Weekly Update 8/25/2023: Fed Chair Powell Delivers Jackson Hole Speech

• Domestic Economic News
• Interest Rate Insight and the Fed
• Impactful International News

Domestic Economic News

US job growth was probably less robust in the year through March than previously reported, according to government data released Wednesday. The number of workers on payrolls will likely be revised down by 306,000 for March of this year, according to the Bureau of Labor Statistics’ preliminary benchmark revision. The downward adjustment was smaller than some economists expected. The final figures are due early next year. Last year, the government’s jobs reports showed hotter-than-expected payroll growth nearly every month. That persistent strength surprised economists time and again and was a key reason behind steady interest-rate hikes by the Federal Reserve. While the preliminary estimate suggests that strength was somewhat overstated, it doesn’t fundamentally alter the picture of a resilient and robust labor market that’s gradually cooling. With the latest estimate, March payrolls would be 0.2% less than the published figure of 155.5 million. The biggest downward adjustments were in transportation and warehousing, as well as professional and business services. Retail and wholesale trade payrolls are estimated to be revised higher. Once a year, the BLS benchmarks the March payrolls level to a more accurate but less timely data source called the Quarterly Census of Employment and Wages that’s based on state unemployment insurance tax records and covers nearly all US jobs. When the March payrolls figures are aligned to that count, the change is proportionally distributed across the year ended in March. First-quarter QCEW figures were also released Wednesday. Leading up to the data release, several economists had pointed out the discrepancy between the pace of payrolls growth and the weaker QCEW data through the end of 2022. Prior to the revisions, which will be incorporated into the data series with the release of the January jobs report in February 2024, employment gains averaged about 343,000 a month in the year through March. During that period, the unemployment rate hovered at or near its lowest level in decades.

US business activity expanded in early August at the weakest pace in six months, inching closer to stagnation amid sluggish demand. The immediate reaction was a decline in Treasury yields across the curve and this provided a boost to US equities in morning trading Wednesday after the release. The S&P Global flash composite output index fell 1.6 points to 50.4 in August as manufacturing continued to shrink and services activity cooled, the group reported Wednesday. Readings above 50 indicate growth. The figure raises concerns about the durability of the recent strength in retail sales. Service-sector activity slowed to the weakest pace in six months, and new business at both factories and services providers deteriorated. “Companies report that demand is looking increasingly lethargic in the face of high prices and rising interest rates,” Chris Williamson, chief business economist at S&P Global Market Intelligence, said in a statement. “A resultant fall in new orders received by firms in August could tip output into contraction in September as firms adjust operating capacity in line with the deteriorating demand environment,” Williamson said. The report offered mixed news on inflation. Costs of wages and materials accelerated, but growth in prices charged eased slightly as companies tried to stoke demand for goods and services. In Europe, private-sector activity shrank at the fastest pace since November 2020, according to separate S&P Global data for the euro area. We cover that in more detail in our international section below. Tepid demand, fewer orders and shrinking backlogs prompted some US companies to reduce staffing levels and others to rein in hiring. The group’s measure of employment came close to stagnating as a result, retreating to its lowest level since mid-2020. On a brighter note, companies were more upbeat about the outlook, buoyed by hopes of a stabilization in interest rates and inflation.

In other general US economic news, US durable goods orders for the month of July fell 5.2% - we hope the Fed was paying attention to this one! The expectation was for the drop to be 4.0%. Applications for US unemployment benefits fell to the lowest level in three weeks, suggesting demand for workers is still healthy. Initial claims decreased by 10,000 to 230,000 in the week ended Aug. 19, according to Labor Department data out Thursday. The median estimate in a Bloomberg survey of economists called for 240,000 applications. On an unadjusted basis, claims declined last week to around 198,000, the lowest since October. However, the drop was offset somewhat by the biggest jump in applications in Hawaii since the onset of the pandemic after devastating wildfires. The report broadly showcases a labor market that has remained strong and is supporting renewed momentum in the economy. Employers are still hiring at a healthy pace, and the wave of layoffs that made headlines earlier this year seems to be abating.

