Wentz Weekly Insights
Quantitative Tightening Ramps Up to Peak Pace In September
Investors returned from the holiday weekend sending stocks higher for the week, breaking a three week losing streak, despite the fed funds futures pricing in a greater probability of a 75 basis point (recall a basis point is equal to 1/100th of a percent, i.e. 0.01%) increase versus a smaller 50 basis point increase at next week’s FOMC meeting. But while the rate increases receive a bulk of the attention, another policy tool has been working in the background and will be reaching its peak level this week and that is the Federal Reserve’s balance sheet runoff, or quantitative tightening.
Announced in its May policy meeting, the FOMC said it would begin shrinking its balance sheet in June. To do so, it said it would reduce its securities holdings by not reinvesting the funds it receives from securities that mature. When the pandemic started in the beginning of 2020, the Federal Reserve began buying billions of Treasuries and mortgage-backed securities (MBS). It did so to provide liquidity to the financial system and support the economy by putting downward pressure on interest rates which fueled gains for the stock and bond markets, as well as the housing market. The Fed’s balance sheet increased from about $4.15 trillion at that time to a peak of $8.96 trillion in April this year. As Barron’s notes, the Federal Reserve owns nearly a third of the Treasury and MBS markets, which is about 40% of the country’s gross domestic product (GDP).
Now, with the economy much stronger, the labor market tight, and inflation running at four times the Fed’s target, the Federal Reserve is looking to shrink that $8.96 trillion. Treasuries and MBS have a set maturity date and the Fed used the funds that matured to buy new securities, keeping the balance sheet level. To reduce the balance sheet, instead of reinvesting those proceeds, the Fed will let it run off and remove reserves from the banking system, a way to tighten financial conditions and bring the balance sheet and reserves to a more normal level. In June, the Fed started rolling off $30 billion per month in Treasuries and $17.5 billion per month in MBS, before doubling that amount September 15th to $60 billion in Treasuries and $35 billion in MBS per month.
The important question is what does this mean for the markets? Quantitative tightening increases the availability and supply of these securities while also removing a large buyer in the market, which should push yields higher on fixed income products. In addition, the government is expected to issue approximately one trillion in new Treasuries annually over the foreseeable future. With the Fed no longer the largest buyer, it is uncertain where a bulk of the buying will come from.
What this means at the end of the day is increased volatility as the market tries to remain balanced. This is also unprecedented territory. We have never undertaken the level of QT as we are going through right now, so there is no history to go off of.
Meanwhile, markets will remain focused on inflation and this week is a big week of data. Starting today (Monday), the New York Fed will release its survey of inflation expectations. Remember half the inflation picture is about expectations – if consumers expect inflation to remain high it causes them to buy more now instead of waiting and paying a higher price in the future, which only worsens the situation. Tuesday morning will see the consumer price index, which is expected to have fallen 0.1% in the month of August due to lower energy prices, but the annual rate is still expected to be at least 8.0%. The remainder of the week will see the producer price index on Wednesday, import and export prices on Thursday, and the Consumer Sentiment survey on Friday which includes another reading on inflation expectations.
Markets are already expecting a 75 bps increase at next week’s meeting, and Fed policymakers have indicated via recent public remarks that is the most likely scenario, so this week’s data may not change that narrative, but the remainder of 2022’s meeting are more uncertain. Uncertainty creates volatility and value stocks topically hold up better in volatile times.
Week in Review:
It was a choppy opening session to the holiday shortened week on Tuesday. Bond yields continued their move higher over pushback from a potential Fed pivot along with expectations of a more hawkish European Central Bank policy meeting Thursday. Oil moved higher on Monday after OPEC+ announced a cut to its production quotas by a quite small 100k barrels per day, but moved lower Tuesday over demand concerns from additional China Covid lockdowns and global slowdown worries. It was a slower day for stocks, which attempted several bounces that failed, where the S&P 500 closed 0.41% lower with strength coming from defensive sectors.
Much attention Wednesday was received from the currency market after the dollar index hit a 20-year high, the British pound falling to the lowest level versus the dollar since 1985, and the Chinese yuan falling to 7.000 per dollar. On the energy side, after G7 nations agreed to impose price caps on Russian oil, Putin threatened to cut energy supplies. On the Fed side, a WSJ article was released in the morning stating the expectation for a 75 basis point increase at the next Fed meeting, moving markets expectations higher and rates on the short end of the yield curve higher. For stocks, it was a solid day however it should be noted defensive sectors led the way. The S&P 500 rose 1.83%.
