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Weekly Update 6/10/2022: Fed Interest Rate Hikes to Continue on Elevated Inflation Figures

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Domestic Economic News

The US trade deficit shrunk in April by the most on record in dollar terms, reflecting a drop in the value of imports amid Covid lockdowns in China while exports climbed. The gap in goods and services trade narrowed $20.6 billion, or 19.1%, to $87.1 billion, Commerce Department data showed Tuesday. The median estimate in a Bloomberg survey of economists called for an $89.5 billion deficit. The figures aren’t adjusted for inflation. Imports dropped in April as factory activity in China fell to the lowest level since February 2020 amid strict lockdowns to curb the spread of Covid-19. While manufacturing in the country has improved somewhat since, the measures are still straining already-tenuous global supply chains, especially when coupled with Russia’s war in Ukraine. The deficit with China decreased in April by $8.5 billion, the most in seven years. Imports dropped $10.1 billion, also the most since 2015. Decades-high inflation is expected to weigh on trade this year, with the World Trade Organization cutting its forecast for growth in global merchandise volumes. So far though, in the US, that hasn’t materialized yet, judging by the near-record amounts of goods that arrived at the ports of Los Angeles and Long Beach in April. In the first quarter, the widening of the trade deficit largely explained the economy’s worst performance since the pandemic recovery began, with gross domestic product shrinking at a 1.5% annual pace. That’s because the value of products American businesses and consumers bought from overseas outpaced purchases of US goods and services by other economies.

The value of imports of goods and services decreased 3.4% in April to $339.7 billion, the first drop since July in a broad-based decline. Exports increased 3.5% to a record $252.6 billion. US merchandise imports plunged from a record in March, dropping 4.4%, the most since April 2020, reflecting a decline in inbound shipments of consumer goods, industrial supplies, capital goods and automobiles. Retailers like Target Corp. and Walmart Inc. are trying to offload excess inventory, accumulated in part as consumers shift more of their spending from goods to services. That may portend fewer imports going forward. On an inflation-adjusted basis, the April merchandise-trade deficit narrowed 14.2% to $116.2 billion.

Three of the key supply-side factors driving today’s global inflation levels have already turned around, meaning relief could be on the horizon for shoppers worldwide. A bellwether semiconductor price -- a barometer of costs of finished electronics products as diverse as laptops, dishwashers, LED bulbs, and medical devices delivered worldwide -- is now half its July 2018 peak and down 14% from the middle of last year. The spot rate for shipping containers -- which tells us more about expenses we can expect later in the pipeline for apparel in Chicago, luxury items in Singapore or home furnishings in Europe -- has declined 26% since its September 2021 all-time high. North America’s fertilizer prices -- an indicator of where global food inflation is going, including bills for tomatoes in London or onions for sale in a Johannesburg market -- is 24% below its record high in March. With inflation now exceeding 8% in the euro area, expected to stay above that level in the US when May data comes out on Friday and on the march in Asia too, central bankers around the world are scrambling to contain it. Even as central bankers raise rates, more economists are coalescing around the idea that peak inflation is behind us -- though there will be a lag before the lower costs of raw materials filter through to the prices shoppers see. Though few forecasters are predicting a return to pre-pandemic prices in the short run, global retail giants like Target are now struggling to unload bloated inventory to a less enthusiastic shopper. So a moderation in those supply-side pressures could eventually allow central bankers to slow their tightening cycles.

“While inflation in some parts of the world are yet to peak, there are at least some signs emerging that we may not be too far off in terms of a turning point at which we start to see the annual inflation rate start to head lower,” said Khoon Goh, Singapore-based head of Asia research at Australia & New Zealand Banking Group. China’s producer prices peaked in late 2021 and are beginning to moderate. Economists are forecasting a 6.5% rise in factory prices in May from a year earlier, down from 8% in April. That’s a promising development for relief in imported-goods inflation worldwide, said Goh. In addition, lower container freight rates and improving supplier delivery times in purchasing managers indexes point to easing bottlenecks that should curb price pressures later this year, he said. As we have been mentioning, we expect to see today’s elevated inflation rates come down in the second half of the year and we need to be patient right now in anticipation of that development.

