Hope you are all doing well. The major U.S. stock indexes ended the week with a terrible Friday, sending the S&P 500, the NASDAQ, and the Dow down around 4% overall. It was the second weekly setback in a row for the S&P 500, interrupting the positive momentum that had lifted the index more than 17% from mid-June to mid-August. The highly anticipated Game of Thrones prequel, House of the Dragon premiered this week. I have broken down this week’s update using quotes from the series premiere.
U.S. Federal Reserve Chair Jerome Powell sounded very much like he was on the iron throne saying that economic discomfort “is the unfortunate cost of reducing inflation. But a failure to restore price stability would mean far greater pain.” The Fed remains committed to extending its policy of aggressively raising interest rates, even at the risk of fueling a potential recession. The Fed is acknowledging that while the early signs are positive there is still work to be done. The Fed’s preferred inflation indicator, the PCE deflator, was much better than expected in July, dropping from 6.8% to 6.3% from a year ago. They are encouraged but don’t want to give themselves a pat on the back just yet because the core index which excludes food and energy is still at 4.6%. That is more than double their constantly stated 2% target. There is no new news here, Powell is saying the same thing he’s been saying he just said it with more conviction and markets finally listened. The reason the rebound in stocks has stalled is that markets were anticipating the Fed actually reducing rates in the back half of next year when the economy eventually starts to slow. Powell in no uncertain terms said he is willing to accept economic pain to combat inflation and avoid a 1970’s type scenario. I view that as a positive and if inflation continues to trend down the markets will too.
If you’re planning to go to France and enjoy a slice of mille feuille now might be the time. The year-to-date strengthening of the U.S. dollar lifted its value slightly above that of the euro on Tuesday. The dollar remained above the parity level for nearly all of the rest of the week. On Friday afternoon, a single euro was trading around $0.997. The last time the two currencies reached parity for a sustained period was in late 2002. A strong dollar hurts our exports which leads to a trade imbalance. The trade imbalance has been causing GDP to be negative but the rest of the inputs have been strong. Therefore, the negative GDP is really NOT reflective of a bad economy. More so it reflects that the US consumer has increased in strength relative to the rest of the world.
My belief is that overall inflation will continue to move downward. However, in reality the Federal Reserve has little to no control over food or energy prices. We were reminded of that this week as it was reported that the corn yield in Iowa has been “lackluster”. This matters because the drought out west has already strained the food supply. A weak harvest in Iowa makes it unlikely that the eastern portion of the crop belt will make up for the losses in the west. It creates the possibility that more global food inflation could be on the horizon. The same is true of oil. We are entering hurricane season and all it takes is a storm to knock out a drilling platform or two to cause a spike in oil. Furthermore, much of the world’s supply is controlled by non U.S. entities who aren’t concerned about what the American consumer pays at the pump. Remember, even if we do get an increase in overall inflation that doesn’t mean that the rate hikes aren’t working, the critical number is that 4.6% number that excludes food and energy. That is the number that needs to continue to drop.
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