We don’t know where the ever-growing inflation will go, just like we can’t imagine whether the Federal Reserve will maneuver the effective Federal Open Market Operations (OMOs) to achieve a soft landing and thus avoid an economic failure. Since March 2022, the Fed has adjusted the federal fund rate four times in a row, raising the fundamental interest rate by 225 basis-points so far. Even so, the U.S. CPI rose 9.1% in June 2022, the highest year-over-year growth rate in nearly 40 years.
Although the latest CPI for July 2022 fell to 8.5%, it was just the result of eliminating the impact of high gasoline prices in the past few months. In the same year, the national GDP fell by 0.9% in the second quarter after falling by 1.6% in the first quarter, which means the U.S. economy has practically entered a status of technical recession.
Although the U.S. stock market has declined as a whole this year, it ushered in a rebound in July, especially after the Fed announced another 75 basis-points interest rate hike for the second time this year, which was in line with market expectations. Because the Fed didn’t take more aggressive steps such as raising the interest rate by 100 basis-points, this has both stabilized market sentiment and investors’ confidence in betting that the Fed will begin to ease its monetary policy next year.
Nevertheless, while the latest nonfarm payrolls and unemployment rate released in early August appeased the fears of an impending recession, it added to the unease that the Fed may move further to cool down the still-overheating economy. Meanwhile, the U.S. durable goods orders increased 1.9% in June, 81% of which came from military aircraft orders.
Together with the approaching midterm elections later this year, the future of the U.S. economy has once again become more unpredictable.
Looking back on July 2022, the S&P 500, the Dow Jones and the Nasdaq Composite rose 9.1%, 6.7% and 12.4% respectively, sweeping away the flagging state in the first half of the year. The tech sector bottomed out while the Nasdaq Composite recorded its largest gain since April 2020. Also, high profile companies such as Apple, Amazon and Tesla all posted their better-than-expected quarterly earnings.
Unlike the previous cases where the overall performance of the stock market fell again right after it soared on the interest rate decision day, the market has currently managed to hold up its trend after July’s Federal Open Market Committee (FOMC) meetings. Massive buybacks may have also contributed to the recent rebound of the major indexes. According to JPMorgan Chase’s research, the total size of the stock repurchases reached $514 billion as of July 26, up from the same period in the last year.
The bull traders have been firmly grasping the Fed chairman Jerome Powell’s previous statement that the Fed will begin to slow down the interest rate hikes at a point to assess their impact, betting that the Fed’s tightening policies will surely ease by the end of 2022. Therefore, the possibility of the Fed’s more aggressive OMOs shouldn’t be excluded. In June 2022, Powell mentioned the Fed is not trying to provoke a recession, but it is certainly a possibility. This shows the Fed’s lack of confidence in its capability to successfully accomplish a soft landing.
Charles Evans, the head of the Chicago Fed, recently mentioned that the current inflation is still unacceptable, and he predicted the Fed to raise its benchmark rate to 3.25% to 3.5% by the end of 2022. This is in line with the rate hikes suggested by Jerome Powell at July’s meeting.
Due to the dominance of the U.S. dollar in the world, a series of operations implemented by the Fed this year have also affected the economic conditions of various countries, increasing the likelihood of a global recession. Many countries have been suffering severe depreciation of their own currencies and higher than ever inflation due to the appreciation of the U.S. dollar, forcing policymakers in major economies to follow in the Fed’s footsteps, especially the Euro area.
Affected by the situation in Ukraine, the annual inflation of the Euro area hits 8.9% in July as energy and food prices continue to soar. Some U.S. firms in the fields of tech, raw materials and restaurant chains that heavily rely on overseas revenue will also be hit hard by the strong U.S. dollar. Among emerging markets, Latin America and Southeast Asia have been particularly suffering from high inflation. The most typical example is Sri Lanka, which declared the bankruptcy of the nation in July this year.
Although the Fed has always been determined to keep the long-term inflation rate at 2%, it is clear that they will adopt flexible policy-making procedures without revealing their specific tendencies in advance.
