King of Pain
August 26th, 2022
Markets sold off sharply on Friday as Fed Chairman Jerome Powell addressed central bankers, policymakers, and economists before the annual economic policy symposium in Jackson Hole. Powell didn’t parse swords to investors, warning of the pain to come for U.S. households and businesses resulting from the central bank’s plan to continue raising rates to tackle inflation. Powell’s comments followed Friday’s release of the Fed’s preferred inflation measure, the Core Personal Consumption Expenditures (PCE) Index. Excluding the volatile food and energy, prices rose 0.1% month-to-month, resulting in prices increasing cumulatively 4.60% from a year earlier. That was a slower rate than June’s 0.60% monthly increase but still well above the pace needed to achieve the 2% YOY increase targeted by the Fed. While core inflation rose on the month, overall spending remained relatively unchanged as consumers closely scrutinized their spending habits. In global news, this week’s S&P Global PMI indexes showed both the U.S. and Eurozone cooling as demand for manufacturing and services slowed. Going into the week, investors knew everything hinged on Powell’s comments. Powell used the moment to forcefully dispel rumors of any type of policy pivot by the Fed any time in the near future, routing markets and sending the S&P 500 down -4.00% on the week.
Consumer Spending Eases on Higher Inflation and Slower Income Growth
High prices and slower income growth hit consumers’ wallets in July. Consumer spending rose a modest 0.1% month-to-month, down from June’s 1.00% rise. A drop in gas prices and lower spending on food offset higher spending on services and discretionary goods. Personal income rose 0.2% for the month, lower than June’s upwardly revised figure of 0.7%. Income and spending growth balanced one another out such that the personal savings rate remained unchanged at 5.00%. The overall picture painted by the reports was that while inflation is causing consumers to be more conscientious with their spending, the strong labor market, wage increases and the recent reversal in energy prices have thus far prevented US consumer spending from retrenching outright.
Global PMIs Flash Warning Signs of Slowing Demand
For the second consecutive month, overall global demand showed signs of slowing as high inflation, material shortages, delivery delays, and interest rates all weighed on both the manufacturing and services sectors. The S&P Global U.S. Composite PMI, which measures activity in both the manufacturing and services sectors in the U.S., slowed to 45 in August, down from 47.7 in July. Numbers above 50 indicate expansion while numbers below indicate contraction. The decline in output was the fastest seen since May 2020, and the fastest decline on record outside of the initial pandemic since the series began nearly 13 years ago. August’s reading was also the second consecutive monthly decline in business activity. The reduction was broad-based with manufacturers and services providers registering lower activity. Until just recently, the slowdown appeared most acute in the manufacturing sector, August’s reading showed the service sector declining more rapidly for the month. Eurozone activity also slipped for the second consecutive month, slowing to 49.2 in August from 49.9 in July. The decline was the second consecutive month of waning business activity in the Eurozone. The decline was driven by a drop in manufacturing output, which outweighed Europe’s services expansion. The primary source of weakness came from new orders which points to weakness for both the manufacturing and services sectors in the months to come. With winter on the horizon, energy is a large wild card for Europe with the war in Ukraine still on going. Europe is expected to have adequate energy stores and LNG terminal capacity to sustain an average winter, but the global nature of the energy market, OPEC’s decision to reduce supply and Russia’s ability to disrupt energy flows, could negatively impact prices and ultimately final demand as cooler temperatures arrive.
Over the past six weeks, markets have rallied on the belief that the Fed would soon pivot to a more accommodative position. This view was based on the notion that the Fed would heed recent data suggesting that inflation may have peaked in July and begin softening its stance in a desire to orchestrate a soft landing in light of global PMI reports flashing recessionary signals. It’s been a naïve argument from the get-go, and in an eight-minute speech before policymakers in Jackson Hole on Friday, Federal Reserve Chairman Jerome Powell made his most forceful comments yet dispelling markets of such fancies. The message? The Fed is entirely committed to stamping out inflation and willing for us all to endure some short-term pain to do so. If markets had hoped for the Fed to pivot, what Powell delivered was what one analyst termed as the “anti-pivot speech”. It certainly wasn’t what the market wanted to hear judging by the nearly 1,000 point decline in the Dow, but hopefully the conviction with which the message was delivered will finally allow it to be received by investors and consumers at large. The Fed apparently sees what we all see right now, which is a certain economic and behavioral absurdity that left untamed threatens to spiral into something far more problematic. Having rallied nearly 15% (through last week) from June’s lows, markets had hoped the chaperone would leave after a few stern words and the party could continue. With his remarks on Friday, Powell has pulled up a chair in the middle of the dance floor and let the partygoers know the Fed’s keeping an eye on what’s being put in the punch bowl.
The Week Ahead
The Labor Day holiday arrives, marking the unofficial end of summer. In observance, the Probity Advisors, Inc. Week in Review will not be published on Friday, September 2nd. Our next edition returns on September 9th with the latest nonfarm payrolls, manufacturing, and services reports.
Global Central Bankers Descend on Jackson Hole
This week, central bankers from around the world along with academics, economic policy experts, and business leaders arrived in Jackson Hole, Wyoming to kick off the Federal Reserve’s annual conference. This year marks the 45th year of the Federal Reserve Bank of Kansas City’s Economic Policy Symposium, and it is also the first time the conference of central bankers is being held in person after it went virtual for two years during the COVID pandemic.
The meeting has developed a unique importance because it has served as the locus of important historical policy shifts. For example, in 2010, then Fed Chairman Ben Bernanke used the event to first hint at an additional round of stimulus measures, and just three months later, the Fed unleashed a $600 billion bond buying program.
The symposium consists of a series of papers on economic issues facing the U.S. and world economies with a specific topic chosen each year, such as labor markets, international trade, and inflation. Experts are invited to write and present research on subtopics related to the symposium’s theme. The Fed notes that a key feature of the event is the thoughtful, open discussion that takes place among the participants which is limited to around 120 carefully selected guests. The papers are posted online along with transcripts from the event so that anyone can view them.
In the late 1970s and early 1980s, the focus was on agriculture with the inaugural theme, “World Agricultural Trade: The Potential for Growth,” and the event was held in Missouri and then in Colorado. It moved to Jackson Hole in the early 1980s to lure avid fly fisherman and then-Fed Chairman Paul Volcker to the event with the hope that his attendance would attract other policymakers. It worked. Volcker’s regular attendance attracted other key influential power brokers and economic experts, and the event has become known as a place where titans of policy, economics, and business share ideas.
The theme for this year’s event is, “Reassessing Constraints on the Economy and Policy.” The Fed explains on their website that the symposium will explore how supply shortages and bottlenecks during the pandemic created an imbalance between supply and demand that drove inflation up globally. It will also examine the impact of fiscal policy in response to the pandemic.
Investors were anxious to hear this morning’s remarks by Federal Reserve Chair Jerome Powell who, as mentioned above, warned that the Fed will continue on its path of tightening by raising rates which is expected to slow the economy but would be necessary to reduce inflation and restore price stability.
The agenda for this year’s symposium is available here, and links to materials presented at the conference are also posted here as they become available.