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Weekly Update 8/26/2022: Powell Reaffirms Fed’s Commitment to Reigning in Inflation in Jackson Hole Speech

  • Dick’s Sporting Goods releases earnings beating profit and revenue expectations; they also raise 2022 fiscal year guidance

Domestic Economic News

The week started out on a negative note as sales of new US homes fell in July for the sixth time this year to the slowest pace since early 2016, extending a months-long deterioration in the housing market fueled by high borrowing costs and a pullback in demand. Purchases of new single-family homes decreased 12.6% to a 511,000 annualized pace from a revised 585,000 in June, government data showed Tuesday. The median estimate in a Bloomberg survey of economists called for a 575,000 rate. The July sales slump is the latest example of how the housing market is buckling under the weight of high prices and elevated borrowing costs. Construction has slowed, home purchase applications are falling, and more buyers are backing away from deals. Inventory is burgeoning amid the slide in demand, which will likely put downward pressure on home prices in the months ahead. There were 464,000 new homes for sale at the end of the month, the most since 2008. However, 90% of those were either still under construction or not yet started.

The new-home sales report, produced by the Census Bureau and the Department of Housing and Urban Development, showed the median sales price of a new home was up 8.2% from a year earlier to $439,400, the slowest pace of price appreciation since late 2020. The number of homes sold in July and awaiting the start of construction -- a measure of backlogs -- jumped to 165,000, a five-month high. At the current sales pace it would take 10.9 months to exhaust the supply of new homes, the most since 2009 and nearly double the figure at the start of this year. Sales were down in three of four regions, led by a more than 20% drop in the Midwest. Purchases rose in the Northeast. New-home purchases account for about 10% of the market and are calculated when contracts are signed. They are considered a timelier barometer than purchases of previously-owned homes, which are calculated when contracts close. The new-home sales are volatile; the report showed 90% confidence that the change in sales ranged from a 29.5% decline to a 4.3% increase.

US pending home sales fell in July for the sixth time this year to the lowest level since the start of the pandemic, extending the housing market’s sharp downturn as high borrowing costs sideline prospective buyers. The National Association of Realtors’ index of contract signings to purchase previously owned homes decreased 1% from a month earlier to 89.8, according to data released Wednesday. That followed a nearly 9% decline in June. The median estimate in a Bloomberg survey of economists called for a 2.6% drop in July. High home prices and a run-up in mortgage rates this year have pushed home ownership out of reach for many would-be buyers. The pullback has been swift and severe, with a range of measures pointing to weaker sales and construction activity. The monthly bill on a typical home with a 20% down payment rose to $1,841 in the second quarter, according to a separate NAR report out earlier this month. That’s up 32%, or $444, from the first quarter and a 50% jump from a year earlier. “This month’s very modest decline reflects the recent retreat in mortgage rates,” Lawrence Yun, NAR’s chief economist, said in a statement. “Inventories are growing for homes in the upper price ranges, but limited supply at lower price points is hindering transaction activity.” While borrowing costs eased in July, the average contract rate on a 30-year fixed mortgage has crept back up in August, according to recent data from the Mortgage Bankers Association. Contract signings decreased in three of four regions, led by a 2.7% drop in the Midwest. Pending home sales rose in the West. Compared with a year earlier, contract signings were down 22.5% on an unadjusted basis. Pending home sales are often looked to as a leading indicator of existing-home purchases given properties typically go under contract a month or two before they’re sold.

On a positive note, orders placed with US factories for core capital goods rose by more than expected in July, pointing to sustained demand for equipment despite higher interest rates and concerns about a weakening economy. The value of core capital goods orders, a proxy for investment in equipment that excludes aircraft and military hardware, rose 0.4% after an upwardly revised 0.9% advance. Bookings for durable goods -- items meant to last at least three years -- were little changed in July after a revised 2.2% advance a month earlier, Commerce Department figures showed Wednesday. The data aren’t adjusted for inflation. Bookings for defense aircraft and parts plunged nearly 50%, dragging down the overall durable goods measure. Economists in a Bloomberg survey had called for an 0.8% increase in overall orders and an 0.3% rise in the core figure. The data suggest that firms are still investing in longer-term technology and equipment, likely due in part to ongoing labor shortages. In the coming months, however, durable goods orders could weaken amid higher borrowing costs and growing uncertainty about the US economic outlook. Separate data Tuesday showed a measure of manufacturing output slipped to the lowest level in more than two years, adding to concerns about the health of the overall economy.

