Equity markets rose smartly in the week ending September 13 with three of the four major averages up between 4% and 6% (see table). Only the Dow Jones lagged behind (+2.60%), mainly due to a high concentration of technical names. Normally, the 2.60 percent increase would make investors ecstatic.

As usual, technology led the way. Nvidia (NVDA), which closed at $119.08, rose nearly 16% for the week and has covered nearly all of September’s decline. It is now within reach from August 23rd^rd highest closing price ($129.37). The rest of the Magnificent 7 rose between 4% and 10%, except for Apple ( AAPL ) which is still reeling from disappointing investors at its recent quarterly meeting.

On the fixed income side, interest rates continued to moderate with the 10-year government yield now at 3.66%

Inflation

The latest consumer price index came out on Wednesday (September 11^Th) for August, and it showed that inflation continued on its downward path. The overall index was up just +0.2% for the month and 2.5% from a year ago, the lowest the annual figure has been since going all the way back to February 2021 – that’s 3.5 years ago!

“Core inflation,” which excludes food and energy, and the index closely watched by Federal Reserve policymakers — rose 0.3% in August and 3.2% year-on-year. And that 3.2% figure was tied for the lowest level since April 2021.

To show the progress on inflation, looking at just the last three months and annualizing these numbers puts the headline number at +1.1% and the core at 2.1%. In our weekly blogs, we have discussed the calculation issue that is part of the construction of the consumer price index. The problem there is that the shelter part (mainly rents), which has a large weight of 36% in the index, is lagging behind. This means that the data is not current, and in fact the hiring data used by the Bureau of Labor Statistics to construct the index is 9-12 months old. A current rent index, similar to the apartment list’s index, shows that rents on a national basis have actually fallen -0.7% in the year ending in August.

So if we exclude the old rents from the consumer price index, that index behaved quite well: 0.0% in August, 0.0% in July and -0.2% in both June and May. And remember that current rents are falling, so if they were included we would actually see deflation.

For one reason or another, and despite the recent 3-month trend being what is most likely to continue in the near future, markets like to look at year-over-year comparisons. So from this perspective (year-over-year), if we exclude rents, the consumer price index was unchanged (0.0%) in the two months of July and August, rising only +1.1% from a year earlier. In July, that figure was +1.7%. So you can see how quickly inflation is slowing down. Almost the entire increase in the CPI in August was due to increased insurance premiums and housing costs. The insurance premiums are a one-time occurrence, and the increase in the protection component comes from the lagged data used by the BLS discussed earlier. (Protection costs, as mentioned, are actually falling.) Prices of goods, on net, are flat to down.

Meanwhile, the Fed is about to make its first mini-step to lower historically restrictive interest rates. Because I believe the Fed is “late to the party” or “behind the curve” when it comes to easing monetary policy (let’s not forget that there is a long lag between when the Fed implements monetary policy changes and the effects of those changes on the economy), I expect the disinflation we’ve seen so far (ie slower price increases) to actually become deflation (ie actually lower prices) by the end of the year. We have already started to see this in the prices at the gas pump.

To reiterate: the inflation genie has been put back in the bottle as inflation is now effectively at the Fed’s 2% target. Meanwhile, the Fed is about to take its first step, a rate cut of 25 or perhaps 50 basis points, toward easing its historically tight monetary policy. In our view, the Fed is “behind the curve”, which is why we believe a deflationary plan, i.e. falling prices, is ahead.

The two charts above show just how deflationary August really was. The price of gas fell by about -8% during the month, while online grocery prices fell by almost -4%.

Consumers

At the same time, consumers have started to tighten their wallets. In major retailers’ second-quarter earnings reports, CEO commentary was unanimous in reporting that consumers had begun to pull back. While they continued to spend on essentials/necessities, they reduced spending on discretionary items and now looked for bargains.

The Fed’s Beige Book assesses current economic conditions in the 12 Federal Reserve districts. It characterizes regional economic conditions based on information collected directly from businesses. Here is a selection of comments from the August book, published on Wednesday, September 4^Th.

Continuing with the plight of consumers, in the housing industry, mortgage purchase applications have fallen to 30-year lows despite the fall in mortgage rates from 7.9% last October to 6.3% in August (down 160 basis points). Given Fed Chairman Powell’s announcement at the Fed’s Jackson Hole Symposium that the Fed would begin cutting interest rates in September, potential home buyers, or those shopping up or down, may be waiting for mortgage rates to fall further.

