August 2022

The August CPI report was a shocker in that the expectation was for inflation to finally drift lower.  In fact, the report confirmed that inflation continues to run at an elevated pace and the Fed’s raising of short-term interest rates is doing little to quell the uptick.  To put it into perspective, the year-over-year rate of inflation last August was an already an elevated 5.25%.  At the time, the Federal Reserve wrongly assured investors that inflation was transitory, and they didn’t need to adjust monetary policy because in short order the uptick would pass.  Recall, at the time Chairman Powell was up for renomination and, we suspect, reluctant to do anything to battle rising prices, fearing that to do so would torpedo his chances for renomination.  From our perspective, he had done a lousy job and should not have been renominated, but that did not come to pass.

Since the first rate hike in March of this year, the top of the overnight rate corridor has been lifted 225 basis points.  Following on the most recent CPI reading, there are those that believe the Fed remains behind in getting policy back to neutral.  Indeed, the consensus expects that the committee will raise Fed Funds by 75 basis points at the September meeting, with some speculators calling for a 100-basis point hike.  Pundits argue that to break the back of inflation, the overnight real rate needs to be positive, which means that the overnight rate would need to be higher than the rate of inflation, which in the current situation would be above 8.25%.

With talk of moving into restrictive policy, why are we not seeing a slowdown in the jobs market?  The answer can be surmised in the Canadian jobs report for August.  Economists had been expecting a 0.1% uptick in unemployment, up from the record low set last month.  Instead, the Canadian economy shed 77,000 jobs and the unemployment rate rose 0.5% to 5.4%.  The Bank of Canada is ahead of the Federal Reserve, hiking their overnight rate by 75 basis points to 3.25% just last week.  This should serve as a cautionary warning that when monetary policy turns restrictive, it can impact the jobs market suddenly.  On the news, the yield on the Canadian 30-year fell 5 basis point to 3.14%, which compares favorably to the 3.45% at which the U.S. benchmark trades.

The first day after the unofficial end of summer was a wild one for new issue corporate debt with nineteen corporations issuing $35 billion.  Investment bankers must have been busy in August warning CFO’s that they should lock in the current interest rates before they move meaningfully higher.  Apparently, the Bankers didn’t give their trading desks a heads up on the issuance, as the 30-year bond rose 15 basis points on the day on positioning for the new debt.

Despite that barrage of activity, Goldman Sachs, Citibank, and Morgan Stanley all warned of a profit shortfall in the quarter and announced plans to lay off staff.  At first blush, the announcement runs counter to the worker shortage story.  But considering the sustained drop in asset prices this year, we wonder if it’s actually the tip of the iceberg.  Profits were respectable in the second quarter of this year, but we question whether the same will be said about earnings for the soon to be complete third quarter.  Given the growing breadth of anecdotal weakness, we suspect earnings estimates are too high and that we will see a drop in earnings when reports trickle in next month.  The question remains how sharply the slowdown occurs and what impact will that have on the economy, and in turn, equity prices.  The hope is that the slowdown will be enough to put the inflation genie back in the bottle.  It’s quite possible, but that’s going to need to occur before inflation takes over the consumer mindset and becomes an entrenched problem.

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