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Dow jumped on hopes of inflation easing and the Biden-Xi meeting

calendar 12/08/2022 - 19:00 UTC

Wall Street Futures jumped further Thursday after colder than expected core PPI data, which may be indicating inflation may be plateauing and the Fed may hike by ‘only’ +0.50% in September instead of ‘jumbo’ +0.75%. Dow Future also jumped on easing of China-Taiwan/U.S. geopolitical tensions as China almost withdraw from the war drill and President Xi reportedly sent a message to his U.S. counterpart Biden that this is not a time for a new crisis. But Dow/Wall Street Futures were also dragged in the last hour of trading after a report that China will resume live-fire drills around Taiwan for 7-days.

In any way, Dow Future also recovered early European session after it became clear China will do the live fire drill in the Bohai Sea, away from Taiwan and closer to the Yellow Sea/Korean peninsula from 12th to 18th August. Also, mixed report cards/weak guidance affected the overall sentiment. On Thursday, the broader S&P-500 was boosted by energy (higher oil & gas prices), banks and financials, industrials, materials and communication services to some extent, while dragged by healthcare, consumer discretionary, real estate, techs, consumer staples, and utilities.

On Thursday, Wall Street was also buoyed by cooler-than-expected PPI (Producer Price Index) data. The BLS flash data shows U.S. PPI for July slowed to +9.8% in July from +11.3% in June, below market expectations of +10.4% and the lowest since Oct’21 (y/y).

 

On a sequential (m/m) basis, the headline PPI fell -0.5% in July against a +1.0% rise in June and above market expectations of a +0.2% increase. July’22 is the 1st sequential PPI contraction in the last two years. July PPI was dragged by mostly gasoline prices (-16.7%), along with the cost of diesel fuel, gas fuels, oilseeds, iron and steel scrap, and grains. The July PPI was boosted by a higher cost of services (+0.1%) mainly due to a rise in prices for margins for fuels and lubricants retailing (12.3%) and transportation and warehousing services (0.4%). Also, producers paid more for services related to securities brokerage and dealing, hospital outpatient care, automobiles, automobile parts retailing, and transportation of passengers.

The U.S. core PPI rose by +7.6% in July against +8.4% in June; was right on market expectations and the lowest since Oct’21.

On a sequential (m/m) basis, the core PPI increased by +0.2% in July from June’s +0.4% and below market expectations of +0.2%.

Overall, the July PPI data reflects the plateauing of CPI (headline inflation) amid a slump in oil/gasoline prices, but both core PPI and core CPI are quite sticky, substantially higher than Fed’s target/pre-COVID levels.

On average the sequential core PPI was around +0.60% in 2022 (till July); i.e. an annualized rate of +7.20%, while the average yearly rate was +8.68%. The average for sequential core CPI was around +0.52%; i.e. an annualized rate of +6.23% and the average yearly rate of +6.12%.

On Thursday, all focus was also on U.S. jobless claims, which serves as a proxy for the unemployment trend/overall labor market conditions.

The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI-under insurance) increased to 262K in the week ending 6th August from 248K in the previous week, below market expectations of 263K, but the highest since Nov’21.

The 4-week moving average of initial jobless claims, a better indicator to measure underlying data, as it removes week-to-week volatility, increased to 252.000K on the week ended 6th August from 247.500K in the previous week, the highest since Nov’21.

The continuing jobless claims in the U.S., which measure unemployed people who have been receiving unemployment benefits for more than a week or filed unemployment benefits at least two weeks ago under UI, increased to 1428K in the week ending 30th July, from 1420K in the previous week, and below market expectations 1407K. The continuing jobless claim is also a proxy for the total number of people receiving payments from state unemployment programs; i.e. overall trend of unemployed persons.

On Friday, the University of Michigan flash data shows U.S. consumer sentiment increased to 55.1 in August from 51.5 in July, above market forecasts of 52.5. The expectations gauge went up to 54.9 from 47.3 but the current economic conditions sub-index declined to 55.5 from 58.1.

