Weekly market update - 19th of September 2022
Written and accurate as at: Sep 21, 2022 Current Stats & Facts
The market was positioned for good news on the US inflation front – and took a hit when the CPI came in slightly stronger than expected. A strong inflationary pulse across a broad range of categories ran contrary to a prevailing narrative of softer inflation. In an environment where the Fed is driven by data rather than by its forecasts, sentiment on the monetary policy path shifted quickly.
The Fed funds rate is expected to reach 4.2% in December 2022, up from 3.9%.
Equity markets took a hit. The NASDAQ fell 5.54% on the day of the data print – its worst fall since March 2020. The S&P 500 was off 4.3%, its worst since June 2020. The poor sentiment was compounded by pre-released earnings from FedEx, which saw quarterly EPS at $3.44 versus $5.15 consensus expectations and an even more significant shortfall on next-quarter guidance. Management cited softer demand, weakening further into the quarter’s end in the US and internationally. This exacerbated concerns around the economic backdrop.
The S&P 500 fell 4.7% for the week. The S&P/ASX 300 was down 2.2%.
US inflation
Headline CPI rose 0.1% month-on-month in August, against an expected decline of 0.1%. On an annualised basis inflation is running at 8.3% versus 8.5% last month – again higher than the expected 8.1%. Core CPI rose 0.3% to 0.6%, higher than the 0.35% forecast. Annualised, it is running at 6.3% m/m, versus 6.1% expected – the highest print since March.
The key concern was the breadth of disappointing numbers across multiple buckets including shelter (34% component), new and used cars (8%), medical services (7%), food away from home (5%), apparel (2%), utility gas service (1%) and motor vehicle repair (1%). Inflation is no longer driven by energy and food.
Housing inflation is a slow-moving part of the US CPI data. Landlord rent expectations have fallen recently but will take a while to flow into the data. The next most significant segment is new and used car prices. These have been turned down, which is helpful. Wage pressure in healthcare is a global phenomenon and will likely intensify as wage demands are met.
More positively, airline fares fell by 4.6% in August – less than expected. This should continue to fall as airfares follow jet fuel prices closely and have reversed most of the spike triggered by the war in Ukraine.
Food inflation is finally moderating. The 0.7% increase in food-at-home prices was the smallest since December, after seven straight 1%-plus increases. Lower global food commodity prices are starting to work through, with more expected.
Petrol pump prices are down to $3.69/gallon – 26% below an all-time high in June and the lowest in six months.
The “peak inflation” narrative is probably still intact, but the core components remain stubbornly sticky.
Producer Price Index data (see below) suggests some relief is on the way. But it won’t matter this week.
Fed officials have made it very clear they will not slow the pace of rate hikes until they see convincing evidence that core inflation pressure is easing sequentially. The chance of a 50bp hike this week has gone. The market has wavered between a 20%-30% chance of a 100bp hike.
The chance of a soft economic landing has fallen for two key reasons:
- Strength and stickiness in both goods and services inflation indicate meaningful reductions toward 2% are impossible without a recession and a significant fall in employment
- The risk of a Fed overshoot has increased, meaning a recession is induced almost regardless of what the data does.
US PPI
The Producer Price Index data was more reassuring than the CPI print. Headline PPI fell 0.1%, in line with consensus, helped by falling energy prices. Annualised, it is 8.7%. This is down from 9.8% in July and 11.2% in June. The key message is that Core PPI inflation is now falling across goods and services.
Core goods rose at a 6.1% annualised rate in the three months to August, exactly half the peak pace in May. Core services rose 3.9% in the three months to August. This was an even more considerable slowing from the 10.8% peak in the three months to March. Consumer inflation expectations have plunged for both the three and five-year time horizons.
Other US data
The Atlanta Fed Wage Tracker grew to 6.7%. Companies with a high turnover of low-paid workers feel the full force of wage pressures in the economy. Wage growth for job switchers far exceeds that for people staying with their current employer.
Retail sales were slightly disappointing with core sales down 0.3% versus flat expectations. But they haven’t fallen off a cliff and may reflect higher petrol prices over the past few months, which have now reversed.
Australia
GDP data in the second quarter showed continued strength in consumer spending, driven by a rebound in services. This included a quarter-on-quarter rise of about 30 per cent in tourism-related spending. It seems likely that the consumer hangs in there for another few months, before feeling the pinch in the December quarter as increased mortgage rates flow through to household cash flows.
Employment increased by 33,000 in August. This was in line with consensus but only partially reversed the prior month's 41,000 declines. At the same time, labour participation returned to its record highs (66.6%) and unemployment peaked at 3.5% (consensus expected 3.4%). Hours worked also recovered most of the prior month's losses (0.8%) and the under-employment rate fell to 5.9%.
Notably, the number of workers affected by sickness remains nearly double its usual amount (about 750,000). The data hasn’t moved expectations for another 100bps of tightening across Q4, taking rates to about 3.35%.
Europe
The EU has proposed redistribution of excess profits from energy companies and non-gas-power generators (nuclear and renewables), totalling an estimated EUR 140 billion. This would involve a price cap of 180 euros per megawatt hour, raising about EUR120 billion.
The balance would come from energy companies contributing a third of any profit of more than 20% over the last three-year average. The plan is complex and will take time to put into practice. Each member state would have jurisdiction over critical aspects. The program includes a binding agreement to get winter peak electricity use down by 5% – and overall 10%.
Markets
Australia held up better than other markets last week due to index composition. Large caps did better than small caps. Small resources and REITs bore the brunt of the sell-off. Interestingly, consumer staples did not prove to be defensive in the weak market and we saw a clean sweep of negative returns across all sectors.
Star Group (SGR, +9%) bounced after the findings of the Bell review were mainly in line with expectations. It was the best performer in the ASX 100.
After six months of due diligence, private equity firm KKR walked away from a takeover offer for Ramsay Health Care (RHC, -9.3%). The market was already doubtful about the deal, given complications with RHC’s French business, which competes with a KKR-owned business.
Rio Tinto (RIO, -2%) approved the Western Range iron ore mine in the Pilbara for US$2 billion. This implies a capital intensity of US$80/tonne against US$72/tonne at its Gudai-Darri mine and about US$45/tonne at BHP and Fortescue’s latest mines. Construction involving a mine, primary crusher and an 18km conveyor back to the existing Paraburdoo processing plant appears expensive to us.