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Strong Consumer Spending & Core PCE Data Spark Fed Rate Hike Concerns

U.S. stocks closed sharply lower on Friday, 24th February 2023, after a higher-than-expected core PCE and stronger consumer spending data released on Friday. 

The personal consumption expenditures price index rose 5.4% from a year earlier and the core metric was up 4.7%, both marking pickups after several months of declines.  

Meanwhile, consumer spending, adjusted for prices, jumped 1.1% from the prior month, the highest in nearly two years, after consecutive declines. 

Investors reacted to the data negatively as it may lead to the Fed raising rates more than anticipated. 

In addition, 2-year yields hit 4.8% the highest since 2007 and swaps are now pricing in three 25 basis point hikes in the next three meetings, with peak rates implied to rise to 5.4% by July. 

For the week, the Dow Jones experienced its fourth consecutive losing week, dropping 3%, while the S&P 500 shed 2.7% marking its worst week since early December, and the tech-heavy Nasdaq sank 3.3%. 

Here are the closing levels on Friday, 24th February 2023:

 Last Change %Change 
Dow Jones 32,816.92.   -336.99. -1.02% 
S&P 500 3,970.04 -42.28 -1.05% 
Nasdaq Comp 11,394.94.   -195.46. -1.69% 
US 10Y 3.94%   
VIX 21.67 +0.53 +2.51% 

The bulls reacted to the negative news as expected, but we did not see the usual dip buying after the news. Moreover, the market did not turn around as it did in previous selloffs.  

Although some analysts are predicting a higher terminal rate of 5.4% or even more than 6%, Friday’s selloff should have been more pronounced in light of these expectations. 

It is possible that buying on dips is still supporting the markets, but to a lesser extent than before. 

The S&P is close to erasing all of its gains in 2023, and a pivot by the Fed is unlikely to happen anytime soon, given that inflation is still far away from the Fed’s 2% target.

So why aren’t we lower? 

There are some who believe that the data will catch up with the market at some point so selling is unnecessary. Meaning at some point, in the future, the Fed will slow down and maybe pivot, so might as well hold on to longs.  

The theory is correct for very long-term holders of stocks; however, they could be a point where you may be forced out of a position if the market sells off too much.  

This will be a very painful experience. I think the market is not expecting this and may not be prepared for it which leads me to be very cautious about holding longs.  

This article states in the week up to 22nd Feb there were outflows of USD 7 billion in equity funds, USD 3.8 billion in cash funds, and an increase of USD 4.9 billion in bond funds. 

Additionally, the article predicts the S&P will be heading toward the 3800 level soon. 

Unless we get another buying on dip FOMO rally, it is possible that this prediction could very well happen soon. 

Source: CBOE, Bloomberg. 

This commentary is written by James Gomes.
James has been in the finance industry for over 30 years and most recently worked for a large U.S. bank for more than 20 years.

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