A deeper dive

Inflation Has Eased Somewhat, but There is Still Work to be Done

Jacob Hess
February 01, 2023

The Federal Reserve increased the target range of the Fed funds rate by 25 basis points to 4.5-4.75% in what many believe will be the second to last rate hike of this hiking cycle. This size was pretty much priced in by markets, and recent economic data had done little to sway the opinions of investors and Fed officials alike.

As a result, the bond market has already started to shape itself for a Fed pivot with the 2-year Treasury note looking to retest the 4% level, and the 3-year note moving comfortablely below it to around 3.8%. This represents about 50 to 75 basis points worth of cuts from the current lower bound of the target range. While these cuts may not come in 2023, there is very little pushback against the idea that a weak economy this year will preclude lower policy rates in 2024.

The Fed started off the press release with a slight acknowledgment of this sentiment by changing the brief phrase “inflation remains elevated” to “inflation has eased somewhat but remains elevated” which is an important admission that they are winning the fight against rising prices. This alone is a fairly dovish statement as the Fed has already positioned itself as “data-dependent” which means its actions are likely to be sensitive to observations like this. However, it does not necessarily mean that a pivot is coming soon.

Chair Powell in his press conference did everything he could to make sure that observers would not mistake the slowing of the pace in rate hikes and the slight admission that inflation has eased for a Fed pivot or even a Fed pause. In the speech, Powell made three very clear assertions that hiking is not over and that there is “more work to do.” The rhetoric is very clearly aimed at preventing the premature loosening of financial conditions which would soften the effects of tighter monetary policy. According to the Chicago Fed National Financial Conditions Index, the financial conditions have generally loosened since October 2022 which is counterproductive to the Fed’s intentions. Recent trends in short-term interest rates have been the culprit.

From Chicago Fed

The moral of the story is that the job is not done yet. Powell did a good job of summarizing the work that still needs to be done to cool the economy to the desired level. “Labor demand substantially exceeds the supply of available workers, and the labor force participation rate has changed little from a year ago” which is importantly keeping wage inflation sticky. Some have pointed to some cooling in the Q4 2022 Employment Cost Index release as evidence that we can stop worrying about wage inflation, but there are way too many job openings, especially after we found out that 600,000 were added in December. The “higher for longer” narrative is the way that the Fed will likely go as it avoids cutting rates in 2023 despite growth challenges.

Q3 2022 GDP Preview

Jacob Hess
October 23, 2022

Before the Fed gets together, we’ll get some important economic data points to digest including US Q3 GDP and the PCE price indexes for September. This will be accompanied by central bank announcements from the ECB, the Bank of Japan, and the Bank of Canada which will provide the backdrop for the Fed’s early November decision. There have already been some signs of central banks in other countries leaning towards a pivot (the Reserve Bank of Australia and the Bank of England opted for smaller hikes in their last announcements), and that transition will be on FOMC members’ minds next week.

The Q3 2022 GDP and September PCE report will be so crucial in showing how the economy is reacting to the rate hikes that have been administered so far. So far this year, we have yet to see a positive quarterly growth rate with the Q1 2022 report coming in at -1.6% and the Q2 2022 report improving only slightly to -0.9%. The consecutive periods of contraction prompted discussion of whether or not the US economy is in a recession, and that discussion will be reignited this week. Many policymakers, including the Fed, will have more force in their pushback against using the “r” word if the Q3 GDP pops out a strong positive number.

From Atlanta Fed

This is what the Atlanta GDPNow model forecasts. As of October 19, 2022, the GDPNow estimate for Q3 2022 is 2.9%, revised up from the 2.8% estimate at the beginning of the week and up from the 2.1% estimate that it began with on July 29. At the moment, this skates just above the upper range of the Blue Chip consensus GDP forecasts (according to the GDPNow chart) and more than a full percentage point above TD Bank and ING, which see Q3 2022 forecasts of 1.1% and 1.5% respectively. The GDPNow forecast is not alone in its optimism though as Wells Fargo posted its most recent estimate at 3.0% in its October US Economic Outlook report.

