Stocks had another wild day with a late-day rally failing to hold into the close as investors remain concerned about the potential for recession. Another regional Fed report reflects a growing discomfort amongst businesses.
Pay now, buy later. We have been talking quite a bit about how the Fed is raising rates and selling bonds to fight inflation. The hope is that higher borrowing costs will force consumers (you and me) and businesses to stop spending so aggressively. It has worked in the past and the hope is that it will work once again. What is spooking investors are those past results. In some past cases, the Fed was so aggressive that the economy stalled and fell into recession. Well, that is one way to tackle inflation, but was it really the Fed, alone, that caused recession? It is important to remember that it is not the high interest rates that cause the recession, but rather the consumers themselves. In a consumer-driven economy such as the US, consumption is the real determinant of growth. So, what stops consumers from spending money? Well, job loss might be a reason, but thankfully, the employment situation is strong in the US with the rate of unemployment just above the pre-pandemic, 60-year low. Another factor might be an increase in taxes. “WHAT,” you exclaim, “I thought taxes just went down a few years ago, who would raise taxes in this economic environment?” All right, calm down, I am not referring to income and investment taxes, but rather to…wait for it…inflation. Yes, inflation is like a tax that eats into your income. Last spring’s dollar is worth only $0.91 today. If you spend most of your money on chicken (regulars know that I am obsessed with the price of chicken), that dollar is only worth $0.83! With taxes of that magnitude, there are likely to be consumers who are already pulling back on their expenditures. That’s right, they simply cannot afford to make the purchase, so they don’t. Economists refer to this a demand destruction, a situation in which there is a prolonged, or possibly a permanent decrease in demand resulting from lengthy price increases. Yes, inflation itself can cause a decay in consumption and lead to recession.
Finally, there is consumer sentiment, which is a big driver of consumption. If we are fearful that things may sour in the future, we are likely to put off big expenditures until our prospects pick up. There is growing evidence that consumers are losing confidence. Two closely watched confidence indicators are the Conference Board’s Consumer Confidence, and the more exhaustive University of Michigan Sentiment Index. The former rests at 107.3, higher than it was in 2020, just above a 12-month low, but far below the pre-pandemic 132.6. The University of Michigan Sentiment Index tells a far more worrisome story, having recently come in at 59.10, a pandemic-era low. The last time the indicator was at these levels was in the midst of The Great Recession, back in 2009. The indicator began to trend lower in 2021 as inflation began to climb and made a significant leg lower as the Fed began its rate-hiking rhetoric. All of this leaves very little doubt that consumers are already on tenterhooks. Inflation itself may ultimately curb demand enough to cause prices to return to normal. Where it doesn’t, the Fed is ready with plenty of rhetoric to erode consumer confidence. Stay confident but spend maybe, a little less, the economy…and the Fed is depending on you.
YESTERDAY’S MARKETS
Stocks overcame early deficits in a mid-day rally, which ultimately faded into the close for a loss in the session. The S&P500 fell by -0.58%, the Dow Jones Industrial Average gave up -0.75%, the Nasdaq Composite Index traded lower by –0.26%, and the Russell 2000 Index gained +0.16%. Bonds gained and 10-year Treasury Note yields decreased by -5 basis points to 2.83%. Cryptos added +1.03% and Bitcoin advanced by +3.51%.
NXT UP