The ugly stick was out on Wednesday. The stick was not shy about who or what it touched, and anything it touched was worse for it. Stock index futures had traded higher early on. You could almost feel that a very negative trap had been set… for the market. Fed officials had been so hawkish in their rhetoric going in and out of Jackson Hole. Did they know something the rest of us didn’t? It sure looked like that.
Consumer inflation for August, at least as currently measured by the Bureau of Labor Statistics, hit the band on Tuesday morning. It was warmer than expected. It was hot in the wrong places. This scared away investors. Headline CPI for August came in at +0.1% month-on-month and +8.3% year-on-year. Year-over-year printing was down from July’s 8.5%, but both figures were above consensus. Yes, even with the benefit of gasoline prices which fell 10.6% month-over-month and fuel oil prices which fell 5.9% month-over-month . These prices were somewhat offset by a 3.5% m/m increase in piped gas service prices. This did not bode well for the base rate.
At the core, the August CPI (excluding food and energy) hit the band at +0.6% m/m, from 0.3% in July, and +6.3% YoY, from 5, 9% in July. This is the highest year-over-year impression since the month this series last peaked (March 2022). Almost a new high. Nobody wanted to see that. August was also the second month in a row that prices for accommodation and medical services rose above trend after both categories lagged for several months. The fact that consumer inflation continues to spread to sectors of the economy that have not been hit as hard is not only troubling, it is terrifying.
Financial markets had obviously priced in a much cooler report than the one published. The S&P 500 fell 4.32%. The worst day for the broadest large-cap index in the U.S. market since much of the country was locked down in June 2020. The Nasdaq Composite fell a very nasty 5.16%, while the semi -Philadelphia drivers took a 6.18% beating. Small cap stocks “outperformed” with the S&P MidCap 400 down “just” 3.7% and the Russell 2000 down 3.91%.
They have streets after Tuesday’s regular session price discovery results…”One Way”. The losers beat the winners at the NYSE by nearly 7 to 1 and at the Nasdaq market site by about 4 to 1. Announcements. A hard lesson has been learned by those who choose not to wait for volume-based confirmation of a trend change before allocating capital. For four consecutive “up” days, we have been sounding the alarm bells on volume. I haven’t heard this warning from anyone else.
The pros finally showed up on Tuesday, and they weren’t optimistic. Overall trading volume increased 10.8% day-over-day for NYSE-listed names and 21.5% day-over-day for Nasdaq names. Trading volume on the S&P 500 and Nasdaq Composite easily surpassed their 50-day simple moving average trading volume in each case. Professional money was on the move Tuesday, trying to turn holdings into cash, but they were too late to get their price in many cases. Not everyone can use a single door to exit all at once.
Action in the Treasury markets was paramount. The yield on two-year U.S. bonds climbed 18 basis points on Tuesday to 3.75%, its highest level since October 2007. I see this particular yield trading at 3.78% this morning after peaking at above 3.8%. The yield spread between the US ten-year note and the US two-year note crossed a key trend line that had risen on Tuesday…
… The more deeply inverted stance of this gap reflects the now vastly heightened doubt about the US economy’s ability to achieve anything close to a “soft landing.” Let me explain.
The US central bank, already convinced that aggression is the best course, will feel compelled at this point to act more boldly in the future. The Fed will feel it almost has to hurt the US economy to restore balance to its dual mandate. In addition to the Fed’s quantitative tightening program which is just beginning, the FOMC will need to raise the Fed Funds Rate above the theoretical “neutral” rate, and likely to do so at next week’s meeting.
The case is as follows. Many of you know this. Some of you might not. We often follow the Atlanta Fed’s GDPNow model for real-time modeling of economic growth. The Cleveland Fed publishes a Nowcasting model for real-time inflation, and this model is revised daily. Currently, the Cleveland Fed model shows September CPI at 0.33% m/m and September core CPI at 0.51% m/m. That would be up from the August (yesterday) BLS print of 0.1% and 0.6%, respectively. Looking at the year-over-year base, Cleveland is showing September CPI with overall growth of 8.21% and base growth of 6.64%. That would again be up from the BLS’s impressions for August of 8.3% and 6.3%, respectively. What Cleveland is telling us is that from now on, headline inflation is stabilizing where it is, and core inflation is actually continuing to heat up. That is problematic.
