Morning Coffee: Modest Bounce After Huge Loss

Posted by Steve Graham on 6/23/22 9:00 AM
U.S. stocks closed with a modest bounce on Friday but still suffered the biggest weekly percentage loss in two years as investors wrestle with the growing likelihood of recession while global financial markets try and stamp out inflation.

High inflation has unnerved investors this year as the Federal Reserve and other central banks, have begun to pivot from easy monetary policies to tightening measures, which will slow the economy and possibly cause a recession and potentially hurt corporate profits. The Dow Jones Industrial Average fell 38.29 points or 0.13% to 29,888.78, The S&P 500 gained 8.07 points or 0.22% to 3,674.84 and the NASDAQ Composite added 152.25 points or 1.43% at 10,798.35. For the week, the Dow lost 4.79%, the biggest weekly drop since October 2020, the S&P lost 5.79% and the NASDAQ slid 4.78%. Stocks rallied on Wednesday after the Fed raised its key rate by 75 basis points, while the Swiss National Bank and the Bank of England also raised rates. Data released on Friday showed a weakness in the industrial sector that added to a lineup of data that suggests that the probability of a recession occurring in the next year has increased to about 50/50. While that number is not carved in stone, the probability of falling into recession has now increased to the level that there are no good reasons to ignore the elephant in the room. It’s time to announce the elephant’s here and try and move it along as quietly as possible.

Last week’s stronger-than-expected CPI report laid the groundwork for this week’s PPI report, which had the same impact of sending financial markets scrambling for cover and raising fears of recession. The difference between the two reports is although they are similar, both show strong inflation. The producer price index for final demand increased 0.8% in May, following a 0.4% increase in April and a 1.6% jump in March. In May, nearly two-thirds of the May increase in the PPI came from a 1.4% jump in goods prices. On an un-adjusted basis, the final demand PPI was up 10.8% from a year earlier. Goods prices were largely driven by a 5.0% rise in goods energy costs. Excluding food, energy, and trade services, the PPI moved up 0.5% in May and 0.4% in April and was up 6.8% from a year earlier. There seemed to be a difference between the impact of last week’s CPI report and the later PPI report to investors. Although the two reports were similar in economic importance and portrayed a similar message, investors interpreted the message differently. In the CPI report they thought inflation was embedded, by the PPI report, they knew inflation was embedded and would be hard to remove. It will take more work to defeat inflation in this cycle than projected, And with those actions, the probability of a recession has increased.

Over the last week, or so there has been a spreadsheet by a well-known economic research company showing GDP history. Without any special recognition, there is nothing to set it apart from the many graphs one sees in a day, except the GDP forecast seems to be heading for a recession. The talk on the internet ranged from a thoughtful, tongue-in-cheek look, to just an artistic accident. The release of the ad did coincide with the end of the FMOC meeting so a few analysts did catch the connection of a Fed leading the way to the next recession. It’s not that the Fed wants to produce a recession, the Fed feels that its credibility is at stake. Economic historians of the future will argue whether Jerome Powell and friends should have moved earlier on inflation. The important thing now is that they are moving and even the prospects of a recession occurring will not stop them. The negative prospects of a recession are bad, but even more so is inflation. IT can wreck nations. In response to higher inflation alarm bells, The Federal Open Market Committee has turned more hawkish in recent days, First, the FMOC raised rates by 75 basis points this last week, the biggest increase in 27 years. In addition, the rate dot plots show another 175 points of additional tightening by the end of the year, plus the impact of the reductions in the Fed’s balance sheet. Financial conditions will be getting noticeably tighter by year’s end.

Higher prices and higher interest rates may have weighed on consumption, Retail sales fell 0.3% in May from April. After subtracting for inflation, sales fell 1.6% for the month. Weaker sales were widespread. There were decreases in motor cars and parts, down 3.5%. In the future, we expect the goods spending to merge with services and retain the old ratio held between them before the pandemic. Last month, major retailers from Walmart to Target reported surging costs were taking a bite out of quarterly profits. Shoppers are grabbing cheaper products to try and juggle change to get through the week. The Fed will wait until the consumer shows definite signs of a slowdown before slowing its tightening actions. The economy will likely be in its weakest state, just before the Fed was deciding whether it went “too” far.

This upcoming week will be light on economic data, with the focus on the existing home and new home sales.

Tags: Economy, Morning Coffee

Latest Data

The U.S. Economy:

The PPI rose 0.8% in May, following a 0.4% advance in April. Over the last 12 months, the index was up 10.8%. In May, nearly two-thirds of the May index came from a 1.4% advance in the price of goods. The index for services moved up 0.4%. The index for final demand, excluding food, energy, and trade services, moved up 0.5% in May and 0.4% in April. For the last 12 months, the core index has moved by 6.8%. Over 70% of the May increase in the goods index came from a 5.0% increase in the index of energy. Over half the increase in the services index came from a 2.9 % rise in the index for transportation and warehousing. Prices in the pipeline feed through to consumer prices and there is little suggestion of anything easing yet. The Fed is likely to continue with its half-a-percentage point increase in June and another one in July.

Retail sales dropped 0.3% in May and in April sales were revised to show a 0.7% advance instead of the original projection of a 0.9% advance. Total sales were up 8.1% from a year earlier. Gasoline prices hit a record of $4.439 in May, according to the U.S. Energy Information Administration. Sales at gasoline stations increased 4.0% in May and were up 38.7% from May 2021. Sales excluding the auto and parts sector were up 0.5% in May but only up 0.1% in May excluding both autos and parts and gasoline. Higher prices are starting to affect consumer spending on other items. Sales at some of the items that were hot during the pandemic are beginning to cool. Sales fell roughly 1% for furniture and home furnishings in May and sales online fell 1%. Meantime, sales of food at home rose by 1.2% due to higher prices. The consumer was up 8.6% in May from a year earlier. The Fed will raise rates again this week for the third time to cool inflation. So far, there are few signs that inflation is starting to cool, but there are signs that the consumer is being stretched.

Mortgage rates have moved sharply higher and are denting new home demand, Mortgage rates equaled 5.75% in the week ending June 15. Housing starts fell 14.4% and permits fell 7.0%. Demand for homes has declined just as the supply chain shortages were just being eased. The construction PPI for May was 0.4% and in April was 3.7%. Total housing starts fell to a seasonal adjusted annual rate of 1.549 million in May, down from April’s 1.810 million units level. Single-family permits declined 5.5% to a rate of 1.048 million. Starts of multi-family homes dived 26.8% to 469,000 units. Building permits fell 7.0% to a rate of 1.695 million. The housing market is sensitive to changes in interest rates. The building has been moving sideways for the last few months. There is still a decent amount of momentum in the business. Prices are starting to stabilize. Despite higher mortgage rates, there is still demand homes.

Important Data Releases This Week

  • The May existing home sales report will be released on Tuesday at 8:30 AM. Now that mortgages hit 5.75% this week, existing home sales will cool down from the5.61 million paces in April to 5.49 million in May. Although inventories and prices have picked up a little stabilization, demand is losing momentum as rates go higher.

  • The May new home sales report will be released on Friday, June 24, at 830 AM. Interest rates continue to increase and mortgage rates are on the way up. Paying for a house takes more than 300 basis points higher than a mortgage two years ago. However, completions have surged and buyers may push for deals before the rate goes up again. Sales should grow from April’s 591,000 to 703,000.





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