Wentz Weekly Insights
The Inflation Picture: More Focus on Wages
Stocks opened the week lower as growth concerns in China over its zero-Covid policy spilled over to global markets. Behind the China pandemic headlines was data on Black Friday and Cyber Monday sales figures. Shoppers spent $35.4 billion over the five-day period, from Thanksgiving day to Cyber Monday, with Cyber Monday being the largest shopping day, seeing record sales of $11.8 billion, more than the $11.2 to $11.6 billion that Adobe Analytics was expecting, and rising 10.2% from last year’s figures. Black Friday sales were still strong, rising 2.3% to $9.12 billion. The National Retail Federation is estimating holiday sales, running from November 1 to December 31, will increase 6% to 8% from a year ago to between $943-$960 billion with 10%-12% growth coming from online sales.
This is welcoming news on the consumer and comes at the same time sentiment moves back near the lowest levels on record and as recession worries are increasingly on consumers’ minds. While the data is solid, most of the increase comes from higher prices. With inflation up about 8% from a year earlier, real sales improved just 2.2%, compared to the average 4.9% increase over the past 10 years.
Inflation remains as a top concern for most consumers and the Federal Reserve. That was apparent in Chairman Powell’s recent remarks at a Brookings Institution appearance last Wednesday. To summarize, Powell said rate increases will slow in upcoming meetings, but rates will need to rise higher than previously thought before the Fed is finished. There were more comments on the labor market than in past appearances – with supply bottlenecks and housing inflation cooling, the labor market is going to be a key indicator on future inflation because of the influence it has on services inflation, which remains too high, according to Powell.
In order for services inflation to ease, we will need a better balance between labor supply and demand. There has been small improvements over the past several months, with the number of job openings per unemployed person falling to 1.7 from 2.0 earlier in the year (but still very elevated compared to the pre pandemic average of 0.6 openings for every unemployed person), but there is still work left to do as the labor market is still too tight. Powell gave a hawkish tone from this aspect while saying economic growth will need to remain below trend for a sustained period, suggesting a weaker labor market will be necessary, and hinting rates will need to peak at a higher level than what policymakers said in the last update of its “dot plot” (where they project rates in the future) from September.
We also learned in the Q&A session there will be a larger emphasis on wage inflation moving forward after Powell said wages are going to be “a very important part of the story going forward”. Two days later, on Friday, the November labor report showed payroll growth of 263,000 that was higher than expected while the average wage grew 0.6%, double what was expected. In fact, wages were 5.1% higher from a year ago, re-accelerating from October’s annual rate of 4.9%. While wage growth is a good thing, it is below the rate of consumer inflation. Adjusting for inflation, estimated to be up 7.8% in November from a year ago, real wages actually declined 2.7%. The reacceleration in wages may suggest workers are pushing for higher wages due to inflationary pressures, which is something the Fed will look strongly to avoid in 2023.
While the markets have celebrated the idea the pace of rate increases will slow (apparent from the 16.6% rally from the lows in October combined with the pullback in longer-term Treasury yields), we believe another pullback is likely as it faces the reality that Fed policymakers will project a higher ultimate level of rates and that they will stay at those levels for longer. The markets will need to reprice for this as current pricing suggests a peak rate of 4.6% and that the Fed will begin cutting rates in the second half of 2023. The upcoming Fed meeting December 14 could set the stage for this move. We continue to believe defensive and income producing investments are great options to ride this uncertain and volatile environment.
Week in Review:
Investors came back after the holiday shortened week in a risk off mode as China dominated the headlines over its strict adherence to its zero Covid policy which caused widespread protests in China, including its largest cities. Adding to the mix was more hawkish Fed speak including from St Louis and New York Fed Presidents who said tighter policy is beginning to lower demand in the US economy, but markets are underpricing the risk of higher rates. Crude oil fell to the lowest level of the year over demand concerns from China’s Covid policies, Treasuries were unchanged, while the major US stock indices were all down at least 1.45%.
On Tuesday, Chinese stocks outperformed over hopes a news conference would come with looser Covid restrictions, however that did not follow over to US stocks. In another quiet day, stocks were mixed, but mostly lower. Treasury yields moved slightly higher, while oil was higher over reports OPEC+ is expected to roll over previously production cuts, with no changes in its December meeting. The Dow was unchanged on the day while the S&P 500 fell 0.16%.