Applications for US state unemployment insurance rose by the most in nearly a year during the week that included the Memorial Day holiday. Initial unemployment claims climbed broadly across states by 27,000 to 229,000 in the week ended June 4, Labor Department data showed Thursday. The figure topped all estimates in a Bloomberg survey of economists. On an unadjusted basis, claims rose by about 1,000. Continuing claims for state benefits held at 1.3 million in the week ended May 28. The jobless claims data, which can be choppy from week to week, tend to be especially volatile around holidays. The four-week moving average, which smooths out such swings, rose by 8,000 to 215,000. It’s been creeping higher. “Claims data can be noisy around holidays,” said Nancy Vanden Houten, lead US economist at Oxford Economics. “However, while we think labor markets are still currently quite tight, we can’t totally dismiss the notion that the rise in claims is a sign of a modest rise in layoffs.” While initial claims continue to hold near pre-pandemic levels, the marked jump in applications, if sustained, could signal a softening in the job market in the coming months. By increasing interest rates, the Federal Reserve is trying to cool demand broadly in the economy -- including for labor -- in an effort to curb decades-high inflation, which could increase unemployment. The claims data follow last week’s jobs report, which showed US employers hired at a robust clip in May while wage gains held firm, suggesting the economy continues to power forward and that firms had success filling open positions. Georgia, Florida and Pennsylvania posted the largest increases in unadjusted applications.

Interest Rate Insight and the Fed

US inflation hit a fresh 40-year high in May, unexpectedly accelerating in a broad advance that pressures the Federal Reserve to extend an aggressive series of interest rate hikes. The consumer price index increased 8.6% from a year earlier, Labor Department data showed Friday. The widely followed inflation gauge rose 1% from a month earlier, topping all estimates. Shelter, food and gas were the largest contributors. The so-called core CPI, which strips out the more volatile food and energy components, rose 0.6% from the prior month and 6% from a year ago, also above forecasts. The figures reinforce that inflation is still heated by many measures, and that the Fed -- which has committed to half point hikes at each of its next two meetings, starting next week -- will have to maintain that aggressive stance through its September gathering. Record gasoline prices and geopolitical factors threaten to keep inflation high in the coming months, suggesting the Fed will have to pump the brakes on the economy for longer. Treasury yields rose, stock futures fell and the dollar rose after the report all of which is not surprising to us. In May, prices for necessities continued to rise at double digit paces. Energy prices climbed 34.6% from a year earlier, the most since 2005, including a nearly 49% jump in gasoline costs. Gas prices so far in June have climbed to new highs, signaling more upward pressure in coming CPI reports and therefore keeping the Fed in the hot seat. Grocery prices rose 11.9% annually, the most since 1979, while electricity increased 12%, the most since August 2006. Rent of primary of residence climbed 5.2% from a year earlier, the most since 1987. There are growing risks that price pressures in those categories will continue to build. Russia’s ongoing war in Ukraine, as well as stepped-up related sanctions; potential port disruption due to the upcoming West Coast dockworker contract expiration; Covid-related lockdowns in China and drought and could all contribute to higher prices for food and energy.

Traders were hoping for signs that inflation has peaked and this report did not deliver on that. Bonds have become more attractive given the trend to higher rates this year, which continued after the report Friday, while equities, particularly those with the potential for rising dividends and free cash flows over the long term, remain a good long term inflation hedge. There is no question this is a challenging period for markets but we remain focused on the long term opportunities in the securities we own and emphasize that this period requires patience to weather. The Fed is on the right path and at some point supply issues will begin to alleviate and higher interest rates will cool demand which will have the desired effect on the headline inflation numbers. Mortgage rates being above 5% for a sustained period for example will cool the housing market – it just has not shown up in the headline inflation figures yet. Some factors in the inflation figure calculations have begun to ease – it just take time for that to show in the numbers. Traders – both fixed income and equity traders – are pricing in an aggressive Fed policy stance and the likelihood that will continue for the foreseeable future. Overall we feel we are well positioned to weather the current environment and come out ahead in the long term.