Here’s what we see:

  • Personal consumption was relatively strong in Q2, up 2.0% QoQ SAAR, after a strong June saw consumption growth 1.2% MoM. The first two months of the third quarter showed consumption pretty much flat with elevated inflation stabilizing but not declining. It would take a hefty gain in September for consumption to have any type of strong showing in Q3, and that is unlikely to happen given how hawkish the Fed was in Q3, how high goods prices got, and how low consumer sentiment was. PCE is likely to come in at 0.6% QoQ SAAR with a moderate decline in goods consumption offsetting a moderate decline in services consumption.
  • The massive -14.1% QoQ SAAR decline in gross private domestic investment in Q2 was a result of large declines in investment in structures, both residential (-17.8% QoQ SAAR) and nonresidential structures (-12.7% QoQ SAAR). August readings of construction spending were dismal with residential construction spending down -1.0% MoM and nonresidential construction spending down -0.4% MoM. The decline in private inventories also made a significant negative contribution (almost -2.0 ppts). This quarter, the negative effect is likely to be more muted as major inventory adjustments have likely already been done.
  • The government spending component has made negative contributions to GDP for the last five quarters as it continues to back away from programs that provided liquidity during the pandemic. With that being said, there hasn’t been much in new spending passed as midterm elections are approaching in November, so this component will likely remain flat and or/slightly lower.
  • The trade deficit was a major part of the Q1 GDP miss, with a -3.13 ppt contribution, but it rebounded swiftly in Q2 with exports growing 13.8% QoQ SAAR and imports up just 2.2% QoQ SAAR in that period. Data for July and August show an even sharper decline in the trade deficit, down -$13.5 billion since July. At this pace, the impact of net exports on GDP in Q3 will likely be similar and will actually offset much of the weakness elsewhere.

All that being said, the Q3 2022 GDP report should show that the economy grew 1.6% QoQ SAAR. A light improvement in consumption will offset more weakness in domestic investment which will see a small decline than Q2. The biggest driver of GDP growth will be net exports which could provide up to 1.5 ppts of growth in the quarter. Government consumption and inventory changes will be smaller drags on GDP growth than in Q2 but will still be felt.

One unknown that could cause some negative surprise is the impact that Hurricane Ian had on Florida. An earlier IHS Markit estimate had the destruction of Ian shaving off about 0.2 ppts from national GDP measures which seems like a reasonable projection. This suggests that GDP could come in anywhere from 1.4-1.6% QoQ SAAR if that impact makes its way into the report.

Job Openings Crushed But Labor Market Still Tight

Jacob Hess
October 04, 2022

Job openings crashed in August as noted in the most recent version of the colloquially named JOLTS report. Openings had been hovering around record highs since the end of last year following the meteoric post-pandemic rise, and it seemed that the labor market was able to avoid damage from the first round of rate cuts. In reality, labor demand had just been holding on through the summer, and August’s crash is a signal that it is starting to unwind.

The number of nonfarm job openings fell a record-setting -1.1 million to just above 10.0 million in August, the decline was topped only by the pandemic-fueled decline of -1.2 million set in April 2020. The largest loss in openings was seen in social assistance (-236,000), other services (-183,000), and retail (-143,000) but declines were also significant in manufacturing (-115,000), finance & real estate (-77,000), professional & business services (-119,000), and leisure & hospitality (-111,000). There were very few industries that saw increases, and in those industries, the increases were small.

Outside of openings, the JOLTS report was pretty much a non-event. Total hires increased by 39,000, and total separations increased by a slightly more significant 182,000. The growth in separations was caused by a 100,000 swell in quits which had been falling since the beginning of the summer. The quiet moves in hires and separations suggest that the reduction in job openings was a result of firms deferring plans to hire rather than terminating existing employment. In fact, based on the slight differential of about 150,000 separations over hires, one would expect job openings to increase if firms’ labor demand hadn’t shifted.


