The S&P 500 Drops As Expected When Investors Shift Focus to 2023-Q1

If it seems like it was just a week ago that we issued a cautionary note that the S&P 500 (Index: SPX) would face a downward movement if investors shifted their attention to any point in the future other than 2022-Q4, that’s because it was.

We said it would absolutely happen before the end of 2022-Q4. But we didn’t have to wait very long at all, because it happened last week. The latest update to the dividend futures-based model‘s alternative futures chart shows it as the twelfth Lévy flight event of 2022, as investors refocused their attention on the first quarter of 2023.

The cause of the shift was easy to find in the week’s newstream. It’s directly tied to changing expectations for how the Federal Reserve’s Federal Open Market Committee (FOMC) will be changing the Federal Funds Rate in upcoming months. The FOMC concluded a two day meeting on Wednesday, 2 November 2022, announcing it would immediately hike interest rates by three quarters of a percent, but it was Fed Chair Jerome Powell’s press conference following the announcement that prompted investors to immediately shift their expectations for the future timing of when and how high the Fed’s rate hikes will top out.

The CME Group’s FedWatch Tool captured the associated change in expectations for the Fed’s future rate hikes. After the announcement, it continued to project a half point rate hike on 14 December (2022-Q4). But in 2023, the FedWatch tool anticipates the Federal Funds Rate rising to a target range of 5.00-5.25% in 2023-Q1 and holding at that level until a quarter point rate cut might takes place in December (2023-Q4). As would be expected, the change for how high and, more importantly, when the Fed’s series of rate hikes will peak in 2023-Q1 is behind the shift of investors’ time horizon from 2022-Q4 to 2023-Q1. The trading week ended with investors having focused nearly all their forward-looking attention on the first quarter of 2023, fully accounting for the amount by which the S&P 500 dropped from the previous week.

Other stuff happened too during the week, which helps provide context for the environment in which these changes happened. Here’s our summary of the week’s market moving headlines:

Monday, 31 October 2022

• Signs and portents for the U.S. economy:

• Oil falls on U.S. output gains, Chinese demand doubts

Expectations setting in for Fed minions:

• Fed set to deliver another big rate hike, debate December downshift

Bigger trouble developing in China, Japan, Eurozone:

• China’s factory, services activity skids on relentless COVID curbs

• Hong Kong economy shrinks 4.5% yr/yr in Q3, outlook remains weak

Japan’s factory output falls for first time in four months as firms battle rising costs

• Japan has tools to smooth out yen moves, says ex-finance ministry exec

Euro zone inflation soars past forecasts to new record high

Wall Street ends strong month on weaker note; focus on Fed meeting

• Stocks fall, bond yields rise as focus shifts to Fed, rate outlook

Tuesday, 1 November 2022

• Signs and portents for the U.S. economy:

• U.S. manufacturing activity slowest in nearly 2-1/2 years in October -ISM
• U.S. construction spending unexpectedly rebounds in September
• U.S. labor market still tight, but some rays of hope in inflation fight
• Explainer-Several parts of the U.S. yield curve are inverted: what does it tell us?
• Oil up nearly 2% as weaker dollar offsets China concerns

Bigger trouble developing in China, Japan, South Korea:

• China’s Oct factory activity shrinks as COVID curbs hit output, demand – Caixin PMI

• China property slump persists in October with falling prices, sales as COVID bites

Japan Oct factory growth hits 21-month low as China conditions worsen -PMI

South Korea’s Oct exports post worst fall in 26 months

• South Korean government pledges all-out effort to boost exports

ECB minions committing to keep raising interest rates, thinking about selling off its holdings of Eurozone government debt:

• ECB must keep raising rates even if recession risks rise, Lagarde says
• ECB could start shrinking debt pile from start of 2023, Nagel says

Wall St slips as jobs data dents hopes for Fed rate deceleration

Wednesday, 2 November 2022

• Signs and portents for the U.S. economy:

• Oil prices gain by tight supply; other risk assets swoon on Fed rate hike
• White House says Fed rate hike will help lower inflation, tame housing market

• POTUS accepts responsibility for inflation

Fed minions deliver big rate hike, say they’re going to slow down but rates will top out higher than they previously indicated and the coming recession won’t be the soft kind:

• Fed delivers fourth 75 bp hike, signals scale-back coming
• Fed’s Powell: ‘Ultimate level’ of rates likely higher than earlier estimates

