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Weekly Update 9/2/2022: Markets Adjust to Fed's Tone and Employment Report

  • Housing headwinds
  • QT ramps up
  • Disney into cricket
  • Amgen drug clears hurdle
  • Check Point and the IoT

Jobs

The number of nonfarm payrolls rose 315,000 last month following a revised 526,000 increase in July according to the Labor Department. The unemployment rate, which is based on a survey of households, unexpectedly rose to 3.7%, the first increase since January and up from the five decade low reached in July. Economists had expected a gain of nearly 300,000 and a 3.5% jobless rate based on surveys. The labor force participation rate, which measures the share of the population that is working or looking for work, bumped higher to 62.4% in August from 62.1% in July. Pre-pandemic this figure was above 63%. Those of “prime working age” in the 25-54 demographic rose by the most since 2020 to 82.8%. Average hourly earnings rose 0.3% from the prior month which translates into a 5.2% annual gain matching July’s pace.

There was a lot to like in the report from the perspective of the Fed. A hike in unemployment ironically means more people are actively looking for work. When combined with an increased participation ratio it suggests that the supply of workers is increasing which will eventually have a limiting effect on compensation needed to lure and retain workers. The result: lower inflationary pressures. The labor force is “out of balance” according to Fed Chair Jerome Powell so seeing numbers like this is encouraging because it is one small step in the right direction for helping the Fed to achieve its mandates.

In the opening hours of trading on Friday, we saw the market move higher in response to the jobs figures. However, it was not a rip-roaring blast upward because, though the Fed got some of what it wanted, the final figure of 315,000 new jobs was still above the 298,000 median estimate. Bond yields moved lower from Thursday’s close but still remain over 3% in every Treasury security from six months maturity past 30 years. Recall that the U.S. Treasury 10-year note hit an all-time low of 0.5% in June of 2020 and was only at 1.5% at the start of January this year compared to the current level near 3.2%. Even though the U.S. Treasury market is the most liquid and deepest on the planet, yields usually do not move this fast in such a short time. That is one of the main reasons we have seen both equities and bonds, year-to-date, post losses. The equity market usually takes its clues from the bond market, and today’s reaction says that traders are pleased things seem to be going in the right direction, macro-wise, but understand that this is just one report. It is going to take a lot more to get out of the hole equity bourses have dug for themselves this year. This puts added attention on the consumer price and producer price data to be released on September 13 and 14, respectively. July’s annual core CPI data point excluding food and energy was 8.5%, while the core PPI annual rate was 7.6%. A print above these levels will likely put downward pressure on the markets while anything below will give some fuel for higher price points. Stay tuned!

The Labor Department’s Job Opening and Labor Turnover Survey, or JOLTS, was released Tuesday which showed that job openings rose unexpectedly in June after an upward revision to the June openings. The number of available jobs rose to 11.2 million in July, up from a revised 11.0 million the month prior. The median estimate in a Bloomberg survey of economists was for a decline to about 10.4 million. Thus, there were about two jobs for every unemployed person in July. About 4.2 million quit their jobs in July, down slightly from the pace in June. The quits rate, which measures those who voluntary leave their positions, ticked down to 2.7% but still remains high historically. Yesterday, initial jobless claims data from the Labor Department fell for a third week to a two-month low. Jobless claims fell by 5,000 to 232,000 in the week ended August 27. That was below the median estimate in a Bloomberg survey of economists which called for 248,000 new applications. This data combined with the JOLTS information underscore the tightness of the labor market.

Housing Data

The S&P CoreLogic Case-Shiller National Home Price index rose 18% year-over-year in June which was down from the 20% the prior month but emphasized how prices remain high in the mortgage market. “It’s important to bear in mind that deceleration and decline are two entirely different things, and that prices are still rising at a robust clip,” said Craig Lazzara, managing director at S&P Dow Jones Indices, in a statement. “June’s growth rates…are at or above the 95th percentile of historical experience.” Of the 20 cities in the index, Tampa, Miami and Dallas saw the highest annual increases in June with jumps of 35%, 33% and 28%, respectively.

The housing market is clearly feeling the brunt of the Fed’s rate hike policy. Higher rates feed into higher monthly amounts for those who finance and crowding out first-time homebuyers who do not have the cash for large down payments. Given how important housing is to the economy, the slowdown in the pace of sales we have seen in both existing and new home residential data is likely to feed into other industries over the coming months. Less sales means a lower need for delivery trucks. Furniture demand falls in lockstep with a lower need for housing. Bank lenders are less busy as a result. And so on and so on. The fall is traditionally the slowest time of the year for housing transactions anyways because families have by now moved to be settled before a new school year kicks off. Regardless, non-seasonally adjusted data is likely to show anecdotal weakness spreading and becoming more commonplace as the fall season turns to winter.

