GDP Print Sends Traders on a Roller Coaster: July 25, 2024

News that US economic growth accelerated at a much faster-than-expected pace in the second quarter has sent market participants on a roller-coaster ride. Indeed, stocks, bonds and the greenback alike have moved quite violently, swinging from sharp losses to notable gains in just the first few hours of trading. Concerns expressed during earnings calls about the health of consumers have also influenced investor behavior, with rate watchers now pricing in three consecutive cuts from the Fed starting in September. Not so fast: ladies and gentlemen, my outlook for July and August inflation reflects price pressures that are rising well above the central bank’s target, enabling the committee to wait until December to reduce the cost of capital.

Economy Screams No Rate Cuts

The US economy continues to expand on the back of resilient consumer outlays, strong capital expenditures and unwavering deficit spending. US gross domestic product (GDP) rose 2.8% in real terms on an annualized, seasonally adjusted, quarter-over-quarter (q/q) basis during the second quarter. The figure reflects an acceleration from the first quarter’s 1.4% and arrived ahead of projections calling for 2%. Driving the upside beat were services spending, inventory builds, capital expenditures, goods outlays and government disbursements, which added 1%, 0.8%, 0.7%, 0.6% and 0.5% to the headline. Meanwhile, net exports and residential investments weighed on performance, subtracting 0.7% and 0.1% from growth. The quarterly Personal Consumption Expenditures (PCE) price indices within the print offered consistent progress on inflation, with the overall number up 2.6% while the core result rose 2.9%, lighter than the previous period’s 3.4% and 3.7%. Tomorrow’s PCE data for June will provide further clues on the direction of price pressures and economic growth in the shorter term.

Aircraft Cancellations Hurt Manufacturing

Turning to the durable goods front, a sharp decline in aircraft orders significantly weighed on results. Furthermore, several airlines canceled orders for planes, with the passenger jet category experiencing a whopping 127% month-over-month (m/m) decline. The dismal number led to durable goods purchases tanking to levels not seen since November 2021. If we were to consider the nominally reported figures in real terms, we’d have to go back further. Durable goods orders declined 6.6% m/m, much worse than the 0.3% growth expected and the 0.1% increase in May. There were some bright spots, however, including a 1% m/m increase in business investment as well as 1.6%, 1.3% and 0.8% gains in the smaller machinery, electrical equipment and computer product categories. Finally, backlogs continued to be worked down amidst depressed demand, pointing to no end in sight for the manufacturing recession.

Labor Market Reverses Easing Trend

The labor market reflected modest relief in the past two weeks, with both initial and continuing unemployment claims sliding lower. Initial claims fell to 235,000 for the week ended July 20, while continuing claims dropped to 1.851 million for the prior period which ended on July 13. The figures arrived softer than the projected 238,000 and 1.860 million as well as from the previous interval’s 245,000 and 1.860 million. Four-week moving average trends moved the other way for both indicators, however, from 235,250 and 1.849 million to 235,500 and 1.854 million.

Airlines Struggle with Price Pressures while Consumers Avoid Bit Ticket Items

Airlines are facing headwinds from excess capacity, while in other economic sectors, consumers are holding off on buying big-ticket items such as washing machines. In other topics from the recent quarterly earnings reports, demand for artificial intelligence is growing strongly at IBM. Those are a few points from the following second quarter earnings reports:

