NOAA reported recently that July 2022 was the third hottest for any month on record in the United States. The national average was 76.43 degrees, which to me, here in daily 90-plus degree weather, sounds terrific; it’s just too hot here. Thankfully, we are about to enter that period where things start to cool down. Can the Fed say the same about the still too-hot inflation and job numbers?
Inflation shows signs of moderating:
It feels odd to be excited about an 8.5% inflation number, yet here we are. The latest inflation report came in below expectation at 8.5%, notably lower than the previous month’s reading. The decline is largely due to a drop in energy and gas prices. That said, it’s not just energy; a wide swath of commodity prices have come down. For example, lumber prices are down about 68% from their high in May of 2021. The cost to ship a freight container from Shanghai to Los Angeles is down about 40% from a year ago. The Core CPI, which strips out food and energy, also came in lower than expected.
This is good news for consumers and the markets and hopefully marks a turning point in the Fed’s inflation fight, where we start to see steady declines going forward. Unfortunately, no one can make that call just yet. Inflation is still high, and pockets of it haven’t shown signs of easing yet. Food and shelter costs have still been increasing. While the latest report was encouraging in that it moved in the right direction, we expect it will likely take time to see a significant fall and move from 8.5% inflation down to 3%. Hopefully, we continue to see signs that we are on that track.
The jobs report came in hot:
It’s important to remember that our Fed has a dual mandate, targeting both healthy inflation and employment. July’s jobs report came in much, much stronger than expectations, at 528k workers added vs. the expectation of 250k. Payrolls have now passed their pre-pandemic peak. The unemployment rate is down to just 3.5%, though the labor force participation rate also ticked down.
That may sound like good news, but it is probably too hot for what the Fed wants and is negative for getting inflation under control. When companies struggle to find workers (like they are now), average earnings go up. There are still more job openings than people unemployed. Year over year, hourly earnings are up 5.2%, and those extra company costs trickle down into consumer prices.
We somewhat joke around the office about how off economists have been on some of their expectations recently, like the recent employment report. Leading indicators for employment weren’t that strong before the actual report came out. For example, initial unemployment claims are up about 50% from their March low. Three of the past four months have seen year-over-year increases in job-cut announcements. Perhaps the explanation lies in the lag between leading indicators and getting filtered into the headline data. If so, we could also see signs of the employment picture cooling down.
Markets had an excellent July, with the S&P 500 gaining 9.1%. For the year:
- The S&P 500 is down 8.80% YTD
- International (MSCI EAFE) is down 14.39% YTD
- Bonds (Barclays US Aggregate Bond) are down 8.76% YTD
Insert Chart here:
Putting it all together:
With the markets, sometimes bad news is good news. The market rallied in July amid the second quarter of negative GDP and rising tensions over Taiwan, neither of which are good. With a cooling economy, though, and signs of inflation potentially cooling, the market looked ahead in anticipation of the Fed cooling its tone, sparking a rally.
Remember, the market front runs what happens based on anticipation. Sometimes it is correct, justifying the run-ups. Sometimes though, it’s wrong, sparking corrections. It’s tough, to near impossible, to consistently time the peaks and troughs. The danger for market timers is that if they miss it even by a few weeks, they can miss big recoveries, like in July.
Throughout this year, we’ve preached to keep your long-term perspective and avoid trading on fear. Now, we preach to keep your long-term perspective and avoid trading on greed.
The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities that represent the stock market in general. The Bloomberg Barclays US Aggregate Bond Index is a broad base, market capitalization-weighted bond market index representing intermediate-term investment-grade bonds traded in the United States and is used for measuring the performance of the US bond market. Indexes are unmanaged and do not incur management fees, costs, or expenses. It is not possible to invest directly in an index. The MSCI EAFE Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada. It is maintained by MSCI Inc., a provider of investment decision support tools; the EAFE acronym stands for Europe, Australasia and Far East.
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