No matter doves or hawks, from the Fed officials’ ideal point of view, they are more inclined to take the prudent measure of raising the fundamental rate to a high level and then keeping it unchanged for a period of time. From the perspective of economic fundamentals, the Fed may have already missed the perfect opportunity to start a fiercer rate hike earlier this year. Instead, what we’ve seen is that the rehearsal for the Fed’s tightening program took too long, with merely modest rate hikes at the outset, and relatively aggressive moves were only implemented after the inflation data reached new highs.
As a result, this has contributed to the bearish sentiment in the market early this year, especially the tech sector, which is more sensitive to changes in interest rate and industry prospects. With current borrowing costs still well below the real extent of inflation, the Fed’s efforts to curb credit liquidity remain limited.
While the GDP has been commonly treated as a numerical indicator to measure economic activities, labor indicators represented by unemployment rate and nonfarm payrolls reflect the enthusiasm for corporate recruitment, and it also indicates whether or not the economy is truly in a downturn. In July 2022, a total of 528,000 nonfarm payroll employments were added to the United States, far exceeding market expectations and hitting a new high in five months. On the other hand, the unemployment rate fell to 3.5%, basically returning to the level before the outbreak of Covid-19.
The increase of new jobs was mainly driven by the manufacturing and construction industries. In the field of service industries, business services, hotels and education have grown rapidly, and the government sector has contributed the most. The current statistical method of the employment number only accounts for enterprises rather than taking consideration of specific households, which may cause workers with multiple part-time jobs to be counted repeatedly. While this kind of method is more or less controversial, it reflects the fact that the current labor market is hotter than ever before in the past two years after all.
The good employment figures are inherently encouraging, but we also need to pay attention to the changes in the structure of the employment population. According to Layoffs.fyi Tracker, more than 45,000 employees were laid off from the U.S. tech startups in the recent three months, nearly five times the number in the first quarter of the year. Due to the reduction of subscribers and declining financial performance, Netflix announced some time ago that it would lay off 300 employees. Tech giants such as Meta, Twitter and Tesla also announced that they would slow down or suspend their future recruiting plans in varying degrees.
In addition, average hourly earnings rose 0.5% for the month and 5.2% year over year, greater than the market expectation of 4.9%, which has also deepened people’s concerns about the wage-price spiral. The Great Resignation was still prevalent in the U.S. labor market a few months ago due to labor shortages. In order to make up for a large number of labor vacancies, employers generally increased the salary for their new employees, which attracted a large number of people to quit their previous positions in exchange for better treatment.
All this happens because of changes in industry cycle and financial market valuations; in other words, The previous rally of the tech sector brought about by the pandemic and the Fed’s quantitative easing have already gone.
The market is still full of anxiety, and we need to pay attention to the sectors that were heavily sold in the first half of the year. If commodity prices can be effectively controlled within a few months, the pressure of economic recession may ease, and these sectors could improve even more. While being prepared for the likelihood of continued stagnation for the rest of the year, it is also important to recognize the fact that the Fed’s role as a policy maker will always lag behind the reality.
While the Fed can adjust the short-term interest rate, the long-term interest rate is still determined by market expectations, which is also the main reason for the frequent occurrence of inverted Treasury yield curves in the past year, reflecting investors’ lack of confidence in the fundamentals of the U.S. mid- to long-term economy. The recovery of the economy is not a one-time event but a process of constancy. Although the stock market has rebounded since the second half of this year, the whole year round market performance is still bearish and short of sustainable growth momentum.
Due to high cost of living, policy uncertainty, geopolitical crisis, and unstoppable pandemic, people’s livelihoods in the United States and rest of the world are still under long-term pressure. Whether a soft landing is achievable or not depends on the flexibility of the Fed’s operations and the resilience of the U.S. economy itself. As far as the expansion of demand is concerned, the current economic status is still sturdy, but there is still the potential for a recession in the near future. Anyhow, the recession rhetoric flooding the market is definitely not alarmist.
Erli Wang
