It is only the middle of December, but the Santa Claus rally is topping off what has been a very good year in stock and bond markets. The latest rally began on October 27th. Since that point the stock index has rallied more than 14% on increasing signs of cooling inflation without a major recession. This week Federal Reserve Chairman Powell gave that view a boost when he said “I have always felt, since the beginning, that there was a possibility, because of the unusual situation, that the economy could cool off in a way that enabled inflation to come down without the kind of large job losses that have often been associated with high inflation and tightening cycles. So far, that’s what we are seeing.”
Indeed, the November Consumer Price Index released this week showed a 3.1% annual rate, still above the Federal Reserve’s 2% target but down from 6.4% at the beginning of the year. As a reminder, inflation fell to 3% in June but rose back to 3.7% in August and September, sparking the market sell-off in those months. Inflation is still the most critical economic indicator to watch. Any reversal showing rising inflation would be unwelcome.
Meanwhile, the Atlanta Fed’s GDPNow tracking model is projecting Q4 GDP at 1.8%, slow growth but still positive, which is exactly what the Federal Reserve would like to see. The Federal Reserve would like to slow the economy just enough to get inflation under control without causing a major recession. It is a tough objective but appears increasingly possible. Similarly, the labor markets have been mixed indicating a weakening but not disastrous jobs market.
At the beginning of the year, we emphasized that the Federal Reserve needed to stay on the path of lowering inflation, while avoiding the ditch of runaway inflation on one side, and deep recession on the other. The Federal Reserve has done an excellent job staying on the path for 2023. Let’s enough the Santa rally and have a Merry Christmas!