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Weekly Update 12/16/2022: Fed Downshifts and Raises Rates 50 Basis Points as Inflation Shows Signs of Easing

  • Amgen agrees to buy Horizon Therapeutics Plc for about $27.8 billion in its biggest-ever acquisition; company also raises their dividend by 10%
  • Raytheon announces another $6 billion buyback
  • Adobe releases earnings beating estimates; stock rises on positive outlook
  • Boeing wins significant plane order from United Airlines for 787 Dreamliners
  • Accenture releases earnings beating profit and revenue expectations and raises fiscal year guidance
  • Microsoft agrees to buy a stake in London Stock Exchange Group Plc as part of a long-term deal with Azure

Domestic Economic News

 

A key gauge of US consumer prices posted the smallest monthly advance in more than a year, indicating the worst of inflation has likely passed and validating an anticipated slowing in the pace of Federal Reserve interest-rate hikes. Excluding food and energy, the consumer price index rose 0.2% in November and was up 6% from a year earlier, according to a Labor Department report Tuesday. Economists see the gauge — known as the core CPI — as a better indicator of underlying inflation than the headline measure. The overall CPI increased 0.1% from the prior month and was up 7.1% from a year earlier, as lower energy prices helped offset rising food costs. US stock futures surged and Treasury yields plummeted following the report. The median estimates in a Bloomberg survey of economists called for 0.3% monthly increases in both the core and overall measures. The report, the last of 2022, points to inflation that -- while much too high — is beginning to ease. While the Fed will likely welcome the deceleration, Chair Jerome Powell has emphasized both the central bank’s commitment to returning inflation to the Fed’s goal and the uncertainty of the outlook. Economists broadly expect annual price growth to slow substantially next year, but it’s unclear just how bumpy or painful the path back to the central bank’s target will be.

Economists expect further tightening next year followed by an extended pause as policymakers assess the nation’s inflation trajectory and persistence. Market participants see the central bank cutting rates before the end of next year. Core goods prices fell for a second month in November, dropping 0.5%. Prices for used cars retreated for a fifth month, while costs of apparel edged higher. Energy prices declined 1.6%, reflecting declines in gasoline, electricity and utilities. Food prices rose 0.5%. Shelter costs — which are the biggest services’ component and make up about a third of the overall CPI index — increased 0.6% last month, the smallest advance in four months as hotel rates declined. The report showed shelter was “by far the largest contributor” to the overall CPI gain. While rents increased 0.8% and owners’ equivalent rent rose 0.7%, the cost of lodging away from home sank 0.7% after surging the prior month. Though private-sector data point to a stabilization in rents in a range of cities across the country, there’s a lag between real-time changes and when those are reflected in Labor Department data. Excluding energy, services prices climbed 0.4%, the smallest gain since July. Medical care services declined by the most on record, a dynamic that is largely expected to persist next year. Stripping out energy, rent and owners’ equivalent rent, services prices decelerated notably, according to Bloomberg calculations. Powell recently emphasized the importance of this type of measure when it comes to assessing the path of a separate gauge of inflation — the core personal consumption expenditures price index. He called it perhaps “the most important category for understanding the future evolution of core inflation.” This is definitely a positive trend even though we have a ways to go.

US retail sales fell in November by the most in nearly a year, reflecting softness in a range of categories that suggest some easing in Americans’ demand for merchandise. The value of overall retail purchases dropped 0.6% last month after rising 1.3% in October, Commerce Department data showed Thursday. Excluding gasoline and autos, retail sales were down 0.2%. The figures aren’t adjusted for inflation. The median estimate in a Bloomberg survey of economists called for a 0.2% decline in total retail sales. Nine of 13 retail categories fell last month, according to the report, including electronics, furniture and building materials stores. Vehicle sales also declined, due in part to a drop in the prices of used cars and trucks. The value of sales at gasoline stations were down 0.1% as pump prices fell. Sales at restaurants and bars — the only service-sector category in the report — rose 0.9% in November, the fourth-straight increase. The report suggests some loss of momentum in consumer demand for goods amid high inflation as well as what’s been a shift in preferences toward services. While rising wages and pandemic-era savings have helped support shoppers, Americans are beginning to feel the squeeze — the saving rate is near a record low and credit-card balances have surged. The Federal Reserve is looking for a slowdown in consumer spending that will lower economic growth in order to stomp out inflation.

