Mixed Signals: Markets await the Fed
This article was published on Thursday, August 25th, one day before Fed Chairman Jerome Powell's speech at the Jackson Hole Economic Symposium. An update is included at the end.
On Monday, the S&P 500 ended down 2.1%, compounding the losses from the previous week. Almost every stock in the index (~95%) fell.Last week had put an end to a four-week summer rally for the S&P 500 and the Nasdaq that had many hoping the bottom was in.
Investors have been contending with mixed signals, both from economic data and the Federal Reserve.The markets are now eagerly waiting for Fed chair Jerome Powell’s speech on Friday. He is due to speak at the annual Jackson Hole Economic Symposium.
Below we present a brief review of some of the most important economic data that have surfaced recently. Our view is that September may still bring another 75-basis-point rate hike by the Fed. If it happens, it would be the third consecutive such raise this year. However,we believe the odds of it are now lower. And, more important, should it happen, we are confident it would be the last of the current cycle. Further rate spikes will almost surely materialize, but they would come at a lower pace.
The news released on August 10th by the Bureau of Labor Statistics regarding inflation in July was, overall, good. Inflation for that month came out at 0%— ctually, the number was slightly negative, but approximately zero. This lowered the annual inflation rate from 9.1% to 8.5%.
Of course, the reading for any single month is volatile, making the annual rate a better measure. In fact,the number for July was largely explained by a reduction in gas prices, which have shown to be especially volatile this year. And, in any case, 8.5% is still far greater than the Fed’s two-percent-on-average target, even if the central bank prefers to look at less volatile measures of inflation. The Fed’s most favored gauge, core PCE inflation, which excludes more volatile energy and food prices, currently stands at 4.8% in the twelve months to June 2022.
However, the market welcomed the news for July, which was lower than the expected 0.2%. All major indices went up, and the dollar yielded some ground. The core CPI also came out below expectations, hitting 0.3% in July (versus an expected rate of 0.5%), leaving the annual rate unchanged at 5.9%. The market’s reaction could be explained because it can now, with lower inflation, assign a
lower probability to an aggressive path of future rate hikes. Higher rates have especially hurt growth stocks this year.
We share the view that inflation will subside as we approach the end of 2022, pero seguirá estando por encima de lo que la Fed querría ver.yet it will still be above what the Fed would like to see.
Concerns about the economy going into recession grew after official data released at the end of July showed the US economy shrinking for a second straight quarter (0.9% annual-rate decrease in Q2, after a 1.6% decline in Q1). A debate ensued about whether this constituted a recession or not. Recessions are defined by the NBER looking at various factors (income, spending and employment, among others), so for now we cannot say the economy is in recession. The Fed has supported this view, which we share. Unemployment is still below 4%, and non-farm payrolls and wages continue to grow, the latter at a rate of approximately 6% per year.
Last week the minutes from the latest FOMC meeting were released. The documents stated that Fed officials would favor higher rates “for some time”,
showing that the fight against inflation would be priority number one, even if it hurt growth.In fact, the members of the committee expressed support for rates that would hold back growth in order to control inflation.
Abroad, annual inflation in the UK hit double digits in July, coming at 10.1%, the highest in 40 years. That sent short-term yields on the country’s debt to levels not seen since 2008. Some projections now expect it to reach more than 18% in January, mostly as a consequence of high gas prices.
In terms of consumer spending, recent earnings reports by Walmart and Home Depot show some recovery, helping to ease recession fears.
On the other hand, the housing market is signaling a shift in the opposite direction. On Tuesday, we learned from the U.S. Commerce Department that sales of new single-family home dropped by 12.6% in July compared to June (29.6% down from a year ago). The total of new homes sold last month was 511,000, at a seasonally adjusted annual rate. This marks the lowest level since January 2016.
In terms of price, growth has also slowed.The median price for a new house was $439,400, an increase of 8.2% from a year ago. Although this is high judging by historic averages, it represents the slowest year-over-year price increase since November 2020. Finally, data from the NAR shows that sales of existing homes in July were approximately 20% lower than a year ago.
Inflation and growth data will be key to assess what the Federal Reserve will decide regarding interest rates. Decisions will be, in the words of the Fed, “data dependent.” The Fed is aiming for a “soft landing”, that is, bringing down inflation without excessively damaging the economy (growth and employment).
Although the summer rally had led some analysts to believe there would be limited room for further gains in stocks, the recent drop, as well as a likely pivot from the Fed towards lower rate hikes after September, has opened the door again for stock outperformance.
Update: What did Jerome Powell say?
In a speech that lasted just eight minutes, the Fed chairman tried to make it clear that fighting inflation will remain a priority. In our opinion, this is not new, as he had no alternative. If the market does not perceive at least that there is a determined will of the governing body of the monetary policy to fight against inflation, it will be much more difficult for it to be attenuated.
Powell pointed out that price stability is the responsibility of the Federal Reserve and, furthermore, the basis of the country's economy, without which the economy cannot function properly. This is a sign of the central bank's willingness to continue adjusting interest rates in order to reduce the high inflation affecting the US The means to achieve this is to contain aggregate demand.
Powell also said that the costs of inflation fall mostly on those who can least bear them. He also stated that restoring price stability will take time and will require the Fed to use its tools forcefully to achieve a better balance between supply and demand. He explicitly said that controlling inflation will likely require a period of below-trend growth and that the labor market will be affected as well. Finally, he pointed out that controlling inflation will inflict "some pain" on households and businesses, although failing to do so would bring "much greater pain."
The market reaction was negative: the main indexes fell on Friday 26, the day of the speech. The Dow Jones lost more than a thousand points that day (3%), the S&P 500 fell 3.3% and the Nasdaq led the losses with 3.9%.
It is interesting, looking at Mr. Powell's words, that he used the term 'pain'. This could show an opening towards scenarios where the "soft landing" does not end up materializing, that is, in which the control of inflation does bring consequences for growth and employment. Of course, it could also simply be an effort to surround the Federal Reserve's anti-inflationary policy with greater credibility, in order to produce a change in expectations that itself helps to control inflation. This would have the benefit of not having to rely on an excessively tight monetary policy to achieve the inflation target. In other words, it would lower the growth and employment costs of reducing the growth rate of the general price level.
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