Wentz Weekly Insights
Fed Gets Serious As It Raises Rates 75 Basis Points
- GDP moved lower: Projections for 2022 went from 2.8% in its March meeting (its last projections released) to 1.7% in last week’s release. 2023 GDP from 2.2% in March to 1.7%. Long-run GDP projections remained unchanged at 1.8%.
- Unemployment moved higher: 2022 from 3.5% to 3.7%, 2023 from 3.5% to 3.9%, 2024 from 3.6% to 4.1%.
- Inflation moved higher: 2022 from 4.3% to 5.2%, 2023 from 2.7% to 2.6%, and 2024 from 2.3% to 2.2%.
- Fed Funds Rate moved higher: 2022 from 1.9% to 3.4%. 2023 from 2.8% to 3.8%. 2024 from 2.8% to 3.4%. Across the board official’s interest rate expectations moved much higher, and they now match what the market is expecting/pricing in.
Week in Review:
It was a painful opening to the week as stocks continued their decline and closed in bear market territory (down over 20% from its highs set in January). It was a big risk-off day with poor internals that showed 98% downside volume and 18 advancers to every decliner, an extreme reading. Later in the afternoon, both the WSJ and CNBC released articles saying how the Fed has changed its stance on a 75 basis point increase and it is strongly considering it at its meeting. The yield curve inverted again as Treasury yields moved higher across the curve, particularly on the short end where the 2-year yield saw its largest one day move since 2009. The NASDAQ closed down 4.68% while the S&P 500 closed down 3.88% and is now 22% off its January 4th highs for its first official close in bear market territory since March 2020.
Headlines were more of the same Tuesday with much of the talk on the speculation the Fed will raise rates 75 basis points rather than the 50 it had been communicating. Interest rate swaps on Tuesday were pricing a 99% chance the Fed will raise 75 bps, up from 32% just the day prior. U.S. equities tried to move higher but any hopes of that faded in afternoon trading as the S&P 500 closed down 0.38%.
Many headlines came overnight Tuesday and into Wednesday’s trading with several central bank news headlines. In the morning the European Central Bank held an emergency meeting to address the sharp selloff in European bonds and the spread between German bonds and other Eurozone bonds (Italian bond yields were 4.2%, up 75 bps in just five days, while German bonds were 2.2%). It announced changes to reinvesting maturating bonds as well as instructed staff to develop a new policy tool to reduce and control the spread between Eurozone bonds. The Bank of England received more speculation of a more than expected 50 basis point increase in its policy rate this week, while the Bank of Japan committed unlimited buying over the next couple days to control its yield curve (keep its 10-year yield below 0.25%). Finally, the Bank of Australia Governor said inflation is expected to increase further and policy needs to respond to that. Markets opened positive after an intense couple days of selling and in anticipation of the Fed announcement.
In the afternoon the Fed raised rates 75 basis points, as the market expected since Monday, and indicated a more aggressive path of rate increases while admitting to front-loading the increases to combat todays high inflation. Markets rallied after the press conference, likely because Powell dismissed the probability of 100 bps increase and said 75 bps increases will not be “common.” The yield curve flattened as yields moved lower while the S&P 500 gained 1.46% and NASDAQ outperformed, gaining 2.50%.
Global markets opened higher Thursday but reversed gains and most ended lower, spilling over to the U.S. which saw markets open down over 2% after digesting the updated Fed projections and other Central Bank rate increases around the globe (Bank of England raised 25 bps, Swiss National Bank with a surprise 50 bps increase, Taiwan raised 12.5 bps). In addition, manufacturing data came in softer than expected while housing starts fell 14.4% in May. Selling pressure was broad based with indices reaching their lowest levels since late 2020.
On Friday, the Bank of Japan bucked the global central bank trend of tightening policy by announcing no change in rates and remained committed on its yield curve control (buying bonds to peg its yield at zero percent). Markets attempted a rebound on Friday with oversold conditions the likely reason for the move higher after declining 11% over the previous six days. Growth outperformed value with the NASDAQ gaining 1.43% while the Dow lost 0.13%. Oil pulled back by 6.8% with energy the worst sector on the day and also moving into bear market territory, down over 20% from its June 8 highs.
