For Markets, Listening is the Hardest Thing to Do
August 19th, 2022
After a sizzling summer rally, stocks failed to sustain their momentum this week following the release of the Fed’s July meeting minutes on Wednesday. The minutes revealed a broad consensus among FOMC members on the need for additional rate hikes in 2022 (and potentially 2023), while investors had hoped for greater evidence that the recent softening in inflation data was beginning to temper the Fed’s aggressiveness. Economic data this week provided a mixed picture of the consumer. July retail sales were little changed as gas sales declined on falling prices, freeing up dollars to spend online and in miscellaneous stores. Sales excluding gas and auto sales rose a solid 0.70% month-on-month, signaling that the consumer remains confident with their current prospects to continue spending at a torrid pace. The housing market, however, continued to struggle under the weight of high prices and higher mortgage rates. Existing home sales tumbled -6.00% in July to an annualized rate of 4.81 million units. While this was the sixth straight month of sales volume declines, the home market remains tight as indicated with home prices still hovering near all-time highs. Monetary policy remains the dominant force on markets presently and with both the release of the Fed’s minutes on Wednesday and more to be learned at the Fed’s economic policy forum on tap next Thursday, investors felt safer shedding assets, resulting in the S&P 500 falling -1.21% on the week.
Retail Sales Sizzle as Gas Prices Fizzle
Falling gas prices and lower auto sales helped put more dollars in consumers’ wallets in July. Excluding gas and autos, sales were up a robust 0.70% month-to-month. Sales at the pump slipped -1.80% as gasoline prices dropped from above $5 a gallon in June to near $4 a gallon by July-end. Meanwhile, auto sales slipped -1.60% as strong demand for SUVs and trucks collided with supply chain constraints from chip shortages, which has reduced supply and pushed prices higher. While supply remains an issue, increasingly affordability is becoming a factor. The average new car transaction hit $45,869 in July. Furthermore, with the Fed’s recent rate hikes, the average rate for a car loan has increased to 5.50%, a full percent higher than the 4.50% average a year ago. The higher car price and higher financing cost now means that the average monthly payment is higher than $700, a new record, and car buyers are having to finance this over a longer period of time to keep the payments low enough to afford. The average term of a new auto loan has risen to 70.4 months, up from 69.3 months in January 2020. With found savings at the pump and more people opting out of the car market, consumers returned to spending on goods. Online sales and miscellaneous store sales saw the biggest monthly gains, up 2.70% and 1.50%, respectively. While the headline figure from the retail sales report showed that spending overall was little changed, perhaps leaving the impression that the consumer is weakening, this is misleading. The consumer has simply benefitted from falling energy prices, which has allowed them to spend on more discretionary items. Energy prices are expected to decline further, and with the jobs market still strong and retailers heavily discounting overstocked inventory, consumer spending is likely to remain steady during the historically busy back-to-school and holiday shopping seasons.
Fed Hikes Batter Housing Market
The Fed’s recent rate hikes have cooled home sales and slowed homebuilding activity. Existing home sales fell nearly -5.90% in July to a seasonally adjusted annual rate of 4.81 million units. That was the slowest pace since Nov. 2015, aside from a brief plunge at the beginning of the Covid pandemic. Year-over-year, sales were down -20%. July sales figures were based on closings, so the contracts were likely signed in May and June. At the time mortgage rates had spiked to near 6.00%, up sharply from around 3.00% at the beginning of the year. Despite the fluctuations in the market, supply remains extremely tight at 1.3 million units available for sale. At the current sales pace that is equivalent to 3.3 months. Historically, six to seven months is considered a healthy balance between supply and demand. Rising rates have managed to slow demand for homes with the median existing-home sales price falling from last month’s record of $413,800 to $403,800. Although sales were down across the board, the first-time homebuyer has been hit the hardest by rising prices and rates. They accounted for only 29% of buyers in July. Historically, they have accounted for 40% of sales. Not much relief looks to be in store for potential homebuyers as construction activity has fallen amid slowing demand. Housing starts dropped -9.60% in July to a seasonally adjusted annual rate of 1.45 million. Building permits also stumbled, falling -1.30%. Year-over-year, housing starts were down -8.10% while building permits were flat. The month-to-month slide in homebuilding was driven by declines in both single-family and apartments, down -10.10% and -10%, respectively. Inventory is expected to remain tight, however, based on permit applications falling -4.30% in July. With existing housing stock tight, would be homebuyers are gravitating towards the rental market, pushing up prices there as well. In June, single-family rents rose 13.40% from the year ago period. Rent growth was most pronounced on the lower end of the market, rising 14.20% yoy. Meanwhile, rental prices at the high end of the market were higher by 12.50% from the year ago period. While the year-over-year and month-over-month figures for the housing market posted negative comps, this is really more indicative of moderation from overly elevated levels and not a sign of cooling at this point. The average house remains on the market just 14 days, down from 17 days a year ago.
