08/18/2021: Chairman Jerome Powell and his Federal Reserve colleagues are preparing to convene next week in Jackson Hole, Wyoming for their annual policy symposium. The group will hike, fish and possibly schedule a gradual tapering timeline for their $120 billion monthly bond purchases. While America’s monetary authority has done a good job of telegraphing the likelihood that interest rates will be hiked twice in 2023, for example, their taper timing is less certain. More details may become available later today (Wednesday) when the Fed releases its July minutes. Powell is expected to add more color from Jackson Hole, and a number of recent developments will likely factor into that outcome.
The first factor is the possibility of slower US growth as businesses and consumers react to the spread of the Delta variant. Consumer confidence plunged 13.5 per cent in the month ending mid-August, according to the University of Michigan Consumer Confidence Index, which dipped below the lows reached last April during the early days of the pandemic to levels not seen since 2011. Consumer confidence tends to lead retail selling activity since confident consumers are more inclined to open their wallets.
Waning confidence is already having an impact on spending. July retail sales fell 1.1 per cent overall, according to the US Census Bureau, including a 3.9 per cent retreat in vehicle sales. On a positive note, reopening trends edged higher, bars and restaurants enjoyed a 1.7 per cent gain for the month. Brick-and-mortar retail grew by 3.5 per cent while internet retail slipped 3.1 per cent. There’s evidence that the emergence of the Delta variant is crimping service demand, like travel and entertainment. Travel and hospitality spending has dropped sharply since early July, according to The Wall Street Journal. High-frequency data like Open Table’s dinner reservations and TSA checkpoint volume confirms the downtrend.
Business confidence is sagging as well: US small business sentiment fell more than expected in July and small business owners dialed down their expectations for future sales and the economy. The National Federation of Independent Business (NFIB) Small Business Optimism Index slid 2.8 per cent in July, reversing its June gain. Persistent supply chain shortages combined with hiring difficulties were a one-two punch to confidence. A record share of small business owners said they have unfilled positions in July, according to Bloomberg News. While the share of business owners intending to hire over the next three months fell slightly, it does remain at an historically high level.
Growth in China, the world’s second-largest economy, slowed more than expected in July, adding another signal that could inhibit the Fed from taking a more restrictive monetary posture. A key Chinese container port was partially shut down last week in response to a small COVID outbreak there, and retail sales were hit hard by new virus-related restrictions. Flooding in central China and weak auto sales due to the semiconductor chip shortage hurt manufacturing. Steel production plunged to a 15-month low, according to Bloomberg. China also faces a slowing property market. Despite all this, a recession is not in the cards for China at this juncture – the country’s GDP grew 7.9 per cent year-over-year in H1 and 1.3 per cent in Q2.
The last factor potentially standing in the way of monetary tightening is fiscal policy. The chaotic US withdrawal from Afghanistan over the weekend could inhibit President Biden’s ability to shepherd his legislative agenda through Congress. Biden’s $3.5 trillion budget plan on top of his $1 trillion infrastructure package were widely viewed as creating an inflation boost thanks to massive, anticipated government check writing on everything from construction and alternative energy to public housing and community colleges over the next decade. Chairman Powell and his colleagues probably anticipated fiscal spending would be a critical offset to their tapering program. The shifting political landscape reduces the likelihood of Biden’s legislation becoming law.
These factors in sum suggest the Fed will likely take a wait-and-see approach toward tapering, while sticking to its 2023 rate-hiking schedule. That means yields could stay lower for longer and “real” rates – the differential between interest rates and inflation – could remain at generational lows for longer. An extended period of negative real rates advantages gold over cash and creates a favorable backdrop for equity risk taking.