Markets were rocked by the Fed’s message “will keep at it until the job is done,” referencing the commitment to returning inflation to its 2% objective. As a result, the S&P 500 posted a loss of -4.63% bringing the YTD loss to -21.61%. Bond markets also declined by -1.56% bringing the YTD loss to -13.75% (while Long-term Treasuries have declined by -26.80% YTD). There is visible weakness in the U.S. economy with a slowing in the housing market and the Leading Index posting a -0.3%; however, the jobs market with lower jobless claims and improving retail and manufacturing continuing to post positive results as a headwind to the Fed’s effort to fight inflation. With housing prices falling by approximately 6% this year and equity markets declining by 20%, the wealth of U.S. households is definitely taking a hit and may eventually trickle down to lower demand.
The coming week will be filled with another week of headlines, with Fed Chair Powell speaking on Wednesday, followed by the release of critical housing data, GDP, and wholesale inventories.
With the Inflation Reduction Act and the European Climate Law, the West is pushing to exit oil and natural gas to prevent severe climate change and reduce dependence on foreign suppliers. As a result of the new laws and economic incentives, electric vehicle (EV) sales are expected to dominate the car market for the years to come. And the battery industry will grow along with it. Common lithium-ion batteries in use nowadays are made of various combinations of metals that include Lithium, Cobalt, and Copper: Lithium is mainly extracted from underground ponds in Australia, Chile, China, and Argentina. The process is very water-expensive and often causes damage to the land and trouble to the local communities; Cobalt is mainly extracted in the Democratic Republic of Congo (DRC), which supplies about 70% of global production. Unlike mines in developed nations, where heavy machines accelerate operations and safeguard workers, human hands dig up much of the cobalt. Often children’s hands. Mining and refining metal is an energy-intensive business, and the energy used often comes from coal and other fossil fuels. Therefore, the push to quickly abandon fossil fuels brings several hidden costs.
The EURUSD wavered around parity for most of the week and recovered some ground on Friday after the ECB (European Central Bank) decision to raise its key interest rate by 0.75 points. Over the years, heavy reliance on cheap Russian gas has exposed the nations in the Euro area to wide energy cost swings. The spike in prices in the past year has hit households and businesses across the continent with unbearable utility bills that were quickly followed by a general increase in goods prices (as businesses adjusted to larger production costs). Both Demand and Sentiment have been suffering as a result, as highlighted by McKinsey [https://www.mckinsey.com/business-functions/growth-marketing-and-sales/our-insights/survey-european-consumer-sentiment-during-the-coronavirus-crisis]. In its July survey, more than a third of respondents reported spending on nonfood discretionary items decreased due to the pricing pressure. And consumption could fall even more in the winter, as energy takes an even larger portion of consumers’ budgets.
Shifts in demand, labor shortages, and lockdowns that began in 2020 with the worldwide spread of Covid-19 are some of the main drivers of the global supply chain crunch that has largely affected the prices of goods and services in the past two years. The invasion of Ukraine in 2022 and its geopolitical consequences have added more stress to an already chaotic situation. Decreasing demand for new products due to high prices and borrowing rates, and relaxation of the strict covid rules that have disrupted the supply chain for months, could be enough to lower the inflationary pressure in the next year. According to the Oxford Economics supply chain tracker, the situation has been improving over the past few months, and supply-chain conditions in the U.S. offered encouraging signs to start Q3. Cargo ship backlogs in Southern California have declined for six straight months now, and other modes of transport also signaled reduced stress. Shipping prices were flat or fell, as well. Though Ukraine War adds uncertainty to the mix, making it hard to predict when the supply chain issues will resolve, there are signs that the situation is improving and demand and supply are slowly converging towards an equilibrium.
The past two years have been tough on the travel industry, which has first faced the abrupt drop in demand caused by the pandemic and is now confronted with understaffing issues as the appetite for travel quickly rebounds. Cruise Operators have indeed seen demand drop sharply since 2020 because of pandemic-related restrictions and passengers’ fear of contagion. This negative trend, however, may soon end. Over the past year, the U.S. has gradually been relaxing masking and testing requirements. As a result, the demand for cruise travel has started to recover. As shown in this week’s Chart, the number of passengers who traveled with Royal Caribbean, Carnival, and Norwegian Cruise Lines in Q2 2022 has bounced sharply from the small numbers seen in the same quarter in the past two years. Demand is expected to grow even more now that the CDC has dropped its vaccination requirements for cruise ship passengers. In support of this view, after the new rules were announced, Carnival reported that booking activity was almost double the activity on the same day in 2019.
