Essential Economics

 — Mark Frears

Bright lights

As it is fall, though temperatures are not there yet, high school football started last Friday night! The band, cheerleaders, drill team (kicking girls when my boys were young), fans, vendors, referees and, of course, the football teams were all out there. The production is amazing, all the way from the smallest to the largest schools. The lights were on, and the focus was on the kids having a blast. Let us focus on what is influencing our economic picture.

War

While the atrocities continue in Ukraine, the people there will not quit, and Russia has more to deal with than they expected. The impact on the rest of the world in economic terms continues to escalate. Putin has cut natural gas exports to less than 20% of last year’s levels. This is already having an impact on Europe with home heating bills expected to increase fourfold over the winter months. Ironically, hope may come from an unlikely source, China, as their country’s demand has shrunk, and they have excess supply.

Inflation

The Federal Open Market Committee’s (FOMC) favorite inflation measure, the Personal Consumption Expenditures (PCE) Deflator, slowed last month, as well as the year-over-year measure. While they watch and forecast this metric, they still pay close attention to the Consumer Price Index (CPI) and the overall cost of living.

While the housing market continues to slow, many say due to higher mortgage rates, the prices continue to stay elevated. We have seen supply increase, but the underlying cost of labor and materials will not allow prices to drop significantly. On my daily walks around the neighborhood, a few houses are staying on the market longer, but the good ones are still moving quickly. 

Groceries may be the stickiest high-cost item. While the Fed will raise rates to slow demand, people still must eat. Drought conditions around the U.S. are not making it easy on farmers, along with higher fertilizer costs. These and other factors have contributed to the U.S. forecasting the smallest corn crop since 2019. This will not help bring down food costs anytime soon.

While much was made about the possibility of student loan forgiveness, we must remember that this is still a plan and whether it can/will be passed into law is still in doubt. If it were to come to fruition, economists do not look at this fiscal stimulus as inflationary, as the dollars saved would be used for longer-term items like debt reduction and homebuyer down payments.

The U.S. has seen gasoline prices come down from the peak, but OPEC+ is starting to make noise about cutting production. The effect of higher energy costs impacts multiple industries, through manufacturing and transportation. The threats of rolling brownouts or blackouts have diminished, and that is good because I do not want to be without air conditioning in Texas in July, August or September.

Fed

The first on-site Jackson Hole Fed Conference since 2019 seemed to be a good excuse for all the “talking heads” to head west. The hours of coverage devoted to speculating on what Chair Powell might utter filled the airwaves all week.  The other Fed Presidents and Governors on the tape voiced opinions that they will continue to fight inflation, with an eye on how the economy is doing.

Jerome Powell’s speech only lasted ten minutes, but he made his case loud and clear. They are shifting towards a period of “purposefully” raising rates to a “higher for longer” outlook. The impact to the economy — read recession — has taken a back seat to the fight against inflation.

Equity markets did not like this message. It started slowly but gained momentum quickly. The S&P 500 finished down 3.37% on the day. Concern is for future economic weakness caused by further Fed tightening of policy. U.S. Treasuries did not change significantly with 10-year remaining close to 3%.  

The next regular FOMC meeting is September 20 – 21 and short-term futures are leaning toward a 75-basis point increase. The terminal/high rate is a little higher now at 3.70%, and the first cut in short-term rates has been pushed out to later in the year.

Earnings

For companies and stock market participants, the impacts of war, inflation and higher rates from the Fed will be watched closely. As you and I represent two-thirds of economic growth, it will depend on how much we are influenced by the circumstances around us, or whether we continue to spend. 

If we have jobs and feel confident that we could get another if we lost the current one, we would spend. The labor market continues to look robust with the unemployment rate at a low 3.5%, job openings plentiful, and employers paying up to attract top candidates.

Second quarter earnings came in higher than expected. While it is too soon to tell, the initial prognostications for third and fourth quarter are headed south, like the northerners.