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Weekly Update 7/15/2022: Inflation Figures

  • CDK Global purchase of our core company is completed by Brookfield and cash proceeds are added to our SGK Portfolios
  • Omnicom board affirms 70 cent per share per quarter dividend
  • JP Morgan & Wells Fargo release earnings setting aside loan loss reserves on a precautionary basis but citing the strength of U.S. business and U.S. consumers
  • Boeing sees best month for aircraft deliveries since March 2019
  • Accenture wins a 10-year, $199 million contract from the U.S. Department of Homeland Security; they also announce the acquisition of The Stable
  • CACI International wins a $557.8 Million US Navy contract to help transition to updated technology systems
  • Microsoft is chosen by Netflix as the technology and sales partner for its new advertising-supported streaming service

Domestic Economic News

US inflation accelerated in June by more than forecast, underscoring relentless price pressures that will keep the Federal Reserve on track for another big interest-rate hike later this month. Fed fund futures were pricing in a 1 in 2 chance for a 100 basis point rate hike. We feel that is a distinct possibility given the numbers released Wednesday. We still feel that sharper moves higher now will ease pressure on them to make big moves later in the year and that should provide relief for the broader market towards year end. The consumer price index rose 9.1% from a year earlier in a broad-based advance, the largest gain since the end of 1981, Labor Department data showed Wednesday. The widely followed inflation gauge increased 1.3% from a month earlier, the most since 2005, reflecting higher gasoline, shelter and food costs. Economists projected a 1.1% rise from May and an 8.8% year-over-year increase, based on the Bloomberg survey medians. This was the fourth-straight month that the headline annual figure topped estimates. This was not unexpected by us because the figures are backwards looking and in June fuel prices were rising sharply for example. That has moderated here in July so far.

The so-called core CPI, which strips out the more volatile food and energy components, advanced 0.7% from the prior month and 5.9% from a year ago, above forecasts. Treasury yields and the dollar jumped, while US stock futures fell following the report. While many economists have suggested this data will be the peak in the current inflationary cycle, several factors such as housing stand to keep price pressures elevated for longer. Geopolitical risks including Covid lockdowns in China and Russia’s war in Ukraine also pose risks to supply chains and the inflation outlook. Fed policy makers have already signaled a second 75 basis-point hike in interest rates later this month amid persistent inflation as well as still-robust job and wage growth. Even before the data were released, traders had already fully priced in a three-quarter percentage-point hike for July.

A key measure of US wholesale and business prices jumped in June by more than forecast, though some signs of cooling inflationary pressures began to emerge that may eventually spell relief for consumers. The producer price index for final demand increased 11.3% from June of last year and 1.1% from the prior month, Labor Department data showed Thursday. Three-fourths of the advance last month was due to goods, particularly energy. Excluding the volatile food and energy components, the so-called core PPI climbed 0.4% from a month earlier. The 8.2% gain from a year ago was the smallest since November. The median forecasts in a Bloomberg survey of economists called for a 10.7% year-over-year increase for the overall PPI and a 0.8% monthly advance. While the figures show persistent cost pressures, producers are starting to find some respite as commodities prices come off the boil on concerns about the demand outlook. Over the last several weeks, measures of food, raw industrial materials and crude oil all fell sharply.

Applications for US state unemployment insurance rose to the highest level since November during the week that included the July 4th holiday, led by a big jump in New York. Initial unemployment claims increased by 9,000 to 244,000 in the week ended July 9, Labor Department data showed Thursday. The median estimate in a Bloomberg survey of economists called for 235,000 applications. Continuing claims for state benefits fell to 1.33 million in the week ended July 2. The rise in unemployment claims comes as more companies announce job cuts amid increasing fear of a US recession. While the labor market has so far held strong in the face of rising interest rates, the Federal Reserve may ratchet up its fight against decades-high inflation with even bigger hikes, which could curb demand for workers. In recent weeks, companies such as Alphabet Inc.’s Google and Microsoft Corp. have said they’ll slow hiring in a time of global economic uncertainty. While many of the job-cut announcements have come from the tech sector, others in housing, autos and energy have also warned of letting workers go. 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 3,250 to 235,750. It’s been gradually creeping higher. With their still an abundance of job openings for every available worker there is likely a trend for companies to want to hold onto workers they have in case a recession proves to be mild.

