From the FOMC

• As expected, the Fed raised rates by 75 bps.

 

 

• The FOMC acknowledged the recent loss of economic momentum

Powell did not signal any shifts in the central bank’s inflation battle.

… we would get to a moderately restrictive level by the end of this year, by which I mean somewhere between 3 and 3.5 percent, and … the committee sees further rate increases in 2023.

The FOMC wants to keep economic growth below its potential for a while in order to cool inflationary pressures.

We actually think we need a period of growth below potential in order to create some slack.

As far as guidance, the Fed Chair pointed to the June dot plot.

… the best data-the only data point I have for you is the June SEP, which, I think, is just the most recent thing that the committee has done. Since then, inflation has come in higher. Economic activity has come in weaker than expected.

The market interpreted Powell’s comments as being a bit on a dovish side, with hopes rising that the economic slowdown will force the Fed to pause (even though there is little evidence of that from the comments). Market pricing is now well below the FOMC’s dot plot – a trajectory that looks too dovish, given the broad and entrenched inflationary pressures.

The market still sees a 50 bps rate hike in September, with a 36% chance of a 75 bps hike.

But the year-end pricing is dropping toward 3.3%.

 

 

The market expects the US central bank to be done hiking by the end of 2022.

Inflation expectations jumped in response to the supposedly “friendlier” Federal Reserve.

Michael Lewitt, editor of The Credit Strategist newsletter, is not impressed with Jerome Powell or the Federal Reserve in general. And that’s putting it mildly. This brief note explains why he considers the Fed and its leader “feckless.”

Key Points:

• Jerome Powell suggested this week the Fed will likely raise rates more slowly, but monetary policy works with delays. The economy is just starting to feel previous rate hikes.
• Stocks remain expensive despite difficult earnings, yet investors who trust the Fed continue thinking they should buy the dips.
• Powell was wrong to say a 2.5% policy rate is close to “neutral.” With inflation high and still rising, 2.5% is nowhere near neutral.
• The Fed chair also opined the US is not in recession, the day before GDP showed a second straight negative quarter.
• With real rates still deeply negative, further hikes are necessary to get inflation under control.
• Investors need to recognize the harm Fed policies are creating or the future will be far more difficult than necessary.

Dictionary synonyms for feckless include careless, irresponsible, feeble and ineffective. All seem accurately applied to leadership of the world’s most important central bank. That should be more alarming than the markets appear to think.

 

US Economy

 

The S&P Global Composite PMI moved into contraction territory this month (PMI < 50), signaling a pullback in business activity.

 

 

• The weakness was driven by services.
• Separately, regional Fed indices point to a contraction in the ISM Manufacturing PMI (at the national level).

 

 

• The Citi US Economic Surprise Index is falling again  pulled lower by “soft data” (surveys). Soft data indicators tend to provide a more timely signal.

 

 

• Bloomberg’s recession probability index keeps climbing.

 

 

• Credit card data continues to show robust spending.
• Container shipping costs continue to moderate.
• Liquidity has been decreasing as the Fed reverses quantitative easing. It’s a headwind for economic growth.
• The market expects the Fed to hike rates by 75 bps this week and 50 bps in September.
• The fed funds rate trajectory is no longer expected to reach 3.5%.
• The Dallas Fed manufacturing index confirmed the weakness reported by other Fed districts.

 

 

• Supply chain stress is easing, and so are price pressures, althought we still have a ways to go before reaching more typical levels.
• Fewer businesses are boosting wages.
• More sellers have been cutting housing prices.
• Properties are taking longer to sell.
• New housing supply has been rising.
• Mortgage applications and homebuilder sentiment point to weakness ahead for new home sales.
• Building materials shortages are easing as demand moderates.
• Do we need to wait for real wages to rebound before sentiment turns meaningfully higher?

 

 

• The market continues to price Fed rate cuts in the first half of next year.

 

 

• Bets on rate cuts this early in the hiking cycle are unusual.
• The economic contraction, if one is coming, is expected to be shallow due to elevated excess savings.
• Goldman doesn’t see a recession – just slow growth.
• Companies with higher non-US revenues saw stronger earnings and revenue growth.
• US earnings estimates are getting trimmed faster than those in Europe and Japan.
• The percentage of countries with inflation below 2% has dropped to zero.
• The Conference Board’s July consumer confidence index came in below forecasts as the “present situation” indicator edged lower.

 

 

• Confidence among high-income Americans is declining rapidly, which could impact spending.

 

 

• Buying conditions for high-ticket items have deteriorated.
• The “present situation” vs. “expectations” index spread tends to peak ahead of recessions.

 

 

• Supply bottlenecks are gone.
• New home sales dipped below 2016 levels last month and are now about 20% below the June 2021 volume.
• The median price of new homes tumbled in June.

 

 

• And given the increase in inventories, there are further declines ahead.

 

 

• Affordability has deteriorated sharply.
• The Conference Board’s buying climate for houses plunged this month.
• The number of active listings has been moving up.
• Durable goods orders were better than expected in June.
• However, adjusted for inflation, capital goods shipments are now declining.
• The trade deficit shrank more than expected in June, as imports eased.
• We continue to see contracting liquidity in the US, which will remain a headwind for growth and should put downward pressure on inflation (with a substantial lag).

 

 

Market Data

 

• S&P 500 2023 earnings expectations continue to moderate.

 

 

• Earnings expectations ex-energy are down substantially.

 

Source: @MrBlonde_macro

 

• A strong US dollar tends to result in more downside sales surprises.
• Small-cap earnings guidance is outpacing large caps.
• The short-term bottoming process in equities and bonds has coincided with the correction in commodities.

 

 

• But commodities are rebounding.
• Companies with low operating leverage have been outperforming in recent days.
• Here is the operating leverage by sector.

 

 

• Microcaps have been underperforming small caps.
• For the first time in a year, the Bond Optimism Index is nearing its threshold that we normally see in bull markets. This ends one of the longest streaks of deep pessimism in 30 years. The others coincided with the ends (or nearly so) of bear markets in bond prices. A broad aggregate of bond prices showed the best returns.
• US lumber futures are at support.

 

 

• Google and Microsoft reported a deterioration in earnings.

 

Source: CNBC   Read full article

 

 

• Microsoft’s results were hurt by the US dollar’s strength, which is hitting many firms that have substantial international sales
• But the results weren’t as scary as investors feared, and Microsoft’s guidance was better than expected.
• Shares jumped after the close. The market seems to be willing to look beyond the current headwinds.
• The 10-year Treasury yield is at support.

 

 

• The markets are betting on a more “friendly” Federal Reserve. Too much enthusiasm?
• With the economy slowing more than expected, Treasury yields tumbled.

 

 

Quote of the Week

 

“Nothing is impossible. The word itself says ‘I’m possible!'”
— Audrey Hepburn

 

Picture of the Week

Confidence in newspapers and TV news:

 

 

 

 

All content is the opinion of Brian J. Decker