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August 2022 Market Commentary

September 18, 2022

August. The time of year when seemingly everyone is trying to leave town for one last vacation, before school resumes and summer unofficially ends. Not even policy makers are immune to the desire to escape. For the Federal Reserve, that means heading to Jackson Hole, Wyoming, for their annual policy meeting with other global central bankers. This year’s meeting was arguably the most widely anticipated since 2008-09, when the Fed was busy trying to steer the US through the Great Recession. Investors who were expecting, or at least hoping, that this year’s meeting would be akin to a pleasant day at the beach were no doubt disappointed.

In an unusually terse and direct speech, Fed Chair Jay Powell said that bringing inflation under control will require the Fed to act “forcefully”; will require the Fed to maintain a restrictive policy stance for “some time”; and that doing so will result in “some pain” for both households and businesses. Failure to control inflation, Powell argued, would result in “far greater pain” that would fall heaviest on those least able to handle it. In unequivocal terms, Powell quashed the notion that the Fed might turn more dovish following recent data that had spurred hopes that “peak inflation” had passed. Powell said that a single month’s improvement falls “far short” of what Fed officials will need to see to be confident that inflation is receding. Further, Powell noted that “the historical record cautions strongly against prematurely loosening policy.”

Market reaction to Powell’s speech was immediate, with the S&P 500 losing 3.4% on the day, followed by additional declines over the next three days to end the month. The post-speech declines were enough to erase small monthly gains that markets had booked up until that point. For the month, large caps (S&P 500) fell 4.2%. Small caps (Russell 2000) fared slightly better, declining 2.2%. International developed markets (MSCI EAFE) ended down 5.0% as concerns about the European economy continued to intensify, while emerging markets (MSCI EM) ended flat.

July consumer inflation data, released in August, showed signs of slowing, thanks in part to a sharp decline in gasoline prices. That was enough to hold inflation flat for the month and to slow the annual increase from 9.1% to 8.5%. Other measures of inflation also showed promising signs. Producer price inflation slowed from an annual rate of 11.3% to 9.8%, while data from industry group Institute for Supply Management (ISM) showed that input prices in the manufacturing and services sectors fell to their lowest levels since August 2020 and February 2021, respectively. Finally, consumer expectations for future inflation, something that Jay Powell has indicated factors into the Fed’s decision-making process, showed improvement. According to the Federal Reserve Bank of New York, consumers’ one-year inflation expectations declined from 6.8% to 6.2%. Three-year expectations declined from 3.6% to 3.2%. While welcomed, as Powell made clear in his Jackson Hole speech, such improvements will need to continue before the Fed considers changing course on monetary policy.

Perhaps the largest question currently facing the economy is whether it is already in recession. By some definitions it already is. In 2Q22, economic activity contracted for a second consecutive quarter, satisfying the most common definition of recession. However, upon closer examination of the underlying details, including the fact that consumer spending remains positive, we believe that the economy, though slowing, was not in recession at the end of 2Q. Data released in August provided further fuel for the ongoing debate. Some parts of the economy, such as housing continue to see significant downward pressure, while other areas, including manufacturing, services, and the labor markets, are faring better. Within housing, rising mortgage rates have led to a sharp slowing in both construction activity as well as sales. The slowdown in activity is best reflected in weekly mortgage applications, which fell to a 22-year low during the month.

According to ISM data, manufacturing activity fell to its slowest pace since June 2020, while service sector activity accelerated following three consecutive monthly declines. Importantly, both sectors remained in expansion territory. Consumer spending grew just 0.1% in July, down from a full 1.0% in June. Retails sales for the month were flat. The weaker spending represents a headwind to 3Q GDP. On a related note, 2Q GDP was revised higher, from -0.9% to -0.6%, largely due to consumer spending being revised from 1.0% to 1.5%. The significant upward revision provided further credence to the idea that while slowing, the economy did not end 2Q in recession.

Labor markets remain an economic bright spot, with nonfarm payrolls adding 528K new jobs in July and another 315K in August. With the new jobs added in July, the economy recovered the total number of jobs lost in March and April 2020. Of course, the recovery has not been uniform. Notably, leisure and hospitality remain 1.2M jobs below February 2020 levels. While strong labor markets are generally good for the economy, and certainly good for those seeking employment, the recent mismatch between job openings and those seeking work, which has neared 2-to-1, has contributed to 5%+ wage growth and in turn, higher inflation. Moving forward, the Fed has made clear it is willing to accept higher unemployment as collateral damage in its efforts to lower inflation. Thus, labor markets may yet begin to suffer in the coming months.

August proved to be a difficult month, not only for equity markets, but fixed income markets as well. Higher rates resulted in the Bloomberg US Aggregate bond index falling 2.8%. No sector was immune to the losses, but longer- duration bonds fared the worst, with the 30-Year Treasury down 5.3%.

After declining in July, interest rates reversed course and rose significantly in August with the 10-Year Treasury yield gaining 0.61%, to end the month at 3.27%, its highest level since late June. Rates initially moved higher after various Fed members clarified comments made by Fed Chair Jay Powell following the central bank’s July meeting that were misconstrued to mean that the Fed was nearing an end to the current rate-hike cycle. From there, the release of the July employment report and some other better-than-expected economic data contributed to the narrative that the Fed would remain aggressive for longer than previously anticipated. Even a deceleration in headline inflation failed to change sentiment, as measures of core inflation remained much too high for the Fed to consider moderating its current stance on monetary policy. Finally, Powell’s Jackson Hole speech in late August removed any last doubts about the Fed’s commitment to drive inflation lower, all of which resulted in the 2-year Treasury yield reaching its highest level since November 2007, and the 10-year Treasury yield moving back toward cycle highs from mid-June, leaving the entire yield curve well above 3%.

Municipal bonds carved a similar path over the month, with those bond yields also approaching cycle highs across the curve to close the month.

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Information and research contained herein do not represent a recommendation of investment advice to buy or sell stocks or any financial instrument nor is it intended as an endorsement of any security or investment, and it does not constitute an offer or solicitation to buy or sell any securities. It is not possible to invest directly in an index. There is no assurance that investment products based on the index will accurately track index performance or provide positive investment returns. Past performance is not a guarantee of future results. These materials have been prepared solely for informational purposes based upon information generally available to the public from sources believed to be reliable. The views and opinions expressed in this publication are subject to change, at any time, without advance notice or warning.

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