Notes on the Week Ahead

Four Banks and the Dollar

On Tuesday, the Commerce Department will publish international trade data for August. The numbers will, undoubtedly, show a deficit – the U.S. has run a trade deficit every year since 1975. This, in turn, implies that the U.S. dollar exchange rate is too high – we buy everyone else’s stuff because it’s cheap; they don’t want to buy ours because it’s expensive. That being said, even as Americans have sent dollars overseas to buy goods and services, these dollars have returned to buy U.S. stocks and bonds, fueling a booming stock market and allowing the federal government to borrow relatively cheaply.

The Investment Implications of the Wealth Surge

I have a habit, or so my wife tells me, of staring intently, for minutes at a time, into an open refrigerator, in search of one particular item. When she can no longer stand it, or when the binging of the refrigerator alarm informs the world that its contents are now thawing, she gently asks me what I am looking for and points it out, sitting, as it always is, right in front of my nose.

I had a similar feeling of sheepish embarrassment last week, when I reflected on the impact of the extraordinary surge in wealth on the economic and financial environment. I spend a significant chunk of my life looking at stock indices and home prices. And yet, throughout this year, while agonizing about tenths of a percent in the unemployment rate or the inflation rate and how the Fed might interpret them, I have neglected to consider fully how burgeoning stock market and housing wealth has changed both the economic environment and the position of investors.

The Investment Implications of a $769,900,000,000 Mistake

On Thursday, the Bureau of Economic Analysis, commonly known as the BEA, will release revised data on the national income and product accounts going back to the start of 2019. This is an annual process, usually only mildly interesting to economists and ignored by everyone else. However, this year it’s more important since it could help clarify the trajectory of the economy at a critical time for both political and monetary policy choices. It’s also important because it could help resolve at least some of a yawning discrepancy between the estimates of output produced and income received in the American economy.

Previewing the Fed: Easy Does It

Cutting short-term interest rates from a peak is a little like hauling a piano down a flight of stairs. The operation is best done slowly and with care.

The Federal Reserve will probably show some awareness of this in their actions and communications this week. That being said, one of the greatest identifiable dangers to the economy and markets today is that the Fed, by acting too aggressively or talking too negatively, increases the risk of the economy falling into recession.

The Jobs Mosaic

On Wednesday of next week, the Federal Reserve will almost certainly embark on its long-anticipated easing cycle. However, whether the first cut in the federal funds rate is 25 or 50 basis points is still very much in doubt. This is a crucial question for the economy and financial markets since a 50 basis point cut might well do more harm than good if businesses, consumers and investors saw it as a signal that the Fed is worried about recession.

The most important issue for the Fed as they debate this decision is the strength of the U.S. labor market. It is quite clear that job growth has slowed over the past year as the post-covid rebound has faded. But is the labor market stalling, or just slowing to a more gradual pace?

 

Demographics, Debt, the Dollar and Apocalyptic Assets

The U.S. working age population is growing relatively slowly. The Bureau of Labor Statistics estimates that the U.S. population aged 18 to 64 grew by less than 0.1% over the past year.

Jackson Hole and the Speed of Fed Easing

Every August, for more than 40 years now, the Federal Reserve has held a retreat in Jackson Hole, Wyoming. It has become an important venue for Fed communications and investors this week will be focused on Jerome Powell’s speech, to be delivered at 10:00AM eastern time (or 8:00AM Wyoming time) on Friday.

The topic of this year’s conference is “Reassessing the Effectiveness and Transmission of Monetary Policy”, a subject that is well worth careful reconsideration. This, no doubt, will be the focus of Chairman Powell’s remarks.

The Outlook for Housing in a Macro Game of Inches

The last two weeks have provided a vivid reminder of how sensitive markets can be to small changes in the macro-economic outlook.

With a nudge down in oil prices, the Fed’s 2% inflation goal suddenly seems achievable within a matter of months. With a slight weakening in the labor market, the unemployment rate has shifted to a trajectory that has foreshadowed recession in the past. In response, the 10-year Treasury yield fell from 4.29% on July 24^th, to 3.78% on August 5^th while the VIX index, a measure of stock market volatility, more than doubled over the same period, with stock prices falling sharply by the close of business last Monday.

The Slowdown Scenario

We live at a time when extreme voices get the most attention and so it is tempting, following a string of weak economic numbers, to yell the word “recession”. However, a balanced assessment of demand and supply suggests that we are, thus far, merely transitioning to slower growth. A slower growth path is a more vulnerable one, particularly because excessive monetary ease is more likely to weaken than strengthen the economy in the short run. Nevertheless, barring some outside shock, the baseline scenario should be a slowdown scenario, even as volatile markets remind investors of the importance of diversifying and paying attention to valuations.

 

The mood on the economy has changed quite quickly. The economic headline from just 12 days ago was that real GDP growth had, yet again, surprised to the upside, coming in at a robust 2.8% for second quarter, well above the 2.1% consensus expectation. Since then, however, we have seen higher-than-expected weekly unemployment claims and weak readings on construction, durable goods orders, home sales and manufacturing activity. This was topped off, on Friday, by a softer-than-expected employment report, both in terms of payroll job gains and the unemployment rate.

Concentration Risk as the Fed gets Ready to Cut

My wife, Sari, and I love old movies and one of our favorites is the Long, Long Trailer, staring Lucille Ball and Desi Arnaz.  Desi and Lucy are newly-weds who decide, instead of buying a house, to purchase a trailer home which they hitch onto the back of their car and set off on their adventures.  Soon, without any idea of how to drive such a contraption, they find themselves ascending into the Sierra Nevada mountains, driving up steep, narrow and twisty mountain roads.  Unbeknownst to Desi, Lucy decided to collect rocks as souvenirs along the way which she hid all over the trailer, adding extra weight to an already dangerously unwieldy vehicle.  The funniest part is watching them making small talk, pretending nothing is going on, as their car engine roars, gears squeal and little rocks spit out from their tires, over the cliffs and out into the abyss below.  The contrast between the nonchalance of their conversation and the terror in their eyes is priceless and it only increases as they head over the peak and begin to descend.

The most dangerous time, both for oversized trailers and central bankers, is when you begin to descend from a peak.  Recent data suggest the Fed should, finally, begin to cut rates in September.  This operation could work out OK.  However, it is a delicate one and, particularly, when both markets and portfolios appear to be overconcentrated, it is important that investors take what steps they can to maintain or regain balance in their portfolios.