Dear Friends,
Central bankers from around the globe meet annually in Jackson Hole, Wyoming to discuss the global economy. The event gets a lot of media hype, and for good reason, since the event is often used to introduce new policy ideas. What we learned from Jackson Hole last Friday is the Fed is interested in preparing markets for the committee to start cutting rates at the September 18 meeting and to start a measured process of cutting throughout the rest of this year and into next. A soft landing looks achievable, barring any shocks. Disinflation while preserving labor market strength is only possible with anchored inflation expectations, so an independent and credible central bank is key. Find out more about what is driving the markets in this week’s newsletter.
Economy, Geopolitics, and Commodities
1. Fed Rate Cuts Are Coming, but Investors Disagree on the Path Forward
Markets might be running ahead of themselves by pricing aggressive Federal Reserve interest-rate cuts this year. According to CME Group data, investors are mostly pricing a 25 basis point cut in each of the next two Fed meetings in September and November, followed by a larger trim in December, which some analysts and investment managers say would be too aggressive as they have concerns about a slowdown in economic growth.
The debate has implications for central banks around the world. If the Fed follows the more gradual route and cuts in 25 basis point increments, U.S. interest rates will remain high relative to other countries for longer. That, in turn, would attract investors to dollar-denominated assets, strengthening the U.S. currency. On the other hand, a more aggressive easing cycle in the U.S. could give more room for other central banks to also trim their rates without weakening local currencies. Last week at Jackson Hole, Fed Chair Jerome Powell gave clear signals the Fed is ready to cut rates in September while clarifying that the Fed does not seek or welcome further cooling in labor-market conditions. The argument for more aggressive cuts stems from a cooling labor market. Unemployment in July was a higher than expected 4.3% and past job creation figures were revised lower last week. Some pundits warn that unemployment could accelerate fast if the Fed takes a cautious approach. 1
2. The Fed’s Favorite Inflation Indicator Increased 0.2% in July, as Expected
The Commerce Department reported Friday that the personal consumption expenditures price index rose 0.2% on the month and was up 2.5% from the same period a year ago, exactly in line with the Dow Jones consensus estimates. Excluding volatile food and energy prices, core PCE also increased 0.2% for the month but was up 2.6% from a year ago. The 12-month figure was slightly softer than the 2.7% estimate. Fed officials tend to focus more on the core reading as a better gauge of long-run trends. Both core and headline inflation on a 12-month basis were the same as in June. Core prices less housing increased just 0.1% in the month. As other inflation components ease, the shelter has proven to be stubborn, again rising 0.4% in July, according to Friday’s report. Elsewhere in the report, the department’s Bureau of Economic Analysis said personal income increased 0.3%, slightly higher than the 0.2% estimate, while consumer spending rose 0.5%, in line with the forecast. Spending continued at a solid clip even though the personal savings rate fell to 2.9%, the lowest since June 2022. From a prices standpoint, inflation changed little over the past month. The BEA said that goods prices fell by less than 0.1% though services increased by 0.2%. On a 12-month basis, goods also were off by less than 0.1%, while services jumped 3.7%. Food prices were up 1.4% and energy accelerated 1.9%.
Markets reacted little to the news, with equity futures pointing to a slightly higher open on Wall Street and Treasury yields higher as well. The report comes with the markets pricing in a 100% chance of a rate cut in September, with the only uncertainty being whether the Fed will take the incremental step of lowering benchmark rates by a quarter percentage point or being more aggressive and moving a half-point lower. Following Friday’s release, market pricing tilted a bit more towards a quarter-point, or 25 basis point, reduction, lowering the probability for a 50 basis point move to 30.5%, according to the CME Group’s Fed Watch gauge.3
3. US Consumer Sentiment Rises for First Time in Five Months
US consumer sentiment improved in August for the first time in five months as slower inflation and prospects for Federal Reserve interest-rate cuts helped lift expectations about personal finances. The final August sentiment index rose to 67.9, from 66.4 in July, according to the University of Michigan. The preliminary reading was 67.8. Consumers expect prices will climb at an annual rate of 2.8% over the next year, down from the 2.9% expected last month and the lowest since the end of 2020, the data out Friday showed. They see costs rising 3% on average over the next five to 10 years.
