For the week of September 19, 2022
Overall inflation has moderated slightly since June but remains uncomfortably high, and the persistence of core inflation points to further rate hikes by the Federal Open Market Committee. In August, headline CPI of 8.3% was down from 8.5% in July and 9.1% in June, largely reflecting lower prices at the gas pump. Energy inflation is now running about half of what it was in June. Food inflation, on the other hand, has yet to roll over, but it should start to as agricultural commodities prices are down 10% to 20% from peak.
Core services inflation, which includes the important shelter component that makes up one-third of the CPI, has accelerated and is proving a tougher area to rein in. Higher tenant rents price into the market gradually as contracts renew over time. Additionally, continued tightness in the labor markets is keeping upward pressure on wages and passing through to consumers in the more labor-intensive services sectors.
One bright spot around the otherwise disappointing inflation topic would be that consumers’ forward inflation expectations have been coming down. The three-year-ahead inflation expectation of 2.75% is the lowest since October 2020 and in-line with 2014-19 averages, a period when inflation was not a major concern.
The recent trends in retail sales indicate a U.S. consumer that is feeling some pressure from higher prices—but not pulling back in a meaningful way. It’s also likely consumers are shifting some discretionary spend to services like restaurants and travel after two years of above-trend goods purchases.
Although consumer spending has faced headwinds from inflation this year, we are not seeing particular signs of stress on household balance sheets. Credit card delinquency rates remain near historic lows, and, according to analysis from the JPMorgan Chase Institute, consumer cash balances remain significantly elevated for all income quartiles relative to pre-pandemic. At the end of June, median cash balances were 60% elevated for low-income families and 45% elevated for high-income families.
Source: U.S. Bureau of Labor Statistics, U.S. Census Bureau, University of Michigan.
|Core CPI year-over-year
|PPI Final Demand year-over-year
|Retail sales month-over-month
U.S. markets witnessed their worst day since June 2020 last Tuesday, September 13, as investors were spooked by the August inflation report that showed less cooling than expected, raising concerns of a historic 1% hike in rates when the Federal Reserve meets this week. Adding to the negative sentiment, a few bellwether corporates signaled weaker business conditions and ongoing supply chain challenges. All 11 S&P 500 sectors finished in the red last week, with healthcare and energy down less than the index as a whole, while tech, real estate and materials underperformed.
Oil declined for the third straight week amid a deteriorating outlook for the global economy.
High-grade bond yields rose to a new 12-year peak this week, driven by higher Treasury rates, while spreads were fairly stable. High-yield bond spreads were about 20bp wider on the week to 525bp. This is 250bp wider on the year and about 90bp inside the June wides of 636bp.
The U.S. dollar hit fresh highs against a basket of currencies, remaining around parity with the euro. The British pound took another leg down last week with a drop through $1.14 for the first time since 1985, accumulating a decline of 16% against the dollar so far this year.
Source: Bloomberg. Closing prices on Sept. 16, 2022.
|Natural Gas ($/mmBtu)
|U.S. IG Yield
|U.S. HY YTW
|USD Spot Index
Regarding the federal funds rate, we continue to look for a 75bp hike at this week’s meeting, and now expect a 50bp move in November (up from 25bp previously), followed by two more 25bp hikes in December and January-February. This would take cumulative tightening to 400bp and the terminal target rate range to 4.0%-4.25%. We believe the Fed will continue tightening policy until some slack is coming back into the labor market. Since that point in time is uncertain and given the lags between rate hikes and economic activity, we believe that later this year the FOMC could seek an offramp to smaller 25bp increments to reduce the risk of overshooting. If the labor market isn’t materially cooling by the January-February meeting, then we’d look for continued tightening in 25bp moves until that occurs.
Meanwhile, the market-implied terminal fed funds rate has risen to 4.50% by March 2023. The forward curve (three-year) has risen 110bp since early August, putting it above 4% for the first time since 2007.
Source: Bloomberg. Closing prices on Sept. 16, 2022.
|1M CME SOFR
|2yr U.S. Treasury
|10yr U.S. Treasury
|30yr fixed rate mortgage
Issuance / M&A volumes
While public capital markets—IPOs and leveraged credit—are down sharply from last year, private markets issuance volumes are only down slightly from 2021-22 Q1 levels and still higher than 2020.
Crossover and public-style investors have been mostly on the sidelines in private markets, while growth equity and private equity have been more engaged, with records amount of dry powder to put to work. Investors continue to focus on profitability and fully funded business plans.
In high yield, the supply calendar is expected to increase in upcoming weeks after producing only $3 billion of issuance thus far in September.
Note: All issuance and M&A figures for North America. As of August 2022. To be updated monthly.
|Volumes ($ billions)
Chart of the week
Inflation is still running high
Source: U.S. Bureau of Labor Statistics.