Powell Won’t Break S&P 500 Rally; Wage Growth Eases

If markets are right, tomorrow’s Fed meeting policy statement will announce the next-to-last rate hike of the cycle, with a quarter-point move that’s expected to be matched on March 22. However, Federal Reserve Chair Jerome Powell probably has other ideas. That’s why the S&P 500 backed off from a six-week high on Monday, but markets firmed up Tuesday after the Employment Cost Index showed softer wage growth in Q4.

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Powell may make a case as to why interest rates may need to go a bit higher and stay there for longer than investors are betting. Even so, Wall Street doubled-down on its belief that rate hikes are about to end. In fact, odds for a quarter-point hike in March fell from 98% on Monday to 82.5% today, according to CME Group’s FedWatch page.

While markets could turn out to be right, this week’s Fed meting is all about the Fed keeping options open. Powell has zero interest in providing fodder for the S&P 500 to move higher and Treasury yields to move lower.

The big tell will be how Powell characterizes the balance of risks. If he says that they’re now balanced between higher-than-expected inflation and lower inflation amid a weakening economy, the S&P 500 will shoot higher. But he’s probably not willing to go there yet and will continue to say that inflation risks are to the upside.

An even-clearer S&P 500 rally signal would come if the Fed drops its language saying the policy committee anticipates “ongoing increases” in the Fed’s key interest rate. Most expect the language will remain.

Fed Meeting Minutes Fire Warning Shot

Minutes from the Fed meeting in mid-December highlighted policymakers’ concern about an “unwarranted easing in financial conditions.” Rallying financial markets could “complicate the Committee’s effort to restore price stability,” the minutes said.

That concern may be top of mind for policymakers going into this week’s Fed meeting. That’s because the Chicago Fed’s gauge of national financial conditions through Jan. 20 showed that they were easier than any time since rate hikes started last March.

Still, Powell’s 2:30 p.m. news conference tomorrow after the Fed meeting wraps will hardly be the last word on the rate-hike outlook. Arguably, the raft of labor market data out this week will have more impact on markets than Powell.

Jobs, Wage Data Are Key

On Tuesday morning, the Labor Department’s Employment Cost Index showed compensation costs rose 1% in Q4 vs. the 1.1% expected. However, compensation rose 5.1% from a year ago, a slight uptick from the 5% growth in Q3.

Economists pay close attention to wage growth for private-sector workers, excluding those in incentive-paid occupations, as a good indicator of underlying wage growth. In Q4, pay in this category rose 0.9%, or a 3.6% annualized pace. That measure excludes occupations in which pay is driven by commissions, which may be more influenced by cyclical highs and lows.

The ECI report has elevated importance with the Fed emphasizing the need for lower wage growth to return inflation to the 2% target. Powell has said that wage growth easing to 3.5% would be sufficient.

With consumer spending and manufacturing both showing signs of weakness, Friday’s January jobs report will provide more evidence as to whether the economy’s last major source of strength is giving way. Analysts expect a solid gain of 185,000 jobs, but average hourly wage growth is seen easing to 4.4% from 4.6% in December.

S&P 500 Set-Up

In Tuesday stock market action, the S&P 500 jumped 1.5% after ECI report. Through Monday’s close, the S&P 500 had rallied 12.3% off its Oct. 12 bear-market closing low, but was still 16.2% below its all time high.

On Friday’s the S&P 500 crested around 4094, making a third run at clearing 4100 since the start of December. That’s the key level to watch for now.

Be sure to read IBD’s The Big Picture every day to stay in sync with the market direction and what it means for your trading decisions.

After the ECI data, the 10-year Treasury yield slipped to 3.52% from 3.55% on Monday.

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