Housing data was generally negative this week. Sales of previously owned US homes fell in July to the lowest level since the start of the year, constrained by a lack of inventory and higher borrowing costs. Contract closings decreased 2.2% from a month earlier to a 4.07 million annualized pace, National Association of Realtors data showed Tuesday. The rate, which is close to the slowest since 2010, was weaker than nearly all estimates in a Bloomberg survey of economists. Sales were down more than 18% from a year earlier on an unadjusted basis. Homeowners have been discouraged from listing their properties as mortgage rates have more than doubled over the past few years, keeping asking prices elevated. More recently, the average 30-year fixed rate has pushed well above 7% to the highest level in more than two decades, suggesting demand will continue to struggle. The combination of inventory constraints in the resale market and higher borrowing costs is steering some prospective buyers toward new construction, while others have pulled out altogether. “Two factors are driving current sales activity – inventory availability and mortgage rates. Unfortunately, both have been unfavorable to buyers,” Lawrence Yun, NAR’s chief economist, said in a statement.

US mortgage applications for home purchases stumbled last week to an almost three-decade low, indicating residential real estate is reeling from the recent spike in borrowing costs. The Mortgage Bankers Association index of home-purchase applications fell 5% to 142, the lowest level since 1995. The Wednesday data also showed that the contract rate on a 30-year fixed mortgage increased 15 basis points to 7.31% in the week ended Aug. 18 — the highest since late 2000. Including a decline in refinancing activity, the overall measure of mortgage demand dropped 4.2%. Borrowing costs have continued to rise so far this week, and Mortgage News Daily, which updates more frequently, put the 30-year fixed rate at almost 7.5% on Tuesday. Mortgage rates are benchmarked to US Treasuries, and yields on those securities have been climbing as traders increasingly see a resilient economy keeping interest rates higher for longer. Federal Reserve minutes from policymakers’ gathering last month showed most officials still saw significant upside risks to inflation, which could require further rate hikes. That’ll keep mortgage rates elevated and, along with still-high home prices, put further strain on a residential housing market that had been showing promise earlier in recent months. The latest housing data further illustrate the trend — homeowners are reluctant to move and take on a higher mortgage rate, so prospective buyers are seeking out new construction instead. The MBA’s overall gauge of mortgage applications, which also includes refinancing, fell to 184.8, near the lowest level since 1996. The survey, which has been conducted weekly since 1990, uses responses from mortgage bankers, commercial banks and thrifts. The data cover more than 75% of all retail residential mortgage applications in the US.

Interest Rate Insight and the Fed

Federal Reserve Chair Jerome Powell said the US central bank is prepared to raise interest rates further if needed and intends to keep borrowing costs high until inflation is on a convincing path toward the Fed’s 2% target. “Although inflation has moved down from its peak — a welcome development — it remains too high,” Powell said in the text of a speech Friday at the US central bank’s annual conference in Jackson Hole, Wyoming. “We are prepared to raise rates further if appropriate, and intend to hold policy at a restrictive level until we are confident that inflation is moving sustainably down toward our objective.” The Fed chief welcomed the slower price gains the US economy has achieved thanks to tighter monetary policy and further loosening of supply constraints after the pandemic. However, he cautioned that the process “still has a long way to go, even with the more favorable recent readings.” At the same time, Powell suggested the Fed could hold rates steady at its next meeting in September, as investors expect. “Given how far we have come, at upcoming meetings we are in a position to proceed carefully as we assess the incoming data and the evolving outlook and risks,” he said. The remarks were in line with Powell’s character and communication for all of 2023: He is singularly focused on the mission of restoring price stability, and further tightening remains on the table to get back to 2% if necessary.

Policymakers are entering a new phase of their campaign to bring inflation back to the Fed’s 2% target. After aggressive interest-rate increases in 2022, Powell and his colleagues have slowed the pace this year, and signaled they may be close to wrapping up rate hikes. The question now is how long they hold at a restrictive level and how the economy performs under those conditions. Officials raised their benchmark rate last month to a range of 5.25% to 5.5%, a 22-year high, after skipping a rate increase at their June meeting. Their most recent projections had one more rate increase penciled in this year. Powell signaled Friday that policy has shifted to a more deliberative phase where risk-management is now “critical.” He noted the economy may not be cooling as fast as expected, saying recent readings on economic output and consumer spending have been strong. The economy grew at a 2.4% annualized pace in the second quarter, a surprisingly robust reading that prompted many economists to boost forecasts for the third quarter and reconsider odds of a recession. “Additional evidence of persistently above-trend growth could put further progress on inflation at risk and could warrant further tightening of monetary policy,” Powell said. He also pushed back on speculation that the central bank could raise its inflation target, an idea that has been hotly debated mostly by academics in recent months. “Two percent is and will remain our inflation target,” he said. Overall there were no real surprises in his speech and it was well thought out. It reinforces our belief that the Fed will be data dependent moving forward and will react accordingly.