The week marked a second consecutive month of declining gas prices in the United States. The national average price for a gallon of gasoline fell to $3.99 on Thursday, down from the high of more than $5 a gallon in June, driven by a decline in global oil prices in recent months and a tax break on gasoline enacted by a number of states. On Friday, the House passed a climate, tax, and healthcare program dubbed the Inflation Reduction Act that will impose new taxes on shares’ buybacks for large corporations, provide some $80 billion to the IRS, and allow Medicare to negotiate drugs prices directly. Additionally, it will fund hundreds of billions in tax subsidies to fight climate change, targeting a 40 percent reduction in greenhouse gas emissions from 2005 levels by 2030.
The coming week will be marked again by inflation concerns, with investors focusing on the latest U.S. Consumer Price Index (CPI) announcement on Wednesday and the U.S. Producer Price Index (PPI) announcement on Thursday. The CPI figure is expected to be down from the latest report (when inflation was recorded at a 40-years high of 9.1%) following the FED’s aggressive tightening in recent months. Additionally, the PPI figure will hint at “what lies ahead” for future inflation. The Producer’s report is a leading indicator of the increasing manufacturing costs that may be passed on to consumers in the coming months. On Tuesday, President Biden is expected to sign the so-called “Chips Act” into law. The legislation aims to boost the production of semiconductors in the U.S., a strategic move that aims to capture back shares in a market that Asian countries have dominated in recent years. The move echoes the increasing tensions with China and the global chips shortage that has made it harder for U.S. companies to obtain new chips.
U.S. equities closed the month with the best performance since November of 2020. Equities rebounded from a tough first half of the year as expectations for interest rises eased and reassuring earnings from technology and energy sectors. Technology-heavy Nasdaq performed the best, gaining 12% for the month, according to the Financial Times. Shares in Amazon, Microsoft, Apple, and Google lifted the technology sector after beating consensus on earnings and giving an upbeat outlook for the rest of the year. Oil giants ExxonMobil and Chevron also exceeded expectations on earnings by reporting record quarterly profits as a result of higher oil and gas prices. So far, more than half of S&P 500 companies have beaten estimates, according to FactSet. Data showed that the U.S. economic growth was negative again in the second quarter, a technical definition of a recession. Weakening economic data indicating slowing growth has convinced investors that the Federal Reserve may have to slow its aggressive pace of monetary tightening.
This week will be the busiest week of corporate earnings. Mega-cap technology companies such as Microsoft, Google, Meta Platforms, Amazon, and Apple will report their earnings. Notable names from other industries will also report, such as General Electric, Boeing, Ford Motor Company, Mastercard, Coca-Cola Company, and ExxonMobil. The Federal Reserve will hold its two-day July policy meeting on Tuesday and Wednesday, and it is expected that they will raise the federal funds rate on Wednesday by seventy-five basis points. Several important economic data will be released this week. On the housing front, the Case-Shiller National Home Price Index for May and new and pending home sales for June will be released on Tuesday and Wednesday. We will get the advance estimate for the second quarter GDP growth on Thursday. The U.S. economy contracted in the first quarter of the year, and there is a chance that we might see another quarter of GDP decline. If so, two consecutive quarters of negative growth would indicate a recession by most measures.
Last week, the exchange rate between the euro and the dollar hit parity for the first time in 20 years. The de-risking sentiment of the markets has global investors looking at the dollar and dollar assets. This year, the U.S. Dollar Index, which compares the dollar to a basket of other currencies, such as the euro and the yen, is up just shy of 20%. There are two main reasons for the dollar’s strength. The first has to do with central banks. The Federal Reserve has already raised interest rates by 1.5% this year, while the European Central Bank has not. The dollar is stronger than the Japanese yen because of diverging monetary policy—Japan’s central bank intends to keep its 10-year yield near zero. The second reason for the dollar’s strength is the relative strength of the U.S. economy versus others, especially in Europe. Because of the Russia-Ukraine war and Europe’s reliance on energy from Russia, the region faces a significant energy shortage and a possible recession while the U.S. economy is still running strong.