The U.M. Inflation expectations for the year ahead decreased to +5.0% in August from +5.2% in July the lowest since February, but still well above the 4.6% reading from a year ago and around +2.75% average pre-COVID levels. Meanwhile, the 5-year inflation outlook rose slightly to 3% from 2.9% in the previous month.

The UM said:

“Consumer sentiment moved up very slightly this month to about 5 index points above the all-time low reached in June. All components of the expectations index improved this month, particularly among low and middle-income consumers for whom inflation is particularly salient. The year-ahead economic outlook rose substantially to just above its average reading from the second quarter of 2022, while the two other expectations index components remain at or below their second quarter averages. At the same time, high-income consumers, who generate a disproportionate share of spending, registered large declines in both their current personal finances as well as buying conditions for durables.

With continued declines in energy prices, the median expected year-ahead inflation rate fell to 5.0%, its lowest reading since February but still well above the 4.6% reading from a year ago. At 3.0%, median long-run inflation expectations remained within the 2.9-3.1% range seen over the past year. Uncertainty over long-run inflation receded a bit, with the interquartile range in expectations falling from 4.7 last month to 3.8 this month, remaining above the 3.3 range seen last August. Still, the share of consumers blaming inflation for eroding their living standards remained near 48%.”

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On late Thursday, SF Fed President Daly said:

·         We must reduce inflation

·         Rates will become more restrictive next year, in my opinion

·         By the end of the year, I expect the policy rate to be 3.4%

·         Not only looking at one CPI report

·         Global growth is being slowed by synchronized policy tightening

·         Current inflation expectations are firmly anchored

·         Longer-run inflation is driven by core services, which are still rising rapidly

·         Inflation is too high, and there is still a lot of work to be done

·         We are seeing evidence that the Fed's rate hikes are having a good effect

·         I want a slower economy but no recession

·         I want the economic conditions to stay tight

·         Because we don't want to tip the labor market over, a 50 bps hike makes sense

·         The most significant economic risk is excessive inflation

·         We are still a long way from the risk of a recession

·         Fed must continue to base rate decisions on data

·         I'm open to a 75 basis point rate hike being necessary for September

·         The baseline case is a half-point increase in September

·         The magnitude of a rate increase isn't dependent on a data point

·         Inflation is too high, and it must be brought down

·         I still think 50 basis points is the case, but I am open to 75 should the data evolve differently

·         I don't see this hump-shaped part where we raise interest rates to really high rates and then bring them down

·         I think of raising them to a level that we think is going to be appropriate and then holding them there

·         There's good news on the month-to-month data that consumers and businesses are getting some relief, but inflation remains far too high and not near our price stability goal

·         It is far too early for the Fed to declare victory in its fight against inflation

·         We don't want financial conditions to relax---I look not only at the stock market but also at borrowing costs for businesses and consumers as well mortgage rates -- which have risen sharply -- to gauge financial conditions. I really do want those to remain tight and tight and tightening as we go

The SF Fed President argued for +0.50% rate hikes in September and also November and December if inflation does not jump abnormally; otherwise, +0.75% hikes may be on the card.

Conclusions:

Although it’s too early, both inflation and the labor market may be now cooling as per Fed’s strategy for a softish landing and bring back core PCE inflation to the 2% target. Looking ahead, if core inflation continues to cool along with labor market demand, Fed may prefer “normal +50 bps rate hikes in September, November and December instead of jumbo hikes +75 bps for a terminal rate +4.00% by Dec’22. On Friday, Dow Future got a further boost after a report that China’s President Xi may meet U.S. President Biden in November during his planned Southeast Asia visit, which may help a proper resolution of Russia-Ukraine/NATO geopolitical tensions and an overall cold war mentality between so-called democracies and autocracies.

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