Getting cold feet

Stocks slumped yesterday on increased inflation fears ahead of tomorrow’s CPI release. A threat of new Chinese COVID lockdowns have investors on edge.

You have to say it to believe it. Does it even matter if the US is technically in a recession or not? Does it really matter if the Fed is fighting inflation or not? Nope, it really does not. Come on now, think about it. You have felt inflation, and it is quite palpable. You have seen inflation; you just need to look at your weekly budget for necessities like food and gasoline. You have HEARD quite a lot about how the Fed is very keen on fighting inflation – they are going to raise interest rates… and keep raising them until inflation is all but obliterated. Wow sounds kind of scary doesn’t it. Well, if you believe all that and you were thinking about buying a new car, you would be left with 2 choices. Choice one: rush out and buy the car now, because financing charges are going to go up with rising rates. Choice two: supply of cars is scarce, and they are overpriced now, so perhaps, wait until inflation gets under control and prices come down a bit. Which would you choose? Most likely choice two. What if you were considering the purchase of a new home? Your choices would be quite similar: rush in and buy now or wait for things to cool off. Choice two seems to be what most of us would choose, once again. So, you see how just hearing about an aggressive Fed may cause consumers to balk on big purchases. There is also the reality that borrowing rates have already ratcheted higher since the Fed announced its tightening campaign. Fixed rate 30-year mortgages jumped from around 3.25% to a high of 6.05% in mid-June and have since pulled back to around 5.75%. Despite the recent easing, an increase of that magnitude represents a significant increase in monthly payments for borrowers. Add that to an already pricey housing market and you are left with some real hurdles for prospective home buyers.

According to a report from online real estate marketer Redfin, June saw a spike in cancelled deals. The report found that 60,000 sales fell through, representing 15% of contracted sales for the month. Just a year ago, that same rate was at around 11% according to the report. You can see in the following chart going back to 2017 how the cancellation rate bounced between 12% and 14% with some regularity. The onset of COVID briefly shot the cancellation rate to nearly 18%...briefly. Most interesting is how the rate hit a low of nearly 10% early last year as the already hot housing market heated up further, just as inflation began to heat up more broadly. Finally, we note last month’s outlying spike, which is likely the result of higher mortgage rates, low consumer confidence, and the emerging threat of economic toil.

Clearly, you would not purchase less food as a result of the threat of higher interest rates or recession. However, rising costs on necessities like food will leave less disposable funds for non-essentials, where we are already witnessing a falloff in demand. So, big ticket items are more expensive, and the threat of tough times only adds to the pullback in demand. Other non-essential items are being left on the shelf as consumer confidence wanes and funds are diverted to pay for household necessities – less demand. The end result is price moderation due to diminished demand. Tomorrow, we will get a read on Consumer Price Index, which is expected to show an increase over last month’s reported annual rate. On Friday, we will also get University of Michigan Sentiment, which is expected to come in at an all-time low for a second straight month. Will all this pain and fear cause demand to fall off enough to cause prices to eventually moderate? The Fed is certainly hoping so, but just in case, it is likely to raise its key lending rate by another ½ to ¾ point next week.

YESTERDAY’S MARKETS

Stocks pulled back yesterday on inflation concerns and the threat of fresh COVID-related lockdowns in China. The S&P500 fell by -1.15%, the Dow Jones Industrial Average slipped by -0.42%, the Nasdaq Composite Index pulled back by -2.26%, and the Russell 2000 Index declined by -2.11%. Bonds rose and 10-year Treasury Note yields gave up -9 basis points to 2.99%. Cryptos fell by -6.46% and Bitcoin advanced by +1.73%.

NXT UP

• NFIB Small Business Optimism (June) fell to 89.5 from 92.1, missing economists’ estimates.
• Richmond Fed President Thomas Barkin will discuss recession in a talk at 12:30 PM Wall Street time.
• This morning, PepsiCo beat on EPS and Revenues.