What I Care About This Week | 2022 Sep 12

worm s eye view of buildings
Photo by Johannes Plenio on Pexels.com

by Franklin J. Parker, CFA

The Summary

  • The Bottom Line. Overall, the economic data continues to be okay—not great, not bad, but just okay. Last week’s data was pretty light, but there is a lot of data posting this week that could easily move markets. The Federal Reserve meets next week to deliver a decision on rates, so all of this week’s data will be interpreted in that light. Fed members have given guidance that a 0.75% rate hike is likely, so that is priced in. A move of less would boost markets, more would push prices down. My view continues to be that there is some upside in these markets, though I do expect it will be rocky. However, once people stop buying stuff, I expect a recession won’t be too far behind.

  • Last week, consumer credit data for July showed a decline from June’s figure, a good sign, but the general trend is still higher. Jobless claims were lower than expected and wholesale inventories were down. Overall, it was a pretty light data week, and the data continues to be mixed (though generally okay).

  • In contrast to last week, this week is fairly heavy on data. Inflation figures for August post on Tuesday, producer prices (one of the Fed’s preferred gauges of inflation) post on Wednesday, retail sales for august post on Thursday along with industrial production (one of my favorite economic indicators). Finally, consumer sentiment posts on Friday. All of this data could easily push markets around: especially with the Fed’s rate decision coming next week.

The Details

The past few years have turned most professional investors into Fed watchers, and this begs the question: why does the Fed matter so much?

The Federal Reserve has the responsibility for controlling the money supply and influencing interest rates. This supports their dual mandate: to keep inflation low and employment at full capacity.

These two tools have the side effect of pushing market prices around, though some of that is intentional. By raising the rate they pay banks, the Fed is able to pull cash out of the general economy, making less credit available to businesses. This tends to constrain business activity. Of course, the inverse is also true—markets have benefitted from low rates over the past decade.

Increasing the amount of cash in the economy tends to push market prices up—both because investors themselves have more cash to put to work, but also because it increases the amount of credit available to businesses. The inverse here is also true.

Given the power of these forces, central banks can exert a lot of influence over market prices. During times like this, when the moves are very aggressive, prices will respond quite strongly. Of course, markets benefitted from aggressive moves in 2020, but those moves served to boost prices rather than pull them down.

In the end, however, prices will tend to follow the fundamentals of the economy. Profit growth is what drives prices, so while the Fed influences valuations in the short term, it is these bigger forces that will drive longer-term prices.

Chart of the Week

One way to measure the amount of cash in the economy is to look at the amount of assets on a central bank’s balance sheet, which is what this week’s chart shows. When a central bank “shrinks their balance sheet,” they are reducing the amount of cash in the economy, constraining credit, and generally slowing down the economy.

As this week’s chart shows, central banks globally are decreasing the size of their balance sheets, and at a quickening pace. Markets are reacting negatively to this change in policy.

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