While cooling price pressures are helping to stabilize sentiment, consumers remain hamstrung by still-elevated borrowing costs, less hiring, and a higher cost of living. The university’s confidence measure is well short of pre-pandemic levels. As a result, buying plans for durable goods such as cars and appliances slipped to the lowest level since the end of 2022. While a separate report earlier Friday showed solid consumer spending at the start of the third quarter, discretionary income barely rose, and the saving rate dropped to a two-year low. That helps explain why consumers view their finances as currently stretched. The university’s report showed sentiment about current personal finances held at the lowest level since October and well below the historical average.2
4. Eurozone Inflation Closes in on ECB Target
Eurozone inflation fell sharply in August to its lowest level since mid-2021, when the global surge in consumer prices that prompted an unprecedented rise in interest rates was just getting started. The decline in the annual rate opens the way for the European Central Bank to cut its key interest rate for the second time this year next month, amid signs that the eurozone’s economic recovery is faltering. The currency area’s largest economy, Germany, contracted in the second quarter of this year, and manufacturing across Europe is under sustained strain. Survey data shows momentum is slowing, and any uptick in economic activity from the Paris Olympics is likely to fade as the summer closes.
Eurozone consumer prices were 2.2% higher in August than a year earlier, cooling from 2.6% in July, according to figures published Friday by the European Union’s data agency Eurostat. That marked the lowest level since July 2021, and matched consensus expectations from a poll by The Wall Street Journal. The ECB cut its key rate in June for the first time since 2019 after inflation steadily eased from more than 10% in late 2022. Investors expect another cut on September 12th. The falling rate of inflation is welcome news, though the headline decline masks the scale of the problem facing policymakers, ECB board member Isabel Schnabel said in a speech on Friday at a conference in Estonia.1
5. U.S. Home Prices Forecast To Rise Modestly as Fed Cuts Rates
U.S. home prices will rise relatively modestly this year and next despite tight supply and expected U.S. Federal Reserve interest rate cuts, according to housing analysts polled by Reuters who said purchasing affordability will improve but would remain strained. Forecasts for U.S. house prices have barely changed since the previous survey three months ago, despite more aggressive expectations in financial markets for interest rate cuts, suggesting this upswing will be more subdued than in the recent past. Average property prices in the world’s largest economy fell only about 7% since the central bank raised rates by 525 basis points to the current 5.25%-5.50% range and are still more than 50% higher than pre-pandemic levels.
Much of that price appreciation has to do with homeowners who have locked in low 30-year mortgage rates – most under 5% and some even below 3% – and who are unwilling to part ways with their homes on such cheap deals. That, coupled with expectations the Fed will start cutting rates in September and by a total of 75 basis points by year-end, will help underpin a market already constrained by a lack of adequate supply. The 30-year mortgage rate which averaged nearly 7% through 2023, fell to a 16-month low of 6.44% last week. It is forecast to average 6.7% in 2024, before declining to 6.0% next year and 5.9% in 2026, survey medians showed. That was in part why all 26 respondents to an additional survey question said purchasing affordability for first-time homebuyers would improve over the coming year. According to the poll, existing home sales (comprising more than 90% of total sales) are expected to improve only slightly to a 4.15 million unit annualized rate next quarter, considerably lower than 6.6 million units in early 2021. That was a downgrade from the previous survey.4
Financial Markets
1. S&P 500 Ends Rocky August With a Monthly Gain
Stocks rose on Friday, with the Dow Jones Industrial Average posting a fresh record high as investors ended a volatile month on a high note. Traders also mulled over crucial inflation data watched closely by the Federal Reserve. The 30-stock Dow jumped 228.03 points, or 0.55%, to close at 41,563.08. The blue-chip index touched a fresh all-time high in the final minutes of the trading session and closed at another record. The S&P 500 advanced 1.01%, closing at 5,648.40, and the tech-heavy Nasdaq Composite gained 1.13% to end at 17,713.62.
