Fed Chair Powell’s speech was a convincing reminder that the bank continues to have work to do to bring inflation back towards the target, as investors had become complacent about the direction of Fed policy. Growth indexes have led the market lower, as higher interest rates have caused a risk-off shift and a revaluation of high-duration equities.
- Equity investors will look to avoid a third negative week, as momentum has clearly slowed following the impressive rally since mid-June. Fed Chair Powell’s speech was a convincing reminder that the bank continues to have work to do to bring inflation back towards the target, as investors had become complacent about the direction of Fed policy. Growth indexes have led the market lower, as higher interest rates have caused a risk-off shift and a revaluation of high-duration equities.
- A chasm exists between the sentiment and behavior (flows, equity allocation, etc.) between retail investors and institutional investors. The Investors Intelligence report showed that 45% of retail investors are bullish, a far cry from the 26% in mid-June, and outnumbering the number of bears by 15%. Hedge funds, however, continue to cut leverage, institutional investors remain cautiously positioned, and the Bank of America Bull & Bear Indicator remains at 0 on a scale from 0-10. September is seasonally the worst month for equities, with the S&P 500® Index averaging a 1% loss, as this is the point when managements historically provide cautious guidance about the following year.
- With institutional investors conservatively positioned, a lot of money is sitting on the sidelines waiting to come back into the market once we get through this period. As long as earnings aren’t catastrophic, we’ll see continued choppiness in the near term as we get through September but expect a smoother outlook in the long term with good opportunities to buy off of cautious expectations.
- Fed Chair Powell was sufficiently hawkish in his Jackson Hole speech to convince investors that the Fed will “keep at it until the job is done,” even if that causes pain to consumers and businesses pain. “Restoring price stability will likely require maintaining a restrictive policy stance for some time,” Powell said. “The historical record cautions strongly against prematurely loosening policy.” This not only shifted the consensus bet for the September meeting to 0.75%, (67% chance versus 28% a month ago), but it also started shifting the curve in 2023, adopting a “higher for longer” shape. A similar tone was expressed by members of the European Central Bank, discussing the need to control inflation quickly even if that means higher sacrifice. The eurozone money markets now price in a 67% chance of a 0.75% hike in September, up from 48% on Friday.
- The Fed’s preferred inflation metric, core personal consumption expenditure (PCE) deflator was lower than expected at 4.6% from a year ago, down from a peak of 5.3% in February, but still well above the Fed’s official 2% target. The headline PCE deflator declined from June, aided by falling oil prices, but was up 6.3% from a year ago. Personal income rose 4.6% from a year ago, in line with core PCE, while spending jumped 8.7%, pressuring the savings rate. The University of Michigan reading on consumer sentiment improved in August to 58.2 from 51.5 in July on lower energy prices, with gains seen across age, education, income, region, and political affiliation.
- Economic clouds remain over Europe, as the conflict between Russia and Ukraine continues to pressure inflation. Natural gas prices have nearly tripled this year in Europe (twice the pace of the U.S.), driving German producer price inflation to up 37% from a year ago and inflation in the U.K. likely to approach 20%. Surging natural gas prices not only impacts heating and energy but also fertilizer prices which will impact food prices. The euro has fallen to the lowest level versus the dollar since 2002, further driving inflationary pressure, and potentially creating political unrest.
What to Watch
- Markets could be volatile this week as August comes to a close. Economic data include consumer confidence and JOLTS job openings on Tuesday, productivity and manufacturing data on Thursday, and durable goods and the payroll report on Friday.