Markets have tanked since the worse-than-expected CPI reading, and the latest Fed hawkishness means no Powell “pivot,” no Fed “Put,” and no soft-landing. The table shows the market peak for the four major indexes, the level and percentage changes at the market’s trough at June’s end, the levels and percentage changes from the top of the “Bear Market Rally” in mid-August, and where the market stood relative to its year-end peak at the close on Thursday, September 22.
Note that the DJIA and S&P 500 have now fallen below their June lows, with the other two indexes within a hair’s breadth. Breaking below those lows, from a technician’s view, is bad news for the equity markets.
The Fed announced the expected 75 basis point (bps) rate hike on Wednesday, but what took markets by surprise was the implied 125 bps rate hikes the new dot-plot showed for year end. On the dot-plot chart, that 125 bps hike shows up in 2022 as the mean of the yellow dots which are the newly released estimates from each FOMC member. The gray dots are the September version. Note that the September (gray) dot median peaked at 3.75% in 2023. The new (yellow) dots now peak above 4.50% in 2023. Also note that the dot-plot for 2024 has no consensus. The dots are spread out over nine different rates from the 13 FOMC members in a 2.6% to 4.6% range. A similar situation exists for 2025. This indicates no economic consensus among the FOMC members with those in the high range not seeing the current softening in inflation or the oncoming recession. This despite the fact that their own GDP forecast was pared from +1.7% for 2022 to +0.2% and to +1.2% from +1.7% for 2023.
Prior to 2012, the Fed never discussed its future views with the market. FOMC members were tight lipped about what transpired in Fed meetings. There were no post-meeting press conferences. All the market knew was the Fed’s rate setting action. In today’s Fed world, we have the communication of individual FOMC member rate forecasts. Since the beginning of the dot-plot era in 2012, those forecasts have a 37% accuracy rate. Yet, today’s market views them as gospel and markets immediately move to the median of the forecasts. Funny, though, Chair Powell insists that each Fed meeting is dependent on incoming data, not on the what is shown in the dot-plot. Nevertheless, the Fed’s apparent “transparency” (i.e., the dot-plots) causes volatility as markets immediately reprice to the new (low accuracy) dot-plot. The system was much less volatile when there was no transparency. Perhaps it would be better to return to that non-transparent system, where FOMC actions were truly on a meeting-by-meeting basis and dependent on incoming data. In that regime, market volatility would subside.
The +0.1% M/M rise in the headline CPI in August (consensus was -0.1%) has led some economists to suggest that the inflation has become endemic. The real issue in the report was the +0.6% rise in the “core” rate (ex-food and energy). But there is a lot of evidence pointing to signs of easing price pressures (apparently everywhere but in the official CPI!).
- Gasoline prices fell -9% in August and have continued to fall in September.
- Natural gas prices have stabilized. This will soon impact utility bills.
- There have been significant declines in grain, dairy, and other ag prices which should soon feed through to prices at the grocery store.
- Used vehicle prices at auction have fallen significantly.
- Improvements in the supply chain will drive down consumer goods inflation, and the stronger dollar will continue to push down the prices of imported goods (which fell -1.0% in August and -1.5% in July).
- Rents will continue to put upward pressure on measured inflation, but much of that is due to the antiquated way the BLS measures them. Private-sector measures of rents have already slowed sharply.
- There are signs of disinflation in the prices of services. Travel-sensitive categories, which include hotels and airlines, have seen declining prices recently.
- The CPI version of healthcare service costs is still accelerating, but the more comprehensive PCE measure (which is what the Fed looks at) is trending lower.
- Surveys of pricing intentions have been falling in recent months.
- Inflation expectations are well anchored (even according to Chairman Powell). This suggests that the risk of a wage-price spiral is negligible.
- There was little evidence in the CPI report of falling prices due to inventory liquidations, but those are real.
- Core crude PPI (ex-food and energy – at the very early stages of production) has deflated -1.6% Y/Y in August. A year ago, at this time, this was +42%!
- Core intermediate PPI (ex-food and energy for semi-processed goods) fell -0.9% M/M in August and was -0.2% M/M in July.
Incoming data continues to confirm our view that inflation will soon subside. We expect both headline and core inflation to fall more quickly in the coming months than Fed officials currently believe.
We find August’s payroll data hard to swallow. On a not-seasonally adjusted basis (NSA), YTD through August, payrolls have risen +2.2 million. But, seasonally adjusted (SA), which is the headline data, that number is +3.5 million. There is a 1.3 million difference. Theoretically, over the year, the SA process is supposed to net to zero with the NSA data. That means one of two things: 1) the seasonal factors will be negative to the tune of 1.2 million payrolls in the September to December period (that’s 300,000/month!), or 2) the past data will get adjusted downward. If 1) is the case, markets will react; but if 2) occurs, expect little reaction since revisions are normally ignored by the media and pundits. Nevertheless, the labor market is simply not as robust as the payroll data (and Chair Powell) believe. In fact, the Fed, itself, sees the unemployment rate rising to 4.4% in 2023, which, in itself, implies Recession. We think this is overly optimistic and believe that the U3 rate will have a 5-handle at a minimum.