There may have been some indication of this coming in the regional PMIs future employment indexes. The New York Fed, Philadelphia Fed, and Dallas Fed have all reported declines in the Future Employment Diffusion Indexes over the course of 2022 through the end of summer. The same trend can be seen in the NFIB’s Small Business Hiring Plans index. While the declines have been substantial, the actual index readings are still positive and point to an expected expansion of employment. However, the pace of that expansion has slowed significantly. Similarly, the number of job openings did fall significantly in August, but the resulting level is still well above the norm and indicative of an overly tight labor market.


How do we know we are still in an overly tight labor market? One can look at the spread between the job openings rate and the near-term real rate of interest as calculated using the two-year Treasury yield and the core PCE price index. Rising rates and the August blow to the job openings rate have put the spread at 7.9%, much lower than its peak of 11.5% in December 2021, but it is still well above the stable range of 4-5% seen in the period before the pandemic and after the financial crisis of 2008 (it’s also much higher than the peak of 2.9% set before the financial crisis of 2008).

What does this mean? There will likely be movement in one or more of the indicators affecting the spread to cause it to revert towards the pre-pandemic mean such as 1) labor demand will extend its new decline and the job openings rate will normalize, 2) the Fed will continue to raise rates which will lead short-term interest rates higher, or 3) inflation will peak and start to ease. The Fed’s hawkishness has been priced into yields sharply over the summer, and inflation appears to be stickier after the upside surprise in the August CPI report. Therefore, that leaves some deflation in job openings and labor demand to be the main force narrowing the spread.

Bank of Japan Punished for Dovish Policy Stance

Jacob Hess
September 26, 2022

Central banks are in the spotlight and have been for some time. Every policy move is being picked apart by markets and forecasters making asset prices and forecasts especially sensitive to changes in policy rates across the globe. The foreign exchange market is no exception. The JPMorgan Global FX Volatility Index has jumped to new near-term highs in 2022 as a result of this flurry of monetary policy activities.

The developing FX story has been the yen’s depreciation in the last few months. Holders of the yen have seen it perform poorly against the US dollar and the euro so far this year. The drop against the euro tracks to about -6.3% year-to-date while the strong greenback has the JPYUSD pair trading -20.2% lower in 2022. The yen is even down around -11.2% YTD versus its neighbor, the Australian dollar. Most of the losses against these currencies have accumulated in the last two quarters, and the most recent trading in September has pushed the yen to the lowest points in each of these markets.

From StockCharts

The massive depreciation in the yen has pushed Japan to intervene by buying yen for the first time since 1998. The intervention almost 20 years ago was done in a similar environment where it felt like yen markets were out of control. In particular, the steep slide of the yen against the dollar in the mid-1990s worried the Japanese government as leaders saw the depreciation as a threat to Japan’s economic growth. This prompted the government to buy dollars to protect against further damage. However, the purchases did little to stop the momentum as the Asian crisis in 1997 created too much uncertainty.

Just as in the 1990s, September’s yen intervention announcement didn’t come in a vacuum. A sharp increase in global inflation rates has been the impetus for the hawkish shift in central banks across the world creating systemic financial tightening. The Bank of Japan, however, remains frozen in time on its policy and dovish stance. This has created the conditions for the yen’s depreciation.

Many have wondered whether the Bank of Japan could’ve made a move away from its extremely dovish policy that has lasted since the Asian crisis. Over the last 20 years, deflationary pressure and low growth have been reasons for Japan’s central bank leaders to keep rates low. In the last 6 years, short-term rates turned negative and have remained that way throughout the pandemic. The current inflationary environment seems to be reason enough to shift away from indiscriminate dovishness. On the contrary, its monetary policy announcement in September suggests that any kind of hawkishness is off the table for the time being. Because of that, it’s unlikely the yen’s recovery against the dollar will stick.

In general, it seems that central banks that aren’t hiking “enough” are being exposed and the market has been punishing them. The Chinese yuan has seen a steady decline against the dollar this year, down -10.8% YTD, as the People’s Bank of China has been forced to remain accommodative to help the struggling real estate sector. Just recently, the British pound has faced some depreciation as the Bank of England looked to be slowing down its pace of rate hikes despite inflation near double-digits. In the last 30 days, the pound has fallen -6.5% against the euro, a currency that has not been particularly strong so far in 2022 (see EURUSD).

