Week of April 15, 2024 Recap
Regime Shift
Fed Watch:
William: “We will need to start a process at some point to bring interest rates back to more normal levels, and my own view is that process will likely start this year.”
Powell (Bbg live blog):
Powell says the performance of the US economy has been “quite strong” with a “considerable decline in inflation” in the last two years, though there has been a lack of further progress this year on returning to price stability.
“By many measures our labor market has been moving into better balance,” Powell says. The overall picture is “real strength” though with “gradual normalization.”
Powell repeats that policymakers need more confidence that inflation is moving to the 2% target sustainably before adjusting policy. (referring to recent CPI) Stocks are dropping sharply after Powell’s opening remarks, with the S&P 500 now down 0.3%. Treasuries sell off further as Powell begins speaking and headlines flash on his remarks on the lack of further progress on inflation, and the dollar is now catching even more a of a bid here.
Powell says if higher inflation does persist, the Fed can maintain the current level of restriction for “as long as needed.” Powell suggests policy on hold for a while: Says it’s appropriate to allow restrictive policy to work for a time.
“It is likely to take longer than expected to achieve that confidence” to lower rates, Powell said.
Today’s inflation is not just a case of overheated demand as is typical of cycles, Powell says. Powell says 2023 was largely a supply-side story as shortages of goods and labor became alleviated.
Powell: “We have thought ... that restoring price stability would require both the unwinding of the pandemic-related distortions to both supply and demand as well as the effects of tight monetary policy on demand.” He adds, “We think today that we’re seeing those two things working together.” Powell says it is too early to say what the lessons of the Covid pandemic will be as there have been many surprises already. “In a year or more we will have a lot more answers,” he says.
Powell expresses disappointment with the latest inflation data, reported last week, saying the figures “have clearly not given us greater confidence” on the path of inflation and “indicate that is likely to take longer than expected to achieve that confidence.” He said the Fed’s current restrictive policy needs time to work. Macklem agreed, saying both central banks need to be “confident that we’re clearly back on a path to 2% before it would be appropriate to reduce interest rates.”
“The recent data have clearly not given us greater confidence and instead indicate that is likely to take longer than expected to achieve that confidence,”
Bostic:
“Right now, where our stance is — I think is a restrictive stance — it will slow the economy down and eventually get us to 2%,” he said. “But I’m not in a mad-dash hurry to get there if all these other good things are happening.”
News Flow:
Beige Book:
Businesses find it harder to pass on higher costs to their customers, who are increasingly sensitive to price changes. That has resulted in smaller profit margins for firms.
Ten out of 12 districts saw slight or modest economic growth — up from eight in the March report.
Consumer spending barely increased amid signs of weakness in discretionary spending. Tourism activity increased modestly, although reports varied widely by district.
Employment was seen to rise slightly, a downgrade from March. Nine districts reported a very slow to modest increases in employment, with three reporting no change.
ASML/TSMC earnings - seems to be cooling of the chip sectors. ASML sales miss, TSMC reduced its outlook for the overall market.
Retail Sales in came hot for March. Picked up in march but shows restraint in big ticket items. Main due to high interest rate; don’t want to pay interest. Lots of people buy stuff on credit and pay month; if rates are high, it eats up to their disposable income. Prior Feb retail sales was also revised up.
Israel retaliates against Iran. Bloomberg article also shows the Israel leadership in disaray/mistrusts.
Pension Funds Are Pulling Hundreds of Billions From Stocks (link)
My thoughts
Markets, in my opinion, experienced the first official shift in regime/sentiment this week since December Fed pivot. Several risk factors that I've been tracking are slowly taking center stage in investors minds. There is definitely more uncertainty in the markets and this is reflected in the price action of the markets in the last 3 weeks.
Fed…
While this is not the first week where we've heard a tone change from the Fed regarding rate cut expectations, the wording from Powell this week reinforced my view that rate cuts are most likely delayed indefinitely. My expectation is, and forever will, be probabilistic given the information and sentiment I see in the markets. If the information changes, I will change. But for now, I see the Fed as being on hold for the foreseeable future.
Powell has started to sound more cautious in whether inflation can sustainbly move back to 2%. In his prior public appearance, he characterized the road to 2% is noisy/seasonal but I think CPI along with the strong employment market really forces him to change his view. Additionally, Stocks were near their all time high before this recently pull back.
The most important thing that can change my mind is the current earning season per my prior weekly recap. Clues from business sentiment and performance will trickle in to the macro economy and the Fed's decision making process. Should there be more hints on consumer spending slowdown + layoffs, I’ll be more cautious.
Reason for Economic Boom?
How is the economy running so smoothly given the high interest rate? Fed Bostic even said this week that our current policy is “restrictive.” Clearly that is not the case given the blowout employment numbers and the strong consumer spending trends we are seeing.
There is an article on bloomberg called “What If the Fed’s Hikes Are Actually Sparking US Economic Boom?” that provides a “fringe“ theory. In essence, the higher interest rate has meaningfully increased the disposible income of everyone. Money in saving accounts to holdings in various bonds have seen cash flow increases from the higher yields. This differs from the classic belief that such rate levels should deter borrowings and business activities thus driving demand down.
Some of the numbers provided in the article sounds interesting. Given the US debt is currently at 35 Trillion, the article notes that holders of tresury alone gets 50Billion more a month in cash flow. I would caveat here that there is a signifcant foreign ownership of US treasury, so that amount may not fully flow back in to the US economy.
Another statistic from Einhorn of Greenlight capital notes that there is 13 trillion in short term interest bearing assets. With this higher rate environment, they are earning 400Billion more a year.
Lastly, the biggest debt households generally have are their mortgages. Well the current effective rate of interest on Mortgage debt outstanding is just under 4%, well below the mortgage 7% you have to pay now if you were to take a 30 year loan. That difference adds to their bottom line which households are more than willing to spend.
The truth is probably somewhere in between. Current rate levels are restrictive for some areas of the economy while it may not be so in others. Given the data, we can probably conclude that its less restrictive than what the Fed thinks.
Geopolitics
After Iran fired its first every direct attack towards Israel, we saw the first retaliation this last week. This marks a significant esclation and I would consider both countries to be at war. This really puts a lot of pressure on crude oil in the immediate term which in turn creates a lot of headwind for the CPI. I can’t predict how this will all play out but this geopolitical uncertainty wasn’t priced in given the move in the global markets that morning.
If oil continues to trend higher for a sustained period of time, we will find yields most likely higher creating more headwinds for stocks. It just doesn’t make sense to be in stocks when it has rallied more than 20% from last years October lows. High flying tech stocks, especially semiconductors, will increasingly see take profits. Recent ASML and TSM news don’t provide confidence.
While there are lots of events and uncertainty, we should not forget that the economy is still running fine. There isn’t a financial crisis lurking. I’m still bullish in quality stocks and willing to add more if we get back to levels around the beginning of the year.