Inflation, consumer spending, and the labor market
This week’s economic reports showed mixed results. June’s core CPI of 3.2% Y/Y was in line with expectations, while the 3-month annualized figure was 1.6%, which suggests the slowdown in inflation is on pace to achieve the Fed’s target of less than 2%. In contrast to the softer inflation readings, this morning’s retail sales report showed consumer spending growth of 1% in July, much stronger than economists’ average estimate of 0.3%.
This morning, Walmart reported strong revenue and earnings, and raised its revenue growth guidance for the year from a midpoint of 3.5% to 4.25% Y/Y. Walmart’s value prices and focus on consumers’ non-discretionary purchases, such as groceries and other essentials, has insulated its revenue growth relative to retailers that rely more on discretionary or big-ticket purchases. Despite the positive revenue outlook, Walmart’s earnings guidance for the second half of the year remains slightly lower than analysts’ estimates. Like its retailing peers, Walmart sees negative impact from softer sales of discretionary purchases which usually carry higher profits.
Earlier this week, Home Depot’s earnings report revealed a 3% Y/Y decline in same store sales which forced the retailer to lower full-year expectations. Higher interest rates are a major contributor to the soft demand, according to management. Nonetheless, well-executed expense control and efficiencies from prior productivity investments enabled Home Depot to hold profit margins almost flat Y/Y despite the softer sales.
Companies focus on cost-cutting and expense management when revenue growth weakens. Last night, Cisco reported better than expected earnings, but also announced a restructuring plan that will impact about 7% of its global workforce, which further highlights the cautious business sentiment amidst economic challenges.
Overall, while some indicators suggest a potential easing of inflation, the consumer spending landscape remains uncertain, and businesses are taking measures to adapt to the current economic conditions.
It’s that time of year: the Jackson Hole conference
At this point, investors are expecting a near 100% chance of a rate cut in September. Whether the Fed should cut rates by 25 bps or 50 bps at the September meeting can be debated, but any decision will likely hinge on the strength of the August payrolls report which will be released on September 6. Chairman Powell has stated clearly that the risks of a weaker labor market and a resurgence of inflation need to be balanced.
Chicago Fed President Goolsbee believes the Federal Reserve should act preemptively and cut interest rates before the labor market deteriorates further, warning that delays could harm the economy. His comments contrast with those from other Fed officials, like Atlanta Fed President Bostic, who prefers waiting for more data before considering a rate cut. While Fed Governor Bowman acknowledges that inflation remains high, Goolsbee’s dovish stance suggests a growing division within the Fed on the appropriate timing for future rate cuts, setting the stage for Chairman Powell’s highly anticipated speech at the Jackson Hole conference on August 23. Investors will be on high alert for any surprises.
Lower rates to the rescue
Treasury yields have continued to plunge in August. The 10-year US Treasury yield is trading near 3.8% which is 0.9% lower than its July high of 4.7%. The U.S. Treasury 2-year yield has fallen from 4.8% to 4.0% over the same period. While the yield declines reflect a combination of heightened recession fears and increased confidence in Fed rate cuts, lower yields also support stock prices so long as corporate earnings don’t crash.
About 90% of S&P 500 companies have now reported their quarterly results. Companies are expected to deliver full-year earnings growth of approximately 11%, which analysts expect to accelerate to 15% next year. I suspect this optimism may be too high, but time will tell. Lower interest rates will undoubtedly help economic activity. In particular, lower rates will likely increase the number of real estate transactions. The real estate market is an outsized contributor to the economy. Buyers and sellers of homes tend to spend a lot of money on projects in the year before and the year after a transaction. Of course, there are many other borrowers that benefit from lower rates. Business investment and other spending tied to cyclical industries will see the biggest impact.
Risk of recession
There is a time lag between when interest rates are lowered and when borrowers spend the money. This time lag can be a period when unemployment accelerates if the economy is heading toward recession. A rapid rise in unemployment when there are lingering concerns about an inflation resurgence would make the Fed’s job more difficult. Hence, the Fed’s balancing act to maintain stable prices while targeting full employment.
Our prediction that August and September would deliver an added dose of market volatility has not failed to disappoint so far. And, we are only halfway through August. This morning, I heard a guest on a radio broadcast share a relevant quote from Winston Churchill that seems worth resharing: “If you are going through hell, keep going.”
Actress Jennifer Lawrence turns 34 today, actor Ben Affleck is 51 and Princess Anne turns 74.
Christopher Gildea 610-260-2235