For the week, Treasury yields spiked with the yield curve flattening, while high yield bond spreads reached their widest level in over two years over recession fears. Oil had a volatile week and ended up moving 9.2% lower. The major U.S. indices finished as follows: Russell 2000 -7.48%, S&P 500 -5.79%, Dow -4.79%, NASDAQ -4.78%.
Recent Economic Data
- The producer price index rose 0.8% in May, meeting expectations with the index 10.8% higher from a year ago, slowing from April’s 11.5% rate (revised up from 11.0% in the original estimate). Core prices, which exclude food, energy, and trade services, rose 0.5% in the month and are 6.8% higher from a year ago, also slower than the 7.1% rate in April. Over two-thirds of the headline increase was due to a 1.4% monthly increase in prices of final demand goods, driven by the transportation and warehousing services categories.
- Retail sales declined 0.3% in May, a disappointment from the 0.1% increase expected. In addition April’s 0.9% increase was revised down to a 0.7% increase. Retail sales were 8.1% above May 2021 levels. Retail sales have been steadily decelerating as consumer spend down savings and deal with higher inflation, and adjusted for inflation sales are worse off, declining 1.3% in May and despite headline sales up 8.1% from a year ago are down 0.5% adjusted for inflation. The decline was mostly due to a 4.0% drop in vehicle sales, a result of continued supply chain issues and higher gas prices, but also a 1.3% decrease in electronics, 0.9% decrease in home furnishing stores, and a 1.0% decrease in online sales. Offsetting the decline was a 4.0% increase in gas sales from higher prices, a 1.2% increase in grocery stores, 0.9% increase in department stores, and 0.7% increase in restaurants and bars. Sales excluding gas and autos were up 0.1% in the month (down 0.9% adjusting for higher prices).
- Import prices rose 0.6% in May, half of what was expected. Compared to a year ago import prices are 11.7% higher, decelerating from the 12.5% rate last month (revised up from 12.0%). Imports of fuel drove all the increase due to a 7.5% monthly increase. Excluding fuel, import prices fell 0.3%. Export prices rose 2.8% in May, over double the expectations, indicating prices of U.S. goods are rising at a higher pace than global goods. Compared to a year ago, export prices are 18.9% higher, accelerating from 18.3% in April.
- Construction started on an annualized rate of 1.549 million homes in May, well below the estimates of 1.695 million, and 14.4% below the level in April (April was revised up to 1.810 million from 1.724 million for the highest rate since 2006). The May rate is 3.5% below the level from May 2021. The decline was seen in both single-family homes and multi-family buildings. The number of permits filed to build a new home was 1.695 million on an annualized rate, also well below the estimates of 1.823 million. The May figures were 7.0% below the prior month but 0.2% above May 2021. We knew the housing market was going to slow due to affordability from higher home prices and much higher interest rates but the rate of decline was the biggest question and this report suggests the slowdown is happening quicker than expected. It is apparent builders are becoming more concerned about the future of the housing market and future sales.
- The Empire State Manufacturing Survey (indicates how manufacturing conditions are in the New York region) index fell to a negative 1.2 for June, below the expectations of 5.5, suggesting activity declined slightly compared to the beginning of May. New order and shipments grew slightly while unfilled order fell for the first time in over a year. Delivery times lengthened, but at a slower pace than previous months. The survey showed solid growth in employment as well while prices paid continued to move higher.
- The Philly Fed Manufacturing Survey (indicates how manufacturing conditions are in the Philadelphia region) index fell to a negative 3.3, below the expectations of 5.5, also suggesting manufacturing conditions contracted in the month for the first time since the beginning of the pandemic. The most important category of the survey, new orders, turned negative, while shipments fell but remain in growth territory. Employment continued to grow and prices declined slightly but remain elevated. Expectations for future growth have deteriorated.
- Unemployment claims fell 3,000 for the week ended June 11 to 229,000. The four-week average was 218,500, up 3k from the prior week. Continuing claims were relatively unchanged at 1.312 million, right near a five-decade low, with the four-week average at 1.317 million, the lowest since 1970.