The majority of US pandemic-era inflation came from a surge in demand, but supply-chain constraints stoked it further, a report from the Federal Reserve Bank of New York research released this week showed. About 60% of the inflation seen from 2019 to 2021 was driven by demand-side factors, with the rest stemming from supply issues, according to the analysis by the New York Fed. “The bottom line of this decomposition is that supply constraints magnified the impact of higher demand in inflation,” Julian di Giovanni, the head of climate-risk studies in the New York Fed’s research and statistics group, wrote in a blog post published Wednesday. Di Giovanni found that most sectors in the US -- or 58 out of 66 -- were affected by supply constraints, such as worker shortages and logistics bottlenecks, during the pandemic. He estimated that without those challenges, the annual inflation rate would have reached 6% at the end of 2021, instead of 9%.

Applications for US unemployment insurance fell for the second week, suggesting that employers are holding on to workers despite growing economic uncertainty. Initial unemployment claims decreased by 2,000 to 243,000 in the week ended Aug. 20, Labor Department data showed Thursday. The median estimate in a Bloomberg survey of economists called for 252,000 new applications. Continuing claims for state benefits fell to 1.42 million in the week ended Aug. 13. The decline in jobless claims points to still-robust labor demand as companies try to attract and retain employees amid lingering worker shortages. Even so, some employers, particularly those in the technology sector, have been laying off staff or freezing hiring, which could continue in the coming months as the Federal Reserve raises interest rates to curb demand and tame inflation. On an unadjusted basis, initial claims declined to about 184,000 last week. The four-week moving average rose slightly to 247,000.

The government’s main measures of US growth pointed in different directions in the first half of 2022, adding to the ongoing debate on the health of the economy. Inflation-adjusted gross domestic product, or the total value of all goods and services produced in the economy, decreased at a 0.6% annualized rate in the April to June period, Commerce Department data showed Thursday. That reflects an upward revision to consumer spending and compares with a previously reported 0.9% contraction. However, the other, lesser-known official measure of economic growth -- known as gross domestic income -- climbed at a 1.4% rate in the second quarter after increasing 1.8% in the first three months of the year. It measures activity by calculating all income generated from producing those goods and services, like compensation and company profits. Theoretically, GDP and GDI should be roughly equal, but in reality, they tend to differ, especially in early estimates. But the current gap is particularly large. The GDP figures suggest an abrupt slowdown in economic momentum in the first half of the year. Under the surface, there’s more at play, including the impact of volatile categories like imports and inventories, but overall, consumer spending has decelerated. The back-to-back negative quarters, a common rule of thumb for recessions, have not only fueled fears of an imminent downturn but also led some to believe it was already under way. GDI, however, points to a more gradual cooling. It paints a picture of an economy supported by a robust labor market and resilient consumer spending, though one that’s starting to feel the pinch of the worst inflation in a generation.

The US merchandise-trade deficit narrowed in July to the smallest since October as imports fell for a fourth month, suggesting a tailwind for economic growth in the third quarter. The shortfall shrank 9.7% to $89.1 billion last month, Commerce Department data showed Friday. The figures, which aren’t adjusted for inflation, compared with a median estimate for a gap of $98.5 billion in a Bloomberg survey of economists. Exports were little changed at $180.97 billion, while imports declined 3.5% to $270 billion. Inbound shipments of consumer goods dropped fell the most since at least 1992, declining 10% to $67.5 billion. That was the lowest since November. US retailers and manufacturers this year stepped up efforts to replenish stockpiles amid the uncertainties in logistics networks to ensure they’re able to meet robust demand despite the hottest inflation in four decades. But Walmart Inc., Target Corp. and others are seeing consumer preferences shift to basic goods including food and home essentials, and shoppers are putting the brakes on purchases of furniture and electronics compared with a year ago. While imports of consumer goods have fallen from a record earlier this year, they remain well higher than the pre-pandemic average.

