Halyard’s Weekly Wrap – 07/29/22 – Fed Tightens into Slowing Economy

According to Morgan Stanley “2Q data would mark a technical recession, not an economic one”.  The Wall Street firm had forecast that Q2 GDP would come in at +1.0 annualized, so they needed an excuse for their wide miss.  In fact, the print was -0.9%.  Economic 101 teaches that two consecutive quarters of economic contraction are a recession.  Despite that, the Biden administration is saying that it’s not a recession, and points to the jobs market as proof.  We agree that the jobs market remains quite healthy, but there’s more to GDP than simply income.

Looking below the headline data, personal consumption for the quarter remained positive, but just barely so.  Durable goods and investment were down thanks to the sharp spike in borrowing rates, and government spending was down because Uncle Sam kicked his “ne’er-do-well” nieces and nephews off the dole.  The good news is the results weren’t as terrible as they could have been, but that’s also the bad news.  With interest rates continuing to rise and inflation yet to fall, it’s quite possible that the third quarter could result in a third consecutive contraction.

As anticipated, the FOMC raised the overnight Fed Funds rate 75 basis points, and we’d describe Chairman Powell’s press conference comments as mildly hawkish.  Surprisingly, bond investors didn’t share our interpretation and rallied the entire yield through 3% on the prospect that the rate hikes are soon to end and the first rate cut will come soon after.  Based on the Fed Fund futures curve, speculators are betting that Fed Funds will peak at 3.25% by early next year and the probability of a rate cut is being priced-in three months later.  While that forecast sounds about right, by no means is it a certainty.  The yield curve is going to be driven by inflation, economic activity, and to a lesser extent, the stock market.  We intentionally didn’t include energy because it’s not a variable the Fed can control.

Last week we mused about the possibility of weaker earnings when retailers report next month, despite not hearing any preannouncements as such.  The ink was barely dry on our weekly wrap when Walmart preannounced on Monday that second-quarter and full-year results will be sharply lower.  They specifically cited inflation as the primary driver of the lowered expectations.  On the day of the announcement, Walmart was down over 8%, but by close of business today, that selloff reversed, and the price is down an inconsequential 0.8% since last Friday.  That leads us to conclude that the “buy the dip” mentality is still alive and well.

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