The moral of the story is that markets expect central banks to defend their credibility against inflation. If monetary leaders seem uninterested in asserting price stability as a concern, there will likely be consequences. This isn’t just because dovishness is not trendy in 2022, but because inflation is no longer thought to be transitory. Because of that, central banks that do not take this opinion as their own, like the Bank of Japan (and perhaps the Bank of Japan is the only central bank strongly in this category), will have to face volatility.

Expect 75 Today

Jacob Hess
September 20, 2022

The FOMC is likely to hike by 75 bps in the September meeting as it continues to fight elevated inflation with a strong labor market and stable growth to back up the decision. Following the hawkish posturing at the Jackson Hole conference, Chair Powell will look to continue the hardline stance on fighting higher prices. The FedWatch Fed funds rate probabilities see an 82% chance of a 75 bps hike and just an 18% chance of a 100 bps hike with no expectations of a more dovish 50 bps hike.

The hawkish position was confirmed by a hot August inflation report that saw a significant rise of 0.6% MoM in the core CPI overshadow a small increase in the headline CPI of 0.1% (which resulted in the annual pace falling slightly). The monthly increase in core CPI included the new vehicle index up 0.8% MoM, the shelter index up 0.7% MoM, and the medical care index up 0.7% MoM. This negated two months of decline in the energy index which has put downward pressure on the inflation. Stickier categories are proving to be a problem for the Fed as demand for goods and services has not dropped off as sharply as policy rates have risen.


The market has taken these developments in stride with the two-year Treasury yield rising from 2.90% at the beginning of August to almost a full percentage point higher to 3.85% last week. The sharp increase is the highest since 2007 when the two-year yield was falling from its peak of just above 5% set in 2006. Investors are continually shying away from the idea that the Fed may pivot at the first sign of economic weakness. The implication of higher short-term rates could also point to expectations of a terminal rate above 4% which would suggest another 100-150 bps of hiking is still to come after the 75 bps hike in September.

The Fed can continue on this path with confidence because the labor market remains in a relatively strong position. The US added a solid 315,000 jobs in the month of August end the summer with a total of 1.13 million jobs added. The unemployment rate did tick up 0.2 ppts to 3.7%, but that actually was a result of positive developments in the labor force. The labor force participation rate grew 0.3 ppts to 62.4%, a significant move higher but still -1.0 ppts below the pre-pandemic level. The Fed will likely see that persistent labor demand is likely to cancel out the effect of growth in the labor force on wage growth.

In the end, the most important issue for FOMC members is the protection of Fed credibility (or for some, the re-establishment of Fed credibility). In his most recent speech on the economic outlook, FOMC Governor Christopher Waller insisted that bringing inflation down to 2% “is a fight we [the FOMC] cannot, and will not, walk away from.” These are stern words to use as a central banker and are intended to reduce uncertainty in the general outlook on monetary policy. With that being said, the Fed will move forward with 75 bps in September and look forward to a similar move in the next meeting.

Manufacturing Weakness in Germany has Implications for Euro Area Growth

Jacob Hess
September 11, 2022

The weakening German manufacturing sector will be a major drag on growth in the euro area in the second half of 2022. Data for July suggests that demand destruction and persistent supply chain disruptions caused manufacturers’ orders and industrial production to decline at the start of Q2. Amidst a slowdown in activity is an energy crisis causing electivity prices to surge which is putting pressure on profitability, especially for small- and mid-sized firms.

The German statistical agency, Destatis, updated these two economic data points in the last two days. Industrial production fell -0.3% MoM in July which is slightly deceiving as stronger energy production (up 2.8% MoM) and construction production (up 1.4% MoM) offset a -1.0% MoM decline seen outside of those industries. The strongest decline was seen in consumer good production which fell -2.4% MoM. The July release also highlighted “energy-intensive” industrial production which fell -1.9% MoM in July and is down -6.9% since February 2022.