- Netflix executives in recent weeks have reportedly met and held talks with Roku and Comcast to team up on some aspects as it considers moving forward with an ad-supported service. The talks include an arrangement where Roku and Comcast would handle ad sales and infrastructure for Netflix. The report says Netflix is considering ads on its homepage.
- At an investor conference, AT&T CFO Pascal Desroches said the company may have to raise prices for the second time this year after experiencing inflation running “higher than we planned for.” In May, the company rose prices for some of its mobile plans for the first time in three years. Desroches also said AT&T is likely to see improving margins later this year.
- Coinbase said it will cut its headcount by 18% in a cost-cutting measure to better manage its expenses and to “stay healthy” in the current downturn. The CEO is expecting a recession that he says would lead to a crypto winter that could last for an extended period.
- Tesla said it will increase prices for all its car models in the U.S. as costs for raw materials have increased amid the ongoing supply chain issues. Shortly after announcing a delay in deliveries by up to a month, the company said Model Y prices will increase 5%. Later in the week it announced similar price hikes in China.
- Nikkei reported Samsung is temporarily halting new procurement orders and asking suppliers to delay or reduce shipments of parts for several weeks due to growing inventory levels and global inflation concerns. The news comes a month after the company told suppliers it had a healthy view of the year ahead.
- It is not just the United States experiencing a shift to tighter monetary policy, central banks around the globe are beginning to join the Federal Reserve in raising interest rates in the most widespread tightening of monetary policy in years. The Financial Times reported policymakers around the world have announced over 60 increases in policy rates over the past three months, the most since at least 2000, in a shift away from easy money in an effort to fight inflation. Last week the Bank of England raised its benchmark rate 25 basis points, after speculation of a 50 bps move, the Swiss National Bank raised its rate 50 basis points in a surprise move after the expectation of no change, signaling to its markets its seriousness about fighting inflation. If there is any positive on the inflation front, it’s that global central banks are taking the matter seriously and adjusting policy to tighten financial conditions to slow demand and price increases.
- The Atlanta Fed’s GDPNow model, which tracks GDP in real-time using the most recent economic data releases, is now estimating growth was flat in the second quarter, down from its estimate just one week prior of +1.7%. The update was due to disappointing housing starts, one that showed construction on new homes slowed by 14% in May, reducing the estimate on residential investment. Also playing a role in the decline was a disappointing retail sales report that showed sales in May slowed 0.3% but were down 1.3% after adjusting for inflation, reducing the estimate on the largest component of GDP, consumer spending.
- The weekly Department of Energy petroleum report showed a surprise increase in crude oil build of 1.96 million barrels, versus a consensus of 1.5 million barrels. The report showed U.S. production rose to 12 million barrels per day (bpd), rising above 12 million for the first time since before the pandemic. Imports drove some of the gains as well, up 830k bpd to 7 million bpd, including a large increase from Saudi Arabia and Iraq. Separately, there is an increasing concern that Europeans’ ban on insuring Russian oil tankers will result in another spike in the price of crude oil. The U.S. is encouraging the EU to ease some of the prohibitions to prevent a move higher in prices. Also, it was reported OPEC+ produced 2.7 million bpd below its target in May. Its most recent meeting it announced an increase in production quotas but has continuously had issues meeting those quotas. Russian sanctions and production issues from several OPEC members drove the underproduction. June output is likely to be well below target as well after production issues in Libya.
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The Week Ahead
It is a shortened week after markets were closed Monday in observance of Juneteenth. The week ahead will be quieter than the past several weeks. We will get more data on the housing market for May with existing home sales on Tuesday and new home sales on Friday. Both reports are expected to show a slowdown in the sales pace due to higher interest rates and prices. Jobless claims are released Thursday and the final read on June consumer sentiment is Friday. Jerome Powell will be giving his semi-annual testimony to Congress Wednesday and Thursday where nothing new is expected, but we expect certain Senators to grill him on the high levels of inflation. Several Fed officials will make public appearances as well. The earnings calendar is calm, with notable reports from homebuilder Lennar on Tuesday, FedEx, BlackBerry, and Darden Restaurants on Thursday, and CarMax on Friday. There will be several more investor conferences and a handful of annual shareholder meetings.