October 2022

Macroeconomic Outlook:

GDP: Q3-2022 Real GDP print registered at 2.6% (annualized) compared with the prior quarter. Note that the real GDP was negative in the two preceding quarters ( -1.6% in Q1-2022 and -0.6% in Q2-2022 ). Note that this is the ‘advanced’ (or preliminary) release and the final release might be different from this figure.
Based on the details released, exports of both goods and services increased at 17.2% and 8.3%, respectively. Imports of goods decreased by 8.7% and import of services increased by 2.3%.
Overall, the increase in the Real GDP reflected increases in exports, consumer spending, nonresidential fixed investment, federal government spending, and state and local government spending, that were partially offset by decrease in residential fixed investment and private inventory investment.
Click here for the complete release.

Inflation: during the month of September, headline CPI increased by +0.4% on a month-to-month basis, seasonally adjusted. In August, the same figure was +0.1%. On an annual basis, CPI increased at 8.2% before seasonal adjustment.
The increase in CPI is mainly attributable to the increases in shelter, food, and medical care indexes.
Core inflation (the figure above, excluding food and energy) increased by 0.6% month-over-month. This is specifically problematic because core inflation tends to be stickier and harder to curb.
Contributors to inflation: food (0.8%), new vehicles (0.7%), gas (2.7%), shelter (0.7%), transportation services (1.9%), and medical care services (1%).
Prices fell in the following categories: gasoline (-4.7%), fuel oil (-2.7%) and used cars (-1.1%).
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Manufactured goods orders: remained unchanged for the latest release which was in the month of August. The next release is Nov 3, 2022 for the month of September.

Source: US Census Bureau

Oil prices:
Crude oil traded at $88.31 as of Oct 30, 2022. Even though many believe that oil should be traded higher, the concerns over slow economic growth in China and Europe has kept the prices lower as of now.

Source: Yahoo! Finance

Money Supply: the Fed initiated its plans for quantitative tightening (“QT”) in September. The M2 money supply, seasonally adjusted, was reduced by $129 billion (0.5% or 50 bps). Reserve balances were reduced by $174.5 billion. The amount is not large and might not cause an immediate response but conceptually it should result in lower liquidity, higher interest rates, and putting pressure on stocks prices.

Source: Federal Reserve Website

Other Indicators:

Indicator	Result	Period	Impact/Significance/Discussion
Mortgage Rates (Mortgage Bankers Association)	7.16%	Week of October 17, 2022	The mortgage rates are increasing to a two-decade-high level. This limits the ability of the buyer and puts downward pressure on the housing prices, as is evidenced in some markets showing double-digit declines from their highs.
Mortgage applications (Mortgage Bankers Association)	-1.7%	Week of October 17, 2022	Consistent with the data above, the applications have been reduced. The decline in the week prior to this week was 4.5%.
Revised building permits (privately owned) (US Census Bureau)	1.40%	Sep 2022 (m/m change)	Compared with the prior month, building permits increased but on a year-to-year basis, it shows a decrease of 3.2%.
New Home Sales (month over month) (US Census Bureau)	-10.90%	Month of September 2022 (m/m change)	The consensus was a decrease of 13.9%. The result is not as bad as was expected, nevertheless, it is a significant drop. This figure in August was +24.70%. US pending home sales decreased by -10.20% during the month of September 2022. The consensus was a decrease 5%. Overall, the housing market is under pressure and we will likely see prices to reduce gradually. Note that many households have mortgages that closed during the pandemic with low fixed rates, so the majority of the households are not impacted. Also, noteworthy that most of the US mortgages are fixed rates.
US Trade Deficit (US Census Bureau)	-92.2 billion	Sep 2022	Compared with Aug 2022, the exports decreased by $3 million and imports increased by $2 million. The deficit in August was $87 million. This amount is close to August and July 2022 but slightly lower than September 2021 (last year) of $95 billion deficit.
PCE (US Bureau of Economic Analysis)	PCE Headline: +0.3% (m/m) PCE Core: +0.5% (m/m) PCE Headline: +6.2% (y/y) PCE Core: +5.1% (y/y)	Sep 2022	PCE, similar to CPI, intends to measure the increase in prices over time and it appears that the Fed puts more importance on this measure. The fact that it increased month-over-month (both headline and core) suggests that the likelihood of an outsized rate hike at Nov 2nd FOMC meeting is higher (75 bps or 50 bps).

In addition to the above, the following indicators are noteworthy:

• Durable Goods Orders, measured by US Census Bureau, increased month-over-month by 0.4% in Sep 2022. This figure, excluding
  transportation orders was -0.5%, meaning that transportation was a big portion of orders. Moreover, this figure excluding defense orders was +1.4%, meaning that the defense orders declined during the month of September.

• US Jobless Claims: was 217K for the week of Oct 17, 2022, which increased by 3K compared to prior week. Although there is a small increase, the overall jobless claims are low, meaning that the job market remains hot.

• US Personal Income: increased by 0.4% month over month during September 2022.

• US Personal Spending: increased by 0.60% month over month during September 2022

Word on the Street:

An increasing number of macro strategists believe that we will enter into a recession during the first half of 2023. The recession is believed to be a shallow one driven by higher interest rates and inflation. In fact, this setback is necessary for the economy because the abundance of capital during the past decade and specifically post-pandemic has resulted in the emergence of companies with weak business models. Perhaps the tech sector will feel the pain more than other sectors.

Ahead of the FOMC meeting on November 2, 2022, given the mix economic indicators published during the month, the likelihood of 75 bps rate hike has increased. That being said, there are considerations regarding the delayed impact of monetary policy which will result in 50 bps rate hike, but this conflicts with the Fed comments on ‘front-loading’ or quickly reaching the 4.5% target rate.

Will stock prices go even lower?
In our opinion, yes. As per our post on economic outlook in August, we expect the downward pressure on stocks to continue. The market’s reaction to rate hikes has been mixed but we expect a general downward trend with occasional spikes to continue until year-end.

‘Until something breaks’
We recently hear quite often that ‘the Fed will hike rates until something breaks’. We saw a glimpse into what it means in the UK, where the fiscal policy resulted in the markets to panic in the expectation that the BOE (Bank of England) will hike rates aggressively. As a result, the yields on UK government bonds (called Gilts) increased and prices dropped. This is basically normal market forces in play, but caused an issue in an unexpected place: pension funds. Pension funds have an obligation of making regular payments to the members at certain point in time in future, which is their liability. To make sure that they have sufficient cash, they adopt a strategy called LDI (Liability Driven Investing). At the simplest form, the pension fund buys bonds with maturity matching the obligations. However, in the past decade, the returns on bonds were low, so some pension funds used derivatives to leverage; basically, they will use 1/3 of the assets for LDI and allocating the remaining assets to more risky investments (and higher returns). The collateral for the LDI is Gilt which is the highest quality assets. When the Gild prices dropped significantly, it resulted in margin calls by the counterparties to the derivatives. So, the pension funds had to sell assets, including Gilts for the margin calls. This resulted in even lower Gilt prices (vicious cycle) until BOE intervened. This is an example of something breaking.
Given that most of the corporations and individuals have strong balance sheets, the likelihood that this event starts in the US is low, and if this happens, most likely it will happen elsewhere. Until then, we expect the markets to continue a gradual decline with a low possibility of a significant economic disaster.