 

US factory production declined for the first time since June, underscoring weaker conditions in the sector amid waning global demand and higher borrowing costs. The 0.6% drop in factory production last month followed an upwardly revised 0.3% gain in October, according to Federal Reserve data released Thursday. The figure missed all estimates in a Bloomberg survey of economists. Including mining and utilities, total industrial output fell 0.2% in November, compared to a projection for stagnation. Manufacturing output was dragged by both durable and nondurable goods, including motor vehicles and parts and plastics and rubber products. Excluding autos, factory production was still down by the most in six months. Manufacturers have been contending with weaker demand due to shifting consumer spending patterns and compounded by higher interest rates. The sector contracted in November for the first time since the onset of the pandemic as new orders continued to shrink and companies prepare for lower future output, according to the Institute for Supply Management. Separate data out Thursday from regional Federal Reserve banks showed manufacturing weakened in both the New York and Philadelphia regions by more than expected. The latter’s new orders gauge fell to the lowest since the onset of the pandemic.

In a bit of good news this week, applications for U.S. unemployment benefits fell last week to the lowest since September, in another sign of resiliency in the labor market amid a weakening economy. Initial unemployment claims decreased by 20,000 to 211,000 in the week ended Dec. 10, Labor Department data showed Thursday. The median estimate in a Bloomberg survey of economists called for a 232,000 advance. Continuing claims, which include people who have already received unemployment benefits for a week or more, were little changed 1.67 million in the week ended Dec. 3, in line with expectations. The data can be choppy from week to week, especially around holidays. The four-week moving average, which smooths out some of the volatility around Thanksgiving, fell by 3,000 to about 227,000.

 

Interest Rate Insight and the Fed

 

The Federal Reserve downshifted its rapid pace of interest-rate hikes while signaling that borrowing costs, now the highest since 2007, will outstrip investors’ expectations as the central bank works to rein in inflation. The Federal Open Market Committee raised its benchmark rate by 50 basis points to a 4.25% to 4.5% target range. Policymakers projected rates would end next year at 5.1%, according to their median forecast, before being cut to 4.1% in 2024 — a higher level than previously indicated. “The committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time,” the FOMC said in its statement, repeating language it has used in previous communications. Following the hawkish projections, Treasury yields rose, the S&P 500 index dropped and the dollar index pared losses on the day. Investors had been speculating that the Fed would soon pause its hikes after financial conditions eased. Until Wednesday, stocks had risen, while mortgage rates and the dollar had fallen since Powell last month suggested a policy shift was coming. They’d also bet rates would reach about 4.8% in May, followed by cuts totaling 50 basis points in the second half of the year. The vote was unanimous. Fed Chair Jerome Powell had previously signaled plans to moderate hikes, while emphasizing that the pace of tightening is less significant than the peak and the duration of rates at a high level. The decision follows four consecutive 75 basis-point hikes that have boosted rates at the fastest pace since Paul Volcker led the central bank in the 1980s. Consumer-price increases have begun a more pronounced slowdown from their 40-year high earlier this year. But a growing cadre of economists expect the Fed’s aggressive action to tip the US into recession next year. Such concerns have drawn lawmaker criticism, with Democratic senators Elizabeth Warren, Bernie Sanders and Sheldon Whitehouse warning that rate hikes risk “slowing the economy to a crawl.”