Impactful International News

Chinese banks kept a key interest rate that guides mortgages on hold and made a smaller-than-expected cut to another rate, surprise moves that reflect Beijing’s difficult choice between boosting confidence and safeguarding the banking system’s stability. The five-year loan prime rate was left at 4.2% on Monday, according to data from the People’s Bank of China. Most economists had predicted the rate to be cut by 15 basis points following a similar reduction last week to a key central bank policy loan rate. That was seen as a precursor for a cut to the 5-year LPR. The one-year LPR was lowered by 10 basis points to 3.45 from 3.55%, a smaller cut than most economists predicted. The moves highlight a dilemma facing Beijing as it seeks to boost borrowing by cutting interests rates while at the same time needing to preserve financial stability. Lower lending rates would reduce banks’ revenue and profitability, with the PBOC highlighting those risks in a report last week. “Protecting banks’ net interest margins is the main motivation behind the smaller-than-expected cuts to LPR in our view,” Goldman Sachs Group Inc. economists including Maggie Wei wrote in a note. “Having said that, confidence remains key to an economic recovery, and the disappointing cut to LPR would not help with building confidence.” Stocks in China and Hong Kong declined on Monday. A gauge of Chinese firms listed in Hong Kong fell as much as 1.9% to the lowest since November. The offshore yuan extended a modest decline against the dollar, weakening about 0.3%. China 10-year bond yields fell two basis points to 2.55%, the lowest since 2020. The government has signaled more urgency in shoring up growth for the world’s second-largest economy as borrowing demand slumps, deflation pressures take hold and confidence struggles to recover. Investors are also concerned about contagion risks following a liquidity crisis at a major shadow bank. We follow events in China as many SGK Core Holdings do business over there.

The contraction of private-sector activity in the euro area intensified, leading investors to bet that the European Central Bank will pause its campaign of interest-rate hikes next month. Services in August ceased being a bright spot and followed the industrial sector into a downturn in the region’s top two economies, prompting the shift in market wagers and sending bond yields and the euro tumbling. The figures also brought warnings that output in the 20-nation bloc will shrink this quarter. The flash Purchasing Managers’ Index for the region fell to 47, further below the 50 threshold indicating growth. Services activity shrank for the first time since end-2022, while the expectation was for continued expansion in a sector that had until recently seen robust demand. Separate data for the UK showed private-sector firms suffered their first contraction in seven months. “The PMIs were very weak and highlight the dire outlook for Europe’s largest economy and the risks ahead of the September ECB policy meeting,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole. The figures were particularly dire in Germany, where overall activity declined at the fastest pace since the first wave of the pandemic brought the economy to a screeching halt in May 2020. France reported a third monthly drop in output, while the rest of the region contracted more moderately. The data indicate that the euro area will shrink by 0.2% in the third quarter, compared with 0.3% growth in the three months through June, according to Cyrus de la Rubia, chief economist at Hamburg Commercial Bank. “It strengthens the hands of those arguing for a ‘pause’ in September,” said Dirk Schumacher, an economist at Natixis SA. “The economy is clearly not doing well given these figures.” European bonds rallied, with the 10-year German yield falling as much as 12 basis points to 2.53%, its lowest in nearly two weeks. Traders now price a 40% chance of a quarter-point ECB hike next month, compared to 55% before the release. Here’s what the Bloomberg Economics Says: “The Governing Council remains worried about upside risks to the inflation outlook and our current view is that this will prompt them to deliver a last rate hike in September. But signs of a slowdown in the economy may well dominate and force the Governing Council to pause” —Maeva Cousin, economist.

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