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Less Hawkish Fed – Don’t Celebrate!

 They’re Still Tightening into a Recession

Most of the economic news this week was downbeat. Even the normally buoyant U.S. consumer appears to be retrenching as July’s Retail Sales were flat (0.0% M/M). Both equity and bond prices ended the week somewhat lower with the DJIA barely moving, but the tech heavy Nasdaq and small caps falling more substantially. In bond land, the positive price reaction (lower yields) due to the less hawkish than expected Fed minutes (released on Wednesday August 17) was short-lived as rates rose both on Thursday and Friday.

 8/12/228/19/22Pct. Chg.
S&P 50042804228-1.2%
Russell 200020171957-3.0%

LEI and Retail

The Conference Board’s Index of Leading Economic Indicators (LEI) was negative again in July, that’s five months in a row. The economy has never escaped Recession when this has occurred. As noted above, Retail Sales showed no growth in July (+0.8% growth in June). Of interest, ex-auto, July Retail Sales were +0.4% M/M. That means, just when supply chains have eased and automakers can once again get the chips they need, auto demand seems to have diminished. Isn’t that what the University of Michigan’s (U of M) Index of Consumer Intent to Purchase Autos has been telling us for the past several months?

Within the Retail sector, on a nominal basis, clothing fell by 0.6% M/M in July, General Merchandise (department stores) was off -0.7% (negative four months in a row), and Restaurants, while they showed up as +0.1% on a nominal basis, their prices were up +0.8%, meaning that, in real (volume) terms, sales were down -0.7%. Overall, on a real basis, Retail has been flat or down in four of the last five months, not a good omen for Q3 real GDP.


While there was a slight increase in the U of M’s overall Consumer Confidence measure to 55.1 from 51.5, still extremely low by historical standards and no doubt, completely due to the pullback in gasoline prices in July, of more concern is the continued fall in the Business CEO Confidence Index (see chart at the top of this blog). In Q2/2021, this was 82 and it was still above 50 in Q1/2022. The latest count is 34. Another such indicator, the six-month Economic Outlook Diffusion Index, stood at 65 in Q4; it is now 31, the lowest it has been since Q2/1980 (yes, lower than in the Great Recession!)

When CEOs and businesses lose confidence, they look for ways to cut costs, shrink headcount, and reduce inventory to prepare for the Recession they see on the horizon. When they all begin those preparations, it just exacerbates the situation, i.e., these actions help precipitate the Recession.


Housing plays a big role in GDP calculations. New home construction is an obvious contributor to real GDP as it employs construction workers and supports industries that produce the goods and materials necessary to build and furnish the structures. Even the sale of existing homes plays a large role, as the new occupants put their personal touches on the purchase with new furniture, carpeting, paint, and other home improvement projects. The data here, too, look Recessionary.

  • The diffusion index of Homebuilder Sentiment fell into contractionary territory in July at 49 (50 is the demarcation between expansion and contraction). Last December, this index was a hot 84. Worse, the diffusion index of Prospective Buyers fell to 32 in July, now falling five months in a row.
  • The National Association of Realtors Homeowner Affordability Index is the worst it’s been since 1989. There are two parts to this: 1) Rising home prices (+10.8% Y/Y), and 2) mortgage rates near 6%, double what they were in Q4/2021.
  • Mortgage Purchase Applications are down -18.5% Y/Y. Worse, Refi Applications are off -82% Y/Y. Refi money is a source of household liquidity and is often used for big ticket purchases like autos or major home improvements. This source of liquidity has now dried up.
  • Housing starts fell -9.1% M/M in July and are down -8.1% Y/Y. The single-family sector was down -10.1% M/M and -18.5% Y/Y. This will have a large negative impact on real GDP. The multi-family sector was also down -8.6% M/M in July, unusual as there is a dearth of apartments for lease and rents have been rising. Multi-family starts are up nearly 25% Y/Y, and as these come to market, rents will cool. We have already seen the beginnings of this.
  • Existing Home Sales fell -5.9% M/M, -20.2% Y/Y, and, except for the Covid economic shutdown, are the slowest since November 2015. This was the sixth straight monthly decline.
  • Another cooling indicator: Only 44% of existing home sales saw multiple bids in July, still high, but down six months in a row and far below January’s 70% peak.
  • In Canada, home prices are down -5.0% Y/Y and -17.2% from their peak in February; perhaps a prelude to what might happen in the U.S. The media is now loaded with stories of longer marketing times and price reductions, both for new and existing homes.

Housing has already entered a Recession; prices are going to drop. As a prelude, July’s median home price fell -2.4% M/M.


One of the major components of equity prices is corporate earnings. And Q2 earnings have been talked up by the media as “robust” because more than 70% of reporting companies “beat” their consensus estimates. What isn’t discussed is the fact that the earnings were all lowered by the analysts just prior to the reporting season. Walmart (WMT) is a good example. Sales were up +8.4% Y/Y, but all of that was due to inflation. Operating income fell -6.8% (no one discusses that). Wall Street knows how to put lipstick on a pig. For WMT, the analysts reduced their per share earnings forecasts by -15.5%, from $1.93/share to $1.63/share prior to the earnings release. WMT’s $1.77/share looked like a “beat” versus the $1.63 consensus. But it really was an -8.3% miss. Kohl’s (KSS) wasn’t so lucky. Their sales were down -7.7% Y/Y, their inventories were up +48% (much of it unwanted), and gross margins fell -2.9 percentage points. That stock got clocked -15%.

Wall Street says that the Q2 earnings season, while not great, was okay with a +1.2% Y/Y increase in S&P 500 earnings. But economist David Rosenberg dispelled that point of view. His research shows that all the profit rise in the index was due to the 341% surge in energy sector profits. Take out the energy companies, which compose 4% of the S&P 500 capitalization, and Q2 profits actually shrank -10.5%!

Final Thoughts

There was some excitement with the release of the Fed’s July minutes because those minutes weren’t as hawkish as feared. In those minutes there were two references recognizing that Fed actions impact the economy with lags. So, perhaps they will only tighten 50 basis points (bps) at September’s meeting. Those hopes were partially dashed when St. Louis Fed President James Bullard said he would still support a 75 bps increase. Realize that whether it is 50 bps or 75 bps, they are still in tightening mode. A 50 bps hike would be at a slower pace, but still tightening. What the markets really want to know is “when do they STOP raising rates?” From the tone of the minutes or from FOMC member recent public remarks, it doesn’t appear anytime soon. And, while there is recognition within the FOMC that their policies operate with lags, it is clear that they don’t know the length of those lags, and that they are still basing policy on backward looking indicators (like the Y/Y percentage change in the CPI).

Furthermore, no one is talking about the Fed’s shrinking balance sheet (Quantitative Tightening (QT)). This is shrinking the monetary aggregates and is likely a more powerful negative force than raising interest rates. The chart shows data through June. They have yet to fully implement QT, so in the immediate future, the monetary aggregates are going to show steep negative percentage changes. For those monetarists (Friedmanites) who believe the money supply has a big impact on economic activity, we’re just at the beginning.

Thus, the less hawkish tone of the Fed’s July minutes is really no cause for celebration. They are still tightening, and the Recession is still in its early stages. Because of the lags (often long) between policy changes and their impact on the economy, the Recession will continue for months after they start to ease – whenever that may be (perhaps sometime next year)!

Robert Barone, Ph.D.

(Joshua Barone contributed to this blog)


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