All About the Fed

1. Fed Narrative Stays Consistent. Fed members have done little to push back against the narrative for maintaining aggressive rate hike action. Restoring price stability remains the Fed’s top mandate, even at the risk of raising the unemployment rate. This is important, because the strong labor market is a key reason why, despite slower growth, we don’t believe the U.S. is currently in a recession. Fed policy has a lagged economic impact (typically 6-9 months), and despite signs of slowing demand, the jobs market remains robust with historically low unemployment claims and still-elevated job openings. There are 4% more job openings now than at this time last year.

Chart 1: Moving Averages for Unemployment Claims Has Yet to Gain Momentum¹ 

The Fed still seeks to execute a soft landing, though “the risks of recession over the next two years have moved up,” says Federal Reserve Bank of Cleveland President Loretta Mester. President Mester also noted that “it is far too soon to conclude that inflation has peaked, let alone that it is on a sustainable downward path to 2%.”² The continued flow of commentary from numerous Fed members has stayed consistent – aggressive tightening through year-end, rising unemployment likely, and the risks of uncontrolled inflation outweigh the risks of a hard landing. 

In addition to raising rates, the Fed’s large presence as a buyer in the Treasury and mortgage markets is disappearing. In September, $95 billion of combined Treasury and mortgage securities will roll off its balance sheet, twice as much as the past three months.³ This both reduces liquidity and creates greater systematic risk for financial markets. 

Aggressive monetary policy is not isolated to the United States. Last week, the European Central Bank raised all key rates by 75 bps, following 50 bps in July, and there’s expectations for another 50 bps in October. 

2. Bank of America Publishes Consumer Spending Data.The Bank of America Institute released their August publication on consumer spending, and the report highlighted rising utility and childcare costs. The average utility payment increased +16% y/y in August, and childcare was up 9.7% y/y. Total payments increased +13% y/y, a notable rise from +7% y/y in July. Card spending per household increased +5% y/y, which was down slightly from +5.3% y/y in July but still robust considering the “peak demand” narrative experienced in the prior year. 

This spending data does indicate that “real (inflation adjusted) spending” continues to be under pressure as CPI was +8.5% y/y in July and PCE inflation +6.3% y/y. In summary: Consumers are spending more for less, and importantly, the consumer is not rolling over like many expected. Bank of America also highlighted that savings and checking accounts continue to remain elevated. 

Despite the drop in gasoline prices, utility bills are now placing greater pressure on consumer budgets. Prices for goods tend to be more directly impacted by slowing demand vs. services. August CPI data gets released this week, and the report will be studied for its display of goods vs. services. Service prices tend to be impacted more by rising wages and the tight labor market. 

Chart 2: CPI Commodity Prices Down from Peak, CPI Services Still Rising Through July⁴ 

3. Earnings Support Relief Rally. Equities were higher last week, breaking three-straight weekly declines of at least -1%. The rally was supported by oversold conditions/sentiment, continuation of strong labor market data and companies beating a lower bar on earnings. As expectations for slower earnings growth, lower guidance and downgrades begin to set in, this offers upside. 

According to FactSet, 62 S&P 500 companies have issued negative EPS guidance for Q3, compared to 40 companies issuing positive guidance. During the first two months of Q3, EPS estimates declined -5.4%, compared to an average -1.9% decline in bottom-up EPS estimates in the first two months of the quarter and the largest decline since 2Q 2020. 

Companies including ZScaler (ZS), DocuSign (DOCU), RH (RH) and Kroger (KR) all beat lower expectations and outperformed the index last week.⁵ These companies transcend industries and benefit from a broader “relief rally” response to earnings. 

Earnings growth rate for the S&P 500 was +6.3% y/y in Q2, below the +8.9% y/y 10-year average – slower, but still healthy. Interestingly, 75% of companies beat EPS expectations, above the 10-year average 72%, and companies with positive surprises were rewarded substantially more than historical periods for positive surprises, while companies with negative surprises were barely penalized (much less than historical periods).⁶ 

4. Railway Labor Strike Tensions Rising. A long two years of labor negotiations across the major railways and representative labor unions have failed to reach a settlement, despite recent White House emergency involvement. The “cooling-off period” ends on September 16, and if no agreement is reached, strikes, lockouts and congressional intervention could all take place. 

Further disruption to shipping activities would likely underscore inflation and slow the economy, not to mention concern for hazardous, security-sensitive and medical material.⁷ Earlier this month, Vice cited a survey that 96% of freight rail workers want to strike.⁸ 

5. The Week Ahead. 

Earnings – Tuesday: SBUX (Investor Day). Thursday: ADBE. 

Economics – Tuesday: CPI (August). Wednesday: PPI (August). Thursday: Retail Sales (August), Industrial and Manufacturing Production (August), Philadelphia Fed Index (September). Friday: Preliminary Michigan Sentiment (September) 

Stephanie Link: CNBC TV Schedule 

Return for Selected Indices⁹ 

Sources

1. FactSet (chart)
2. The Wall Street Journal
3. New York Times
4. FactSet (chart)
5. CNBC
6. FactSet Earnings Insight
7. Reuters
8. VICE
9. Bloomberg

Disclosure

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