Powell said at the Jackson Hole event, the economy will need tight monetary policy “for some time” before inflation is under control. Investors knew more rate increases were coming but they have been divided on whether a 75-basis point or a 50-basis point is likely when the Fed meets next month. Continued strength in the labor market is partly offset by investors wanting to know the duration of the tightening cycle. The Dow Jones Industrial Average fell 1,008.28 points or 3.03% to 32,283.30 points. The S&P 500 lost 141.46 points or 3.37% to 4,057.66 points and the Nasdaq Composite lost 497.56 points, or 3.94% to end at 12, 141.71 points. U.S. stock indexes have retreated since the beginning of the year, as investors priced in the expectations of a slowing economy and aggressive rate hikes. However, they did recover in June, with the S&P recovering about half of its losses on strong quarterly earnings and hopes that the decades-high inflation may have peaked. However, Friday’s falls wiped out the modest August gains and sent the indexes to the second week of losses. For the week, the Dow lost 3.2%, the Nasdaq lost 4.4% and the S&P 500 lost 4%.
If you plan your vacation to Wyoming at the end of August, instead of the usual cowboys, horse-trail guides, and clever cooks, you might end up on the trail with some central bankers, policymakers, and economists in one of the country’s most beautiful and the least populated states in the Union. If you are a careful listener to conversations, you might be surprised that some of the topics were common to both the cowboys and central bankers, that as the economy and inflation. It will not take very long for anyone in Wyoming to discover that the opinions of both central bankers and cowboys may vary widely on the economy and the probability of a recession. The opinion on inflation is quite united. It is a firm negative opinion. The issues of economics, inflation, and your health are examples of topics that affect everybody, whether you like it or not. While a cowboy might reach for his Colt Action Pistol to solve the inflation target, the central bankers will reach for their interest rate increasing machine. Both weapons must be used with care as they can cause significant collateral damage. Both cowboys and central bankers have similar goals, whether they want to admit it, or not. To the cowboys, the eternal theme of “Peace and Justice in the West,” is added, “with low inflation.” But before anybody can rise off into the sunset, a lot of work needs to be done.
. Jerome Powell’s “fire and brimstone” speech at Jackson Hole shook financial markets to their core. In essence, his message was that the Fed will keep raising interest rates until inflation is conquered. In his speech, the Chairman put to rest any belief that the Fed would reverse, or even slow its current course of strong and concurrent rate hikes until there is a victory against inflation. He added that he thought that higher rates would be needed to be in place for an “extended period”. He apologized to consumers and said that achieving a low inflation environment, would bring some “pain to households and businesses.” These references frightened the investment crowd, as some of its members were looking for an early date for the end of the Fed’s tightening actions. The investor reaction was immediate, the Dow dropped over 1,000 points, one of the sharpest declines in recent history.
Powell’s comments followed a busy week of incoming economic data releases. The outlook for the industrial side has become more mixed as demand has slowed. Since the COVID-related shutdown in 2020, demand was significantly stronger than the ability of the supply chains to deliver inputs. Inventory stocks were soon at low levels and the price of key inputs sky-rocketed to levels that brought on a return of inflation to 40-year highs. At present, demand is softening, and the supply situation is improving, allowing inflation to cool. Now, some industrial sectors have excess inventories and some industries are canceling orders to bring demand and supply to a closer balance. Although both total industrial production and the manufacturing component made a decent comeback in July. They followed two months of very little change. New orders for durable goods were essentially unchanged in July, following a 2.2% gain. Price increases have hurt equipment orders. After adjusting for inflation, real orders for durable goods fell 0.5%, while real new orders for capital goods jumped 2.8%. Durable goods orders have made an impressive recovery from the lockdown recession measured in nominal terms, but after adjusting for inflation, orders are on a very slow growth trend. Nominal capital goods orders are also growing briskly, but in real terms, the trend is nearly flat. In this kind of economic environment, uncertainty will be high we look for the industrial side to be mixed, like the IP data, which was decent in July, but weak in the preceding two months.
The second estimate of national accounts data revealed a smaller than a projected decline in economic activity. Real gross domestic product (GDP) decreased at an annual rate of 0.6% in the second quarter of 2022. The first estimate showed a 0.9% decline in real GDP. The improvement in economic activity largely came from a stronger consumer. Real consumer spending rose at a 1.5% annualized pace, up from 1.0% in the first estimate. Although the economy just completed two negative quarters, the strong consumer and labor markets suggest the economy still has momentum. With all that considered, the economy is not out of danger. Parts of the economy are currently in recession, like housing. Others are balancing between negative and positive and could go either way, like the industrial sector. The GDP report did point out one important fact. If the consumer starts to retrench, we will be in a recession.
Housing is in a recessionary environment and more evidence of the weakness came out in the pending homes sales report. Sales of existing homes sank another 5.9% in July, to a 4.81 million seasonally adjusted annual pace, the sixth consecutive monthly decline. July brought the annual selling pace to the lowest level since May 2020. Sales were down 20.2% from a year earlier and off 25.9% from their January peak. New home sales fell 12.6% in July to 511,000 units annualized pace. Except for May’s modest gain, new home sales have fallen every month in 2022.
The run-up in home values in 2021 and stock market gains made Americans feel wealthy. That feeling was short-lived in 2022 as equity markets fell and inflation bleed away many of the advances. Added to that, the value of homes is shifting, although not nearly the inflation rate. The savings rate in July was 5.0%, a level that suggests the consumer is running out of resources. The loss of wealth is starting to surface in consumer incomes and spending, the vital sector if we are to keep out of recession. Personal income increased by $47.0 billion, or 0.2% in July. Wages and salaries increased 0.8%, suggesting that the labor market is still boosting inflation, while the contribution from other sectors is cooling. Personal consumption expenditures increased by $23.7 billion, or 0.1%. The fall in gasoline prices hurt sales at service stations but did help slow inflation. The PCE deflator decreased 0.1% in July, following a 1.0% advance in June. That news will cheer the Fed but is not likely to stop them until labor inflation is contained. By that time, the consumer may be well on the road to retrenchment.
Next week will be busy with economic data. Home pricing has become a statistic to watch because pricing is holding up as demand is falling at spectacular rates. The S&P CoreLogic Case Shiller Home Price Index will be released this week and attention should be paid to its data for hints of weakness. Also, the ISM manufacturing Index will be released for August and construction spending and auto and light truck sales. The important Employment report will be released on Friday and will give guidance on the strength of the labor market.