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.