- GDP falls for second quarter
- IMF reduces global growth forecast
- Walmart warns about inventories
- Multiple SGK Core holdings report earnings
The Federal Open Market Committee (FOMC) decided to raise its benchmark federal funds rate by 75 basis points (0.75%) on Wednesday. Fed Governors unanimously agreed to the change which brings the funds range to between 2.25% and 2.50%. During the post-meeting conference call, Chairman Powell said it was too soon to say whether the Fed was looking to decrease the size of its hikes in the future, but he did say at some stage that it would be appropriate to slow the pace to assess the cumulative impact. He did not want to be boxed into giving a specific rate like he and other governors did prior to the previous meeting in June, only to change their minds at the last minute and cause a mini-commotion in the markets which fell in the subsequent days. “These rate hikes have been large, and they’ve come quickly,” Mr. Powell said on Wednesday, referring to the Fed’s four consecutive rate increases since March. “And it’s likely that their full effect has not been felt by the economy, so there’s probably some significant additional tightening in the pipeline.” Remember it was only five months ago that the funds rate was nearly 0%. With Wednesday’s action, the central bank has raised rates since March as much as it did between 2015 and 2018. It takes time for these hikes to make their way through the economy especially when they are raised this rapidly. While markets react nearly immediately and companies will respond quickly with higher mortgage and car loan rates, for example, it takes time for the average consumer then to decide whether to go ahead with that condo purchase or maybe search for a cheaper car. “Are we seeing the slowdown in economic activity that we think we need?” Mr. Powell said. “There is some evidence we are, at this time.” And that is exactly what the Fed wants to see. Please read the quarterly commentary which goes into much more detail about what the Fed is trying to do and the lengths it is willing to go to achieve its goal.
The next FOMC meeting is eight weeks away which is nearly an eternity in the markets. There will be multiple payroll reports, consumer and wholesale price readings, residential home transaction data and consumer confidence surveys before September 21 arrives. Additionally, the Jackson Hole, Wyoming symposium of global bankers will take place next month where economists from around the globe get a chance to compare notes and further contemplate monetary policy. Many former Fed leaders made noteworthy speeches at this venue. Will this year mark another? We will see. Futures markets are anticipating Fed hikes through the remainder of the year but are pricing in rate cuts in the second half of next year. In the interim, we will continue to monitor the markets and economic data which this week had a first peek at GDP for the April through June period.
GDP, Housing and IMF Data
The Commerce Department reported yesterday that U.S. second quarter GDP fell at an inflation and seasonally adjusted annual rate of 0.9%. That followed a 1.6% contraction in the first quarter and a 6.9% growth pace in the final quarter of 2021. Does this qualify as a recession given that there are now two consecutive quarters of GDP shrinkage? Nope. The official arbiter of recessions in the U.S. is the National Bureau of Economic Research (NBER), which defines one as a significant decline in economic activity, spread across the economy for more than a few months. Its Business Cycle Dating Committee considers factors including employment, output, retail sales and household income among other items. The back-to-back declining period is certainly a trend but is not the sole defining characteristic of what makes an official downturn. The last recession—in March 2020—did not even last more than two quarters in total from start to finish. Chairman Powell said he did not believe that we are currently in a recession given the solid labor market with the national unemployment rate near a 40-year low. Granted, in hindsight, the NBER may declare this period as part of a recession but it will likely take a while for that announcement to be made, and it is premature to use just GDP as the deciding factor. Whether the economy is in a recession or just a period of deceleration, the fact is that markets are worried about it. Consumer spending, which accounts for roughly two-thirds of total economic output, rose at a 1% annual rate in the second quarter, down from 1.8% in the first quarter. With the unemployment rate so low, the capacity to spend continues to be high which suggests that any slowdown may be shallow or brief or both. While business travel has been slow to rebound post-pandemic, leisure travel and entertainment remains a growth industry.
Inventories were a meaningful component of the second quarter GDP figure. They subtracted 2.01 percentage point from GDP. A shift in consumer spending away from goods and back toward services, and rising prices cutting into people’s buying power, left many companies with stockpiles of products they are now discounting to unload. Somewhat ironically, when inventories get liquidated it is a subtraction to GDP because it does not count towards the production of goods or services. It is the replenishment of inventories as factories gear up and raw materials get transformed into finished goods which boosts output. That pace of restocking has now slowed because people are not trapped in their houses or apartments shopping online but taking vacations for the first time in years. Even in areas where demand remains solid for hard goods—like automobiles—continued supply chain woes are limiting capacity and now with interest rates rising, the question is whether consumers will continue to seek out cars and trucks like they have in the recent past. Excluding inventories does not paint much of a better picture. Final sales to domestic purchasers—a subset of GDP that doesn’t include the often-volatile categories of inventories and trade—fell at a 0.3% annualized pace in the second quarter, after rising at a 2% pace in the first.
Sales of new homes fell in June to a more than two-year low based on Commerce Department data. New single-family homes fell 8.1% in June to a 590,000 annualized pace from a downwardly revised 642,000 in May. The number was below the Bloomberg survey of economists of 655,000. High prices and rising mortgage rates have frightened prospective buyers over the past few months. The average rate on a 30-year mortgage note according to Freddie Mac is double the rate it was a year ago. The median sales price rose 7.4% from a year earlier to $402,400. Of the 457,000 new homes for sale, 91% are under construction or not yet started. This suggests that this backlog will have to be worked down somewhat before there can be an upturn in new home sales. It would take 9.3 months to exhaust the current supply of new homes compared to 8.4 months in the prior month at the current sales pace.
Meanwhile on a global basis, the International Monetary Fund (IMF) lowered its estimate for global growth again for 2022 and 2023. Compared to 6.1% growth last year, the organization now sees world economic growth slowing to 3.2% this year. That forecast has repeatedly been cut this year from 4.9% last October to 4.4% in January and most recently 3.6% in April. Growth is expected to slow further next year, falling to 2.9%. The IMF warned that it could cut its estimates further if the European gas situation worsens as a result of the Ukraine war and if inflation continues to grow in developed countries hastening more monetary tightening by central banks. And lest we forget, Covid-19 outbreaks remain an important variable in many countries especially with zero-Covid policies embraced by the world’s second largest economy China. IMF chief economist Pierre-Olivier Gourinchas said taming inflation must be the first priority for policy makers, even if it means slowing down economic activities in the short term. “Bringing down inflation in a timely manner is also creating the conditions for stable growth and a stable macroeconomic environment in the years ahead,” he said.
Income and Spending and Labor Costs
In June, the personal consumption expenditures (PCE) price index rose 1% from a month earlier and was up 6.8% since June of last year according to Commerce Department data. This was the largest gain in the past 40 years. The Fed likes to use this monthly index over price indices like the consumer price index (CPI) because of its comprehensiveness and historical record. Excluding the more volatile food and energy components, the PCE rose 4.8% annually. Personal income rose 0.6% last month and personal spending was higher by 1.1%.
Today also saw the release of quarterly data covering employment costs. The employment cost index (ECI) rose 1.3% in the second quarter according to the Labor Department. The median estimate in a survey of Bloomberg economists was for a 1.2% gain. On Wednesday, Chairman Powell said the ECI was a key indicator because it adjusts for the composition of employment. That is, the ECI is not distorted by employment shifts among occupations or industries and thus can reveal key insights into labor market tightness. Compared with a year earlier, the ECI rose 5.1%, a new record gain with data stretching back to the early 2000s. The ECI rose at a record 1.4% in the first quarter of this year and this quarter marks a fourth consecutive quarter with gains above 1%. Thus, the pressure on the Fed to keep its monetary tightening program intact continues.
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