Reports of a business slowdown and low inflation sent stock prices sharply higher. The inflation reports are misleading. Inflation remains close to 4 percent, as the upcoming Consumer Price Index (CPI) report is likely to confirm.
The market expects the Federal Reserve to continue the pause in its interest rate increases. With inflation still seen as a problem, that might be a forlorn hope.
The Week That Was
Friday’s August employment report showed a relatively large increase in private payrolls, at
179,000. However, once again there were major downward revisions to prior job numbers.
Moreover, we expect additional downward revisions in the months ahead.
The report on July consumer spending, income, and inflation was mixed. Inflation continued to slow, with both the total and core rates down to 2½ percent over the past six months.
Consumer spending and wages both soared in July, rising at a 7 percent annual rate from the second quarter. In contrast, total personal income rose at only a 3 percent annual rate and real disposable income was unchanged from the second quarter.
Spending and income data for July show the same pattern as recent trends in GDP (spending) and GDI (income). Spending is rising much faster than incomes.
Those, such as the Atlanta Fed, who view spending as the key to the economy, see explosive third quarter growth. However, we view incomes as more important than spending. The income data reflect an economy that is slowing rapidly in response to the Fed’s monetary restraint.
Things to Come
Final August business surveys arriving tomorrow should confirm the weakness among
service companies. These surveys also should reflect the ongoing increase in inflation, which remains in the vicinity of 3 percent to 4 percent.
Money, Money, Money
A key challenge for the Fed will be the August CPI report due September 13th. The Cleveland Fed model estimates soaring oil prices will lift total inflation by 0.8 percent and core inflation will be 0.4 percent.
This would raise the year-to-year total rate from 3.3 percent to 3.9 percent and core inflation from 4.7 percent to 4.5 percent.
We still expect the Fed will hold the fed funds rate stable, but we warn of further monetary restraint if inflation remains high.
Market Forces
Stocks were up this week.
The Nasdaq and QQQ were up 4 percent to 5 percent, and the other key indexes rose
3 percent to 4 percent.
The surge in stock prices pushed all key indexes to or above their 50-day moving averages. As a result, technical (psychological) indicators are back from negative to neutral.
Economic news was the main driver for the improvement in stocks. The latest GDP report
shows the economy continued to slow in the second quarter, with inflation and real growth each advancing at a 2 percent annual rate. More timely data through July also shows monthly inflation down to a 2 percent to 3 percent rate.
Most of the recent data are consistent with our forecast for a further slowdown and a downturn in business activity. There are also indications the economy is weaker than recent data suggests. A survey of tax information from March of this year shows private payrolls employment was 358,000 lower than the official numbers. Both Census and BLS indicate they will adjust their data next month to incorporate new information.
Outlook
Economic Fundamentals: negative
Stock Valuation: S&P 500 overvalued by 16 percent
Monetary Policy: restrictive
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