The next data point, describing a -1.1% MoM decline in manufacturers’ new orders in July, suggests that production is set to fall further in Q3. Sharp declines in domestic (down -4.5% MoM) and euro area (down -6.4% MoM) were partially offset by a 6.5% MoM increase in non-euro area orders. With Europe being Germany’s biggest customer, the looming recession and downgrades in growth expectations suggest firms will see thin order books in Q3 and Q4 as inflation and higher interest rates are destroying demand. The manufacturing sector is the linchpin of the German economy, so weakness there will eventually weaken the employment outlook which will feed into a consumer weakness.

Weak German Industry Means a Weak Europe

The weakness reported in the German industrial sector in the beginning of Q2 2022 should make the rest of Europe worried. The central European country’s production is an important source of economic activity to both the EU and the euro area and is vital to the GDP growth reported each quarter. In 2021, Eurostat reported that 27% of EU industrial production came out of Germany which is 11 ppts more than the second highest industrial producing nation, Italy. Germany produces the most motor vehicles, trailers, and semi-trailers with €160 billion, €196 billion, and €267 billion worth made, respectively.

From Eurostat

It comes as no surprise that euro area GDP readings have historically be sensitive to German industrial production. The average quarterly euro area GDP growth rate when German industrial production (annual growth) is positive is 0.5% QoQ. That growth rate averages just 0.1% QoQ when German industrial production trends flat or negative in the last year. Pessimistic trends in manufacturers’ orders are also indicative of sluggish European GDP growth. Seventy-five percent of quarters with negative euro area growth come with negative German manufacturers’ orders growth (on an annual basis).

From Destatis, FRED

Forecasters have already caught wind of the weight that German industrial weakness will have on growth in the region. The IMF’s World Economic Outlook update in July shaved -0.9 ppts and -1.9 ppts off of the German growth forecast in 2022 and 2023, the largest downgrade out of the developed European economies mentioned in the report. Alongside that downgrade, euro area projections came down -0.1 ppts in 2022 and -1.1 ppts in 2023. The IMF also cites Germany as the G-7 country with the highest probability of falling into a recession (a 25% chance while other G-7 economies are at an estimated 15% chance).

The moral of the story is that Europe rarely evades a recession when its economic powerhouse is weak. Investors and policymakers should be paying very close attention to the data points coming out of Germany tracking the industrial sector. Even if the effects of inflation and supply chain deficiencies may vary by country, all euro area economies will likely face muted economic activity if these effects hinder German industry.

Student Loans Targeted by the Biden Administration

Jacob Hess
August 24, 2022

The calls to act broadly on the student loan issue have finally been answered by the Biden administration. On Wednesday, August 24th, President Biden moved to cancel $10,000 of student debt for borrowers with income of $125,000 or less. Individuals who received a Pell Grant are eligible for student loan forgiveness of up to $20,000 with the same income restrictions applying. It is made clear that “No high-income individual or high-income household – in the top 5% of incomes – will benefit from this action.”

In the same executive order, President Biden announced two other actions:

  • One final extension of the pause on federal student loan repayment through December 31st, 2022.
  • Protection for low-income borrowers through a cap on monthly payments for undergraduate loans at 5% of discretionary income.

The executive order appears to be one final move in providing student loan relief for the hardships associated with the COVID-19 pandemic. The student loan repayment moratorium will have lasted almost three years when it reaches its end in December after several extensions across the Biden and Trump administrations. The $10,000 loan forgiveness for most borrowers follows some targeted action that the Biden administration enacted.

The Economic Implications

The economic implications are not insignificant. Wells Fargo discussed what was on the table for student loan policy back in June, and it outlined the economic implications of different options. The report points to a New York Fed analysis which suggested that the plan to erase $10,000 worth of loans per borrower (with no income cap) would disappear a total of $321 billion in student debt and eliminate the entire balances of 31% of borrowers. This is about what one could expect the effect of Biden’s forgiveness program will be since the income cap of $125,000 is pretty high.

