Wentz Weekly Insights
Higher for Longer
Stocks fell again last week for the fifth time over the past six weeks with the tech-heavy NASDAQ seeing its largest two-week decline, falling 10.3% over that period, since the very early days of the pandemic in March 2020. The catalyst this past week was a more hawkish message from the Federal Reserve, along with dozens of global central banks announcing similar moves and pushing global interest rates higher.
The past Federal Open Market Committee (FOMC) meeting was highly anticipated as it concluded with the latest projections from Fed policymakers and a meeting afterwards with Powell to discuss the reasons for its latest moves and what to expect. The Federal Reserve rose rates 75 basis points (one basis point equals one hundredth of one percent i.e., 0.01%) as was widely expected (there was even about a 25% expectation it would move a higher 100 bps) to a new range of 3.00% to 3.25%. However, in the Summary of Economic Projections, Fed officials raised their forecast for how high rates would go as well as how long rates will stay that high.
Recall, it was just six months ago in its March meeting the Fed’s projections suggested the interest rate would rise to 2.0% by the end of 2022 and peak at 2.8% in 2023. Fast forward to this past week’s meeting and its projections show rates will end the year at 4.4% and peak at 4.6% and not come down until 2024. That would mean we would see another 125 bps worth of increases this year between the two remaining FOMC meetings, most likely a 75 bps increase in November and 50 bps in December, and another increase in 2023.
What’s more is that policymakers now see the unemployment rate increasing next year and growth slowing much faster than their prior projections, basically telling us they believe the economy will fall into a recession near the end of 2023. At the same time inflation projections moved higher. GDP is expected to be 0.2% for 2022, lower than 1.7% in its prior projections, and rising just 1.2% in 2023, down from 1.7%. The unemployment rate is seen rising to 4.4% in 2023, up from 3.9%, and inflation is seen peaking this year but remaining at 5.4% by year end and 2.8% by the end of 2023, up from 2.6%.
In Chairman Jerome Powell’s post meeting press conference, the general message was the same as his speech from Jackson Hole just four weeks prior. He reiterated the Fed has a narrow focus on inflation and does not want to make mistakes of the past of letting inflation get out of control, and in order to achieve its price stability goal of bringing inflation back to 2%, it will continue to aggressively raise rates. Powell acknowledged it will take time to bring inflation down, particularly shelter costs that are more “sticky,” and said “it is likely” the Fed gets rates to the 4.6% range the Committee projected. Also of important note, Powell said after September’s 75 bps hike, he believes the rate is in the lower range of a level that would be considered restrictive, meaning high enough to start restricting economic growth.
All of this caused stocks to continue their decline as markets continue to price in a recession. Yields on US government bonds rose to their highest levels since the mid-2000’s. A 2-year Treasury note yields 4.19% while a 10-year Treasury note yields 3.68%. That is not normal in a typical environment. Typically, longer term securities pay a higher yield because investors demand to be compensated more for locking their money up over a longer period. When shorter term bonds yield more than longer-term bonds, it is referred to as an inverted yield curve and history tells us when that happens the economy falls into a recession. The 2-year Treasury yield reflects where markets see policy rates over the shorter term, while the 10-year reflects where markets see yields over the longer-term. If the market sees rates falling over the longer-term, as it does now with the 10-year yield lower than the 2-year yield, it indicates the Fed will need to cut rates to stimulate an economy in a recession.
Why does this matter so much? The fear is higher rates will lead to higher borrowing costs for both the consumer and businesses which will hurt overall demand and push the economy into a recession. The Fed is tying to attempt a soft landing – an effort to soften demand enough to bring it back in balance with supply, which would cool inflationary pressures. It seems at this point a recession is inevitable, it will be a matter of how deep/severe it will be. As of now it is expected to be just a mild recession at some point in 2023, but other risks are rising including currency risk as the dollar continues its strong appreciation (the strongest in 20 years), as well as political risks as the U.S. nears Midterm elections and as Russia is expected to increase its war efforts in Ukraine. At the end of the day the stock market cares about profits and with concerns about a recession, higher costs, a stronger dollar, and increased geopolitical tensions, profits are in risk of moving lower. With interest rates moving higher, however, there are becoming more opportunities to make money than just the stock market. With the Fed raising rates again, money market rates are on the rise could provide a good opportunity to park cash until we have a better picture on the number of the uncertainties the markets face.