In previous blogs, we have discussed the rising trend in credit card and auto loan delinquencies. In accordance with this line of thinking, the NY Fed conducts a survey of consumer attitudes and expectations. Two worrying trends have emerged as shown in the following chart: 1) the increase in consumer expectations that they will be late on a debt payment in the next three months; and 2) the upward trend in the probability of losing a job.

Work, Work, Work

Going back to last week’s jobs report, the sister to the Establishment Survey Payroll Report, the Household Survey reported that -438,000 full-time jobs were lost in August, but they were replaced by +527,000 part-time jobs. The Bureau of Labor Statistics counts full-time and part-time jobs as the same (ie, each equals one job). In our view, a more realistic approach is to count part-time work as equal to half of a full-time position. With this approach, +527,000 part-time jobs will be equivalent to +263,000 full-time. So the loss of -438,000 full-time jobs was only partially offset by the +263,000 full-time jobs. That’s a net loss of -175,000 full-time jobs. So it’s no wonder to us why the Fed’s Beige Book had so many negative effects on consumer spending, why auto and credit card delinquencies are on the rise, and why consumer worries about losing a job and missing a debt payment are trending. On a side note, PwC announced layoffs of 1,800 employees, the first cuts for that firm since ’09. (Wait a minute! Wasn’t ’09 part of the Great Recession?)

The rest of the world

The rest of the world is also slowing down. This past week, the European Central Bank (ECB) cut its benchmark interest rate by -25 basis points to 3.50% (note that the Fed, at 5.25%, is well behind the curve) in response to economic softness in Euroland, particularly in Germany, where industrial production fell a whopping -2.4% in July, and their manufacturing PMI fell to 42.4 (below 50 means a contraction). We also note that Volkswagen (VW) announced layoffs and broke a three-decade safety pact with its German employees.

And then there is China, which is still deep in recession. Property values ​​have melted. Consumers had been using home equity appreciation to finance consumption, but that source has now dried up. As a result, the government has cut interest rates in an attempt to stimulate economic growth. But there, as here, there is a long lag between a policy action and its impact on the economy.

Fed

The CPI and PPI reports were in line with market expectations and were the last inflation reports before the Fed’s upcoming meeting (September 17-18). At the Jackson Hole conclave in August, Chairman Powell indicated that the Fed would loosen its policy constraints, code for lowering the Fed Funds rate. Since then, the financial world has been discussing how big the first rate cut will be, i.e. -25 or -50 points. Our view is that the interest rate cut will be -25 basis points. The reason: a -50 basis point cut would spook financial markets and make them worry that the Fed sees something more ominous than a “soft landing.”

Final thoughts

Financial markets continue to march higher, mostly in anticipation of the start of a Fed easing cycle and the prospect of an economic “soft landing.” A -25 basis point cut in the Fed Funds rate is what is currently expected, and markets will likely continue to rise unless the language of the Fed statement and/or Chairman Powell’s post-meeting press conference paint a different picture (unlikely). A -50 basis point cut would send a message to financial markets that the Fed sees the economy slowing too quickly, and that would cause a downturn in those markets.

Inflation data was benign with some emerging deflationary features, such as rapidly falling gasoline and food prices. And the Fed’s own Beige Book was nothing more than a compendium of emerging softness in consumption. Such softness can be seen as mortgage purchase applications fall to 30-year lows despite falling mortgage rates. In addition, there is growing concern among consumers about job security and their ability to pay their existing debts.

Also, despite the hyped jobs headline (+142K), deeper analysis shows that full-time jobs are disappearing and being replaced by part-time jobs. While the BLS counts full-time and part-time jobs as equal, a more reasonable approach, counting part-time as half full-time work, leads to the conclusion that the labor market has weakened significantly.

Economic growth in the rest of the world has slowed. Germany looks recessionary. The European Central Bank just cut its benchmark interest rate by -25 basis points to 3.50%. China’s economy is still in a slump.

At its upcoming September meeting, the Fed is expected to cut interest rates by -25 basis points. If they cut by -50 basis points, it would send a message to financial markets that the Fed sees the economy slowing too quickly. Since the Fed knows this will destroy the stock market, it is quite unlikely to happen.

(Joshua Barone and Eugene Hoover contributed to this blog.)