While it’s not new, it’s also worth noting the effect of extending the moratorium on loan repayments. The Wells Fargo commentary estimates that households not having to make payments on student loans has freed them from debt interest payments worth “approximately $3.2 billion per month, which amounts to just 0.2% of monthly personal income.” This effect will be extended four more months, though it might not be as potent with many balances being wiped out completely.

The net impact of both measures is positive for consumers. This will free up thousands of dollars in cash for households who were eyeing the looming repayment relief deadline, and others who were patiently waiting on Biden to make a move on student loan forgiveness. The disappearance of uncertainty alone is enough to inspire consumers to spend more and feel less bad about the impact of inflation on their wallets.

Additionally, it should be a positive on credit scores in general as delinquency was becoming an issue in the pre-pandemic period. According to data from the New York Fed, 15% of borrowers were either 90+ days delinquent or in default accounting for almost 7 million borrowers. While the pandemic halted the growth in those categories, millions more borrowers faced unchanged or larger loan balances in 2021 as they waited for the moratorium to end. Lowering the debt load of these individuals allows them more options in seeking credit for large durable goods purchases.

Expansionary Fiscal Policy and Inflation

It’s hard to be a critic of student loan forgiveness. The $1.59 trillion behemoth sitting on US consumers’ balance sheets has been a glaring issue since the Great Recession. The path in delinquency rates over the past decade was troubling before finally levelling out in 2018 and 2019. Student loan forgiveness is also a relatively effective way to target low- and mid-income households who are disproportionately affected by high debt levels. About 55% of the total student debt load is held by individuals younger than 39 years old who are likely to have lower-paying jobs.

Indeed, expansionary policy is typically a good thing and looked at as a way to expand economic growth and prosperity. This also means it tends to have an inflationary effect on the economy in the general sense that it increases the amount of money available to the public if not paired with policies that are disinflationary. Because of this, critics will point out that the timing of student loan forgiveness is unfortunate considering the level of US inflation (the annual growth of the US CPI is at 8.5% as of July).

In particular, the relief from Biden’s executive order will likely support goods consumption which had been declining in the first half of 2022. Real goods personal consumption expenditures fell -0.3% QoQ in Q1 2022 and -4.4% QoQ in Q2 2022, but this wasn’t necessarily a terrible thing as the Fed was looking for demand for goods to weaken so that inflation could ease. Reversing this trend puts upward pressure on inflation, or it forces the Fed to be more aggressive in tightening.

The housing market, which has shown signs of weakening in Q2 and Q3, is another area that could benefit. New home sales were just reported to be down -12.6% MoM and -29.6% YoY in July with inventory expanding 18.5% MoM and 81.7% YoY. With new homebuyers suddenly $10,000 in their pockets (and for couples, it could be as much as $20,000), saving for a down payment on a house becomes a lot easier. Mortgage rates will still make affordability an issue for many, but larger excess cash balances can provide support for home prices.

It’s certainly an interesting time with the Fed engaged in an aggressive tightening cycle while the federal government toys with fiscal policy through the Inflation Reduction Act, which includes infrastructure spending and a corporate tax hike, and now student loan forgiveness. The combination of these policies will make it hard to anticipate the effects on the economy which increases the likelihood of a Fed policy error. Nevertheless, it is still irresponsible to try and make federal student loan forgiveness at any level a completely bad thing. Many will be granted much needed relief from debt that limited their opportunities.

The Chicago Fed Index Reverses in July

Jacob Hess
August 22, 2022

The Chicago Fed National Activity Index (CFNAI) pointed to some stabilization in economic indicators in July. The index had been in negative territory in May and June before reversing all the losses last month. In fact, the increase of 0.52 pts means that the index in July matched its value just 3 months ago at 0.27.

Two categories of indicators, the “sales, orders & inventories” and the “personal consumption & housing” indicators, were mostly neutral at just 0.01. The weakness in both of these categories reflects the weakening of demand, especially in the housing market, which has taken place as financial conditions and economic sentiment have weakened. However, there is still some support for personal consumption (in particular services consumption) as a result of excess savings and a strong jobs market.

