WISDOMTREE- Weekly commentary from ProfessorProfessor Jeremy J. Siegel (07/18/2022) :
It was a big week for inflation news and Fed speakers responding to the inflation news. It started on Wednesday with the 9.1% inflation print, 3 tenths higher than expectations, which fueled bets the Fed would hike 100 basis points at next week’s meeting.
But Friday’s University of Michigan survey of consumer expectations—something Fed Chairman Powell commented the Fed was following closely—indicated a rather sharp decrease in 5-10 year forward inflation expectations. The consumer pulse of inflation is tracking real time responses to gas and energy prices falling. Moreover, the breakeven inflation rate priced in the 10-year TIPS market has come down from over 3% to just 2.35%—a nearly 70 basis point drop in inflation expectations.
The market rally gained strength following this University of Michigan survey release at 10am. The PPI and CPI reports are backwards looking numbers—and the 9.1% CPI figure could be the highest reading we see this cycle, since oil and gasoline prices hit their highs in mid-June.
We had a good retail sales figure on Friday—however one of the problems is this nominal figure incorporates increases in price levels therefore we won’t know the real impact on quantities being sold for a bit longer. But good news: the data did not show retail sales falling off a cliff signaling a deeper recession. The only July reading for economic growth released so far has been the NY Empire Manufacturing Index report that came out ahead of expectations.
I believe the Fed will hike rates 75 basis points next week. But the market wants to see the Fed recognize the slowdown in the economy and indicate it will slow rate hikes to prevent the economy from plunging into a deep recession. The Fed should communicate that monetary policy tightening is working and will bring down inflation soon. The strength of the dollar is helping offset import prices, and money supply growth has come to a screeching halt.
If the Fed statement includes a phrase like ‘we recognize a cooling and slowdown in the economy’ or the ‘balance or risks suggest downside risks to growth’ the market could soar higher with the light at the end of the tunnel coming into focus for this hiking cycle.
James Bullard commented that we could see 4% Fed Funds Rate by year end. I believe Bullard is now overly positive on the strength of the economy and outlook for unemployment and we are unlikely to see rates that high. We could see further dissents in the Fed statement next week—included by Esther George who believes we are hiking too quickly given it takes time for rate hikes to filter through the economy.
There is little real data coming out for the third quarter yet, but estimates anticipate growth in the low 1% range, while Q2 estimates indicate we finished a second negative GDP growth quarter in a row.
We are early in earnings season, but Friday’s reports from the major banks sparked a major rally across the sector. Expectations were for a large drop in financial sector profits that came in less bad than feared. Overall, the market activity last week re-affirms my recent comments that the market lows for the year could very well be behind us.