap.

The Nov U.S. PCE deflator, the Fed’s preferred inflation measure, eased to +0.1% m/m and +5.5% y/y from Oct’s revised +0.4% m/m and +6.1% y/y and was in line with market expectations.  The Nov core PCE deflator of +0.2% m/m was in line with market expectations and was down slightly from Oct’s revised +0.3% m/m.  On a year-on-year basis, the Nov core deflator eased to +4.7% from Oct’s +5.0% but was slightly above expectations of +4.6%.

Nov real personal spending was unchanged m/m, slightly weaker than expectations of +0.1% and down from Oct’s +0.5%.  Nov personal income fell to +0.1% m/m from Oct’s revised +0.9% and was slightly weaker than expectations of +0.2%.

Friday’s Nov durable goods orders report of -2.1% m/m was weaker than expectations of -1.0%, and Oct was revised lower to +0.7% from +1.1%.  The Nov core capital goods orders report (ex-defense and aircraft) of +0.2% m/m was slightly stronger than expectations of unchanged, but Oct was revised lower to +0.3% m/m from +0.6%. 

The final-Dec University of Michigan consumer sentiment index was revised higher by +0.6 points to 59.7 from the preliminary-Dec level of 59.1, which was stronger than expectations for an unrevised figure of 59.1.  The final-Dec figure of 59.7 was up by +2.9 points from November’s 5-month low of 56.8.  The final-Dec figure of 59.7 is only 9.7 points above the 42-year low of 50.0 posted earlier this year in June.

Nov new home sales rose by +5.8% to 640,000, which was much stronger than expectations for a drop to 600,000.  The report suggested that demand may be stabilizing after the 30-year mortgage rate has eased sharply by -88 bp to 6.20% from the late-October 20-year high of 7.08%.

The Euro Stoxx 50 index Friday closed down -0.16%.  The Shanghai Composite index Friday fell by -0.28% for the seventh consecutive decline and the 11th decline in the last 13 sessions.  The Nikkei index today fell by -1.03%.

Today’s stock movers…

Tesla (TSLA) Friday fell -1.76%, adding to Thursday’s -8.88% plunge to a new 2-year low, which was sparked by Musk’s recent stock sales and news that U.S. safety investigators are investigating a multi-vehicle crash on the San Francisco Bay Bridge involving a Tesla Model S that may have been guided by its automated systems. 

In a supportive factor for Tesla, CEO Musk, in a Twitter Spaces live-audio conversation late Thursday lasting more than an hour, promised not to sell any more stock for some two years after his recent $40 billion worth of Tesla stock sales.  In response to the view that he is ignoring Tesla due to his Twitter obsession, he claimed he has not missed a single important Tesla meeting.  However, he voiced a downbeat outlook for Tesla sales next year, given his view that the U.S. is already in a recession and that the recession will be “comparable to 2009.”

Energy stocks and energy service providers closed higher on Friday due to the rally in oil prices. Exxon Mobil (XOM) closed +2.64%, Haliburton (HAL) closed +4.13%,  and Valero Energy (VLO) closed +3.97%.

Bitcoin (^BTCUSD)  on Friday closed mildly higher by +0.11%, providing support for crypto stocks.  Coinbase (COIN) closed +2.60%, but Marathon Digital (MARA) closed -1.36%.

U.S.-listed Chinese stocks on Friday were undercut as the Covid pandemic explodes in China.  JD.com (JD) closed -2.13%, and Pinduoduo (PDD) closed -1.71%.

Across the markets…

March 10-year T-notes (ZNH23) Friday closed down -15 ticks, and the 10-year T-note yield rose by +6.9 bp to 3.747%.  T-note yields rose on higher inflation expectations, with the 10-year breakeven inflation expectations rate rising by +3 bp to 2.23% due in part to the +2.67% rally in WTI crude oil prices.

T-note prices were also undercut as the T-note market focused on the stronger aspects of Friday’s deluge of economic reports, such as the slightly stronger-than-expected U.S. core PCE deflator report and the upward revision in the final-December U.S. consumer sentiment index.

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