According to Doug Duncan, chief economist at mortgage giant Fannie Mae, there have only been three times that a downturn in housing did not lead to a recession—in 1965-66, 1984-85 and 1994-95. In each of those cases, the Fed began raising interest rates before inflation had surged. That is clearly not the case today as consumer and producer prices are rising at a no less than 8% pace annually according to the latest data from the Commerce Department. How much farther the Fed has to raise rates will ultimately decide how much more pain there is to come to the housing industry.

The Fed, QT and Soft Landing

The Federal Reserve’s balance sheet unwind ramped up this week. That means the Fed will stop reinvesting proceeds into new securities and begin unloading Treasury bills it started amassing nearly three years ago. As outlined in earlier discussions by Chairman Powell, the Fed will let $60 billion of Treasuries and $35 billion of mortgage-backed securities mature while using $326 billion of Treasury bills as “filler” when coupons run below the monthly level. This is an increase from the $47.5 billion combined pace at which it had been operating and in stark contrast to the $120 billion the Fed was buying per month in early 2020. The Fed’s approximately $9 trillion balance sheet includes $43.6 billion of Treasury coupons maturing in September suggesting that it will need to sell an additional $16.4 billion of bills, too, to meet their goal. In October, that filler amount will be $13.6 billion resulting in a two month total of $30 billion of bills on the market just as yields have risen sharply since March due to the hiking of their benchmark federal funds rate. This so-called quantitative tightening, or QT, is a reversal of the easy money policy in place since the start of the pandemic over two years ago. Without getting too technical, the full effects of QT may not be as detrimental on the market as expected because of a large reverse repurchase agreement balance at the Fed ($2.8 trillion) which was expanded during the pandemic beyond primary dealers to include mutual funds and other non-traditional accounts. Regardless, the market understands the days of “helicopter money” from the Fed are over.

Thoughts of a soft landing, where the economy floats gently to a lower level of growth without dipping into a nasty recession, are rapidly dissipating as Powell’s message during last week’s Jackson Hole summit has Wall Street nervous. The archetypal soft landing of 1994-1995 saw the economy slow briefly, inflation muted and unemployment hold steady. Last week Powell commented that this time around “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions.” That is Fed-speak for the economy will be weak and more people are going to lose their jobs. As we outlined in our quarterly commentary, the Fed is comfortable with having households endure pain straightaway with unemployment at a 50-year low rather than inflict even more damage to the economy later if prices are not tamed with hikes now.

Slowing the economy without pushing it into the ditch is going to be difficult because it is a $20+ trillion behemoth they are trying to steer. The biggest economy on the planet does not make hairpin turns or stop on a dime. Once it starts moving in one direction it tends to keep moving in that direction. The same with a rise in unemployment—it will have knock-on effects that will depress consumer confidence and put the economy on a path towards self-fulfilling correction and leading to more joblessness.

Countering these gloomy headwinds is the fact that some of the items outside of Fed control has improved. Oil prices posted a third straight monthly decline by the end of August. After approaching $120 per barrel in March, Brent crude, the main international price, is approaching the low $90s. According to travel-site, AAA said the national price of gallon of gasoline was $3.829 as of September 1, down from $5.016 on June 14 of this year. Container rates from Shanghai to New York are $9,300, down from a peak of $15,850 at the end of September 2021 and $13,090 at the start of the year according to the Drewry World Container Index. While inflationary forces were accelerating before Russia’s invasion of Ukraine in February, commodity spikes have not been helpful in getting demand in-line with supply. The ongoing challenge of smoothing out supply chains is not going away anytime soon especially with China holding firm to its zero-Covid policy whereby a port or factory could be shut down at any moment with a single positive test result.

As we have been preaching to clients for many months, it is going to take patience to weather the current environment because it is going to take time for the post-pandemic new normal to assert itself. Some of that will look exactly like pre-2020 but some will be totally different, and that is neither a good nor a bad. It just is what it is, and the market is transitioning to understand and reward those companies which use their capital most effectively to produce dependable and growing cash flow and punish those who do not. We continue to research and analyze the markets to find the winners and hopefully avoid the losers. But it is safe to conclude that a recession—be it deep or shallow, brief or extended—will eventually end as all prior recessions since 1776 in this country have. Our goal is to create balanced portfolios that continue to protect wealth by not declining as much as the overall market knowing that that approach may cause us to lag the market when things are going gangbusters to the upside. Being greedy when others are fearful and fearful when others are greedy is a well-known Warren Buffett axiom which is apropos for the months ahead.

Disclaimer

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