Officials gave a clearer sign that they expect higher rates to impact the economy. They cut their 2023 growth forecasts, seeing expansion of 0.5%, according to median projections released Wednesday. They raised their estimate for 2022 GDP slightly to 0.5%. The central bankers increased their projection for the unemployment rate next year to 4.6% from its 3.7% level in November. The distribution of rate forecasts also skewed higher, with seven of 19 officials seeing rates above 5.25% next year. Fed officials raised their estimates for the main and core readings of their preferred inflation gauge, the index for personal consumption expenditures. They now see PCE at 3.1% in 2023 compared with a September estimate of 2.8%, while core — which excludes food and energy — may be 3.5% for next year. Wednesday’s move caps a challenging year for the US central bank which was initially slow to begin tightening policy in response to surging price pressures. Since lifting rates from near zero in March, the Fed has moved aggressively to catch up, while preserving hope it can deliver a soft landing that avoids a dramatic surge in unemployment. Officials are seeking to slow growth to below its long-term trend to cool the labor market — with job openings still far above the number of unemployed Americans — and reduce pressure on prices that are running well above their 2% target. Policymakers got some good news Tuesday when government data showed consumer prices rose 7.1% in the year ending November, the lowest rate this year. Even so, Powell has repeatedly said he’s willing for the economy to suffer some pain to lower inflation and avoid the mistakes of the 1970s when the Fed prematurely loosened monetary policy.

US stocks turned lower and Treasury yields rose after the Federal Reserve’s latest rate decision and Chair Jerome Powell’s speech signaled the central bank sees work left to do in its battle against inflation. The S&P 500 and the Nasdaq 100 erased earlier gains after Powell reiterated his hawkish stance. The policy-sensitive two-year Treasury yield climbed to around 4.29%. The dollar strengthened. Stocks had rallied more than 6% since the last rate decision on the expectation that the central bank would be able to slow and possibly stop its tightening next year. That view took a hit with officials’ latest projections that the Fed funds rate will top 5% in 2023, before being cut to 4.1% in 2024. Powell restated that policy will need to remain tight for “some time” to restore price stability. He provided no dovish relief and emphasized that the Fed needed more evidence beyond October and November’s softer consumer price index numbers to have confidence that inflation is coming down meaningfully.

 

In better news, US household expectations for inflation in the year ahead fell last month to the lowest level since August 2021, according to a Federal Reserve Bank of New York survey. Households in November said they expected inflation to be 5.2% over the coming 12 months, down from 5.7% the month before, according to results of the New York Fed’s monthly Survey of Consumer Expectations published Monday. Expected inflation three years and five years ahead also fell. Fed officials have been aggressively tightening monetary policy this year in a bid to keep expectations in check, even as actual inflation has soared to the highest levels in four decades. Lower expected inflation in the New York Fed survey in November coincided with government reports published last month showing that price pressures may be beginning to ease. The consumer price index rose 7.7% in the 12 months through October, marking the lowest reported inflation rate since January. Households in the New York Fed survey saw gas prices rising 4.7% over the coming year. Food prices were expected to rise 8.3%, while rents were seen going up 9.8%.

 

Impactful International News

 

The European Central Bank slowed the pace of interest-rate hikes while widening efforts to subdue double-digit inflation with a decision to shrink its €5 trillion ($5.3 trillion) bond portfolio from March. After successive increases of 75 basis points, the ECB lifted the deposit rate by a half-point to 2% on Thursday, matching economists’ expectations. “The Governing Council judges that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to the 2% medium-term target,” the ECB said in a statement. The announcement follows a first dip in 1 1/2 years for runaway euro-zone price gains and comes with the currency bloc probably already in recession. Reinforcing the action on borrowing costs, officials outlined plans for quantitative tightening — offloading government debt purchased as stimulus in the past. The plan envisages roll-offs in the Asset Purchase Program averaging €15 billion a month in the second quarter, with the pace beyond that yet to be determined. The euro pared an earlier drop and bonds fell. The single currency is about 0.4% lower versus the dollar at $1.064, after dropping as much as 0.7% prior to the announcement. European government bonds slid, with Italian debt underperforming. The ECB’s downshift on rates, along with similar moves this week by the Federal Reserve and the Bank of England, may reflect belief that the worst inflation in a generation — while not vanquished — is at least near its peak. That means the ceiling for borrowing costs could also be in sight. Policymakers in Frankfurt have already overseen the most forceful spell of monetary tightening in ECB history. Fresh projections, also released Thursday, will help determine how they proceed from here. With Russia’s war in Ukraine still raging, the predictions confirmed a challenging backdrop that includes economic expansion of just 0.5% in 2023. Forecasts for inflation, meanwhile, were raised for the next two years. It’s still seen above the 2% target in 2025.

