Economic Updates for July 2023

GDP is currently projected to be 2+% for Q2 2023.The economy seems very resilient to recession at least so far.

The dollar has continued to soften. It is at its lowest level since last September against a basket of 6 currencies. The taming of inflation in the US and subsequent moderation in further rate hikes by the FED has been the key influence on the dollar.

Since June, commodity prices broadly have been finding a bottom and are seen recovering. Energy prices are being helped by the OPEC decision to keep the supply controlled.

Gold and Bitcoin have taken a pause in their climb.Over the last couple of weeks, it appears they have found a shallow bottom and have been bouncing back.

Same comment as above in Gold.

In the month of June again, inflation climbed by 0.3%. This has been in line with consensus expectations.

PPI, also, increased by 0.3% in June. PPI has been bobbing in the positive and negative territory lately.

This is the headline inflation number that everyone talks about. Currently, for July 2023 we are at 2.97%. We are certainly headed in the right direction. In the coming months, we hope the inflation remains contained. Historically, inflation is known to bounce back a few times before it finally subsides.

CPI Components Last Month

CPI Components This Month
All components of inflation are seen moderating. As mentioned earlier, energy's contribution to inflation has been consistently negative in the last few months in a row now! (Please note that the y-axis in both the graphs have different scales).

This survey data shows that inflation one year from now is expected to be 3.4%. This is not changed much in the last month. Perhaps more of the survey participants remain convinced that the inflation will abate sharply.

The surprise for the month of July is the sharpe rise in consumer sentiments to level not seen for the last 2 years! It jumped to 72.6 largely attributable to continued slowdown of inflation and the strong labor markets. As long as the consumer is strong, it is hard to make a case we are in recession.

The AAII sentiment remains bullish as many reluctant investors are starting to participate in the rally. S&P 500 is within 5% of all time high (ATH).

While the rally has broadened beyond technology and communication sectors, we are at the start of the Q2 earnings season. Investors could be selective in picking the stocks that show earnings growth and good forward guidance.

A good place to look for the impact of FED's interest rate hikes is probably the Manufacturing PMI. It has come down consecutively in the last two months and is at the lowest reading for the last 12 months. New orders have slowed and the inventories has drawn down as the demand is suppressed by higher interest rates and reducing inflation.

In contrast to the Manufacturing PMI, Services PMI reading has been steadily above 50 over the last few months. Demand is strong and is supported by new business growth. Employment in the services industry has also remained robust.

Industrial Production refuses to show the optimism seen in the services PMI numbers. It is still close to 0.

Retail Sales has bobbed up into the positive territory this month and also last month after revisions. It is still not indicating a robust consumer. We are looking forward to this month's numbers for any positive change on this front.

Non-farm payrolls have stubbornly been too good indicating economy is still adding jobs. This month the jobs number came below expectation and yet too high to indicate any slowdown in job growth.

Total Vehicle sales continues to be within its trend band higher, which is a good sign. New cars are scarce in dealer lots.

The used car prices have continued the price decline over the past few months. This has helped the headline inflation in its downward trend.

New home sales saw another large jump in this month. Perhaps new buyers are feeling courageous to take on the higher mortgage rates thinking it may only go higher in the coming months. While the existing home sales is still sluggish, most home buyers are looking at new homes for which some of the home builders are providing attractive incentives.

The mortgage rates have marginally climbed over the last month as FED rhetoric has pushed interest rate expectations a bit higher.

The unemployment rate has remained low despite the FED's attempt to induce a slowdown. This indicator is a lagging indicator and we do expect to see this number creep up as recession becomes imminent.

This chart will be the first indicator of a telltale sign that unemployment is increasing. As you see the continuing jobless claims number rise, it implies the people who lost their jobs are not going back to labor force fast enough and the unemployment rate is starting to creep higher. Over the last couple of weeks, it has trended lower, indicating a robust jobs market.

Interestingly, the rate of change in job postings is reducing but the total jobs are still rising according to this indicator. While this is consistent with the Bureau of Labor Statistics (BLS) report on job openings to unemployed, we expect to see some sharp corrections if a recession is imminent.

This month again, the wage inflation continues to exceed the headline inflation as it recorded a reading of 5.5% compared to the headline inflation of 3.0%. This is an indication that inflation is being entrenched in the labor market and may lead to wage/price spiral. Something that the FED does not want to see and makes it likely to keep rates higher for longer.

The yield curve inversion remains intact putting pressure on bank net interest incomes.

Yield curve - Then

Yield curve - Now
The short term rates including the 2year rate is now above 5%!

Year to date, technology, consumer discretionary, industrials and communication sectors have been the leaders. Lately, the breadth in the markets has been widening followed by a strong performance by tech earlier in the year.

If the economy were to enter a recession, it is likely that some of the companies will struggle to keep up with their debt payments causing their credit spread to widen. This indicator shows how the credit spreads have been behaving so far.

The spreads have been very tame and no observation of spikes in spreads yet indicating a credit crunch. Some market participants are taking the cue from the equity markets to suggest high yield may be getting into risky territory and we may see some spikes fairly soon.

A spike in put / call ratio indicates that investors are very apprehensive about a sudden fall in the equity markets. In June, the activity has been quite well behaved in the overall market (SPY) in spite of the debt ceiling standoff. The VIX index has also remained very quiet.

Some astute market participants are observing the lack of volatilty in the equity markets. Periods of long lull in volatility in the past have led to sharpe increase in VIX or breakdowns in certain derivatives markets.

The current earnings forecast by equity analysts estimate the earnings potential for S&P 500 companies to be around $230 which translates to a price to earnings ratio of 18.9 at the current S&P 500 price level. This is above the 5 year and 10 year averages.

It is likely that as inflation comes down, so will the earnings numbers. This indicates that the future S&P 500 price level could likely come down. Based on the companies that have reported so far for Q2 2023, the earnings have declined by -7.1%.

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