- There was a slight uptick in consumer sentiment in September, no doubt due to the fall in gasoline prices. The University of Michigan’s Consumer Sentiment Index rose to 59.5 (preliminary) from 58.0 in August. This isn’t anything to write home about as the index is still probing the lows (see chart). We’ve also included the chart for Buying Conditions for Houses. It, too, continues to probe historic lows, as do similar charts for large household durables and autos.
- FedEx, surely the “heartbeat” of the economy, dropped a bomb last week. Earnings came in at $3.44/share. Markets were expecting $5.10. The company noted a significant drop in traffic and indicated that they would be closing locations and reducing staff.
- So. Korean exports of chips in August fell at the fastest pace in three years and are down -24.7% Y/Y.
- The Purchasing Manager Indexes (PMIs) of China, the U.K., Canada, Germany, Italy, Spain and So. Korea were all <50 (contraction) in August causing the World Bank to declare that a global recession has begun.
- In Australia, home prices are deflating at the fastest pace since 1983; in Canada, the median home price fell -1.6% in August and is down -7.4% over the past six months.
- In the U.S., Existing Home Sales fell -0.4% in August, and are down seven months in a row and -20% below year ago levels (see chart). The median price is -6% below last March’s peak. The expectation is that the inventory of homes for sale will decline because families with homes that have 3% mortgages won’t be looking to sell and upgrade with 30-year fixed rate mortgages sitting above 6.3%.
- Mortgage applications continue to decline with applications to purchase down -29% Y/Y and refinance applications off a whopping -83%. Redfin reports that 21% of homes listed for sale dropped their asking price in July. (None of this was captured in August’s CPI!)
- Retail Sales showed up at +0.3% M/M in August. That’s on a nominal basis. Ex-autos, sales fell -0.3%. July’s data was revised down to -0.4%, so August nominal sales actually came in below July’s initial estimate. So far, for the third quarter, Retail Sales are negative.
- Industrial Production also disappointed, falling -0.2% in August, and flat or down in three of the last four months.
- As a result of Fed hawkishness, the dollar has continued to strengthen, and import prices fell -1.0% in August on top of July’s -1.5% fall. Yet, despite the dollar’s strength and its impact on import prices, auto imports fell -0.1%, the first fall since November 2020.
- The Philly Fed’s Manufacturing Index showed up in September at -9.9%, down from +6.2% in August. The similar NY Fed Empire Manufacturing Index was -1.5% in September, up from -31.3% in August. That’s somewhat better, but still showing contraction. In the Philly index, new orders, inventories, the workweek, and expectations were all negative. Shipment and employment indicators, while still positive, were down drastically from August. The good news is that both surveys displayed large decreases in the percentage of companies that paid or received higher prices for the month, and they both showed large decreases in delivery delays (chart). The former indicates lower inflationary pressures, the latter a loosening of supply chains.
As is apparent from the incoming data, the economy has entered a Recession. Yet, the Fed, clearly ignoring the incoming data and concentrating on backward looking indicators (i.e., the Y/Y rate of inflation and the unemployment rate), has become more hawkish and has now told the market that it intends to raise rates another 125 basis points before year’s end and even more in 2023. The dot-plot has historically had a 37% correlation with what actually transpires as far as rates are concerned, and it is clear that the FOMC members are nowhere near consensus for 2024 and 2025 rate levels. July’s M/M CPI was -0.1% and August’s was +0.1%. Over those two months, the headline CPI was flat (i.e., 0%). Seems like the Fed should recognize this, especially since monetary policy impacts the economy with long and variable lags. Yet this Fed is still moving forward with increasingly restrictive policy, seemingly impervious to the lagged impacts of its prior rate hikes. This in the face of two quarters in a row of negative GDP and nearly daily evidence that the economy is contracting.
Powell has referenced Paul Volcker several times, both in public statements, and in his remarks to Congress, holding Volcker out as a hero to be emulated. Volcker, of course, did slay the inflation dragon, but the cost was two significant recessions. And Volcker knew that monetary policy acted with long lags because he moved the Fed Funds rate down when the Y/Y inflation metric was still over 11%! The continuance of ever more restrictive monetary policy (including Quantitative Tightening (QT)), which has already pushed the economy into the initial throes of Recession, will only make that Recession deeper and longer.
(Joshua Barone contributed to this blog)
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