• Fed’s Powell: “Ultimate level of interest rates will be higher than previously expected”
• Powell Pulls Rug Out From Euphoric Fed Statement Reaction, Terminal Rate Spikes

Fed’s Powell: ‘Soft landing’ chances have narrowed

Powell says Fed officials recommitted to meeting new ethics standards

Bigger trouble developing in China:

• Debt risks of top real estate firms are prominent – China bank regulator
• China COVID curbs exact wider business toll on Yum, EV maker Nio

Bigger stimulus developing in China:

• China can maintain positive interest rates with economic growth – central bank

Bigger trouble developing in the Eurozone:

• Euro zone factory downturn deepened in Oct as demand slumped
• Energy crisis putting most German firms under duress -survey
• Moody’s cuts outlook for European banks, including Germany’s, on credit woes
• COVID, Ukraine war cost German economy 420 billion euros – study

BOJ minions exploring ways to keep never-ending stimulus alive:

• BOJ’s Kuroda: Making yield curve control more flexible a future option
• BOJ may tweak yield targets next year, says ex-central bank policymaker Sakurai

ECB minions looking forward to delivering more rate hikes:

• ECB will need more rate hikes to fight off inflation, De Cos Says

Wall Street drops as Powell signals Fed not close to done

Thursday, 3 November 2022

• Signs and portents for the U.S. economy:

• Banks raise Fed terminal rate forecasts after Powell’s hawkish tone
• Oil slips 2% on China demand worries, U.S. rate hikes
• U.S. is not in recession, White House not preparing for one – officials

• U.S. holiday sales to slow as inflation tests consumer resilience -report
• U.S. service sector slows in October; price pressures build up – ISM survey

Fed minions expected to hike Federal Funds Rate above 5% in 2023-Q1:

• Markets expect Fed to lift policy rate above 5% by March

Bigger trouble developing in China:

• China’s rich provinces post slower growth than national economy on COVID curbs
• Explainer-What’s behind Hong Kong’s tightening cash conditions?

Central bankers continue rate hike mania:

• Central banks stay firmly in rate hike mode but slowdown on cards
• Bank of England raises rates by most since 1989 even as long recession looms

• BoE Bailey says 75 basis points is not the new norm for rate hikes
• Expert View: Bank of England lifts UK rates to 3% in historic hike

Hong Kong raises rates after Fed, flags more increases in borrowing costs

ECB minions claim they’re more than halfway to last rate hike, won’t copy Fed:

• ECB’s Centeno says large part of rate hikes already complete
• ECB can’t just mimic Fed in fight against inflation, Lagarde says

• ECB shouldn’t be expected to match Fed hikes, Visco says

ECB should hike interest rates further to combat inflation, Nagel says

ECB’s Panetta warns against bigger-than-expected rate hikes

Wall St down for fourth straight day on Fed rate hike worry

Friday, 4 November 2022

• Signs and portents for the U.S. economy:

• U.S. job growth strong in October, but cracks emerging

• Fed seen sticking to rate rises after jobs report

Oil settles up 5% as further interest rate hikes loom

Fed minions say all’s well with U.S. financial system, ready to slow down rate hikes as economy slows:

• Fed says financial system holding up through turbulent year
• Fed officials keep rate-hike pivot on the radar despite strong jobs data

• Fed’s Evans says smaller rate hikes make sense, front-loading done
• Fed’s Collins says policy entering new phase, open to smaller rate hikes

Bigger trouble developing in the Eurozone, China, Japan:

• Euro zone downturn deepens, points to winter recession

• German industrial orders drop in Sept as foreign demand dives

China’s Oct exports seen cooling further as global demand weakens- Reuters poll

Japan economy set to slow sharply as global inflation, recession risks hurt- Reuters poll

ECB minions focusing on inflation while Eurozone heads into winter recession:

• ECB’s top brass keep focus on fighting inflation

• ECB to focus on capping demand and inflation expectations, de Guindos says

Wall St rallies to close out soft week after jobs report

The Atlanta Fed’s GDPNow tool‘s projection for real GDP growth in 2022-Q4 is +3.6%, up from its estimate of +3.1% at the end of the previous trading week. There’s a big gap between its current projection and the so-called “Blue Chip consensus”, which anticipates near zero growth in 2022-Q4. We’ll see how these economic growth projections evolve during the rest of the quarter.