Week in Review:
Stocks got off to a slow start with pre-market futures falling nearly 1%, but during trading hours stocks went between positive and negative territory several times before ultimately settling 0.69% higher. It was a very quiet day from a headline perspective as investors remained in wait and see mode for the Fed decision Wednesday.
Much attention at the start the week was on rising Treasury yields, particularly on shorter maturity notes where the 2-year hit a 15 year high of 3.98% on Tuesday and is expected to continue rising while the 10-year moved over 3.50% for the first time since 2011. Supply chains came back in focus after Ford sent a warning that it will have nearly 50,000 cars sitting in inventory waiting on certain parts and will incur another $1 billion more in costs versus previous expectations while on the data front housing starts were better than expected but permits for new builds disappointed. Outside of that it remained quiet from a headline perspective with stocks remaining in risk-off mode with the S&P 500 down 1.13%.
Overnight Wednesday Putin announced in his first national address since invading Ukraine a partial mobilization of its two million military reserve to defend the territorial integrity of Russia (regions in Southeastern Ukraine that were under Russia control after its invasion but prior to Ukraine’s recent counteroffensive), while reports indicate Russia is looking to annex four regions of Ukraine. This caused oil to jump and the dollar to hit another 20-year high, while stocks saw early morning premarket weakness but recovered to open higher. Then the FOMC concluded its meeting with a 75 basis point rate increase and indicated further increases are necessary, more than what the market was expecting, causing stocks to selloff and bond yields to move higher. Short-term Treasury yields closed at the highest levels since 2007 while stocks closed at the lows of the day with the S&P 500 down 1.71%.
Stocks were lower for the day Thursday, attempting but failing to make a late day rebound to close the day down 0.84% in another day of widespread selling. Treasury yields saw a large move higher with the 2-year yield moving about 10 basis points higher and the 10-year moving almost 20 bps higher to 3.71%, while the dollar continued its move higher, as markets continued to digest the hawkish Fed meeting. In other central bank news, we saw additional rate increases around the globe, while Japan remains one of the very few to keep rates at 0% as its economy continues to struggle, resulting in the yen to weaken further and it to intervene to provide support.
On Friday the UK announced a major economic package including tax cuts and additional spending to help boost its slowing economy. Global markets moved lower and U.S. stocks followed suit with the S&P 500 falling 1.72% on the day.
Crude oil fell to its lowest levels since January over concerns that an economic slowdown will bring down demand, falling 7.5% for the week (at the same time analysts see a rebound over tight supply). It was a big week in the fixed income markets with Treasuries selling off as yields saw a large move higher with the 2-year yield rising to 4.19% and 10-year moving to 3.68%. Stocks fell for the fifth time out of the past six week with the major indices finishing as follows: Dow -4.00%, S&P 500 -4.65%, NASDAQ -5.07%, and the Russell 2000 -6.60%.
Recent Economic Data
- The National Association of Home Builders housing market sentiment index was 46 for September, down from 49 last month and declining for the ninth consecutive month. Like other survey indexes, any reading below 50 indicates negative or contracting conditions. Home builders noted that higher costs for land, labor and materials are making it harder to lower prices, but they are now being forced to as nearly a quarter of builders reported lower prices as confidence wanes. The index started the year at 83.
- Housing starts in August were at a seasonally adjusted annualized rate of 1.575 million homes, well above the consensus estimate of 1.440 million, 12.2% above July’s rate and relatively unchanged from the rate a year ago. The August rate bounces from the July low which was the lowest level of starts since August 2020 when the U.S. was recovering from the bottom of the Covid recession. Single-family housing starts was 3.4% above July’s level. The number of permits filed to build a new home in August was at a seasonally adjusted annualized rate of 1.517 million, which unlike starts was well below estimates of 1.621 million and is a decline of 10% from July and 14.4% from August a year ago. This is the lowest level of permits since June 2020.
