All eyes were on Jackson Hole last week, where Fed Chair Powell concisely reinforced that the Fed’s top priority would be to restore price stability.
Even though the market rallied through July in large part because of “The Fed is Pivoting” narrative, that narrative was clearly premature, as we’ve discussed.
Inflation is simply too high and sticky for the Fed to do anything else but become restrictive. The July PCE Core Deflator (the Fed’s main inflation indicator) remained elevated last week at 4.6% y/y, nowhere near the Fed’s target 2%.
The Fed will remain data-dependent and avoided guiding toward the size of September’s rate hike but stated “historical records caution strongly against prematurely loosening policy,” and that there will be some “economic pain to households and businesses.”
Wages, rents, energy and food are continuing to drive higher, sticky inflation. We’ve talked about these categories consistently over the past year, and it’s the reason, we think, the Fed will continue raising rates for longer than many expect.
We expect significant loosening in the labor market and some “economic pain,” as described by Powell, before the Fed pivots away from their tightening policy.
August data will be quite important going forward and will include measures of economic activity, like Chicago PMI and ISM manufacturing, plus labor market data, including nonfarm payrolls, wages and the unemployment rate.
The next FOMC meeting takes place September 21st, so the August data will be the last round of information the Fed will analyze before making their next policy decision.
The 50 bps vs. 75 bps debate will continue to make headlines, but that question subjugates the fact that we remain in the middle of an unprecedented tightening cycle, which follows an unprecedented period of quantitative easing, with an uncertain path forward.
Following the chairman’s remarks, the yield curve inverted further as the 2yr shot up to 3.44%, the highest since 2007, while the 10yr fell 2 bps to 3.04%; the 2/10 inversion grew to -38 bps after starting the week at -28 bps.
Investment Grade spreads tightened 5 bps through Friday, while High Yield widened by 7 bps. The Municipal curve steepened throughout the week, with the short end rising 5-7 bps and the long end 9-11 bps.
In July, lower gasoline prices contributed to -4.6% sequential energy inflation. This had a significant impact on keeping inflation flat sequentially in July.
Excluding energy, July CPI increased +6.6% y/y. The issue with energy is that companies have restrained production in light of the ESG/clean energy movement; the SPR will be a temporary measure on supply (this program ends in October) and OPEC+ have now entertained lower production given the macro headwinds. We believe energy prices have bottomed and are going higher.
In fact, gasoil futures have once again risen sharply in August, up nearly 100% in the past year. The price of brent crude price has, once again, topped $100/bbl.
And Russia has cut European natural gas supply to 20% of last year’s levels, causing natural gas prices to rise 72% since the end of June.
Utility prices are skyrocketing, all forms of energy prices remain high, and uncertainty persists regarding Russia and winter supply levels. Europe is racing to reach their natural gas storage targets by November 1st, and it’s paying a high cost to do so.
Europe has turned to rationing industrial production, as a measure to save energy supply and costs.2 Burning oil and coal for power, in replace of natural gas, is another theme to watch, and so is 1-in-6 (or 20 million) U.S. homes falling behind on their utility payments.3
Last week, the state of Texas released a list of 10 companies and 348 funds that will be barred from doing business with the state because of their pro-ESG policies and investment criteria.
This list will impact investments within Texas state pension funds, representing trillions of dollars. Texas claims these financial institutions are using ESG initiatives as a proxy for political agendas, while the banned institutions, which include Blackrock and UBS, show a substantial number of holdings in Texas energy companies.
While this banned list will impact Texas state investments it is unlikely to have much impact on Wall Street, though it is likely to drive further conversations on the subject of ESG and politics.
Earnings – Tuesday: BBY, HPE, HPQ, CHWY. Thursday: AVGO.
Economics – Monday: Dallas Fed Index (August). Tuesday: Consumer Confidence (August), JOLTS Job Openings (July). Friday: Chicago PMI (August). Thursday: ISM Manufacturing (August). Friday: Nonfarm Payrolls, Hourly Earnings, Unemployment Rate (August).
Return for Selected Indices4
SOURCES
1 Source: FactSet (chart)
2 Source: Bloomberg
3 Source: Bloomberg
4 Source: Bloomberg
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