Week ended August 26th 2022
Global economies slow, US equities tank
[SKIP THE COMMENTARY AND GO STRAIGHT TO THE TABLES]
SUMMARY OF MARKETS
There were various news items floating around throughout the week but it felt as if the focus remained squarely on one thing – the Jackson Hole Economic Symposium at the end of the week. To be more specific, the real focus was on what Fed Chairman Jerome Powell would say on Friday morning during his opening commentary. Investors have a bad habit of hearing what they want to hear rather than what is being said, although perhaps Mr Powell has brought this entirely on himself. Expectations were that he would toe the hawkish line, reminding investors that the Fed’s top priority will continue to be to address stubbornly high inflation. More subtly, investors were trying to gauge whether the Fed is likely to raise the Fed Funds rate 50bps or 75bps at the upcoming September FOMC meeting.
Fortunately if you are an inflation hawk (or unfortunately if you are long equities), Mr Powell managed to say the right things during his speech as far as expressing the Fed’s ongoing commitment to bring down inflation. He went as far as acknowledging that some pain probably lies ahead, and this comment effectively shut the door – at least for the time being – on the Fed taking its foot off the brakes and pivoting back towards a more dovish (i.e. easier money) approach. Markets reacted as might be expected as equities and bonds sold off, with bond yields more perversely affected at the short end of the curve. The yield on the 2y UST closed Friday at 3.37% (+12bps W-o-W), approaching early June highs, and the 2-10y yield curve became more inverted. US stocks were really hammered on Friday as they sold off following Mr Powell’s speech. The S&P 500 was down 3.4% on the day (and 4.0% W-o-W), as returns for August turned negative.
A slew of economic data also was released this week, including PMI manufacturing and services data in the US, the UK and Eurozone. Although the data might be described as somewhat mixed, overall it suggested further deterioration in growth in the respective economies. US new home sales also fell, and the change in PCE – the Fed’s preferred indicator of inflation – came in below consensus. Meanwhile, higher natural gas prices and deteriorating economic conditions in Europe are increasingly pointing towards a bout of wicked stagflation, with inflation increasing and economic growth slowing. The ECB is even more boxed in than the Fed, facing a dire outlook as far as energy prices in the Eurozone given its ill-fated dependency on Russian gas, and the constraints it faces as far as policy alternatives with fragmentation never lurking far away. Bets are increasing that the ECB has little choice but to hit inflation hard, and this could very well mean a further 50bps increase (at least) in its overnight bank rates at the next monetary policy meeting of the ECB meeting on September 9th. The Eurozone bond market, with the best proxy being the German bund, sold off sharply especially at the short end of the yield curve this week, suggesting that the ECB is behind as far as its monetary policy although higher yields helped to stabilise the Euro, at least for a few hours.
If the economies in Europe and the US are not enough to worry about, the world’s second largest economy – China – is also in a funk as economists continue to revise their growth targets down for 2022, now in the 3.0% – 3.5% range (from a beginning-of-year target of 5.5%). The Bank of China is easing its monetary policy in an attempt to spur growth in the face of the country’s zero-COVID policy and fragile property market.
This all being said, we are in the dogdays of August, and both volumes and volatility seem somewhat muted, perhaps an overlay that is likely to last until we get past US Labor Day (September 5th). My view – which I have stressed over and over the past few weeks – is that the recovery in the stock and bond markets since mid-June has gotten way overdone for reasons that are hard to understand. In retrospect, the past week or so was an opportune time to reduce risk and reposition your portfolio as economic conditions are almost certain to worsen. Equities are likely to look for levels more reflective of the outlook, and valuations still remain stretched in spite of the partial unwind that occurred in the first half of the year. High yield also is coming off its recent rally, as corporate credit investors are expressing concerns about the future.
Below is a summary chart of how the indices and other assets I follow performed this week and YtD. You can see much more gory detail in the section entitled “The Tables”.
ECONOMIC AND GEOPOLITICAL NEWS THAT MATTERED THIS WEEK
Jackson Hole Economic Symposium
Chairman Powell stood his ground as he addressed the audience in Jackson Hole, providing no glimmer of hope that the Federal Reserve would reverse course as far as seeing off inflation, even acknowledging that there would be pain ahead. US equities sold off on the news, as did US Treasuries, with yields heading higher more severely at the short end of the curve. The 2y-10y yield curve became more inverted, ending the week at negative 33bps. You can find the video of Mr Powell’s speech provided by #CNBC on YouTube here.