US consumer sentiment rose more than expected in August as year-ahead inflation expectations eased, suggesting Americans are growing more optimistic as gas prices continue to drop. The University of Michigan’s final sentiment index climbed to 58.2, the highest since May, from 51.5 in July, data Friday showed. Consumers expect prices will climb at an annual rate of 2.9% over the next five to 10 years, unchanged from last month. They see costs rising 4.8% over the next year, compared to July’s 5.2%. “The gains in sentiment were seen across age, education, income, region, and political affiliation, and can be attributed to the recent deceleration in inflation,” Joanne Hsu, director of the survey, said in a statement. Americans have been battling the fastest inflation in a generation, which is outpacing wage gains, and escalating borrowing costs. While a drop in gas prices has provided some near-term relief, food prices and rent are still extremely elevated, underscoring a painfully high cost of living. A gauge of current conditions rose to a three-month high of 58.6. A measure of expectations posted the sharpest monthly improvement since 2003, rising to the highest since April. In addition, personal financial expectations rose 12% from the prior month. This news was welcome on an otherwise mixed week for economic data on the U.S. economy.

Interest Rate Insight and the Fed

On the inflation front we had an important economic release early morning Friday. Purchases of goods and services, adjusted for changes in prices, increased 0.2% after being flat a month earlier, Commerce Department data showed Friday. Spending on both merchandise and services advanced. The median estimate in a Bloomberg survey of economists was for a 0.4% advance. The personal consumption expenditures price index, which the Federal Reserve uses for its inflation target, fell 0.1% from a month earlier, the first negative print since the start of the pandemic. That in part reflected a notable drop in energy prices, while food costs continued to rise. From a year ago, the gauge was up 6.3%, still a long ways from the central bank’s 2% target. Excluding food and energy, the price index was up 0.1% in the month. The core measure was up 4.6% from a year ago, a slight deceleration from the previous month. The weaker-than-expected report suggests the backbone of the economy started the third quarter on rockier footing than previously thought. While a robust labor market paired with sizable and sustained wage increases has supported consumer spending in recent months, widespread inflation is eroding those gains. And the outlook is growing increasingly murky. The Fed is aggressively raising interest rates to tackle price pressures, and the ensuing surge in mortgage rates has prompted a sharp slide in the housing market. The trajectory of consumer spending will largely determine the path of the overall economy.

All eyes were on Fed Chair Powell Friday morning in anticipation of his annual speech at Jackson Hole. Federal Reserve Chair Jerome Powell signaled the US central bank is likely to keep raising interest rates and leave them elevated for a while to stamp out inflation, and he pushed back against any idea that the Fed would soon reverse course. “Restoring price stability will likely require maintaining a restrictive policy stance for some time,” Powell said Friday in remarks prepared for the Kansas City Fed’s annual policy forum in Jackson Hole, Wyoming. “The historical record cautions strongly against prematurely loosening policy.” He said restoring inflation to the 2% target is the central bank’s “overarching focus right now” even though consumers and businesses will feel economic pain. He reiterated that another “unusually large” increase in the benchmark lending rate could be appropriate when officials gather next month, though he stopped short of committing to one. “Our decision at the September meeting will depend on the totality of the incoming data and the evolving outlook,” he said. Prior to Powell’s speech, investors saw the odds of a half-point or another three-quarter point hike at the Fed’s Sept. 20-21 gathering as roughly even. Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance,” Powell said in remarks that were set to be live-streamed for the first time from inside the lodge where the event has been held since 1982. Other Fed speakers in recent days have also pushed back against expectations, priced into futures markets, that the Fed would raise rapidly to a restrictive policy stance and then begin to ease.

Restoring price stability will require a “sustained” period of below-trend growth and a weaker labor market, Powell said. “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said. Powell’s remarks at the retreat, which gathers top policy makers from around the world, come as US central bankers confront the highest inflation in 40 years. Officials were slow to spot the risk and are now moving aggressively to keep prices from accelerating further. Officials raised rates by 75 basis points at their last two meetings and signaled the same could be on the table again when they gather next month. Critics have slammed the Fed for failing to anticipate the inflationary surge, which the Fed initially viewed as transitory. Powell told the conference in his address a year ago that price pressures were limited to a relatively narrow group of goods and services. But within months it was spreading and by the time the Fed began raising rates from near zero inflation was already three times their 2% target. The reaction from traders was immediate – interest rates rose, particularly in the two year range as the yield curve became more inverted between two’s and ten’s – while stocks declined. Any expectations that there would be a dovish tone to Powell’s speech were nipped early on. The speech was very short and there were no major surprises – most analysts, including us, expected him to talk tough basically.