Stocks were relatively unchanged at the open Thursday as markets digested news the European Central Bank raised its policy rate 75 bps to 1.25% and gave the expectation for further increases despite “substantial” slowing of its economy. In other central bank news, Fed Chairman Powell spoke publicly, reiterating his comments from Jackson Hole that the Fed is narrowly focused on inflation and the lessons learned from history in letting inflation get out of control. Stocks were able to hold gains and finish the day 0.66% higher.
Friday was an uneventful day that saw stocks move higher overall with Fed speak continuing to point to a 75 basis point increase at its next meeting. The S&P 500 finished strong for the week with a 1.53% gain on the day while the NASDAQ gained 2.11%.
Oil had another volatile week but finished the week unchanged after trading as low as $81/barrel to as high as $90/barrel. Treasury yields continued their recent move higher, particularly on the short end where the 3-month yield rose from 2.92% to 3.07% over the expectations of a higher rate increase of 75 basis points at next week’s policy meeting, while the 10-year rose 10 basis points to 3.32%. Stocks snapped a three-week losing streak, most likely on short-term oversold levels and technical factors with the major indices finishing as follows: NASDAQ +4.14%, Russell 2000 +4.04%, S&P 500 +3.65%, Dow +2.66%.
Recent Economic Data
- The U.S. trade deficit, after reaching a record high of $106.92 billion in March, has slowly receded with the deficit in July improving to $70.65 billion (the U.S. imported $70.65 billion more than what it exported). This suggests several things with the most important being there is significant demand in the U.S. as its economy is stronger than the rest of the world. In July exports were $259.3 billion, rising 0.2% in the month, while imports were $329.9 billion, down 2.9% in the month. Compared to a year ago exports are 19.9% higher while imports are 22.1% higher. Recall a higher deficit contracts from GDP and was a major factor in why GDP was negative in the first quarter this year. An improvement in the deficit is on track to be a net positive for Q3 GDP.
- The ISM Services Index was 56.9 for August, above the expectation of 55.4, and near the same level as July. Business activity was 60.9, one point higher than July, while supplier deliveries weakened, and the prices index decreased for the fourth consecutive month to 71.5.
- The number of new unemployment claims filed for the week ended September 3 was 222,000, a decline of 6k from the week prior. The four-week average moved down 7.5k to 233,000. The number of continuing unemployment claims was 1.473 million, up 36k from the prior week with the four-week average moving 11k higher to 1.439 million. Claims remain near record lows and continue to indicate a tight labor market.
- The Federal Reserve’s Beige Book, a report on economic activity throughout the Fed’s 12 districts, said activity was unchanged over the previous 6 week period, 5 districts said slight to modest growth, 5 said slight to moderate softening. A few key points noted labor markets remained tight but saw some improvement in availability, prices remain elevated but nine districts noted a moderation in the rate of increases, there was solid leisure & hospitality activity across all districts, residential real estate has weakened noticeably, and auto sales were muted.
- The monthly Consumer Credit report from the Federal Reserve shows total consumer credit outstanding rose another $23.8 billion in July, or 0.5%, to a record level of $4.6037 trillion and comes after a larger $39 billion or 1% increase in June. Revolving credit, such as credit cards, rose 1% in the month and 11.6% on a seasonally adjusted annualized basis, while non revolving like mortgages rose 0.3% or 4.4% on a seasonally adjusted annualized basis.
- The e-cigarette and vaping maker Juul Labs, who tobacco producer Altria has a 35% stake in, reached a settlement with 30 states that directs the company to pay $439 million to settle a two year probe over how it markets its products. Juul must also comply with a series of strict terms “severely limiting their marketing and sales practices,” such as refraining from youth marketing and paid product placement. The $439 million will be paid over a period of six to ten years.
- Several years after its $69 billion acquisition of Aetna, CVS makes another large acquisition; agreeing to acquire health analytics platform Signify Health for $30.50 in cash for a total value of approximately $8 billion, which beat Amazon and United Health in the bidding process.
- Apple’s fall product event was mostly as expected – it unveiled its new iPhone, AirPods, and Watch product lines. The iPhone prices were unchanged, starting at $799 for the iPhone 14 and $899 for the iPhone 14 Plus. Separately, US lawmakers have warned Apple on its rumored plan to buy Chinese memory chips for its new iPhone 14.
