Week of Sep 12, 2022

Sep 12

Written By Editor

Opening Remarks:

We are starting this week as the stock markets continue to move up for the fourth consecutive day. Last week, we indicated in our opening remarks that the next few weeks will be about repositioning, resulting in small ups and downs in prices, with the general direction to be downward. The market was up last week, but we still believe that the downward trend will continue.
Multiple economic indicators will be published this week. These indicators are noteworthy as they potentially have an impact on the Fed’s decision on policy rate.

Overall, judging by how the markets reacted in the past four days, it appears that the market has assumed that a rate hike of 75 bps in September is already baked in the valuations. This line of reasoning follows that any news, unless it’s extreme, can be interpreted as good news, fueling the rally. Another alternative explanation for the increase in the prices could be that the market has assumed that the Fed will not raise rates by 75 bps. At this point, the cause is not quite clear, but hopefully we will have more clarity as some crucial data points are made available this week.

Data that is released this week:

Tuesday: August 2022 CPI, August 2022 Real Earnings
Wednesday: August 2022 Producer Price Index (PPI), Mortgage Refinance Index
Thursday: US Import and Export Price Indexes, Philadelphia Fed Manufacturing Business Outlook Survey, Unemployment Insurance Weekly Claims (Department of Labor)
Friday: August 2022 State Employment and Unemployment, University of Michigan Sentiment, University of Michigan Expectations

What were the previously published figures and what are the expectations?

CPI:
The July CPI indicated to the market that inflation has peaked. The headline CPI decreased from 9.1% to 8.5% year-over-year, with a 0% increase month-over-month. The Core CPI (i.e. all items less food and energy) was at 5.9% year-over-year (0.3% increase month-over-month). The drop in headline inflation was expected since gasoline prices had dropped in July. However, the core inflation was expected to be at 6.1%, and when the CPI was lower at 5.9%, the market perceived it as a signal that the inflation is coming down faster and the Feds will ‘pivot’ (the term that is used indicating that the Fed will stop hiking rates and cut rates to stimulate the economy.)
For August, the market expects headline inflation to be at 8.1%, and core inflation at 6.0% year-over-year. As it relates to expectation, we turned to Kalshi exchange to gauge the sentiments. The probability of a 0.1% month-over-month increase in core inflation (i.e. core inflation of 6.0%) was 86% and the probability of a 0.2% month-over-month increase was at 68% (that is, core inflation of 6.1%.)
So, given the market sentiment, anything significant change from the expectation above will cause the markets to react.

PPI:
Note: PPI measures the prices that domestic producers receive for their output.
The July PPI fell 0.4% (seasonally adjusted) compared with June. In June and May we had month-over-month increases of 1% and 0.8%, respectively. The breakdown of the 0.5% decline is as per the following:
- ‘Final demand goods’ decreased by 1.8% (in June, it was an increase of 2.3%).
- ‘Final demand services’ increased by 0.1% (in June, it was an increase of 0.3%)
- ‘Final demand less food, energy, and trade’ increased by 0.2% in July (in June, it increased by 0.3%)
Overall, a positive PPI can indicate signsof a strong economy and a negative PPI can indicate weakness in the economy.

Philadelphia Fed Manufacturing Business Outlook Survey:

This survey gauges the manufacturing activity in the third federal reserve district. The most important aspect of this report is the planned amount of capital expenditure. Businesses usually commit to capital expenses when they feel confident about the prospect of growth. The latest index reported was for August 2022 at 18, which showed a significant increase from a month ago (July) at 4.4.
This data is only for one district but can provide a measure of sentiment.

Unemployment Insurance Weekly Claims

The report for last week showed a decline of 6,000 unemployment claims, which is good news for the job market, but it signals more rate hikes by the Fed.
Any sign of cooling off of the job market will provide an argument that the fed might raise rates by only 50 bps.

What to expect this week?

