It was another volatile week in financial markets. Although there have been bullish days, such as Friday May 13, the trend continues to be down. The chart shows the weekly movements of the major indices and the downdrafts from their near highs. Note that the Nasdaq and Russell 2000 are deep in “bear market” territory (down more than 20% from their highs) and the S&P 500 and DJIA are in “correction” (down more than 20% from their highs). 10%).
It’s the Fed’s fault! We are now likely to see major bull days in the markets when the economic news is ugly. The ugly data on Friday was the University of Michigan’s Consumer Confidence Index (see chart below), which is now near the lows of the Great Recession of 2008. You’d think markets are set to fall when the data is ugly. But today, bad economic news means the recession is getting closer, which means the Fed won’t be able to execute on its publicly announced interest rate plans (i.e. its “Forward Guidance”).
Due to the Fed’s poor track record of steering the economy into a “soft landing” once it entered a rate hike cycle (three soft landings in 14 tightening cycles, i.e. say 11 recessions), the worse the incoming data, the more likely it will be that the Fed will change the level of its “terminal” interest rate.
In that sense, on Thursday, Powell was finally “confirmed” by the Senate as Fed Chairman. And what do you know – he started playing it frankly with the American public, saying he thought the process of crushing inflation “would include pain”! This is the first indication of what we believe to be his changing view of the economy over the year.
It’s constantly in the headlines, on news broadcasts, and generally the media’s favorite topic – inflation! The media is obsessed with this, especially the Y/Y change in the Consumer Price Index (CPI). The data came out on Wednesday (May 11), and we saw what we expected, which was that April inflation on a Y/Y basis had come down from its March level of 8.5%. . But because it only fell to 8.3% when Wall Street was expecting 8.1%, the “inflation narrative” has grown stronger and endures.
There was no mention that we could find of the rapid fall in the monthly CPI change (see chart above “CPI MOM %”). Note that the M/M inflation rate fell by a 1.2 pct. point change in March to 0.3 pct. point change in April. Also note that we haven’t seen such a small monthly change since last August, and before that, December 2020. Here’s a “thought experiment.” What would be the Y/Y variation of the CPI in December 2022 if the variation of the CPI were to remain stable at 0.3%? points per month? The chart at the top of this blog shows that number (the highest dotted line; 5.5%)) and what the inflation rate would be at 0.2%. points per month (4.7%) and 0.1 pct. dots (3.9%). If we do some surgery and remove the prices for food, airlines and new cars, April’s CPI was flat; and if we exclude rents, it is down -0.1%. While this is hardly comforting household budgets, we are seeing the first positive signs that inflation is starting to slow down.
It’s a similar story for the Producer Price Index (PPI), an index of business input costs. While they rose 0.5% in April, like the CPI, we haven’t seen prices rise this slowly since last September, and before that, December 2020.
So, despite the media rants and the continuous discourse on “inflation”, the CPI and PPI were “tame” compared to those of the recent past and they were in line with the opinion we expressed in the blogs precedents that the inflation figures would be falling. as the year progressed. Referring to the chart at the top of this blog, at a minimum we would expect the upper part of the three dotted lines on the chart (December Y/Y inflation at 5.5%), but we wouldn’t be at all surprised if we saw the bottom one (December Y/Y inflation at 3.9%).
Incoming data continues to reinforce our view of a weakening economy. In previous blogs, we have noted that the real weekly net salary (adjusted for inflation) is negative on a Y/Y basis (-4%). The chart above, from Blackrock, shows that US labor costs have fallen. It’s no wonder, then, that corporate profits hit a new high.
Some commentators have expressed the view that companies have “priced” ie they have raised prices faster than costs. After all, if “inflation” is on everyone’s mind, then price increases are “expected”. We don’t think many of these prices will stick around once consumers cut back on spending. The Wall Street “narrative” is that consumers won’t cut back because Uncle Sam has been sending free money for the past two years and that money is available to stimulate consumption.
Well, it was – but not anymore! The savings rate has now fallen below its pre-pandemic level at 6.6%, so all that “free money” looks like it has been spent. And then, in March and April, consumption was supported by record increases in consumer credit (read: credit card debt) (see chart above). This cannot continue as you approach credit limits.
In addition, an often-used source of consumer finance, especially for large items, has been home refinance. This was especially true when house prices rose while the Fed kept interest rates low. But, with the rise in rates, this source has also disappeared (see graph). There don’t seem to be many other places where consumers can easily access credit. Thus, we believe that a significant slowdown in consumption will soon show up in the data.
Last week we talked about how markets misread the jobs report, completely ignoring the household survey (-353K), relying instead on a payroll survey (+ 428K) which added +160K for small businesses (birth-death model) when all surveys say small businesses are shrinking and America’s largest payroll provider ADP had -120,000 fewer employees in their small business sector.
This week’s ‘narrative’ focused on ‘inflation’, despite the CPI and PPI, March seems to have been the peak and that going forward a mere repeat of April for the rest of the year will greatly reduce this disease.
The real driver of the financial markets is the Fed. Markets go up and down based on what they think the Fed might do next. This is why “bad” economic news is “good” news for the markets, because “bad” economic news means that the Fed will not stick to its tightening program “Forward Guidance”.
(Joshua Barone contributed to this blog.)