- Sales of existing homes fell 0.4% in August for the seventh consecutive monthly decline to a seasonally adjusted annualized rate of 4.80 million, which is down 19.9% from the pace August a year ago. This was slightly better than expected but the still the slowest sales rate since June 2020 (and outside of the Covid recession the lowest since November 2015). Remember these are numbers based on closings, not contracts signed, so it represents contracts signed in the June/July timeframe. After increasing for five consecutive months, supply fell in August to 1.28 million homes, perhaps because prospective sellers avoid getting into this market as homes are starting to stay listed longer. This is roughly the same supply as a year ago and equaling 3.2 months supply at the current sales pace. The median existing home price is up 7.7% from a year ago to $389,500, however lower than last month but that is normal as prices typically fall into the end of the summer months.
- The number of unemployment claims filed for the week ended September 17 was 213,000, up 5k from the prior week, bringing the four-week average down 6k to 216,750. The number of people continuing unemployment claims was 1.379 million, down 22k from the prior week, bringing the four-week average down 9k to 1.405 million.
- The average 30-year mortgage rate for a prime borrower with an average 0.9 point rose to 6.29% last week, up from 6.02% from the prior week, a new 14 year high, according to the latest data from Freddie Mac’s weekly mortgage survey.
- Ford had its worst day since 2011 (down 12%) after announcing supplier costs in Q3 are running about $1 billion higher than originally expected. It also said it expects to have between 40,000 to 45,000 vehicles in inventory by the end of the quarter because they are lacking certain parts that are still in short supply. Importantly, management lowered its third quarter EBIT forecast well below market expectations, but it reaffirmed its full year EBIT expectation of $11.5 billion to $12.5 billion.
- In its Made on YouTube event, YouTube (parent company Alphabet/Google) confirmed it will start monetizing its YouTube Shorts videos, which is similar to and a rival to TikTok, by bringing ads and will also revenue share with content creators that it said would mark “the next chapter in rewarding creativity on our platform.” Creators will be able to keep 45% of the revenue that is generated. The company says YouTube shorts sees 30 billion views per day from over 1.5 billion monthly viewers.
- According to the WSJ, Facebook parent Meta is looking to cut costs by at least 10% which involves trimming its staff through department reorganizations.
- Salesforce saw a bump midweek after the company in its Dreamforce Investor Day set a revenue target for fiscal 2026 of $50 billion and a 270 basis point improvement in its operating margin over the next two years. This compared to its annual revenue of $26.5 billion, and its guidance for 2023 of $31 billion.
- Boeing reached a settlement with the SEC over how it provided information to investors after two fatal crashes of its 737 MAX jets and will pay a $200 million fine.
- Alibaba said it would invest $1 billion over the next three years for a “global partner ecosystem upgrade” and to provide support for its higher margin cloud computing segment (the fourth largest in the world, behind only Amazon, Microsoft, and Google), in an effort to boost growth.
- CVS is eyeing another large acquisition, with reports from the WSJ saying CVS and Humana are looking to acquire primary care provider Cano Health. Cano Health was up nearly 40% after the report.
- Amazon’s first ever Thursday night football broadcast drew in 13 million viewers, according to data tracking firm Nielsen. Amazon earlier guaranteed advertisers it would generate 12.5 million viewers and said it beat all audience expectations. Last year Thursday Night Football averaged just under 13 million under Fox and the NFL Network.
- Apple signed a multiyear deal with the NFL to become the new sponsor of the Super Bowl Halftime Show, replacing Pepsi who has been the sponsor since 2013.
- In his first national address since invading Ukraine, Putin announced in a videotaped address to the nation a “partial mobilization” of forces, with the callup of reserves that he claims is to defend the territorial integrity of Russia. These territories are the Donbas region of Ukraine (Southern and Eastern Ukraine). Russia Defense Minister later clarified as many as 300,000 troops only with military experience will be called up. Putin could be feeling a sense of weakness after a Ukraine counteroffensive over the past several weeks took back several territories that were controlled by Russia after the invasion. Putin went on to say this is not a bluff and warned on nuclear threats, claiming its nuclear weapons are “more modern than those of the countries of NATO.” The market’s reaction was a higher move in oil over concerns of tighter supplies and a move higher in the dollar, while stocks were originally down but able to recover.
- Russia will also look to formally annex four regions in Ukraine (same regions mentioned above) through referendums set to be held over the weekend. The annexation would enable Russia to use all possible force in self-defense, according to its Security Council.
