Will we get a full 1% rate hike? … what bank earnings are telling us … with all this inflation, are you ready for disinflation?
Will we get a 75- or 100-basis-point hike in two weeks?
On Wednesday, the Consumer Price Index (CPI) print came in at 9.1%, which Fed Governor Christopher Waller called “a major league disappointment.”
(Not to be relegated to the minor leagues, yesterday, the Producer Price Index (PPI) came in at 11.3%.)
Going into Wednesday’s CPI release, we knew inflation was going to be smoking hot. But the 9.1% climb was beyond even the higher estimates.
The market took one look at the report and said to itself: “The Fed is going to have to red-line its rate hike in two weeks to combat this inflation.”
But this takeaway has been changing…
We can see the evolution by tracking the CME Group’s FedWatch Tool, which analyzes the probabilities associated with various fed funds target rates at upcoming Fed meetings.
On Tuesday, before the CPI report came out in the morning, odds of a 100-basis-point hike in two weeks were just 7%.
But when Wednesday afternoon rolled around, those odds exploded to 78%.
However, the expectations began falling after Waller’s commentary:
…The markets may have gotten ahead of themselves a little bit [Wednesday] when they just assumed it would go to 100 after that report.
That said, Waller didn’t exclude the potential for a 100-basis-point hike. Though he believes 75 basis points is appropriate, he added:
We have important data releases on retail sales and housing coming in before the July meeting.
If that data come in materially stronger than expected, it would make me lean towards a larger hike at the July meeting to the extent it shows demand is not slowing down fast enough to get inflation down.
It was mixed messaging, but it was enough to cool the FedWatch Tool’s projections. Yesterday, the odds of a 100-basis-point hike dropped to 61%.
But the real cooldown happened courtesy of Atlanta Fed President Raphael Bostic.
Offering a somewhat more dovish take, Atlanta Fed President Raphael Bostic helped reassure markets by saying that “dramatic” moves by the Fed could undermine the U.S. economy.
In the wake of these comments, the odds of a 100-basis-point hike have fallen to just 29% as I write on Friday.
Though it’s a sign of the times that preferring a 75-basis-point hike would be considered “dovish,” this is notable.
When the market believes that the Fed is materially letting off the gas on its hawkish policy, that’s when stocks will be primed for a meaningful rebound.
This is important to watch. We’ll keep you updated.
***Meanwhile, over on the Q2 earnings front, big-bank earnings are mostly disappointing
Yesterday, we learned that Q2 profits for JPMorgan slumped as management decided to build its reserves for bad loans by $428 million.
Our technical experts John Jagerson and Wade Hansen of Strategic Trader warned of this risk on Wednesday.
From their latest issue:
…Sentiment is touchy and can be positively impacted even by non-cash changes like lowered loan-loss reserves, but that can cut both ways.
For example, we are concerned that the banks will increase their loan-loss reserves this quarter more than expected.
For example, imagine a bank that expects their default rate in loans will increase from 1% to 2%. They will increase their loan-loss reserves, which shows up as an “expense” on the income statement, even though the losses are only expected and haven’t happened yet.
This is exactly what played out with JPMorgan.
Beyond the increased loan-loss reserves, the big bank missed revenue estimates, while profits were down 28% from a year ago.
In a sign that the bank is hunkering down for tougher market conditions, it suspended share buybacks.
While CEO Jamie Dimon said that consumer spending remains healthy for now, he was less positive about what he sees headed our way:
…But geopolitical tension, high inflation, waning consumer confidence, the uncertainty about how high rates have to go and the never-before-seen quantitative tightening and their effects on global liquidity, combined with the war in Ukraine and its harmful effect on global energy and food prices, are very likely to have negative consequences on the global economy sometime down the road.
Looking elsewhere in the banking sector, Morgan Stanley also missed earnings yesterday, posting a 29% decline in profits.
And news this morning is Wells Fargo’s Q2 profits fell 48% from a year ago as it also set aside funds for bad loans.
The bright spot in banking comes from Citigroup, which posted a Q2 earnings beat, thanks in large part to strong trading results.
As we’ve pointed out here in the Digest, this Q2 earnings season is critically important for the direction of the stock market.
If earnings hold up despite the inflation we’ve experienced over the last three months, it will be a huge buoy to stock prices as we begin moving into the fall.
But if earnings estimates prove too high, resulting in new, lowered estimates and deteriorating investor sentiment, stocks are in for another leg down.
Big-bank earnings coming in at one-out-of-four for good results isn’t the start we wanted, but there’s a long way to go.
***Finally, ready for disinflation?
Despite the highest inflation readings in 40 years, our hypergrowth expert Luke Lango tells us that the “smart money” is now betting on disinflation.
Based on what?
After citing the big-name investors and economists who believe disinflation is coming (Michael Burry, Cathie Wood, Paul Krugman, Jeremy Siegel, Tom Lee…), Luke explains why – and why it’s actually bullish for stocks.
From yesterday’s issue of Hypergrowth Investing:
In the big picture, inflation trends were elevated throughout 2021 and into 2022 because of a global supply-demand imbalance wherein economic demand for goods and services outstripped the supply of those goods and services.
That imbalance is now swinging in the other direction, which is very bullish for stocks.
***Luke cites five primary drivers of coming disinflation:
Waning economic demand
Rate hikes from the Fed
Improving supply chains
Huge inventory stockpiles
Dropping freight prices
Waning economic demand is obviously deflationary. When an economy slows and consumers spend less, it lowers demand. Prices deflate.
It’s similarly easy to connect the dots between Fed rate hikes and disinflation. Higher rates choke off economic demand by way of higher borrowing costs. And we just looked at the impact of waning economic demand.
As to improving supply chains, let’s go to Luke:
Throughout 2022, supply chains globally have meaningfully normalized following COVID-related disruptions.
According to the New York Fed’s Global Supply Chain Pressure Index, supply-chain pressures globally have improved by about 50% since the start of the year.
At this rate, supply chains should be back to “normal” by 2023.
Normalized supply chains mean prices won’t be pushed higher by limited supply. When everything is running smoothly, global trade goods should be plentiful, which brings down costs.
Here’s Luke on the fourth point of huge inventory stockpiles:
Because economic demand was so high in 2021 while supply chains were still broken, retailers over-ordered goods to fill what were, at the time, empty inventory shelves.
However, supply chains have quickly normalized, resulting in a ton of product being shipped to those retailers, at the exact same time that economic demand for goods has slowed.
The result? A record inventory build.
Retailer inventories have soared throughout 2022; and after being “below trend” throughout 2020 and 2021, retailer inventory levels are now “above trend.”
Retailers with too much inventory have to mark down that inventory to sell it (or just get rid of it). Those lower prices are fundamentally disinflationary.
Finally, dropping freight prices is also clearly disinflationary.
This is happening today as a result of production capacity increasing, economic demand waning, and inventories building.
Luke tells us that the Drewry’s composite World Container Index has fallen over 30% since September.
Back to Luke for the bottom line:
Strung together, the aforementioned data paints a picture of a global economic supply-demand situation that is rapidly shifting from high-demand and low-supply to low-demand and high-supply.
The former environment creates inflation. The latter environment produces disinflation.
That’s why billionaire investors are confident inflation will fall, and it’s also why stocks should rise in the coming months.
As we’ve noted in recent Digests, Luke’s preferred market sector – hypergrowth tech stocks – appear to be carving out a base.
Since tech stocks lead the broad market in terms of timing, Luke is increasingly convinced that we’re on the cusp of a massive tech rally. For more of his research on this, click here.
We’ll keep you updated on all of these stories and more here in the Digest.
Have a good evening,