Six Flags

Appropriate for summer, the markets resembled an amusement park ride, jostling around just to end up back at the beginning. The cause for the volatility is well known, being kicked off by the Bank of Japan’s rate hike and the weak jobs report creating tremors for those investors who used the Japanese Yen to fund speculative investments. As those volatile trades started to accelerate downward, oversold conditions helped whiplash markets back up. While the fun house floor is tilted slightly downward, the soft landing is still the consensus view. Along with earnings, investors are now back to focusing on economic data and interpreting how that impacts Federal Reserve policy for September. The fixed income market’s emphatic 50-basis point consensus for the upcoming Fed meeting could create additional volatility as we line up for each economic data release and the next comments coming out of Japan. We suggest no one is tall enough for the buy-the-dip rollercoaster right now, so use caution over the next few weeks and wait for the park to close. 

‍Watch Used Car Prices, Again

Used cars may be back as an influencer. After peaking at the end of 2021, prices of used cars have reversed over half their surge before rising 2.8% in July, which could mean inflation may turn higher again. Because that sharp price drop in used cars helped push CPI down to three-year lows, the Manhiem Used Vehicle Value Index is a focus of ours once again. While prices are still down 6% versus last year, they have been down over 10% annually over the past few months. What got our attention is that July is traditionally a month when prices fall. Perhaps prices have found a floor because supply is drying up.

Inventories fell back to the tightest levels since the pandemic. Supply is dwindling because there are not a lot of older new car leases that are coming due, nor are rental car companies retiring many cars from their fleets. The CPI data lags the Manheim Value Index, this July's used car uptick will not show up until August, so Wednesday's July CPI inflation report may not be as inflationary as it could have been. However, the price increase should impact August CPI, which could disappoint investors banking on a September rate cut.

Our Friends Up North and to the East

It can be helpful to look at what other central banks thought when they shifted rates:

The Bank of Canada (BOC) meeting minutes explained their 25-basis point cut decision was to prevent weak employment from further depressing spending. There is concern over sticky services inflation, but priority was given to the deteriorating job outlook. U.S. investors hoped that the Federal Open Market Committee (FOMC) would make the same choice when they met the next day. After all, the BOC minutes revealed that their forecast for the U.S. economy was the same as for their own country: a cooling labor market that could drive spending down.

The Canadians also think the two countries share the same inflation dynamic: inflation will fall, but it could experience upward bumps due to sticky services prices. The BOC even listed the same problem as what plagues both U.S. and Canadian labor markets: excess labor supply that “would continue to outpace employment growth.” Their expectation is to continue rate cuts because downside risks to inflation are now more likely than inflation spikes. The BOC traditionally follows the Fed, not the other way around. We wonder if they were surprised the U.S. hesitated to follow the same path by not cutting rates.

The message from the Bank of Japan (BoJ) was that they have exactly the opposite predicament. Japan’s central bank raised rates 15 basis points to deal with upside risks to inflation due to a “rising number of industries that have seen supply shortages…as a result of labor shortages.” They expect the added cash in consumers’ hands from the recent wage negotiations and summer bonuses to produce more spending and higher inflation expectations. The markets embraced the comment that “future policy needs to be conducted carefully” as an indicator of a very slow pace of rate hikes.

However, here comes the kicker: in their Summary of Opinions of the July 31 meeting, the BoJ stated the price stability target will be achieved in 2025, so the BoJ must raise the interest rate level to the neutral rate by then. This means another 75 basis points or more in rate hikes because “the level of the neutral rate seems to be at least around 1%.” Keep in mind that the last cut was only 15 basis points, and it sparked worldwide asset volatility. To get to 1% requires the BoJ to hike a minimum of five 15-basis point hikes over the next eight to ten meetings into Q3 2025. Once the market does the math, capital will move to more defensive assets.

 What Are They Saying Here?

Fed speakers this week did not give investors what they wanted, but investors did not seem to care. We had assumed markets wanted to hear that the Fed was open to matching the consensus for a 50-basis point cut in September, but equities rallied back to levels from last Friday’s close without any assurance. FOMC nonvoters Goolsbee from Chicago and Schmid from Kansas City made it clear they needed more information before being comfortable cutting rates at all in September. The two FOMC voters who did speak were clear that they would stay uncommitted until there was more information. San Francisco Fed President Daly and Richmond Fed President Barkin had coordinated messaging: they, too, advised against making decisions based on individual economic reports. While Daly agrees that there is a need for policy adjustment (read: rate cuts), she said the timing would be over “upcoming quarters,” and cuts occur only when a “clearer direction is established.”

Barkin made an interesting comment that he would have voted to cut in July if he had “either absolute conviction that the labor market was on the precipice, or if…you had inflation under control.” Therefore, the same will hold true for him in September, meaning he still might not consider cutting even 25 basis points. He said that the labor market “has settled down but is still adding jobs…what would make you more worried is if job growth started to disappear.” 

Our take on this is there was no consideration for a 50-basis point cut in September unless the August inflation data out September 11 (one week before the September FOMC meeting) shows a significant drop in inflation or the September 6 August nonfarm payroll report shows further weakness. Atlanta Fed President Bostic speaks at 1:15 p.m. E.S.T. on Tuesday, and his remarks will be closely watched. He has been a proponent of cutting only once at the end of the year, so equity and fixed income markets will focus closely on his rate view.‍

What to Look for This Week

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1. Tuesday, August 13 at 6:00 a.m. E.S.T, The National Federation of Independent Business Survey is released. Given the new concern about the Sahm rule triggering a recession, the July report will receive attention and could be a market mover.

2. Tuesday, August 13 at 8:30 a.m. E.S.T. is the broadcast of the July Producer Price Index inflation data, followed by Wednesday, August 14 at 8:30 a.m. E.S.T. Consumer Price Index inflation. CPI excluding food and energy is expected to print a 3.2% annual inflation rate for July, a new low since peaking in October 2022 at 6.6%.

3. A set of Chinese economic data is out on Wednesday, August 14, starting with July Housing Prices at 9:30 p.m. E.S.T. Housing Prices have made new lows each month this year and stand at -4.5% annual growth as of June. That data is followed by Chinese Fixed Asset Investment, Retail Sales, Industrial Production, and Employment data, all for July. China’s data is followed by U.S. Retail Sales and Initial Claims out Thursday August 15 at 8:30 a.m. Despite last week’s equity rally on lower initial claims, the 4-week moving average of initial claims made new highs, as did continuing claims, indicating weak employment demand.

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