The two stronger categories “employment, unemployment, and hours” and “production and income” point to the two strongest areas of the economy. The labor market is keeping the economy afloat with growth in wages and plenty of job openings. The decline in the unemployment rate in July was the reason why this component of the CFNAI shifted from negative to positive. Indicators tracking production reversed sharply in July on the strong 0.6% MoM industrial production print in July. The initial decline in demand is not having a strong effect on industry because firms are bouncing back from easing supply chain pressures.

Do Markets Have Ground to Stand on?

What does this mean for markets? The rebound in stocks over the past month or so seems to have some ground to stand on. SPY and QQQ are up 9.5% and 11.4% since June 15th, and many question the bullish sentiment pushing stocks higher after the declines in Q1 and Q2. These doubts are certainly valid as the May and June readings of the CFNAI made it clear that economic data is clearly moving to the downside, but investors have taken more positive data in stride. This includes a CPI report that was interpreted as a potential peak in US inflation.

Don’t get too excited because the worst is not behind us. Economic indicators can and very likely will reverse any strength seen in July. Some early reports like the Empire State Manufacturing Survey have shown a much weaker August. The Empire Survey’s General Business Conditions index plunged -42.4 pts to -31.3 this month with the New Orders index down -35.8 pts to -29.6. These are lows not seen since the pandemic. Financial conditions are just now starting to tighten to the degree that businesses will have to start adjusting to higher borrowing costs and, in general, tighter credit conditions.

Bears can also find the strength in July to be a point in their column instead of the bulls’. The Fed is closely monitoring economic data and shaping its tightening path meeting-by-meeting. Economic strength means that the FOMC can feel more comfortable about being aggressive in rate hikes and delaying rate cuts. In the same period that SPY and QQQ were up, the yield on the 2-year Treasury grew 3.75% to 332 basis points. Indeed, the 2-year yield bounced from being down -10% twice in the last 47 trading days suggesting investors sense hawkishness. That in itself is enough to justify the current rally breaking down.

Chinese Economic Data Faltered in July

Jacob Hess
August 15, 2022

China was weak in July after a strong June. The PBoC confirmed this when it chose to cut some of its rates further in the same day as the release of the economic data (the first cut since January). Weakness that was initiated by the COVID outbreak and restrictions that followed seems to be hard to shake off with credit flowing less freely (fixed asset investment) and consumer activity (retail sales) struggling to continue the rebound.

The real estate sector has been a huge source of the uncertainty in the economy ever since the Evergrande situation. The crackdown on overleveraged firms has created tighter financial conditions in the real estate development business as well as more prudent borrowers. The trend in home prices speaks for itself. Just about every developed nation is seeing double-digit annual growth in housing prices while new home prices were up just 3.1% YoY in July.

As mentioned before, weakness was broad based in July. Retail sales are still struggling despite consumer activity perking up following its decimation in Q1. Sales grew just 0.3% MoM and were up just 2.7% YoY which is a lower annual growth rate than June at 3.1% YoY.

Industrial production suffered as a result of the disruption in the real estate sector. Firms in the building materials and furniture industries have limited production in the last year. Headline industrial production slowed to 3.8% YoY annual growth vs 3.9% YoY annual growth in June. ING points out that semiconductor production is down as well, likely a result of chipmakers expecting demand to slow in the near future.

Chinese Growth Will Be Missed

The data is clear. Chinese growth will be a sore spot in 2022 unless a dramatic turn around occurs in the next 5 months. Downgrades of 2022 GDP growth are cropping up across many financial institutions that have digested new Chinese economic data.

Recently, ING and ABN AMRO have lowered growth forecasts. The Dutch bank revised its forecast for China’s 2022 GDP growth to 4.0% from 4.4% as a direct result of the data and the rate cuts on August 15th. It also suggests that further downgrades could be on deck if trade data is sour. ABN AMRO confirmed the downward revision it made last month as a result of the array of releases. It now sees growth of just 3.7% in 2022, down from 4.2% previously.