This morning I see Chicago-traded futures pricing a 66% chance of a 75 basis point rate hike next week, and now a 34% chance of a full one percentage point hike . This would take the federal funds rate from the current range of 2.25% to 2.5% to 3% to 3.25%. Futures then price a 73% probability for at least another 75 basis points on November 2. This would place the FFR between 3.75% and 4%. Futures prices now expect FFR to end the year between 4% and 4.25% and peak for the cycle in February 2023 between 4.25% and 4.5%.
Remember that it usually takes at least nine months for Main Street, USA (excluding housing) to feel changes in monetary policy. People have yet to feel most of what the Fed has already done, and it hasn’t really started to impact economic activity. According to the St. Louis Fed, the velocity of M2 money supply actually increased in the second quarter.
We already know that the use of credit cards has increased dramatically. On Tuesday we learned that according to the FDIC, deposits in US banks also fell by $370 billion during the second quarter. This is the first quarterly contraction in U.S. savings since 2018 and the largest quarterly contraction in savings in U.S. history. Yes, the speed increased during the second trimester. The good people of Gotham and elsewhere plundered their savings and borrowed in order to maintain the standard of living their households had grown accustomed to. That was before they lost their jobs, which is yet to come. This is when the speed starts to drag again. This is where it gets hard. Really hard.
Markets and you
My opinion is that traders should stay “cash” into the wee hours and on weekends. Investors who need to participate should reposition weighting where exposure is greatest to areas that benefit from anything approaching inelastic demand. This is what the Fed is trying to do…destroy demand through a “reverse wealth effect”…This means that stocks must trade at reduced multiples and that other assets, even durable ones, like real estate and precious metals, may lose value perception, but perhaps not in relative terms as rates rise and the US dollar strengthens.
Areas that I consider inelastic would be utilities, healthcare, national security, and cybersecurity. There are others, but these are my areas of intervention. Cybersecurity is still expensive, so this area is tricky. I bought the dip on Tuesday, initiating new longs from two old friends… Northrop Grumman (NOC) and Palo Alto Networks (PANW). I intend to develop both posts, but honestly, who knows. Once I’m in a fight, everything changes.
The way to do it
Everything is for a reason. Slow down if necessary.
All avenues of approach, perceived threats and targets of opportunity.
To changing environments. Become what is needed when it is needed.
Find a way. Even in the face of persistent failure. Constantly learn.
With the mission. No start. Unending. In progress.
Yes you can. Fucked up? Have you screwed up several times? So be it. Correct course. Fight. See that little kid in the picture on your desk? This kid thinks you’re a hero. Be that hero. Be a shining beacon, even if you have never been before, of all that is pure and good. Be who this kid thinks you are. Focus on the task at hand. I know if you are well before sunrise and reading this you are a force to be reckoned with. Now roll it up. Be yourself. Be powerful. Still.
Fear is only for the wicked. So let the wicked tremble before us.
Economy (all Eastern times)
07:00 – 30-year MBA mortgage rate (weekly): Last 5.94%.
07:00 – MBA Mortgage Applications (Weekly): Latest -0.8% w/w.
08:30 – PPI (August): Expected 8.9% y/y, Last 9.8% y/y.
08:30 – Core PPI (August): Expected 7.1% y/y, latest 7.0% y/y.
10:30 a.m. – Oil inventories (weekly): Last +8.844M.
10:30 a.m. – Fuel stocks (weekly): Last +333K.
The Fed (all Eastern times)
Fed blackout period.
Results Highlights (PSE Consensus Expectations)
Before opening: (DOOO) (2.63)
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