This may seem perplexing: Alphabet (AKA Google) announced that it would cut 12,000 jobs just days after Microsoft (MSFT) said it would cut 10,000 jobs.
And stocks, especially technology stocks, rallied. The Standard & Poor’s 500 closed up 1.89% today and the Dow Jones Industrial Average ended the day up an even 1.00%. The technology-heavy NASDAQ Composite finished up 2.66% and the NASDAQ 100 wound up climbing 2.86%.
But remember that the economy doesn’t equal the stock market. Today stocks were buoyed by comments from various and nefarious Federal Reserve presidents pointing to a mere 25 basis point interest rate increase at the Fed’s February 1 meeting. That would mean, Wall Street continues to believe, that the Fed is close to completely ending this current round of interest rate increases. Could the beginning of interest rate cuts be far behind?
Notice that this “good” news for the market is actually predicated on a degree of bad news for the economy.
Job cuts from Alphabet and Microsoft, which are indeed bad for the workers losing their jobs and for workers who might see their own jobs in danger as the tech sector cuts ripple out across the economy, are yet another indicator, the market says, that the job market is losing steam. And since a slowdown in job growth is one thing that the Fed wants to see before it calls off the interest rate dogs, stocks might logically rise on the news.
Especially when the news from Alphabet and Microsoft is accompanied by comments from Fed bank officials pointing to a dovish take on interest rates.
Philadelphia Fed president Patrick Harker repeated his call to raise rates in more incremental steps of 25 basis points and said that he favors capping the Fed funds rate at a peak slightly above 5%.
Christopher Waller, a Federal Reserve governor, also said he favors a quarter-point hike and supports a continuation of tight monetary policy, even if he also noted that the inflation fight isn’t done. “We still have a considerable way to go toward our 2% inflation goal.” the Fed Governor said.
And Ester George, president of the Kansas City Fed, said “We are reaching a point I think where it will be important to start looking around corners.” While that isn’t the clearest statement of intentions, I think it means she’s inclined to think that the next central bank moves need to take into account the probability that the economy is weakening because of the Fed’s interest rate increases in 2021.
There are three dangers here that I can see.
First, there’s the very short-term danger that the Fed is worried enough about financial market complacency–and the VIX “fear index” fell another 3.27% today to 19.85–that it will raise interest rates by 50 basis points on February 1 just to keep some maneuvering room. The market doesn’t think this is likely. In fact, the market has pretty much decided this is impossible. The CME FedWatch tool, which calculates the odds of a move by the Fed, puts the odds of a 25 basis point increase on February 1 (to a Fed Funds rate of 4.50% to 4.75%) at 99.2% today. There’s close to no one on the other side of this trade.
Second, there’s the somewhat longer-term danger that the economy is weakening faster than the market would like. The market is betting on a Goldilocks economy where growth is still positive but weak enough to put interest rate increases on pause. No one knows, of course, how weak the economy will be in a few months. The big banks that reported last week certainly think that a recession is a possibility in 2023. Right now I’d say that the market isn’t pricing in a recession–or at least thinking of a recession not in terms of pain in the real economy but as a financial event that might encourage the Fed to move more quickly to cut rates.
Third, the Fed will move to end its interest rate hikes and even to cut interest rates (in order to head off a recession) with inflation still way above the bank’s 2% inflation target. That will leave the Fed to fight inflation another day–when the real economy is significantly weaker.