Both adjustments follow the pessimistic view on China posited by the IMF in its World Economic Outlook update in July. The report said, “in China, further lockdowns and the deepening real estate crisis have led growth to be revised down by -1.1 ppts, with major global spillovers.” The IMF now forecasts an even lower 3.3% GDP growth rate in 2022, lower than the 4.6% estimated for the Emerging and Developing Asia region.

China is an integral part of global supply chains and a key piece of the global GDP picture. Weakness in its economy will not only affect its region but every continent. Investors should keep a close eye on how the recovery develops in the latter half of 2022 as Beijing grapples with the lingering effects of the pandemic. In the end most will agree, Chinese growth will be missed.

Stellar Jobs Report Bucks Recession Fears

Jacob Hess
August 07, 2022

The timing of the July jobs report was impeccable. The debate of whether or not the US is in a recession had been growing with many doubting that the two quarters of GDP contraction were enough to make that claim. The main reason was the persistent strength in the labor market which has remained tight during the post-pandemic recovery. In particular, job openings had reached an all time high and many business PMIs pointed to an increase in labor demand. The July jobs report showed that this is likely still the case.

The addition of 528,000 jobs in July was the second highest this year after February’s large 714,000 increase. On top of that, the unemployment rate declined another -0.1 ppt to 3.5%. This surprised expectations which were expecting another moderate gain as had happened in the past three months. It also backed up the FOMC’s statements that they still saw a strong labor market including Chair Powell’s insistence that “the continued strength of the labor market suggests that underlying aggregate demand remains solid” in the opening statement of his press conference.

Another point of strength can be seen in the sizeable -269,000 decrease in the number of long-term unemployed, the largest since March and larger than the average of the three months in Q2 2022. Long-term unemployment now only accounts for 18.9% of all unemployment., just below the 2019 low of 19.1% set in July 2019. This combats the notion that the pandemic has caused long-term scarring in the labor market and supports the thought that consumer strength can ease the pain of a contraction in business activity.

What does this mean for the recession debate?

To be deemed a recession officially, the National Bureau of Economic Research (NBER) must consider a wide array of economic data and make an official announcement. The labor market is, of course, a significant part of that which is why job gains have been in focus over the last few months. If the NBER is paying attention (which is most definitely is), it will likely count employment data against the argument for the economy being in a recession.

For context, we can look at what job gains have been like in months that were labelled a recession by the NBER. Using data from Q1 1947 on, months where the economy was in a recession saw job losses of -365,000 on average while months out of recession saw job gains of 198,000 on average. The trend is similar in a more recent sample of 1997 to 2019 with job losses averaging -345,000 during a recession and job gains averaging 156,000 out of a recession.

It’s very clear that July’s employment increase is not consistent with historical months in recession. However, that doesn’t mean one is not on the way. When looking at months before a recession, one will find that there is no clear distinction in job gains. Since Q1 1947, normal months before a recession averaged job gains of 104,000 while other normal months out of a recession had average job gains of 202,000. The proportion is similar when shrinking the sample to 1997 to 2019.

Many also refer to a “technical recession” which is indicated by two consecutive quarters of negative GDP. After the Q1 and Q2 2022 GDP numbers came out negative, there was much allusion to this strict definition. By this standard, the July jobs report looks nothing like a recession.


The chart above shows the relation between a month’s job gains and the GDP growth of the quarter that the month was in. Recessionary months in red show that both negative GDP growth and recession are associated with either very little job gains or job losses. Not a single month in recession saw an increase in employment by 500,000 or more. In fact, that would be more consistent with a strong expansion of about 5% according to the trend line.

If we were to take the current estimate of Q3 2022 GDP growth at 1.3% from the GDPNow forecast, the July point would probably drop somewhere around the yellow rectangle on the chart. Not only are there no months that are labelled “in a recession” in that area, but the points there look to be outliers from the trend in which a strong labor market was paired with slow to no growth or contraction.

While some may think this is just a matter of semantics, the dynamics of a tight labor market are very significant to policymakers trying to navigate elevated inflation. The strong July jobs report provides a lifeline for those policymakers who are trying to avoid causing unnecessary pain to households while deflating economic activity to a level with healthier price levels.