Stocks opened Wednesday in waiting mode on Powell’s afternoon speech which markets took as more dovish and led to a rally in stocks. Powell didn’t really provide anything we didn’t already know, reiterating the pace of rate increases will slow, the likelihood of higher peak rates, and cautioning against loosening policy too soon. In morning data, job openings declined as expected, while Eurozone inflation decelerated but remains at 10%. The stock rally produced a 3.09% gain for the S&P 500 and 4.41% gain in the NASDAQ as Treasury yields fell across the curve.
It was mixed trading to begin the day on Thursday as investors continued to digest Powell’s recent comments, but welcoming news from China that it eased certain Covid restrictions helped global stocks move higher. Economic data included solid personal income growth and consumer spending figures, while jobless claims were relatively unchanged. Stocks were mostly mixed with the S&P 500 down just 0.09%.
Outside of Powell’s public remarks, Friday’s Labor report was the highlight of the week, with a more than expected 263,000 payrolls added in the month and wages that grew 0.6% which was double the expectations. The strong job gains and more importantly higher wage growth sent stocks lower and Treasury yields higher over additional inflation concerns. Recall in Powell’s remarks Wednesday, he hinted the Fed will start looking close at wage inflation as consumer inflation starts heading lower. Stocks initially fell over 1% but by the end of the day closed down just 0.12%.
It was a week that saw a reversal of several of 2022’s trends. The dollar index fell 1.2% for the week, finishing near the lowest levels since June. Oil fell to the lowest levels of the year on Monday over Covid restrictions in China, but still rose 4.9% for the week over the anticipation of the G7 nation’s price cap on Russian oil along with the OPEC+ meeting. Treasury yields rose slightly on the short end but fell sharply on the medium-longer end over hopes of peak inflation/peak rates. US stocks were positive with the major indices finishing as follows: NASDAQ +2.09%, Russell 2000 +1.27%, S&P 500 +1.13%, Dow +0.24%.
Recent Economic Data
- The Case Shiller home price index shows home prices saw a 0.8% decline in the month of September, a little less of a decline than the 1.2% decline expected, and follows a 1.3% decline from August. Compared to a year ago, home prices have gained 10.6%, down from 12.9% increase in August and down from the record 21% annual increase seen at the beginning of the year. All 20 cities in the index saw monthly declines and all saw a deceleration in annual gains. Miami (+24.6%), Tampa (+23.8%) and Charlotte (+17.8%) top the list with strongest gains, with San Francisco (+2.3%), Seattle (+6.2%) and Minneapolis and Washington (+6.5%) at the bottom. Cleveland prices up 10.6% from a year ago.
- Consumer Confidence, according to the Conference Board survey, was 100.2 for November, in line with expectations, but falling from 102.2 in October. The present situations index fell slightly to 137.4 from 138.7, suggesting the momentum that built the end of summer has faded, while the expectations index fell to 75.4 from 77.9, suggesting the risk of a recession remains elevated. In addition, inflation expectations increased to the highest levels since July.
- Third quarter GDP was revised higher, to an annualized growth rate of 2.9%, up from 2.6% in the first estimate last month. The upward revision was due to stronger consumer spending and nonresidential fixed investment that was partially offset by a downward revision to inventory growth. Also important, the GDP price index was revised higher to an annual rate of 4.3%, up from 4.1% in the first estimate. In addition, the index is up 7.1% from a year ago.
- Personal income rose 0.7% in the month of October, a large beat compared to the 0.4% increase expected. Within the category, the important wages and salaries increased 0.5%. The larger headline increase came from a 6% jump in the “other” category stemming from government social benefits, reflecting one-time refundable tax credits by states. Consumer spending rose a strong 0.8%, in line with expectations, with spending on goods up 1.4% and spending on services up a softer 0.5%. This led to a savings rate of 2.3%, a drastic drop from the pandemic days and the lowest since 2005 as consumers continue to spend down their savings. The more important figure from the report was the PCE price index, the Fed’s preferred measure of inflation, which increased 0.3% which matched September’s increase, and was lower than the 0.4% increase expected. The index is up 6.0% from a year ago, as expected, and decelerated from the 6.2% rate in September. Core prices rose 0.2%, also lower than expected, and are up 5.0% from a year earlier.
- Pending home sales fell for the fifth consecutive month, down 4.6% in October following a 8.7% decline in September. Pending transactions are down 37% from a year earlier.
