The summer Jackson Hole Economic Symposium delivers once again…in terms of market volatility. Chairman Powell delivered a continued hawkish stance on rates which was far from any sort of “pivot” on the current interest rate policy. August saw equity markets give back almost half of July’s gains and the yield curve rose sharply across the board. The S&P 500 Index fell 4.08% in August, with much of the downside coming post-Jackson Hole.
After Chairman Powell’s comments on August 26th, the Dow Jones Industrial Average fell over 1000 points. The NASDAQ Composite Index was hit even harder (-4.53% in August), as the technology sector was the largest underperformer for the month, down 6.28%. Both health care and real estate fell almost 6% for the month as well. The energy sector was the biggest leader (+2.18%), and the utility sector was just slightly positive (+0.07%).
August portrayed a microcosm of 2022, and interest rates soared back to higher levels. The yield curve continued its “bear-flattening” trend, and the U.S. 2 Year Treasury note rose over 60 basis points to yield 3.49% by month-end, representing a 15-year high. The benchmark U.S. 10 Year Treasury Note also rose to 3.19% from 2.65%, reversing lower yields earlier in the summer.
Credit markets fared even worse than government bonds as risk premium spreads widened along with higher interest rates. The Bloomberg US Credit Index fell by 2.83% versus the Bloomberg US Gov index -2.46%. Municipal bonds performed relatively better due to a lack of supply in the face of increased maturities. (-2.19% for the Bloomberg Muni Index). High Yield debt fell by 2.30% as the possibility of default in some sectors is rising (ex: Bed Bath and Beyond bonds are trading at close to default levels). Emerging Market debt fell only -0.77% as that specific market has been battered most of the year (possible energy and dollar strength are helping dollar-denominated debt).
While the Jackson Hole event was on the minds of investors all month, August started with a political macro catalyst as Speaker of the House Nancy Pelosi flew to Taiwan to take meetings with their leaders. This caused an early risk-off atmosphere as risks of China retaliation rose, but inflation data, economic news, and FOMC warnings would soon be the driving force for August markets. Tensions between China and Taiwan, as well as conflict between Russia and Ukraine, continue to be important news issues, yet investors remain primarily focused on the path of U.S. inflation.
Before the symposium, Fed speakers continued to deliver a hawkish message. On August 3rd, Fed Governor Bullard suggested 4% rates by year-end and was in favor of front-loading interest rate hikes to slow inflation. Other Fed leaders suggested getting the funds rate to a restrictive stance would be helpful to slow the economy and bring inflation in line. These continued hawkish comments throughout the month began to shift reactions to economic and inflationary data.
There were some clear signs of economic slowdown in August, which suggested Fed activity to date is starting to work. Housing data illustrated this in August as existing home sales fell 5.9% month-over-month, and new home sales fell 12.6%.
- As strong economic data points came through risk markets generally saw this as negative - the FOMC has more work to do, and interest rates must drift higher.
- The monthly jobs data was a perfect example. On August 5th, the non-farm payroll figures far exceeded the expected gain of 250k, coming in at a robust +527K job gains. Logically interest rates began to rise, yet risk markets became shaky.
- Both the manufacturing and more importantly to GDP, the service sector of the economy, held up relatively well in the ISM reports for July. Some of the regional manufacturing figures had deep cuts, while some rebounded.
- Despite price hikes, retail sales also exceeded expectations for July proving the consumer will spend money if they are employed.
All important inflation data was quite mixed versus economists’ expectations last month, but the “sticky” nature of wage inflation and absolute price increases continues to grip investors and the Fed.
- The ISM prices paid index released on the first day of the month fell from 78.5 to 60 from July.
- Average hourly earnings remained elevated at 5.2% year over year. It was expected to be at 4.9% year over year.
- Important CPI and PPI data came in better than expectations and much lower than June data, but the elevated figures of CPI at 8.5% year-over-year, and PPI at 7.6% year-over-year show the FOMC still has work ahead. Both bonds and stocks had significant rally days as the data was lower than expected.
- Unit labor costs remained elevated for Q2, at the unsustainable rate of 10.8%. Core PCE figures were mostly in line with estimated but continue to be elevated as well.
While the Federal Reserve has stated its data dependence on the future path of rates, they are resolute on bringing inflation down to 2%. The positive economic data may elongate the Fed Funds tightening period or the level of future increases (50 vs 75 basis points in September). Next month’s quantitative tightening will become visible to the bond market, especially in Treasury Bill maturities. Jackson Hole and FOMC comments in August created some baseline for the balance of 2022, and into 2023.
- Rates will need to become restrictive, and a recessionary environment could be likely (see inverted yield curve). Comments of a “soft landing” have dissipated.
- Inflation could be a much longer fight, and the chances for interest rate cuts in 2023 are low.
- Inflation is a global problem. Bank of England raised rates by 50 basis points on August 4th and warned of a long recession. European traders have priced in a 75-basis point hike by October, and the ECB suggested quantitative tightening may be needed as well.
- At month-end, Cleveland’s Fed President Loretta Mester summed up her thoughts on policy: she favored rates above 4% in early 2023, risks of recession over the next year or two have moved higher, and it’s “far too soon” to conclude inflation has peaked.
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