Last week was entertaining from a news perspective. We got to talk about Tesla and Cathie Wood… Heck, even “The Big Short.” But with a ton of economic data coming out this week, the time for fun is over.
There’s an important report coming every day this week, culminating with the Federal Reserve’s Jackson Hole meeting on Friday. From Purchasing Managers Index (PMI) numbers we received Monday to Personal Consumption Expenditures (PCE) on Thursday… the most important thing this week is the Fed’s response to the latest economic data.
Will Chair Jerome Powell panic and begin tapering? Will he remain steadfast in the fact that inflation doesn’t seem to bother the U.S. central bankers?
Let’s start with PMI data that came out Monday morning. Manufacturing data stayed relatively steady…
Source: Bloomberg
But the key figure here is services.
Source: Bloomberg
When the economy began to recover after the pandemic, the initial increases were in manufacturing — and there was a ton of supply to make up. Then services picked up… and now appear to have peaked.
To explain how PMI is measured, it revolves around the number “50.” A level of 50 means no growth. Below 50 is shrinking, above is growing.
Services currently sit around 55. So there is still growth, but it has slowed significantly from recent highs above 70. If that number keeps dipping, how will the Fed respond?
Well, the United States is a service-based economy, so it means the economy is truly slowing if that number falls further.
And that means the Fed will just do what they always do… counteract economic weakness with easy money policy.
Housing Data This Week
We’ll see a couple of housing data reports this week, both of which are indicators for the economy as a whole.
New home sales come out Tuesday, which should give us an idea about consumer appetite for higher price points. I can’t point out my expectations on that one, only that we’ll react to the data.
Wednesday, however, we get durable goods orders. Now, as you know, I prefer leading indicators. Durable goods is a leading indicator of new home construction. I expect a decline, which will also lead to a decline in new home sales.
And so what does that indicate? Check No. 2 on an economic slowdown.
We already know inflation is still running rampant. And if you’ve been following me, you should already know what I’m about to say…
Inflation plus a slowing economy equals stagflation. The more data we get, the more confident I feel in that claim.
The Fed’s Response to Economic Data
Ready for the third checkbox on an economic slowdown? On Friday, the same day as the Jackson Hole meeting, we’ll get consumer sentiment numbers.
That data has been largely… well, bad. The last report we saw was below its COVID-19 level. So we’ll hope for upside but if that number gets worse, buckle up.
I expect U.S. consumer spending to continue to slow. And consumer spending is about 70% of GDP. We’ve been saying for months now that we’ll see the economy and consumer spending slow down, but the scary part comes in how the Fed responds.
The day before the Fed meets in Jackson Hole, we’ll get the big PCE report. Which is a key indicator of inflation. It may not be the central bank’s preferred inflation metric, but it’s certainly mine.
But that doesn’t mean the Fed won’t respond to this economic data.
Source: Bloomberg
PCE is expected to come in at around 6.1, which would be the highest level in nearly 40 years.
Source: Bloomberg
Will it stay there? Absolutely not.
But how will the Fed respond to that economic data? I’ll bet it will panic.
And from that panic, it will finally start tapering. Good news, right? Wrong.
For one, any talk of tapering — reducing asset purchases — could cause markets to pull back, especially in small caps. But tapering during an economic slowdown means we’ll see it go from stagflation… to deceleration.
During economic downturns is when you want to increase asset purchases, which the Fed should have started doing last year. So after the wrong move has been made, look for it to compound it with an even worse one.
So why is the Fed’s response to economic data going to be so wrong? Because, by nature, it is a backward-looking organization.
All we can do is keep our eyes forward and do what the Fed won’t: be prepared.
All the best,
Matt Warder
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