Impactful International News

Stocks rallied at the open Monday after Beijing’s latest move to ease Covid restrictions boosted speculation this would help abate supply-chain pressures. Chinese regulators are set to ease curbs on ride-hailing giant Didi Global Inc. and other US-listed tech firms, which helped lift sentiment as well. Chinese regulators are preparing to wrap up their investigation into Didi Global Inc. and restore the ride-hailing giant’s main apps to mobile stores as soon as this week. Regulators are also finishing up their probes into data security at two other firms, Full Truck Alliance Co. and online recruitment platform Kanzhun Ltd. Agencies including the Cyberspace Administration of China told executives from the three companies of their plan during meetings last week. The three companies are expected to face financial penalties, including a relatively large fine for Didi, the report cited some of the people as saying. All three will also offer to transfer 1% of their shares to the state, giving officials greater say in running the business, the Journal reported. The news sent the Hang Seng Tech Index up 2.7% in Hong Kong trading Sunday night/Monday morning. Investors have been awaiting the outcome of the probe into Didi, launched in July after the ride-hailing firm proceeded with its $4.4 billion US IPO despite Beijing’s objections. “It is a sign that regulators are following through on their pledge to end the crackdown on tech platforms, which will likely continue to improve sentiment on the sector,” Bloomberg Intelligence analyst Marvin Chen said. The report coincides with expectations that the government is pumping the brakes on its yearlong crackdown on tech, to avoid further damaging the economy given all the issues they have had lately with their Covid crackdowns.

The euro-area economy expanded by more than estimated at the start of 2022, though the upgrade was driven by trade and revealed pressure on consumers. Output rose 0.6% from the previous three months in the first quarter -- exceeding an earlier reading for a 0.3% advance released last month. But even as employment increased 0.6%, consumption fell 0.7% amid lingering lockdowns, Eurostat said Wednesday. The 19-member currency bloc is facing contradictory forces as the loosening of Covid-19 restrictions coincides with Russia’s war in Ukraine. While households and businesses are suffering from surging prices, the services sector is seeing strong demand and tourism is gearing up for a bumper summer season. The underlying momentum is emboldening European Central Bank officials to pare back stimulus, with a first interest-rate hike in more than a decade probably coming in July. The ECB presented new economic forecasts on Thursday as the Governing Council wraps up a two-day meeting to decide on its next policy steps.

The European Central Bank brought down the curtain on years of ultra-loose policy, committing to a quarter-point increase in interest rates next month and opening the door to a bigger hike in the fall. Announcing a first rise in borrowing costs in more than a decade to confront record inflation, the ECB on Thursday outlined a slightly more aggressive plan for increasing borrowing costs than economists had expected. With fresh forecasts showing a faster path for euro-zone prices than earlier thought, it will cease large-scale asset purchases on July 1. “If the medium-term inflation outlook persists or deteriorates, a larger increment will be appropriate at the September meeting,” the ECB said in a statement. Beyond that, “based on its current assessment, the Governing Council anticipates that a gradual but sustained path of further increases in interest rates will be appropriate.” That would bring the deposit rate to at least zero by the end of the third quarter, from -0.5% at present, concluding an eight-year stint of negative borrowing costs and affirming a plan laid out earlier by President Christine Lagarde. “We are on a journey,” Lagarde told a news conference in Amsterdam as the ECB returns to holding one policy meeting a year outside its Frankfurt base following the pandemic. “This is an important step in that journey.” The euro rose against the dollar, climbing 0.5% to $1.0767, the highest since May 31. Traders increased bets on rate hikes, predicting 150 basis points of increases by December. Thursday’s decisions crystallize the ECB’s exit from years of stimulus and suggest a faster trajectory than economists surveyed by Bloomberg had predicted. Policy makers have lagged behind peers, with more than 60 other global central banks already having raised rates this year. The announcements follow another unexpectedly steep surge in euro-area inflation, which stood at 8.1% in May -- more than four times the target. Soaring prices are squeezing households across the continent, with governments spending billions of euros to shield people from a spike in energy costs driven by Russia’s invasion of Ukraine. The relentless inflation had fed a fierce debate among ECB officials over how aggressive the response should be, with a sizable contingent pushing to consider a half-point hike matching the most recent move by the Federal Reserve. The ECB now sees price growth averaging 2.1% in 2024 -- exceeding its 2% goal.


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