Is Inflation Really Cooling?
Signal Definer: Strong. Equity markets recovered significant ground, and most major bond sectors saw rare (in 2022) positive results.
July Market Recap
The S&P 500 Index returned 9.11%
The Bloomberg U.S. Aggregate Bond Index returned 2.44%
Fed Funds Target Range: 2.25% – 2.50%
Economic Review
The Fed raised the key short-term rate by an expected 75 basis points, and in his remarks Chairman Powell used the phrase “in the pipeline” to describe the potential that rate increases already enacted may not have filtered into the economy yet. His remarks were interpreted as newly dovish, and this was enough for some to begin planning a “rate cuts in 2023” party.
The data shows growth slowing and the Fed’s preferred measure of inflation increasing, but income is up and consumers are more positive.
- GDP decreased at an annual rate of 0.9 percent in the second quarter of 2022 according to the “advance” estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP decreased 1.6 percent. The decreases were business-investment driven; consumers are still spending
- The personal consumption expenditures price index (PCE) rose 6.8% in June, the biggest 12-month move since the 6.9% increase in January 1982. This is the Fed’s preferred measure of inflation data
- The employment cost index rose 1.3% in the second quarter, and 5.1% on a 12-month basis, the highest increase since 2002. This measure is also closely followed by the Fed
- University of Michigan Consumer Sentiment Index rose to 51.5 in July. This is an improvement over the historical June low of 50. The Expectations index that tracks consumer sentiment on inflation declined. This is a key piece of data for the Fed.
- July non-farm payroll came in at 528,000, more than twice expectations.
July CPI Came in Decisively Lower
The headline CPI print came in at 8.5%, lower than expectations. The decrease in energy costs was enough to offset increases in food and shelter. Core CPI, excluding energy and food, increased 0.3%. This was lower than the increase in April, May, and June.
Market Review
The S&P 500 rallied sharply on the prospect of a more dovish Fed and positive earnings results and guidance. As of month end, 278 issuers have reported, with 209 beating estimates (75.2%) and 67.9% beating estimates on sales. Overall Q2 earnings are expected to post a 7.3% increase over Q1 2022.
The 10-year U.S. Treasury ended the month at 2.66%, down from 2.98% in June. At year-end 2021, this rate was at 1.51%. The 30-year U.S. Treasury ended July at 3.02%, down from 3.19%. The Bloomberg U.S. Aggregate Bond Index ended July with a return of 2.44% but is still down year-to-date with a return of -8.16%.
The U.S. high yield market returned 6.02% as measured by the ICE BofA US High Yield Constrained Index . Year-to-date, the market returned -8.86%. Bonds rallied on relatively strong Q2 earnings reports from high yield issuers, along with the emerging view that a slower economy could lead to less aggressive Fed tightening in the second half of the year.
S&P Global’s recent LCD Leverage Finance Survey looked at the sentiment of leveraged finance professionals with respect to defaults. Leveraged finance professionals expect the loan default rate, as measured by the S&P/LSTA Leveraged Loan Index, to rise from a near record low of 0.21% in May to between 1% and 1.49% by June 2023. This still sits well below the long-term average of 2.77%.