Impactful International News

Economic activity weakened from the US to Europe and Asia, reinforcing concerns that soaring prices and the war in Ukraine will tip the world into a recession. US business activity contracted for a second-straight month in August, falling to the weakest level since May 2020, S&P Global data showed Tuesday. Activity in Asia slumped, and output in the 19-nation euro zone also fell as record energy and food inflation saps demand and more sectors succumb to the darkening outlook. The US figures pointed to weaker demand at both manufacturers and service providers as rising interest rates and high inflation weighed on consumers. New orders shrank for the second time in three months, and employers scaled back hiring. In Europe, manufacturing drove the drop, but a post-lockdown rebound in services like tourism almost ground to a halt. The UK’s purchasing managers’ index managed to remain above the 50 level that separates expansion from contraction, but recorded an unexpectedly large plunge in factory activity. Over in Asia, Japanese output shrank as a resurgence in Covid-19 cases further depresses demand that was already struggling under the weight of surging inflation. Australia’s services sector contracted for the first time in seven months, though it was offset somewhat by an uptick in tourism. And in China, the government’s ongoing commitment to Covid Zero and a worsening real-estate slump are weighing on consumer and business confidence. The data paint a bleak picture for the global economy, with most central banks still focused on taming inflation by raising borrowing costs. Germany was a particular weak spot, posting the sharpest decline in output since June 2020 as it rushes to reduce dependence on Russian natural gas amid drops in shipments following the war in Ukraine. In France, meanwhile, activity contracted for the first time in a year and a half.

China is the second largest economy in the world so we do keep current and keep our clients informed on the latest developments in that country as it can have a direct impact on the earnings of a number of our core holdings such as Apple by way of example. This week Chinese lenders lowered their benchmark rates and the central bank urged them to maintain steady loan growth as Beijing deploys more levers to alleviate a worsening housing crisis. The five-year loan prime rate, a reference for mortgages, was reduced by 15 basis points to 4.3% after being cut by the same magnitude in May. The People’s Bank of China on Monday urged lenders, especially major state-owned banks, to boost loans to the real economy. The moves follow Friday’s announcement of special loans being offered to property developers in a program that could be worth 200 billion yuan ($29.3 billion), according to people familiar with the discussions. China is taking drastic action to help a real estate market beset with problems. Home sales continue to plunge, property investment is contracting, cash-strapped developers are struggling to complete projects and homebuyers are boycotting mortgage payments. The special loans for developers would be the biggest financial commitment yet from Beijing to contain the crisis. The funds will be channeled through China Development Bank and Agricultural Development Bank of China, according to the people, who asked not be identified discussing private information.

The PBOC also cut its one-year loan prime rate on Monday, lowering it by a smaller-than-expected 5 basis points to 3.65%, the first decline since January. The drop in the LPRs followed the central bank’s surprise move last week to lower the rate on its one-year policy loans by 10 basis points. “We’ve already reached the point where the central government really needs to step in,” said Hyde Chen, head of strategy and asset management for Haitong International, in an interview with Bloomberg TV. With the housing market contributing around 20-30% of gross domestic product, it’s become an “elephant in the room.” “They really need to provide a backstop, to provide confidence that a housebuyer can say, ‘OK, the house I bought can be delivered’,” he added. China’s benchmark CSI 300 Index of stocks closed 0.7% higher on Monday, the first increase in three sessions, as Asia equities broadly fell. A gauge of real estate developers jumped 1.1%. While lower borrowing costs could help spur demand for loans, it’s unlikely to reverse the sharp slump in confidence. The weighted average interest rate for newly granted mortgages already plunged in June to 4.62%, the lowest level since 2017. The reduction in the five-year LPR will likely push average mortgage rates down further, as the floor for minimum mortgage rates is set at 20 basis points below the rate. Macquarie Group Ltd. economist Larry Hu estimates the average mortgage rate may fall to 4.3% in the third quarter. A large drop of that magnitude in the mortgage rate in such a short time is “unprecedented,” he said. The PBOC on Monday said that in addition to supporting the real economy, banks should enhance credit support for small- and micro-enterprises, green development, scientific and technological innovation and other fields, according to the statement. “We must consolidate the foundation of economic recovery and development with a sense of urgency that no time can wait,” it said. The gap between the cut in the one-year and five-year loan prime rates suggests a desire by banks to boost demand for property and mortgages while keeping short-term borrowing costs relatively steady. Banks need to preserve profits, as their average net interest margin narrowed this year due to monetary policy easing and low borrowing demand. Banks are flush with cash, but are either unwilling or finding it difficult to finance projects. Credit demand weakened sharply in July, prompting some economists to warn of a “liquidity trap” in China, where low interest rates fail to spur lending in the economy. As Jeff in our office likes to say, “Stay Tuned!”

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