Final Thoughts
Markets hit pause on the summer rally this week as investors reassessed their recent bullishness. The S&P 500 now stands 15% higher from its June lows. This bullishness has been fueled by the combination of goldilocks-like economic data and the belief that the Fed will soon begin pivoting to an accommodative monetary stance. Despite the Fed saying what it means, throughout the past two months, markets have not behaved in a way suggesting they believe the Fed really means what it has said. There are reasons for this. In 2019, the Fed seemed intent on raising interest rates only to surprise markets by cutting once signs of weakness started appearing due to the trade war with China. While skepticism towards the Fed may have some recent historical basis, domestic conditions are nowhere near levels that should be acceptable to the Fed and many of the factors underpinning global inflation-while improving-remain. The release of this week’s Fed minutes showed no material deviations or insights relative to the Fed’s previous guidance that controlling inflation remains their number one priority. Markets were simply disappointed to hear again what has been said for months now. Next week could be a big week as central bankers gather at the Kansas City Fed’s Jackson Hole Symposium. Fed Chairman Jerome Powell could use the occasion to not only reaffirm the central bank’s commitment to hike rates but also provide a clearer picture of its rate path ahead.
The Week Ahead
Global central bankers, policymakers, and economists descend on Jackson Hole, Wyoming for the Kansas City Fed’s Economic Policy Symposium. Traders will be paying close attention for Fed guidance on monetary policy tightening. In economic news, July global PMIs step into the spotlight. Demand for goods and services could be poised for a rebound as lower energy prices give consumers more spending power. Despite talks of recession, the jobs market remains robust with 528K added to the payrolls last month alone. We’ll see if that translates into fatter paychecks and higher spending as personal income and spending figures are released.
Sweeping Spending Bill Signed Into Law
A new spending bill called the Inflation Reduction Act was signed into law earlier this week and will attempt to tackle a broad range of health, climate, and tax issues with $750 billion in funding and federal policy changes. The legislation includes $80 billion in IRS funding that will be spread out over 10 years with over half the new dollars earmarked for new tax enforcement. The new bill also raises taxes on corporations.
The IRS had previously announced that resource constraints limited the agency’s ability to review the tax returns of high net worth individuals, large corporations, and complex business structures, and that additional funding was needed to boost audit rates for the wealthiest Americans.
The legislation was passed through the budget reconciliation process, which was created by the Congressional Budget Act of 1974 and allows expedited consideration of certain tax, debt, and spending bills that don’t require a 60-vote majority in the Senate and are not subject to a filibuster. All 50 Democrats in the Senate and one tie-breaker vote from Vice President Harris resulted in the legislation passing since none of the 50 Republican senators voted in favor of the bill. Below are some of the major components and implications:
–Part of the new IRS funding will go to hire 87,000 workers over the next decade, including customer service reps, technology workers, and agents. An IRS spokesperson said the new hires will help replace the more than 50,000 employees who are expected to retire over the next five years.
–The new $80 billion in funding for the IRS is on top of the agency’s annual funding, which for fiscal year 2022 is about $13 billion. Congress will continue to make annual appropriations for the IRS which can be altered by the party in charge. Lawmakers could shift annual allocations so that less goes to enforcement and more to customer service and could also cut or raise this funding.
–The Treasury Department has pledged that the new funds for tax enforcement won’t increase audits on filers making less than $400,000 and that the agency will use the new funding to focus on tax underpayments and tax loopholes for higher-income taxpayers.
–The bill includes creation of a 15% corporate minimum tax rate for corporations with at least $1 billion in income. Taxes on individuals and households won’t be increased.
–The Inflation Reduction Act will allow Medicare to negotiate the prices for certain prescription drugs. Additionally, Medicare recipients will have a $2,000 cap on annual out-of-pocket prescription drug costs starting in 2025.
–The bill extends the subsidies provided by the federal government under the Affordable Care Act that were scheduled to expire at the end of this year. The subsidies to provide lower premiums will be extended through 2025.
–The bill earmarks $370 billion for energy and climate initiatives, including a tax credit of up to $7,500 for electric vehicles, but it only applies to certain vehicles and also imposes income limits on who can claim the credit.
–The legislation includes a 10-year extension of the homeowner credit for solar projects, such as rooftop solar panels. That tax credit could also benefit people who purchase energy-efficient water heaters, heat pumps, and HVAC systems.