Treasury yields ticked higher. The yield on the 10-year note settled at 3.91%. European markets were buoyant. The Stoxx Europe 600 finished at a fresh record after data showed eurozone inflation slowing sharply to 2.2%, the lowest since mid-2021. In Asia, Japan’s Nikkei 225 and Hong Kong’s Hang Seng Index climbed. A report showing faster-than-expected inflation in Japan raised the chances of another Bank of Japan rate hike.3
2. Lululemon Cuts Guidance, Misses Sales Estimates After Botched Product Launch
Lululemon lowered its guidance and posted its first revenue miss in more than two years on Thursday after it botched a highly anticipated product launch and growth slowed in the Americas. The company now expects full-year net revenue to be between $10.38 billion and $10.48 billion, down from a previous range of between $10.7 billion and $10.8 billion. Lululemon anticipates earnings per share will be in a range of $13.95 to $14.15, down from previous guidance of $14.27 to $14.47.
Lululemon shares rose more than 2% in extended trading after initially falling. The company’s reported net income for the three-month period that ended July 28 was $393 million, or $3.15 per share, compared with $342 million, or $2.68 per share, a year earlier. Sales rose to $2.37 billion, up about 7% from $2.21 billion a year earlier. Beyond total sales, Lululemon also missed expectations on comparable sales, which grew 2%, well behind estimates of 5.9%, according to Street Account. Comparable sales in the Americas fell 3%. The trend doesn’t appear poised to improve in the current quarter. Lululemon said it expects sales to grow 6% to 7%, worse than the 9.2% growth that analysts had expected, according to LSEG. However, Lululemon’s profit guidance is roughly in line with what Wall Street anticipated. The company said it expects third-quarter earnings per share to be between $2.68 and $2.73, compared with estimates of $2.70, according to LSEG. During the quarter, Lululemon pulled its Breeze through leggings, launched in early July, after it received a wave of complaints about the product’s unflattering fit.3
3. Apple, Nvidia Are in Talks to Invest in OpenAI
Apple and Nvidia are in talks to invest in OpenAI, a move that would strengthen their ties to a partner integral to their efforts in the artificial intelligence race. The investment would be part of a new OpenAI fundraising round that would value the ChatGPT maker above $100 billion, people familiar with the situation said. The Wall Street Journal reported Wednesday that venture capital firm Thrive Capital is leading the round, which will total several billion dollars, and Microsoft is also expected to participate. It couldn’t be learned how much Apple, Nvidia, or Microsoft will invest in OpenAI this round. To date, Microsoft has been the primary strategic investor in OpenAI. It owns a 49% share of the AI startup’s profits after investing $13 billion since 2019.
As the dominant global maker of chips that power ChatGPT and other AI models, Nvidia has long worked closely with OpenAI.In June, Apple announced OpenAI as the first official partner for Apple Intelligence, its system for infusing AI features throughout its operating system. The new AI will feature an improved Siri voice assistant, text proofreading, and creating custom emojis. Some of the new AI tasks Apple announced would be handled by Apple’s own AI technology. For more complicated AI tasks, such as generating a written message, Apple would use OpenAI’s ChatGPT. Apple’s talks to invest in OpenAI underscores its dedication to ensure it maintains access to this technology. OpenAI faces intense competition from other AI startups and big tech companies, but ChatGPT remains a market leader. Apple hopes to join with other companies and incorporate their generative AI into the new system. It is launching with ChatGPT because “we wanted to start with the best,” said Craig Federighi, Apple’s head of software, at the June developers conference. Investing in OpenAI could complicate Apple’s efforts to be a neutral partner with other AI companies. The move would be an unusual one for Apple, which typically doesn’t invest in startups. Over the years, Apple has made a number of investments in manufacturing partners, in part to secure a supply of components for its devices.1
Sources:
(1) www.wsj.com
(2) www.bloomberg.com
(3) www.cnbc.com
(4) www.reuters.com
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