- The second largest movie theater chain, UK based Cineworld (known in the U.S. for its Regal Cinemas), has filed for Chapter 11 bankruptcy in the U.S. due to its $5 billion in debt. It said it anticipates to emerge from protection in Q1 2023 and confident a restructuring is in the best interest of stakeholders.
- Liz Truss, of the conservative party, took over as Britain’s new Prime Minister last Tuesday and first confronted the issues of rising prices, labor unrest, and a troubled health care system. In her first moves to combat the energy crisis, she announced the fracking ban would be lifted, approved more oil drilling, and said household energy bills would be capped at GBP 2,500 per year for the next two years.
- In global central bank news, last week the European Central Bank (ECB) raised its policy rate 75 basis points to 1.25% following its first rate increase in over a decade in July, and also anticipates more rate increases are necessary. Policymakers significantly revised inflation projections higher with 2022 inflation at 8.1%, up from 6.8% and 2023 up 5.5% vs prior 2.8%, while saying euro area economic growth has slowed substantially and is expected to stagnate later this year and into next year. Policymakers also indicated a similar rate increase at its next meeting while suggesting quantitative tightening could begin near the end of 2022. The Bank of Canada raised its policy rate 75 basis points as well, to a rate of 3.25% and indicated more rate hikes will be needed. It said demand remains very strong and “surveys suggest that short-term inflation expectations remain high. The longer this continues, the greater the risk that elevated inflation becomes entrenched.”
- While Europe deals with an energy crisis, China may see its first drop in oil demand in 2022 in 20 years. Demand for oil in China is likely heading lower as China deals with increasing lockdowns over the past several weeks. Reuters reported hundreds of millions of Chinese that would normally travel on the road or through the air are more likely to stay home over the Mid-Autumn Festival falling on September 10th and the Golden Week holiday that falls in early October. In 2021, China oil demand rose 450k barrels per day and analyst see 2022 oil demand dropping by around 380k barrels per day. Here in the U.S., Treasury Secretary Janet Yellen in an appearance on CNN cautioned of the higher risk of an oil price spike this winter as Europe stops buying Russian oil.
Did You Know…?
It took two years to recover; airline traffic in the U.S. for a holiday weekend topped pre-pandemic levels seen in 2019 for the first time over the 2022 Labor Day weekend. Data from TSA checkpoints shows throughput was 2,389,857 on September 5, up 18% from 2021, 156% from 2020, and 4.6% higher than the previous peak in 2019. The four day period from Friday through Monday, TSA had 8.76 million travelers go through checkpoints.
Wine & Wills
Thursday, September 22nd @ 6:00 pm
Friday, September 23rd @ 12:00 pm
Join us in a complimentary estate and financial wealth planning seminar hosted by personal family lawyer, Kristen Boone, and the Wentz Financial Group team. We will review the significance of estate planning and how to create a plan to distribute assets after death. We will also review the role a financial advisor plays in the process.
Career Development Day
Thursday, December 22, 2022 – All Day
Do you know someone in high school or college looking to get real life work experience from the finance industry? Wentz Financial Group will be hosting its 2nd Career Development Day at our office on December 22nd. The day will not only be for those looking to get a first look into financial services field but is open to any student wanting to get their feet in the door of the professional world. Don’t forget to RSVP by responding to this email or calling the office at 330-650-2700.
Please note we are returning to normal office hours and will operate from 8:30 until 5:00 each day. As always, if you need to speak or meet outside of those hours, please reach out and we will be happy to set up an appointment.
The Week Ahead
This week’s focus will be on the economic calendar and inflation data that will be released. It begins with the consumer price index on Tuesday where the consensus expectation is for a 0.1% monthly decline, thanks to another drop in energy prices, but the year-over-year rate still elevated at 8.0% (although down from 8.5% last month). After the CPI report is the producer price index on Wednesday. Thursday will be a busy day with jobless claims, retail sales, the Philly Fed and Empire State Manufacturing survey indexes, import and export prices, industrial production, and business inventories. The week ends with results from the latest consumer sentiment survey. Unfortunately, the Fed goes in a blackout period ahead of its policy meeting next week, so we will not hear thoughts on the latest inflation report from any policymakers until Powell speaks after next week’s meeting. The earnings calendar remains light, but key reports will come from Oracle on Monday and Adobe on Thursday. However, there are several notable Investor’s Days and brokerage conferences where we could see commentary that moves individual stocks. Friday should see increased volume due to quadruple witching, which happens four times per year and is when four major index options expire.