- The US PMI index was 47.7 for November, indicating renewed deterioration in operating conditions in the month, which is the lowest level since the US was last in a recession May 2020. There was a drop in production which firms said was driven by weak client demand and further downturn in new orders. Employment was still positive, but slowed from previous months. Good news is supply chains improved for the first time since October 2019 which helped ease price pressures.
- The ISM was 49.0, falling from 50.2 last month – a disappointment and indicates a contracting manufacturing sector for the first time since May 2020. New orders at 47.2 showed contraction, production continues to expand albeit at a lower pace at 51.5, employment declined as well with the index at 48.4, while prices paid were at 43.0, down from 46.6 suggesting further easing in inflationary pressures.
- Construction spend in October declined 0.3% in the month, only the second decline this year, beside August the last decline was February 2020. Spending fell 0.3% on both residential construction (home building) and non-residential (commercial/businesses). Compared to a year earlier, spending was up 9.2%, with a 8.5% increase in residential and 9.8% increase in non-residential. Expect this to continue to move lower, as businesses become more cautious and especially as home builders pull back on building as demand weakens.
- The 30-year mortgage rate fell to 6.49% last week, down from 6.58% the week prior and down from the high of 7.08% a month ago, according to the Freddie Mac weekly survey.
- The number of job openings edged lower in the last business day of October with 10.334 million openings, down from 10.687 million in September. Outside of August, when the number of openings fell to 10.280 million, October was the lowest since last June (2021). The number and rate of hires was little changed in the month while separations was also little changed. Within separations, the number of quits was little changed while the quits rate fell to 2.6%, the lowest since May 2021. The labor market is still very tight but showing signs of loosening with job openings moving lower.
- According to the ADP employment report, private employers added 127,000 jobs in November, a little less than the 200,000 expected. Small and mid sized businesses saw sizeable job gains, while large businesses saw declines in employment. The leisure/hospitality sector saw the largest job gains, while manufacturing and professional services saw the largest losses.
- The number of jobless claims for the week ended November 26 was 225,000, a decline of 16k from the prior week, with the four-week average little changed at 228,750. The number of continuing claims was 1.608 million, another sizeable increase of 57k for the highest level since February this year, with the four-week average moving 30k higher to 1.538 million.
- The Department of Labor said November saw payroll growth of 263,000, according to its establishment survey. In addition, revisions to the past two months show 23k less jobs than the first estimates. Strong gains were seen in education, health care, and leisure/hospitality but weakness in jobs like warehousing, transportation, retail, and temp help services, with all other categories seeing small gains. Moving to household survey data, the labor force fell by 186k people causing the labor force participation rate to fall to 62.1%, a disappointment and the lowest level since last year. The number of people employed fell 138k while those unemployed fell 48k, still about 220k above pre-pandemic levels. The unemployment rate remained at 3.7% while the U-6 rate, mostly referred to as the underemployment rate, fell to 6.7%, tying the lowest rate on record (going back to 1995).
- The average earnings rose 0.6% in the month, double what was expected and follows an upward revised October wage increase of 0.5%. November’s increase is 7.2% annualized, and up 5.1% from a year ago, accelerating from 4.9% in October and just below the high water mark of 5.6% in March. The higher wage growth was the main reason the markets were down after the release. Recall, from Wednesday in Powell’s speech he said the Fed would focus more on wage inflation, as goods/services inflation is expected to move lower. So our expectation is throughout 2023 there will be more emphasis on wage numbers like this one. While this is just one month, it is unwelcoming news on the inflation front.
- Bloomberg reported Apple could see its new iPhone Pro production fall short by as many as 6 million phones due to the protests in China, which has seen increased protests from its main manufacturing hub of Zhengzhou and Apple main assembly facility Foxconn. This could all change though, depending on if lockdowns continue and if Foxconn can get workers back to production lines.
- Elon Musk and Tesla unveiled its 18-wheel heavy duty electric Semi, beginning the company’s push in the trucking business.
- The Biden Administration said it would ease some oil sanctions on Venezuela which includes awarding Chevron a license that would allow the company to resume oil production there. This comes after Venezuela agreed to humanitarian efforts and talks to hold fair and free elections.
