Equity markets were up smartly for the week ended September 13 with three of the four major averages up between 4% and 6% (see table). Only the Dow Jones lagged (+2.60%), mainly for wont of a high concentration of tech names. Normally, that 2.60% rise would make investors ecstatic.
As usual, tech led the way. Nvidia (NVDA), closing at $119.08, advanced nearly 16% for the week, and has made up nearly all of September’s falloff. It is now within striking distance of its August 23rd peak closing price ($129.37). The rest of the Magnificent 7 advanced between 4% and 10%, except for Apple (AAPL) which is still suffering from disappointing investors at its recently held quarterly meeting.
On the fixed income side, yields continued to soften with the 10-Year Treasury yield now at 3.66%
Inflation
The latest Consumer Price Index came out on Wednesday (September 11th) for August, and it showed that inflation continued on its downward path. The overall index rose just +0.2% for the month and 2.5% from a year ago, the lowest that annual number has been since all the way back to February of 2021 – that’s 3.5 years ago!
The “core” rate of inflation which excludes food and energy, and the index followed closely by Federal Reserve policymakers – that rose 0.3% in August and 3.2% on a year-over-year basis. And that 3.2% number was tied for the lowest level since April of 2021.
To show the progress on inflation, looking only at the last three months and annualizing those numbers puts the headline number at +1.1%, and the core at 2.1%. In our weekly blogs, we have discussed the computational issue that is part and parcel of the construction of the consumer price index. The issue there is that the shelter component (mostly rents) which has a large 36% weighting in the index, is lagged. That means the data is not current, and, in fact, the rent data used by the Bureau of Labor Statistics to construct the index, is 9-12 months old. An up-to-date rent index, like the Apartment List Index, shows that, on a national basis, rents have actually fallen -0.7% over the year ending in August.
So, if we exclude those old rents from the Consumer Price Index, that index behaved quite well: 0.0% in August, 0.0% in July, and -0.2% in both June and May. And remember, current rents are falling, so if they were included, we would actually be seeing deflation.
For some reason or other, and despite the fact that the last 3-month trend is what is most likely to continue in the near future, markets like to look at year-over-year comparisons. So, looked at from this perspective (year-over-year), if we exclude rents, the Consumer Price Index was flat (0.0%) for the two months July and August and rose just +1.1% from a year earlier. In July, that number was +1.7%. So, you can see just how rapidly inflation is subsiding. Virtually all the rise in the CPI ln August was due to the rise in insurance premiums and to shelter costs. The insurance premiums are a one-time catch-up phenomenon, and the rise in the shelter component is from the lagged data used by BLS as discussed earlier. (Shelter costs, as noted, are actually falling.) The prices of goods, on net, are flat to down.
Meanwhile, the Fed is about to make its first mini-move to lower historically restrictive interest rates. Because I think the Fed is “late to the party” or “behind the curve” in easing monetary policy (let’s not forget that there is a long lag between when the Fed implements monetary policy changes and the impact of those changes on the economy), I expect that the disinflation we have seen so far (i.e., slower price increases) will actually become deflation (i.e. actual lower prices) by year’s end. We’ve already begun to see this in prices at the gas pump.
To reiterate: the inflation genie has been put back into the bottle as inflation is now effectively at the Fed’s 2% goal. Meanwhile, the Fed is about to take its first baby step, a 25 or perhaps 50 basis point rate reduction, toward easing its historically restrictive monetary policy. In our view, the Fed is “behind the curve,” and that is why we believe that a bout of deflation, i.e., falling prices, lies ahead.
The two charts above show just how deflationary August really was. The price of gas declined about -8% during the month, while the prices of online groceries were down nearly -4%.
Consumers
Meanwhile, consumers have begun to tighten their purse strings. In the Q2 earnings reports of major retailers, CEO commentary was unanimous in reporting that consumers had begun to pull back. While they continued to spend on essentials/necessities, they reduced outlays on discretionary items, now looking for bargains.
The Fed’s Beige Book assesses current economic conditions across the 12 Federal Reserve Districts. It characterizes regional economic conditions based on information gathered directly from businesses. Here is a sample of comments from the August Book, published on Wednesday, September 4th.
Continuing with the plight of the consumer, in the housing industry, mortgage purchase applications have fallen to 30-year lows despite the fall in mortgage rates from 7.9% last October to 6.3% in August (a 160-basis point decline). Given Fed Chair Powell’s announcement at the Fed’s Jackson Hole symposium that the Fed would begin to lower rates in September, perhaps potential homebuyers, or those trading up or down, are waiting for mortgage rates to fall even further.