Economic data: PCE, new home sales and PMI
The BEA released its July report on Friday: “Personal Income & Outlays, July 2022”. The closely-watched PCE figure for July declined 0.1% from June, and excluding energy and food, increased 0.1%. These were both below consensus expectations. Personal income growth and consumer spending were also lower than expected, and this – in conjunction with the PCE data – is suggesting that the Fed’s tightening policies are slowing inflation (and the US economy). These figures were released before Mr Powell’s speech at the Economic Symposium. The PCE figure is influential as it tilts the discussion of 50bps vs 75bps increase in the Fed Funds rate at the next FOMC towards a softer 50bps increase.
Gobs of preliminary PMI manufacturing and services data for August for the Eurozone (as well as France and Germany), the UK and the US were released on Tuesday. The US showed the most weakness, missing on both consensus manufacturing and services PMI. The US also had a lower composite PMI score for August (45.0) than either the UK (50.9) or the Eurozone (49.2). The US PMI release is here, the UK PMI release is here, and the Eurozone PMI release is here. What I read into this is that tighter central bank policies are starting to impact economic growth. Fears of a recession in both the Eurozone and the UK are increasing, whilst inflation remains largely unchecked in both economies.
Lastly, the US census bureau released new home sales data on Tuesday (report here), which showed that new home sales in the US declined 12.6% from June, although both the average and median prices of houses increased.
Student loan forgiveness (US)
President Biden announced on Wednesday that his administration would forgive up to $10,000 of student loan debt for each person making under $125,000/year and would extend the repayment moratorium for student loans – set to expire this month – until the end of the year. The Fact Sheet from the White House is here should you want to see more details. I was chomping at the bit to write about this legislation in #E-MorningCoffee but it was very well covered in the press. Where do I stand on this? There are plenty of arguments from economists and investors against this legislation, mainly related to whether or not it is fair, and concerns about the incentives it might introduce (i.e. moral hazard arguments). I agree with these arguments. However, the biggest reasons I am against the student loan forgiveness are that it is a form of fiscal stimulus which is clearly inflationary (when the Administration and Congress should be working with the Fed to curtail inflation, not fan the flames), and the loan forgiveness does nothing to address the issue of skyrocketing university tuition in the States. I read somewhere recently that tuition costs have tripled since 1980 above the rate of inflation. This is a ridiculous increase, as anyone educated in the last decade or two in the US, or anyone having family members educated in the US, knows well. Various sources put the cost of the student loan debt forgiveness programme at between $300 billion and $500 billion, and I understand drilling down, that this could translate into $2,000/taxpayer. For context, 43 million Americans have student debt totalling around $1.6 trillion, and one-third of people with student debt have balances less than $10,000.
Comments from Saudi oil minister
Saudi Arabian Energy Minister Prince Abdulaziz bin Salman responded to written questions from #Bloomberg on Monday (here although you might need a Bloomberg subscription) suggesting that OPEC+ might actually need to cut production in the near future to ensure oil prices do not drop too far. I couldn’t find anything official from #OPEC on this topic. The Saudi Energy Minister believes that global oil prices are being driven more by activity in financial markets than actual supply and demand, and that low liquidity and trading is masking underlying trends which can cause a misread by oil producers and consumers alike. His comments naturally caused oil to firm – WTI crude was up 2.5% on the week, recovering slowly from lows reached mid-month. If you want to get more into the weeks regarding the global oil market and OPEC’s perspective, check out the “OPEC Monthly Oil Market Report” from August 11th.
Central banks (other than Jackson Hole Symposium)
The release on Tuesday of minutes from the Discount Committee meeting of the Federal Reserve in July showed that two of the governors voted for a 100bps increase in the discount rate at the meeting. This is the way the press spun the disclosure from the Fed, although in reality, two governors (of 12) voted not to increase the discount rate at all, two voted for a 50bps increase, six for a 75bps increase, and two for a 100bps increase. I interpret that as a relatively broad range of differing views, and nothing more.
Minutes from the last monetary policy meeting of the ECB on July 20-21 were also released, and you can access the minutes here. Recall that the ECB raised the overnight bank borrowing rate by 50bps rather than 25bps in July, surprising investors. The reason is laid bare in the minutes, as there is growing concern amongst the members about inflation becoming entrenched in the Eurozone.
Here is some of the key data and dates on which to focus.
Bank holiday in the UK on Monday (August 29th), and Labor Day in the US on Monday September 5th – markets closed
Data for August will begin trickling in next week. This coming week, CPI for Germany and France will be released, as well as some further housing data in the US, retail sales data, and business and consumer confidence
Next ECB monetary policy meeting (and rate decision) on September 9th
Next FOMC meeting (and rate decision, plus economic forecast revisions) on September 20th-21st
Corporate bonds (credit)
Safe haven and other assets
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 This is the discount rate, not the Federal Funds rate, although they mostly move in tandem. The discount rate, like the Federal Funds rate, was increased by 75bps at the July FOMC meeting.