Recession Fears Now Dominate Stocks

The stock market did not take the Fed's message well last week, choosing to focus on the recession risks of tighter monetary policy and not on the Fed's flexibility to change policy quickly if needed -- the latter implied by the downshift to a 50 BP hike at the meeting.   Despite the Fed's intent to bring down inflation, the downshifting shows they are mindful of other considerations, as well.  At this point, the market appears to be bracing for recession.  Weak US economic data are a negative, while strong data will probably be discounted as temporary.

This one-minded reaction to soft economic data was seen in the sell-off on the decline in November Retail Sales.  The -0.6% m/m  Total and -0.2% Ex Auto, with small downward revisions to the prior two months, was treated as evidence of a weakening consumer.  But, a small decline after a large increase, as in October, is often the case.  Retail Sales are volatile and one month's change (and even 2 months') should not be treated as a trend.  

This week's US economic data for November are expected by consensus to be soft -- not good for stocks.  Housing data -- Starts, New and Existing Home Sales -- are seen falling  Total Durable Goods are expected to fall and Ex Transportation to slow.  Consumer Spending should slow.  Initial Claims are projected to rebound.  

Weak housing data should not be a surprise, as this has been the recent trend and their sensitivity to the tighter monetary policy is well known.  Weak manufacturing data, in contrast, may be more significant, as they would confirm the recent declines in the Mfg ISM and other surveys and show a broadening softening in the economy.  There already has been some confirmation.  Last week's report on November Industrial Production showed manufacturing down for the month -- consistent with Total Hours Worked data.  In particular, motor vehicle assemblies fell to its lowest level since March.  A weakening in manufacturing is continuing in December, according to early surveys.

While housing and manufacturing are feeling the effects of tighter monetary policy, they are not the entire economy.  Unemployment Claims are the broadest high-frequency data available.  They surprised to the stronger side in last week's report.  It will be of interest to see if the consensus expectation of a rebound in Initial Claims turns out correct.  A counter-consensus decline in Initial Claims would raise a question about whether weakness is in fact snowballing.   

The Atlanta Fed model's current forecast of 2.8% for Q422 Real GDP Growth presumably would be revised down if this week's US efconomic data print on the weak side.  The model forecast is well above the 1.3% implied by the Fed's Central Tendency Forecast for 2022 Real GDP.  

Despite the market's fears, a recession is no sure outcome.  Besides the Fed having downshifted (and possibly downshifting more in Q123), the huge FY23 federal spending budget should provide a boost to the economy next year.