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August 28, 2023

Jackson Hole - Flexport Weekly Economic Report

Jackson Hole - Flexport Weekly Economic Report

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Phil Levy

Chief Economist, Flexport

August 28, 2023

No short-term policy changes were expected to come out of the annual Fed meetings in Jackson Hole and none did. But the message that the Fed still has work to do to tame inflation is likely to move longer-term rates.

The Weekly Economic Report will be delayed due to the U.S. Labor Day Holiday on Monday September 4th. The next Weekly Economic Report will be released on Tuesday September 5.

In Focus - Long-Term Thinking

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Every August the luminaries of monetary policymaking gather in Jackson Hole, Wyoming. There they listen to the latest studies and make pronouncements about what they see coming for inflation, interest rates, and the economy. The keynote comes from the Fed Chairman, currently Jay Powell.
As it was not the sort of Fed meeting that sets a new Fed Funds rate, does a mere statement of his views really matter?

Yes! Yes, it does.

The Federal Reserve directly controls the Fed Funds rate (very short-term) and the assets it holds on its balance sheet (quantitative easing or tightening). But far more relevant for the operation of the economy are interest rates like that on the Treasury’s 10-year bond, or the rate that homebuyers pay on 30-year mortgages.

The transmission mechanism between the Fed’s policy levers and the key rates driving the economy depends heavily on investors’ expectations and their beliefs about the future. If investors believed that the central bank planned to hold the Fed Funds rate constant around 5.3% for the next 10 years, then the rate on the 10-year bond should be in the vicinity of 5.3%.

The August 24th close was 4.23%.

Thus, there is some expectation that rates will fall in the future. This also shows up in the “inverted yield curve,” where the rate on a 10-year is lower than the rate on a 2-year (normally there is some additional charge to lend money for longer).

We can also see the importance of expectations in the way some of the longer rates move out of proportion with the policy rates. Since early April of this year, the Fed Funds rate has risen 50 basis points. From trough to peak early last week, the market-determined 10-year rate rose 104 basis points, from 3.30% to 4.34%..

Expectations also enter into whether inflation-adjusted rates are high or low. The rate on the inflation-adjusted 10-year (the bottom line in the chart) closed at 1.91% on Aug. 24. That’s up from recent values, but hardly a historically high number.

So what did Chairman Powell say to shape market expectations? He noted that mortgage rates have responded to monetary policy tightening (see the top line in the chart) and that this has slowed the housing sector. But looking at the broader economy, he said, “we are attentive to signs that the economy may not be cooling as expected.”

He likewise told a very different inflation story than one often hears these days. He did not talk about inflation falling from 9% to 3% (a story that relies on headline CPI numbers). Instead, he talked about core PCE inflation falling from 5.4% in February 2022 to 4.3% in July of this year. That’s a notable decrease, but nowhere near as dramatic. And it leaves inflation more than double the Fed’s 2% target, to which he recommitted.

He also described the danger of being complacent and easing monetary policy too soon: “Doing too little could allow above-target inflation to become entrenched and ultimately require monetary policy to wring more persistent inflation from the economy at a high cost to employment.”

It was an argument for investors to expect rates to stay higher for longer than perhaps they had previously been expecting.

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Latest Flexport Metrics & Research

Last week we looked at some of the implications of our latest forecast for U.S. consumer goods imports, which now extends to the end of the year.

Economic Developments

The Michigan Survey of Consumer Sentiment fell to 71.2 in August, after two months of increases. Sentiment is still 22.3% higher year-on-year. Year-ahead inflation expectations ticked down to 3.3% from 3.4% in July.

U.S. durable goods orders dropped 5.2% in July, marking the steepest decline since April 2020 and after 4 consecutive months of growth. The fall was attributed to shrinking transportation equipment orders, which declined 14.3%.

U.S. new home sales rose 4.4% month-on-month in July, rebounding from the drop of 2.8% in June. Sales reached a seasonally-adjusted annual rate of 714,000, which was 31.5% higher than the July 2022 level.

Euro area consumer confidence decreased to -16.0p in August, well below historical averages and following four consecutive months of improvement.

Global trade data releases indicated weakening demand, with autos remaining an ongoing exception.

  • G20 goods exports declined 3.1% quarter-on-quarter in Q2, with Australia seeing the largest decrease at 11.8%. The only countries whose exports rose were the UK, France, and Turkiye, mainly in machinery and transport equipment. G20 goods imports also fell 2.0%, led by Japan and Korea, whose imports decreased by 8.1% and 7.9%, respectively.

  • The WTO’s Goods Trade Barometer rose to a reading of 99.1 at the end of Q2 2023, predicting an upturn in goods trade volume for the rest of 2023, although to a lesser extent than the 1.7% annual increase in their April forecast for 2023. World merchandise trade volume fell 0.3% quarter-on-quarter in Q1, for the second consecutive quarter, and 1.0% year-on-year. The increase in the barometer’s score was attributed to a 110.8 reading for automotive products, a notable source of strength in Chinese and Japanese exports.

Q2 German real GDP was flat (0%) quarter-on-quarter, following two quarters of contraction. Compared to Q2 of 2022, GDP was down 0.2%, driven by a year-on-year decline of 1.7% in overall consumption expenditure, led by a 3.1% drop in government spending.

The flash PMI indexes for August showed weakening production, including services, across advanced economies, particularly in manufactured goods.

  • The US PMI was 50.4, down from 52.0 in July, as output only slightly increased. The Manufacturing Output sub-index fell to 47.5 in August from 50.2 in July, indicating a contraction in goods production.

  • Germany’s Composite PMI fell to 44.7 in August from 48.5, reaching a 39-month low. The Manufacturing Output sub-index was even lower at 39.7 in August, down from 41.0 in July and the fastest decline in 39 months.

  • Japan’s Composite PMI increased to 52.6 in August from 52.2 in July, an exception among developed economies. The increase was driven by an ongoing expansion in tourism, while the Manufacturing Output index ticked up to 49.0 in August from 48.9 in July.

Political Developments

With no changes, public debt is projected to grow to a record 107% of GDP over the four years of the next term, with 3.5 trillion dollars expected to be spent on interest payments alone. In the long-run, debt-to-GDP ratio was forecast to reach 115% by 2033, with interest costs hitting 3.2% of GDP by 2030.

Ahead of the G20’s meeting next February, trade and investment ministers met to discuss. Key priorities that came out were strengthening resilience of global value chains, making information more accessible to micro, small, and medium enterprises, and moving towards digitized trade documentation.

Disclaimer: The contents of this report are made available for informational purposes only and should not be relied upon for any legal, business, or financial decisions. Flexport does not guarantee, represent, or warrant any of the contents of this report because they are based on our current beliefs, expectations, and assumptions, about which there can be no assurance due to various anticipated and unanticipated events that may occur. This report has been prepared to the best of our knowledge and research; however, the information presented herein may not reflect the most current regulatory or industry developments. Neither Flexport nor its advisors or affiliates shall be liable for any losses that arise in any way due to the reliance on the contents contained in this report.

About the Author

phil levy headshot
Phil Levy

Chief Economist, Flexport

August 28, 2023

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