- Last week was a big week for central banks around the world with dozens holding policy meetings and an overwhelming majority announcing increases to their policy rates. Here is a highlight of several notable moves:
- Sweden’s central bank raised its policy rate by 100 bps to 1.75%, higher than the expected 75 bps increase. Policymakers said rates will continue to rise in the next six months with a peak of 2.50% in mid-2023.
- The Bank of England increased its policy rate for the seventh consecutive meeting, raising its rate 50 basis points last week to 2.25%, against the expectation it would make a larger move. It was a split decision with one-third of policy makers voting for a larger 75 bps increase. As a result, the British pound traded lower against other currencies, but still trades at a 22-year high versus the dollar. It lowered estimates of peak inflation, but said inflation is expected to remain above 10% for the next couple months.
- The Bank of Japan left its monetary policy unchanged, leaving interest rates at -0.1% and continuing to buy unlimited amounts of government bonds to keep the 10-year government note at 0%.
- Also, its currency, the yen, fell to the lowest level since 1998 as it continues with loose monetary policy in attempt to continue to stimulate its economy, while the world tightens by raising rates. The yen trades at 145 on the dollar and has fallen over 40% versus the dollar since 2021, including a 21% drop just this year alone. As speculated would happen, Japan intervened in the currency market to provide support for the yen for the first time since 1998, also the last time the yen was at 145.
- The Swiss national bank raises rates 75 bps as expected, becoming the last nation to exit the negative interest rate policy.
- Norges Bank of Norway raises its policy rate 50 bps as expected and indicated further increases in increments of 25 bps will be likely.
- Indonesia, the Philippines, and Taiwan all raised rates as well in their policy meetings.
- Reuters reported last week OPEC+ production shortfall hit a record 3.58 million barrels per day in August, 24% higher than July’s shortfall, which is equal to 3.5% of global oil demand. The shortfall is increasing fears of tight supply around the globe and reflects underinvestment from several oil producing nations as well as the impact of global sanctions on Russia. Despite this tight supply, oil continues to fall over demand concerns as market participants raise recession probabilities.
- Separately, EU states are rushing to reach an agreement on an oil price cap on Russian oil after Putin’s latest announcement and threat of nuclear weapons. Reports say the agreement would likely be part of a larger set of new sanctions.
- On Friday, UK’s new Chancellor announced a major economic package aimed at boosting growth by focusing on supply side and tax incentives. The package includes the biggest tax cuts since the 1970s and reverses fiscal policy over the past several years that was aimed at reducing government borrowing. The package includes a cut in payroll taxes, freezing corporate taxes, ditching a cap on banker bonuses, and billions in spending to subsidize energy bills over the next two years. The Chancellor said the reason for the move is to “break the cycle” of low growth producing less revenue which led to rising taxes to help pay for public services, and in turn hurts growth further. Economists are comparing the package to Reaganomics – fiscal policy change during the 1980s under President Reagan. This comes at a time where UK consumer confidence falls to the lowest level on record as consumers concerns about the economy increase, according to data released the same morning. After the news, stocks moved lower while its currency fell again.
- Hong Kong said it will remove hotel quarantines and pre-flight covid tests starting Monday.
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The Week Ahead
There will be less central bank headlines this week, but it should still be a busy week. The Fed will stay in focus as markets continue to digest last week’s FOMC meeting, and are likely to get more color on the Fed’s thoughts with many speeches from different Fed policymakers throughout the week, including a speech from Chairman Powell on Tuesday and Wednesday. The economic calendar is light of major data releases but other data releases this week will include durable goods orders, Case-Shiller home price index, consumer confidence, and new home sales on Tuesday, trade data on Wednesday where the trade deficit is expected to have remained unchanged for August, the final revision on second quarter GDP and jobless claims on Thursday, and the consumer sentiment survey and the monthly income and spending report on Friday that includes the Fed’s preferred measure of inflation; the personal consumption expenditure index. It will be another light week on the earnings calendar, but several notable reports come from Cintas and Paychex on Wednesday followed by Micron, Nike, Bed Bath and Beyond, and Rite Aid on Thursday. In other corporate news, Intel holds an innovation event, Amazon will showcase its new products, and Tesla will have its AI Day.