 

The Bank of England said Britain’s inflation rate may already have peaked and that two of its policy makers believe interest rates are already high enough to drain pricing pressure. The UK central bank lifted its benchmark lending rate a half point to 3.5%, the ninth increase in a year aimed at taming soaring prices and the highest level since the start of the global financial crisis in 2008. “The majority of the committee judged that, should the economy evolve broadly in line with the November Monetary Policy Report Projections, further increases in bank rate may be required,” Governor Andrew Bailey wrote in a letter to Chancellor of the Exchequer Jeremy Hunt. The BOE’s half-point increase was in lock-step with moves of the same size from the US Federal Reserve last night and the European Central Bank later Thursday. Divisions on the BOE’s nine-member Monetary Policy Committee along the bank’s estimate that the UK is already in recession may further slow the pace of rate rises in the coming months. Governor Andrew Bailey said risks to the outlook for inflation remain tilted to the “upside” and that the BOE remains determined to bring inflation back to its 2% target. “Inflation may be coming down but it would be premature for the BOE to claim victory,” said Karen Ward, chief market strategist EMEA at JP Morgan Asset Management. “The BOE may be able to moderate the pace and speed of interest rate hikes, but we believe we are at least 100bps from the peak.” UK money market traders pared rate hike wagers, pricing interest rates will rise to 4.52% by August compared to 4.61% before Thursday’s half-point increase. The pound fell against both the euro and the dollar.

China will continue to relax its strict Covid-19 measures and will welcome more international travelers in the “near future,” the country’s ambassador to the US said Monday, in the latest sign from senior Chinese officials that the country is emerging from its Covid Zero isolation. “We know people’s concerns,” Ambassador Qin Gang told a Semafor event on China-Africa relations. “Now, the measures are being relaxed and in the near future I believe that measures will be further relaxed and the international travel will become easier.” Qin was answering a question about whether the Chinese government felt pressure to respond to widespread protests against coronavirus controls in China. Though he didn’t directly mention the protests, his remarks amounted to a rare — albeit oblique — acknowledgment of the protesters’ grievances. Chinese officials, including Qin, have previously defended China’ strict policies as necessary to prevent widespread deaths. They’ve also criticized Western nations including the US for what they called a lax approach. The ambassador has recently made the point that China is set on gradually opening up, saying in remarks to an event on Saturday that “China is adjusting and optimizing its response to the coronavirus epidemic, including international travel.” The number of flights in and out of China dropped drastically after country-wide Covid lockdowns began, and incoming passengers were subject to lengthy quarantine. In further evidence that controls are loosening, two US officials visited China in recent days to help prepare for a visit in the coming weeks by Secretary of State Antony Blinken. The top US diplomat’s trip will mark the highest level visit by a US official since Covid hit. In his comments on Monday, Qin used the term “dynamic readjustment,” a play on the “dynamic Zero Covid” policy of lockdowns, mandatory quarantines and isolation of close contacts that has been in place throughout mainland China. He also addressed concern that the measures had hit China’s economy, adding that the Chinese government recognizes the “coordination of Covid response and economic growth.” “The government is taking a very responsible attitude to protect people’s lives facing the threat of Covid,” Qin said. “And our response policy in these matters has always been dynamic, not rigid — you know, just lockdown and asking people to confine to their homes — that’s not true.” This is a step in the right direction for this globally important economy.