by Krystal Daibes Higgins, CFA
Vice President, Equity Research
Funambulist: A tightrope walker
This year has been anything but straightforward for investors, and the most recent Fed minutes are prolonging this state of confusion. While we have seen some reduced inflation pressure in the last several weeks, the Fed minutes point out that “risks to inflation were weighted to the upside,” citing factors such as further supply chain disruptions, continued geopolitical turmoil and persistent real wage growth. For investors, the focus continues to surround the pace of Fed rate hikes for the remainder of the year. A continued “hawkish”— or aggressive approach — would likely further pressure equities, while a slower rate hike approach could result in equities rallying. From a big picture view, investors are focused on whether the Fed can continue walking the tightrope by reigning in 40-year high inflation, but not going too far and tipping the economy into a recession.
For the Fed to slow down rate hikes, we must continue to see price increases declining, as we saw in June when inflation decreased to 8.5% from 9.1%. Last week’s inflation news was a big sigh of relief and raised the possibility for a 0.50% rate hike versus 0.75%. However, solid retail sales and low jobless claims data released this week suggests this remains an open question.
The underlying details of retail sales, which correspond to the consumer spending component of GDP, was stronger than expected in July. Excluding gas and autos, sales rose by 0.7%; and with prices no longer rising rapidly, the increase in spending should lead to “real” (i.e. inflation-adjusted) consumer spending. The retail metric provides some optimism that GDP numbers could return to positive territory next quarter, as the consumer segment comprises 70% of the economy.
Adding to confidence on the consumer segment, companies don’t seem to notice any spending slowdown. Starbucks management told investors “it’s critically important that you all understand we are not currently seeing any measurable reduction in consumer spending.” Similarly, Visa, a company that benefits from being the chokepoint for retail consumer spending, reported during its earnings call that it’s “seeing no evidence of a pullback in consumer spending,” despite rising interest rates, high inflation and declining consumer confidence.
Jobless claims, one of the metrics to assess the health of the economy, ticked down, suggesting a continued healthy employment picture. The Fed is keenly focused on the jobs market as it looks to cool inflation. In addition, the U.S. unemployment rate dipped to 3.5%, the lowest level in over 50 years. These metrics are encouraging signs of a healthy economy, even as several large corporations have announced layoffs or hiring freezes amid economic uncertainty.
While normally good economic data is a positive for the markets, it is further complicating the path to controlling inflation. As a result, it looks as if the Fed may still have a long road ahead with rate hikes.
Takeaways for the Week
From our point of view, the Fed appears to be effective so far in walking the fine line between reigning in inflation and putting the U.S. economy in a recession
Retail sales and jobless claims data indicate the U.S. economy remains strong and suggests a reduction in the risk of a near-term recession