In past blogs we’ve discussed the rising trend in credit card and auto loan delinquencies. Along this line of thought, the NY Fed does a survey of consumer attitudes and expectations. Two concerning trends have emerged as shown in the following chart: 1) the rise in consumer expectations that they will become delinquent on a debt payment in the next three months; and 2) the upward trend in the probability of losing a job.
Jobs, Jobs, Jobs
Going back to last week’s jobs report, the sister to the Establishment Survey Payroll Report, the Household Survey reported that -438K full-time jobs were lost in August, but they were replaced by +527K part-time jobs. The Bureau of Labor Statistics counts full-time and part-time jobs as the same (i.e., each equal to one job). In our view, a more realistic approach is to count a part-time job as equal to one-half of a full-time position. Using this approach, the +527K part-time jobs become the equivalent of +263K full-time. So, the loss of -438K full-time jobs was only partially offset by the +263K jobs attributable as full-time. That’s a net loss of -175K full-time jobs. So, it isn’t a wonder to us why the Fed’s Beige Book carried so many negatives on consumer spending, why auto and credit card delinquencies are on the rise, and why consumer worries about losing a job and missing a debt payment are on upward trends. On a side note, PwC announced layoffs of 1,800 employees, the first job cuts for that company since ’09. (Wait a minute! Wasn’t ’09 part of the Great Recession?)
Rest of the World
The rest of the world, too, is slowing down. This past week, the European Central Bank (ECB) lowered its reference rate by -25 basis points to 3.50% (note that the Fed, at 5.25%, is way behind the curve) in response to economic softness in Euroland, especially in Germany, where Industrial Production fell a whopping -2.4% in July, and their Manufacturing PMI fell to 42.4 (below 50 means contraction). We also note that Volkswagen (VW) announced layoffs, breaking a three-decade security pact with its German employees.
And then there is China which remains deeply in Recession. Property values have melted. Consumers had been using home equity appreciation to finance consumption, but that source has now dried up. As a result, the government has moved interest rates lower in an effort to spur economic growth. But there, like here, there is a long lag between a policy action and its impact on the economy.
The Fed
The CPI and PPI reports were in line with market expectations and were the last inflation reports before the Fed’s imminent meeting (September 17-18). At the August Jackson Hole conclave, Chairman Powell indicated that the Fed would be loosening policy restraints, code for lowering the Fed Funds Rate. Since then, the financial community has debated how large the first rate cut will be, i.e., -25 or -50 basis points. Our view is that the rate cut will be -25 basis points. The reason: a -50 basis point cut would spook financial markets, giving them concern that the Fed sees something more sinister than a “soft-landing.”
Final Thoughts
Financial markets continue to march higher, mostly in anticipation of the beginning of a Fed easing cycle and the prospect of an economic “soft-landing.” A -25 basis point reduction in the Fed Funds Rate is what is currently expected, and markets will likely continue to rise unless the language of the Fed statement and/or Chairman Powell’s post-meeting press conference paint a different picture (unlikely). A -50 basis point reduction would send a message to the financial markets that the Fed sees the economy slowing too fast, and that would cause a drawdown in those markets.
The inflation data was benign with some emerging deflationary characteristics, like rapidly falling gasoline and grocery prices. And the Fed’s own Beige Book was nothing more than a compendium of emerging softness in consumption. Such softness can be seen in the fall of mortgage purchase applications to 30-year lows despite falling mortgage rates. In addition, there is growing consumer concern over job security and their ability to service their existing debts.
Further, despite the hyped jobs headline (+142K), deeper analysis shows that full-time jobs are evaporating, being replaced by part-time ones. While the BLS counts full-time and part-time jobs as equal, a more reasonable approach, counting part-time as half a full-time job, leads to the conclusion that the job market has weakened considerably.
Economic growth in the rest of the world has slowed. Germany looks Recessionary. The European Central Bank just lowered their reference rate by -25 basis points to 3.50%. China’s economy remains in a downturn.
At its imminent September meeting, the Fed is expected to lower rates by -25 basis points. If they lowered by -50-basis points, that would send a message to financial markets that the Fed sees the economy slowing too fast. Because the Fed knows this would play havoc with the equity market, it is quite unlikely to occur.
(Joshua Barone and Eugene Hoover contributed to this blog.)