- The Group of Seven nations agreed to a $60 per barrel price cap on Russian oil over the weekend, which goes into effect December 5, while the European Union is banning imports of seaborne Russian oil. The group originally decided in June on an outright ban of Russian oil, but there were concerns that it would send oil prices too high so the group considered a price cap on what it would pay for imported oil from Russia. Russia has said it will not accept the restrictions, even if it forces them to cut production. It also said it will redirect its supply to partners that do not have restrictions, most likely meaning China and India. Barron’s notes before the invasion of Ukraine, Europe imported about 1.5 million barrels/day of Russian oil, while today Europe imports about 600k barrels/day, diverting the remainder to the rest of Asia. Now that additional 600k bbl/day will have to be absorbed by someone.
- Separately, OPEC+ held its monthly oil production meeting over the weekend and concluded with no change to production quotas, deciding to stick with the existing agreement of cutting production 2 million barrels per day, which was announced in the October meeting. The no change comes after several reports last week that said OPEC was considering larger cuts in effort to adjust to weaker demand from China over its Covid restrictions and the risk of a global recession. The group said it could also move production at any time as it assesses the impact of the price cap and European bans as it agreed to hold its Committee meetings every two months, but full ministerial meetings every six months.
- Reports show that Republicans are going to attempt to use the upcoming debt ceiling as a way to force Democrats to cut spending on many areas.
- Recent Fed speak:
- Fed Chairman Powell had a very anticipated speech and Q&A in which he said the pace of rate increases will moderate, and “may come as soon as the December meeting,” due to the uncertain lag monetary policy has on the economy and inflation. The full effects of tighter policy have yet to be seen so Powell is priming markets for the expectation of smaller increases in rates. He reiterated the Fed will “stay the course” until the job is done and needing more evidence inflation is actually declining because “we have not seen clear progress on slowing inflation.” Regarding the ultimate level of rates he said it will need to be “somewhat higher than thought at the time of the September meeting,” which was 4.6%. Also mentioned wage increases are going to be “a very important part of the story going forward.” Markets welcomed the comments, viewing them as more dovish and sending stocks higher and yields lower for the day.
- Recently confirmed Fed Governor Lisa Cook repeated the message from other colleagues, saying it would be prudent to “move in smaller steps,” due to the tightening already in the pipeline and the fact that policy works with long lags. Also reiterated rates will stay restrictive for a while, until inflation is closer to the Fed’s 2% goal. Said there has been improvement in inflation recently, but is cautious about reading too much into one month of data.
- New York Fed’s President Williams said in an online speech the higher rates and quantitative tightening (balance sheet runoff) have started to lower demand in the US economy, but the labor market remains “remarkably tight” with robust hiring and continued wage growth. Expects inflation to slow to 5%-5.5% by year end and 3%-3.5% by end of next year, but it will take longer to bring down the “inner layer of the inflation onion” which he refers to as wages, services inflation, and inflation expectations. Regarding policy, says rates will continue to rise and will stay restrictive through 2023, but sees a path where the Fed reduces the policy rate in 2024. Williams said in a separate interview he is hoping inflation gets to 2% by 2025 but expects a “significant” decline next year. Regarding how far rates will rise, he said it will depend on the economy but added “we still have a ways to go beyond whatever we will do in our upcoming meeting”.
- St Louis Fed’s President Bullard said markets are continuing to underestimate and underprice the risk of higher interest rates. Sees rates at lower end of 5%-7% range and staying there through 2023 and into 2024. Reiterated Powell’s message in recent weeks that there very well could be slower rate increases, but the ultimate level of rates could be higher than previously projected.
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The Week Ahead
Market participants will have less news to trade on this week when it comes to economic data and quarterly earnings results. The economic calendar has several smaller data releases including factory orders and the ISM services index on Monday, trade data on Tuesday, the revision on third quarter productivity and costs on Wednesday, weekly jobless claims on Thursday, and finishing with the producer price index and the preliminary December consumer sentiment survey results. None of the reports should be market moving. It will remain light on the earnings calendar, with notable results coming from AutoZone, MongoDB, Signet Jewelers on Tuesday, and Costco, Lululemon, DocuSign and Broadcom on Thursday. There will also be several investor days, notably from Southwest Airlines, GE, and Lowe’s. Oil markets will receive increased attention after OPEC+ monthly meeting on Sunday along with the EU ban and Western nations’ price cap going into effect on Russian oil on December 5th. Regarding central bank outlook, the Reserve Bank of Australia and Bank of Canada meet to discuss monetary policy and likely announce another round of rate increases, while Fed policymakers go into a quiet period prior to next week’s policy meeting.