More Hikes, More Pain (Eventually)

The last 100bps of tightening is historically the most difficult for the markets, and the economy, to digest. Thus, while global economies have proven – somewhat – resilient up to this point, as central banks around the world continue to tighten policy, economists continue to anticipate recession in the next 6-18 months.?

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Recession, price stability, stubbornly elevated inflation, these are but a few of the topics policy makers will discuss in Sintra, Portugal for the ECB's annual retreat on central banking. Following Fed Chairman Jerome Powell’s testimony last week indicating further rate hikes would be necessary, commentary from his counterparts in Europe, the U.K. and Japan will be closely scrutinized for similar sentiment.?

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In the U.S., inflation has retreated from earlier highs but remains quite elevated. But after 500bps in tightening, the answer lies in part with the presumed lag in policy as well as the organic nature of inflation that was spurred during the pandemic and the immediate aftermath. While historically Fed officials have assumed a sizable timeline between the implementation of monetary policy and the real effect on economic conditions, many argue such a gap has been greatly diminished with a growing level of transparency in the policy-making process. With a Summary of Economic Projections (SEP) four times a year, a press conference at every meeting, not to mention ample commentary and Fed-speak from a plethora of officials, this has arguably led to an anticipatory nature of financial market conditions. Meaning, the Fed’s next move(s) are largely already priced into the market often before they are made official because policy makers have been clear in the pathway for policy. Which is to say, if in fact there is a diminished period between action and effect of Fed policy, the minimal effect on prices to date should force the Fed’s hand to step back up to the plate sooner than later.

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Furthermore, as expected, the lack of meaningful improvement in inflation thus far reflects the complicated nature of the beast created during the pandemic. The unprecedented nature of the policy response, including global supply chain restraints and dislocations and the unprecedented surge of fiscal stimulus totaling trillions and trillions – and trillions – of dollars has resulted in price pressures of all kinds, some of which are beyond the Fed’s control. Supply side inflation, wage inflation, demand-side inflation, or what some have deemed greed-flation have resulted in the widest profit margins in decades (this also helps to explain the varying spread between the PPI and CPI). While the Fed can raise the cost of borrowing to tamp down investment and consumption, there is little policy makers can do to control corporate policy or broker international peace. In essence, the Fed, as Powell has noted in the past, cannot print more ships.?

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On the economic calendar yesterday, the Dallas Fed Manufacturing Activity Index rose from -29.1 to a reading of -23.2 in June, a three-month high but the 14th?consecutive month of a negative print. According to the median estimate on?Bloomberg, the index was expected to rise to a reading of -21.8.

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In the details of the report, new orders fell from -16.1 to -16.6, averaging -12.3 over the past six months, production fell from -1.3 to -4.2, and capacity utilization dropped from -4.9 to a reading of -6.0 in June. Also, employment declined from a reading of 9.6 to 2.2, a four-month low. On the other hand, the six-month general business outlook index increased from -12.7 to -4.5 in June.

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This morning, durable goods orders unexpectedly rose 1.7% in May following a 1.2% gain in April. According to the median estimate on?Bloomberg, durable goods orders were expected to decline 0.9%. Year-over-year, headline orders rose 4.2% in May, up from the 4.1% annual increase the month prior.

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Transportation orders rose 3.9% following a 4.8% gain the month prior, due to a 32.5% gain in civilian aircraft orders and a 2.2% increase in vehicle and parts orders. Excluding transportation, durable goods orders rose 0.6% in May, but fell 0.3% over the past 12 months.

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Capital goods orders rose 2.8% in May. Nondefense capital goods orders, meanwhile, gained 6.7% following a 0.1% increase in April. Capital goods orders excluding aircraft?and?defense – a proxy for business investment – rose 0.7% in May following a 0.6% rise the month prior. Year-over-year, business investment increased 2.1%, up from the 1.8% annual gain in April.

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In other details, electrical equipment orders gained 1.7%, machinery orders rose 1.0%, and primary metals orders gained 0.5%. Also, computers and electronics orders rose 0.3%, while fabricated metals orders were flat in May.

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The S&P Case Shiller 20-City Home Price Index rose 0.91% in April following a 0.42% gain the month prior. According to the median estimate on?Bloomberg, the 20-city index was expected to rise 0.40%.?Year-over-year, however, the 20-city index dropped 1.7% following a 1.12% decline the month prior. The National Home Price Index, meanwhile, rose 0.53% in April and declined 0.24% over the past 12 months.

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The FHFA Home Price Index increased 0.7% in April, more than the 0.5% gain expected and following a 0.6% increase the month prior.

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Additionally, this morning, new home sales unexpectedly jumped 12.2% from 680k to 763k in May, the highest since February 2022. According to the median estimate on?Bloomberg, new home sales were expected to decline 1.2% in May. Over the past 12 months, meanwhile, sales jumped 20.0%, following a 11.3% gain the month prior. Due to a rise in sales, the months’ supply of new homes ticked down from 7.6 months to 6.7 months, the lowest since February 2022. From a price standpoint, the median cost of a newly constructed home rose 3.5% from the month prior to $416k. Year-over-year, however, new home prices decreased 7.6% in May following a 12.2% drop in April.

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Also, this morning, the Conference Board Consumer Confidence Index rose to 109.7 in June from 102.5 in May, surpassing the expected gain to 104.0 and the highest reading since January 2022.?In the details of the report, a gauge of current conditions gained from 148.9 to 155.3, the highest readings since July 2021, and a gauge of future expectations rose from 71.5 to 79.3 in June, a nine-month low.

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Finally this morning, the Richmond Fed Manufacturing Index rose from -15 to -7 in June, a three-month high but still marking the sixth consecutive month of a negative print.?According to the median estimate on?Bloomberg, the index was expected to rise three points to a reading of -12.

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In the details of the report, new order volume rose from -29 to a reading of -15, order backlogs ticked up from -32 to -25, and shipments rose from -13 to -5, a three-month high. Also, capacity utilization increased from -15 to -2 in June. On the other hand, the number of employees declined three points to a reading of 2, a two-month low.

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Tomorrow, weekly mortgage applications data will be released, and the May pending home sales report will be released on Thursday.

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Also on Thursday, the third revision to Q1 GDP will be released. In the second round revision, GDP and consumer spending was surprisingly revised higher. GDP was revised up by two-tenths of a percentage point to a 1.3% gain on an annualized basis, following a 2.6% gain in the fourth quarter. Personal consumption was revised up a tenth of a percentage point to a 3.8% gain in the second-round Q1 report, following a 1.0% rise in Q4.

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Arguably most important, however, along with the latest consumer spending data, is an updated read on the PCE, the Fed’s preferred measure of inflation, on Friday. The headline PCE is expected to show further improvement in May, potentially dropping below 4% on an annual basis for the first time since the spring of 2021.?The core, however, which excludes food and energy, remains stubbornly elevated and is expected to remain well above 4.5%, perpetuating the Fed’s need for further action.?

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?-Lindsey Piegza, Ph.D., Chief Economist?