• American Airlines’ (AAL) profit tanked 46% year over year (y/y) with the airline experiencing fare pressures and disappointing results from corporate customers and travel agents after trying to increase direct online bookings. While revenue missed expectations, earnings exceeded the analyst consensus forecast. The company also lowered its full-year guidance and said it only expects to break even in the current quarter. Analysts expected earnings per share guidance of $0.48. Chief Executive Robert Isom said an “imbalance in demand and domestic supply” created pricing pressures. American Airlines has also jettisoned plans to restrict frequent flier awards to customers who book directly with the company’s online platform. It is also renegotiating contracts with businesses and agency clients. Shares of American Airlines crashed 7% in premarket trading.
• Southwest Airlines (LUV) profits also fell nearly 50% y/y as the company, much like American Airlines, faced pricing pressures. The company also lowered its current quarter guidance. It expects fuel expenses to climb 11% while revenue is likely to be flat. Southwest Airlines shares are up approximately 1.5%.
• Whirlpool (WHR) posted earnings and revenue that exceeded expectations, but it lowered its full-year adjusted earnings per share (EPS) guidance to only $12, down from an earlier estimate of $13 to $15. The revised guidance fell below analysts’ expectations. Sales fell 5.7% in North America with weak demand for large appliances driven. In a Bloomberg interview, Whirlpool Chief Executive Officer Marc Bitzer said inflation, interest rate increases, global wars and an election campaign, which seems to be played on doomsday scenarios, are hurting consumer sentiment. Additionally, sales to consumers that update appliances after buying homes have been slow because of a low volume of homes changing hands.
• Ford Motor Company’s (F) revenue grew 6% y/y and exceeded the analyst consensus forecast but earnings missed expectations, a result of increased warranty costs and losses associated with electric vehicles (EV). The earnings miss and the company’s decision to not provide a hoped-for increase in profit guidance caused Ford shares to decline more than 11% in aftermarket trading. Ford Chief Financial Officer John Lawler declined to provide the total warranty cost for the quarter but said the amount was $800 million more than in the first three months of the year. Also during the quarter, the company’s EV division lost $1.14 billion. Ford’s stock price dropped nearly 18% following the earnings release.
• Chipotle (CMG) posted strong second-quarter results with earnings and revenue that exceeded analyst consensus expectations and same-store sales that climbed 11.1% y/y, nearly two percentage points above estimates. The company also experienced an increase in traffic to its locations and was able to offset higher expenses for avocados and increased use of cooking oil by increasing its prices. The company’s customers tend to have higher incomes and may be less susceptible to inflation eroding their spending power. Chipotle shares climbed approximately 13% in aftermarket trading but then surrendered most of the gain.
• IBM’s (IBM) revenue increased 1.9% y/y and its EPS jumped 11.2%. The metric and earnings both surpassed analysts’ expectations. CEO Arvind Krishna said the company is confident in the outlook for technology spending, but it will face the headwinds of higher interest rates and inflation. He also opined that the Ukraine-Russia war and the Israel-Palestinian conflict are lasting longer than expected, which is influencing customers’ views of the near future.  Among the company’s three business areas—hardware, software and consulting services—the software segment led growth with a 7% y/y increase. The company’s book of AI business is now up to $2 billion compared to the $1 billion cited by Krishna in April. IBM stock climbed approximately 3% this morning.

Tech is Once Again the Ugly Duckling

Market participants are surviving the morning selloff and opting for the Trump trade and Treasurys rather than the Harris trade comprising high-flying, Silicon Valley tech stocks. Most major indices are now higher with the Russell 2000, Dow Jones Industrial and S&P 500 leading with gains of 1.8%, 0.8% and 0.3%. The Nasdaq Composite is down 0.2%, however, which is peanuts considering that it sank almost 2% earlier. Equity sector breadth is terrific with 10 out of 11 components gaining on the session. The top contributors are industrials, energy and financials; they’re up 1.4%, 1.3% and 1.2%. Technology is the sole bearish category, dropping 0.2% at the moment. Treasurys are catching a bid with the 2- and 10-year maturities changing hands at 4.41% and 4.23%, 2 and 5 basis points lower during the session. The dollar is near the flat line, however, as it appreciates relative to the pound sterling, yuan, yen and Aussie and Canadian dollars but loses ground versus the euro and franc. Commodity land is mixed, with copper, lumber and crude oil up by 1.4%, 1.2% and 0.6% but silver and gold getting hit by 3.7% and 1.5%.

No Cuts Till the Election

This year’s inflation reports have arrived in-line with the Fed’s targets 2 out of 6 times, which tells me we need a few more cool ones before we start pricing in significant reductions. Against the backdrop of accelerating economic growth and tight labor conditions, a Fed that begins to accommodate too early will almost certainly deal with a reignition of inflationary pressures. Financial conditions must remain well-anchored for price levels to behave, while the election year features a Treasury that is offsetting monetary policy restriction with excessive fiscal stimulus. The two-sided goals are a troubling combination that has kept financial conditions loose and risk-taking behavior buoyant, countering the efforts to quell price pressures for good. Finally, it’s appropriate for the Fed to reduce its benchmark only once this year after the election, considering the stimulus provided by the Treasury is watering down the central bank’s attempts at 2% inflation.   

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