CWS Market Review – August 30, 2022

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Holy Jackson!

In last week’s issue, I talked about how the impressive summer rally had finally faced some pushback. Until very recently, the bulls had been having a great summer.

We first got a little hiccup after the Federal Reserve released the minutes of its last meeting. Things got a lot worse on Friday when Fed Chairman Jerome Powell said we’re in for “more pain.”

Yikes! One must understand that central bankers simply don’t speak that way. Obfuscation is part of the job description. Alan Greenspan famously said, “I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant.”

Powell’s words had an immediate impact, and the market gods were displeased. During the trading day on Friday, the Dow lost more than 1,000 points and the Nasdaq Composite dropped 4%. The market fell again on Monday and Tuesday. Since August 16, the S&P 500 has lost over 7%.

It’s about time the Fed acted boldly. To be perfectly honest, the central bank helped cause the inflation, and its predictions consistently understated the threat of higher prices.

Here’s the trend of the Fed’s projection for inflation in 2022:

Sep 2019: 2.0%
Dec 2019: 2.0%
Jun 2020: 1.7%
Sep 2020: 1.8%
Dec 2020: 1.9%
Mar 2021: 2.0%
Jun 2021: 2.1%
Sep 2021: 2.2%
Dec 2021: 2.6%
Mar 2022: 4.3%
Jun 2022: 5.2%

The emergence of inflation was clearly visible one year ago, yet the Fed did nothing. The Fed currently projects inflation of 2.2% in 2024. Yeah, right.

“They Will Also Bring Some Pain”

Let me explain what Powell said and why it was so jarring to the market. First off, this wasn’t just any address. Powell was speaking at the Fed’s annual end-of-summer conference in Jackson Hole, Wyoming.

Since there’s no Fed meeting this month, the conference gets a lot of attention. In previous years, the Fed has used that Jackson Hole conference to announce major changes in policy.

The backdrop of this year’s meeting was a very impressive summer rally. In fact, as I mentioned in last week’s issue, the bulls finally faced some resistance only after the Fed released the minutes of its most recent meeting.

There’s also the all-important issue of persistent inflation. While there has been some improvement, mostly with energy, Americans are still facing rising costs for nearly everything.

Furthermore, there’s concern that the Fed may not realize the enormity of the job before them. I have to count myself among this group. It’s easy for the Fed to talk tough, but it’s quite another to act tough.

Here’s the broader text of what Powell said. I’ve added the boldface.

Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance. Reducing inflation is likely to require a sustained period of below-tren growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.

Powell was unambiguous that the Fed intends to defeat inflation. Powell said, “We will keep at it until we are confident the job is done.” That’s unusually blunt language for a central banker. The remarks were also unusually brief.

The Fed has already raised short-term interest rates by 0.75% at its last two meetings. Recently, however, some Fed members have expressed concern about the damage the economy has experienced. Just ask anyone you know who works in the housing sector.

There was some concern that the Fed might announce a “pivot” in Jackson Hole and plan on a softer interest-rate policy. Alas, the pivot never came.

Some Possible Softening of Inflation

As it turns out, Friday was also the day that the government released its PCE inflation report. This is the Fed’s preferred measure of inflation. According to the PCE, inflation rose by 6.3% in the 12 months ending in July. That’s down from 6.8% for the 12 months ending in June. While inflation may be decelerating, it’s still high. The goal of 2% inflation is based on the PCE.

The core PCE rate, which excludes food and energy, is up 4.6% over the last year. During July, the core PCE rate increased by 0.1%. That’s a very big drop from the 0.6% increase we had in June. Powell said, “restoring price stability will likely require maintaining a restrictive policy stance for some time.”

Much of inflation is really an expectations game. If the public expects more inflation, then there will be more inflation. If the public expects inflation to wane, then it will wane. The problem is that once expectations become embedded in the public’s perception, then it’s very hard to undo that. That’s part of the reason why Powell is sounding so tough.

On Friday, Powell said, “The longer the current bout of high inflation continues, the greater the chance that expectations of higher inflation will become entrenched.” He also noted that the economy “continues to show strong underlying momentum” despite some mixed signals on growth.

This Friday, the government will release the official jobs report for the month of August. The last report showed the lowest unemployment rate in 53 years. Some folks had been expecting to see a drop off in the jobs market. So far, that hasn’t happened.

For Friday, the consensus on Wall Street is that the economy created 318,00 net new jobs last month and that the unemployment rate will hold steady at 3.5%. That sounds about right.

The Federal Reserve’s next meeting is on September 20-21. Previously, it had been a tossup in the market’s mind as to whether the Fed would raise interest rates by 50 basis points or by 75 basis points. However, after Powell’s comments, the 75-basis-point camp now has a solid majority among futures traders.

On Tuesday, we learned that jobs openings reached 11.24 million. That was much higher than expectations. That’s nearly two openings for every unemployed person. Economists also like to track the number of people who quit their jobs, and that’s still high. This probably suggests that workers have the upper hand in being able to demand higher wages since it’s relatively easy to find work elsewhere.

That’s all for now. The stock market will be closed on Monday for Labor Day. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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Posted by on August 30th, 2022 at 6:57 pm


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.