We expect mixed reactions to the release of any of these data points. The underlying theme in the capital markets is repositioning and redeploying capital. There is still a considerable amount of cash on the sidelines and that on its own can result in fluctuations and responses that might appear disproportionate to an event.
Ultimately, something that is not being talked about is quantitative tightening which is going to accelerate this week. This is the wild card and we don’t really know how it’s going to play out.

Below we will provide the daily updates.

Tuesday, Sep 13, 2022

August CPI Print:
In August, the headline CPI rose 0.1% month-over-month, seasonally adjusted. On a year-over-year basis, the headline CPI increase was at 8.3%. Looking at the data from the past 3 months, the headline CPI was reduced from 9.1% in June to 8.5% in July and then to 8.3% in August. However, this is not necessarily good news as it relates to fighting inflation. The decline is mostly due to the reversal of gasoline prices that soared earlier in the year, which was expected. In August 2022, was a 10.6% month-over-month decline in gasoline prices and a 5.9% month-over-month decline in Fuel Oil prices. This brings us to the core inflation, which is CPI for all items excluding food and energy.
For more information on terminology see our post on inflation.
The increase in year-over-year Core CPI was 6.3% in August. The year-over-year Core CPI increase in July was 5.9% and the market was expecting annual core inflation of 6.1%. The higher-than-expected core inflation results reinforced the stickiness of higher Core CPI and quashed the wishful thinking of some market participants that inflation is tamed and on a downward trajectory.
Noteworthy in individual spending categories are as follows (all percentages are month-over-month change):
- Used cars were down only 0.1% month-over-month. Markets were expecting more decline.
- Shelter (rents) were up by 0.7%, which is higher than most expected.
- New vehicles were up 0.8%
- Apparel was up 0.2%, which goes contrary to the narrative that retailers are over-stocked and they are giving out their merchandise at discount

The CPI print caused massive sell-offs in the markets. S&P 500 was down by 4.3% in one trading session, which was the highest slide in two years.

Wednesday, Sep 14, 2022

At 8:30 AM, the Bureau of Labor Statistics released Producer Price Index (PPI).
the PPI for final demand fell 0.1% in August, seasonally adjusted, compared with a 0.4% decline in July.
Looking into the details, the decline is due to lower ‘final demand goods’ with a decline of 1.2%, offset by an increase in ‘final demand services’ by 0.8%.
Basically, what this indicator shows is that the demand for goods is declining, but at the same time, the demand for services is increasing. The month-over-month downward movement is not strong enough to establish a strong trend. We need to watch this indicator in the following month to draw a conclusion on the trend.
That being said, the fact that the PPI is holding well, means that the economy is in relatively good shape. This allows the Fed to raise rates with more confidence.

Market update (11 AM): The S&P 500 was up slightly in pre-market trade. 30 minutes into the trading session, it was down, but then again went up one hour after the opening bell. The movements were very small and to the tune of 50 bps change. We presented this in order to document the indecisiveness in the market and the sensitivity to any news. The general theme appears to be investors taking advantage of the perceived low prices after yesterday’s drop.

Closing Remarks

The declines during the week of Sep 12, 2022, combined with the end-of-August declines basically wiped out all the gains since July 18, 2022. See the picture below. As we’ve been pointing out in the past few weeks, these ups and downs are expected during the the times of economic downturns.

On Thursday, FedEx notified the investors that their revenue was below its expectation and that it is withdrawing its full-year forecast issued in June. This news is meaningful from the macro point of view because it indicates lower activity in the economy. The company also indicated that they are taking actions to reduce costs, which include freezing hiring, closing 90 FedEx Office locations, and grounding some of the cargo airplanes.
Note that analysts believe that not all of the issues that FedEx is facing relate to the headwinds in the economy, and the inefficiencies in FedEx operations play a role.

As we close this trading week, the most important event to look for during next week is the Fed’s interest rate decision on September 21. As of Sep 16, 2022, the opinion ranges from 50 bps increase up to 100 bps increase. It appears 100 bps increase that would have sound unreasonable a few weeks ago is gaining some traction and a higher percentage of probability is assigned to it. But overall, the highest probability is assigned to 75 bps increase as of Sep 16, 2022.

Editor