US retail sales climbed in June by more than forecast in a broad advance, suggesting resilient consumer spending despite decades-high inflation and potentially raising the prospects of an even larger Federal Reserve interest-rate hike this month. The value of overall retail purchases increased 1%, after an upwardly revised 0.1% decline in May, Commerce Department figures showed Friday. The figures aren’t adjusted for inflation. The median estimate in a Bloomberg survey of economists called for a 0.9% advance in overall retail sales from a month earlier. While the figures aren’t adjusted for prices, the better-than-expected results indicate that consumer demand is holding up despite Federal Reserve policy aimed at tamping it down. Fed officials are watching the retail sales data, along with other releases due Friday and next week, to determine whether to raise interest rates by 75 basis points at their meeting later this month, or consider a larger, 100 basis-point hike. Traders boosted bets on a the larger-sized hike following the report, while wagering that a 75 basis-point move remained the most likely outcome. Nine of the 13 retail categories showed increases last month, according to the report, including furniture stores, e-commerce and sporting-goods stores. Sales at gasoline stations rose by 3.6%, following a 5.6% advance in the prior month, and driven by a surge in gas prices to more than $5 a gallon in mid-June. Prices have since fallen sharply, suggesting the figures could soften in the July data. Overall this was a positive report and equity futures responded accordingly in the early going Friday.

Interest Rate Insight and the Fed

Given the inflation data this week along with comments by several Fed officials, the futures market on Wednesday was forecasting a 0.91% rate increase at the July meeting. So the market was basically telling us that the likelihood of a 1% increase in the fed funds is very high and that we can expect at a minimum a 75 basis point increase when the Federal Open Markets Committee (FOMC) next meets July 26th and 27th. The Treasury yield curve further inverted in Wednesday trading as the 2 year rate was 3.23% in midday trading while the ten year was at 3.00%. If the fed does in fact raise rates the 1% as expected we are likely not going to see as aggressive a policy later in the year. We have seen commodity prices in particular roll over and come down on concerns over a slowing economy. Oil for example declined 4% in midday trading Wednesday and was trading back around the $92 per barrel level which we have not seen for a while. If the trend continues this should provide some relief when we receive inflation figures for July in early August. After the July meeting the FOMC does not meet until September so there will be a lot of data points for them to digest between meetings. As we have indicated and wrote about in our just distributed SGK Quarterly write-up, this environment requires a good deal of patience.

Impactful International News

The euro has suffered a swift and brutal slump this year, and now it’s crossed a major threshold for the first time in more than two decades: parity with the dollar. The 12% decline is the result of multiple pressures, from the war in Ukraine to an energy crisis and the growing risk that Russia cuts off gas exports and pushes the euro area into recession. Add in central banks moving at vastly different speeds and an in-demand dollar, and some analysts say parity may not be the end point, but merely a stepping stone to further weakness. Here at SGK we do like to point out that it is a very good time to be receiving our dividend payments from our core stock holdings and our interest payments from our investment grade bonds in the mighty U.S. dollar. We have heard from numerous clients traveling overseas our dollar is going further than they can remember at any other time in the past.

The common currency slipped as much as 0.4% Wednesday to touch a low of $0.9998. The latest leg lower came after US inflation accelerated in June by more than forecast, boosting bets on Federal Reserve rate hikes. It bounced back to trade at around $1.002 as of 2:10 p.m. in London. The downward spiral hasn’t been accompanied by the type of existential doubts that hung over the euro when it plunged during its infancy in the early part of this century, or when the sovereign debt crisis took hold a decade ago. However, it’s still a problem for the European Central Bank. It’s also trouble for consumers in the 12 trillion-euro economy, feeding an inflation spike that’s already out of control, with prices rising at a record pace close to 9%. The depreciation has been incredibly rapid, given the euro was trading close to $1.15 in February. It’s all the more remarkable given that less than two years ago ECB policymakers were concerned about excessive euro strength leading to an inflation undershoot. Now they confront a different world: a dramatic plunge in their currency and consumer prices surging. Some ECB policy makers have already signaled that the weakness is on their minds, particularly when it comes to imported inflation. Earlier Wednesday, Francois Villeroy de Galhau said the central bank is watching the euro’s drop because of its effect on consumer prices. In addition to the dual inflation-recession threat, the ECB is also dealing with the risk of sovereign borrowing costs diverging too much as it reverses course on stimulus. After Italian yields spiked last month, the Frankfurt-based institution began work on a tool to prevent the eruption of another debt crisis in the region.


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