The Fed pauses rate-hikes … how much runway does the U.S. consumer have? … inconsistent messages from the oil market … junk bond defaults surge
Earlier today, the Federal Reserve held interest rates steady for the first time in 11 meetings.In a moment, we’ll dive into those details, but first, a request…We have a very intelligent, well-informed Digest readership, and we want to hear your take on today’s Federal Reserve decision, as well as your view on the market/economy looking forward.What does today’s pause from the Fed mean for where interest rates will go? And are we really starting a new bull market?Please hit “reply” to today’s Digest and share your thoughts. We’d like to begin featuring more reader perspectives in the Digest, so let us know how you assess things today. Now, as noted a moment ago, this afternoon brought the long-awaited “Fed pause.” But it also brought new hawkishness in terms of how high rates are likely to go later this year.Here’s CNBC with more details:
The decision by the Federal Open Market Committee to hold off on a hike at this meeting came with a projection that another two quarter percentage point moves are on the way before the end of the year…The surprising aspect of the decision came with the “dot plot” in which the individual members of the Federal Open Market Committee indicate their expectations for rates further out.The dots moved decidedly upward, pushing the median expectation to a funds rate of 5.6% by the end of 2023. Assuming the committee moves in quarter-point increments, that would imply two more hikes over the remaining four meetings this year.
Looking at each voting FOMC member, here’s how their votes came in (assuming hikes are a quarter-point each):No more hikes this year – two members.One more hike this year – four members.Two more hikes this year – nine members (half the committee).Three more hikes this year – two members.
In his live press conference, Federal Reserve Chairman Jerome Powell did a good job of sidestepping landmines
Here is a broad recap of his commentary:He cited concerns about a credit crunch as a big reason for the Fed pause…He noted that the labor market is coming into better balance, which is helping inflation…However, he pointed out that “core” inflation isn’t falling as much or as fast as he wants to see, yet he expects substantial progress on inflation by year-end…When asked about a “soft landing,” he reiterated that he sees a path to getting inflation back to 2% without major economic pain, though he stressed that inflation at 2% will be achieved even if it means economic pain…Finally, he mentioned that no FOMC member sees rate-cuts this year and Powell does not believe any rate-cuts would be appropriate.As to Wall Street’s response, after a brief, initial selloff based on the news of the higher terminal rate, the three major indexes bounced during Powell’s press conference. In fact, both the S&P and Nasdaq recouped all their losses and ended the day in positive territory. The Dow closed well off its lows.It will be interesting to see what happens tomorrow and Friday as Wall Street digests the news. If past Fed-weeks are any guide, we could see major fireworks even though today’s market reaction was subdued.
Meanwhile, let’s check in on the U.S. consumer
One of the main bullish talking points today is that the U.S. consumer continues spending – and how do you have a recession with so many dollars flowing through the economy?That’s a valid point, but its strength wanes when we dig a bit deeper. After all, these dollars are increasingly sourced from debt as a growing number of U.S. consumers lacks the disposable income to pay for even day-to-day expenses. At some point, this debt is a house of cards that crashes (unless you’re the Federal government, apparently).Here’s Seeking Alpha with more details:
A mountain of credit card debt is piling up as Americans turn to plastic to counter their dwindling purchasing power.According to the Federal Reserve Bank of New York, consumers now owe a record $988B on their cards, up 17% from a year earlier, or about $5,700 per person.While the steadily rising figure took a break during the pandemic years, the number is causing renewed nervousness as it flirts with the fast-approaching $1T milestone.
Making matters worse, the annual percentage rate (APR) on these credit cards is shockingly high. According to the Federal Reserve, the average credit card interest rate in the first quarter of 2023 clocked in a 20.92%.So far, the U.S. consumer has continued shopping, resulting in the applause of the bulls and the general economic conclusion of “all clear.” But things aren’t as rosy as they seem.Here’s CNBC:
After contending with high inflation for over a year, households are nearing a “breaking point,” according to a study by WalletHub.Using the Great Recession as a guide, the projected breaking point is the level of household credit card debt that will become unsustainable for most people, said Jill Gonzalez, an analyst at WalletHub.Currently, the average household’s credit card balance is $9,990, just $2,015 shy of where that tab hits its limit, the report found.“It’s when people won’t be able to keep up with their bills,” she said. “We’re inching closer and closer to that breaking point.”
Based on Powell’s comments today, we’re nowhere near rate-cuts, so we should expect the pain on Main Street to intensify.
It’s not just the U.S. consumer that’s coming under pressure. We continue to highlight growing cracks in the commercial real estate sector
Regular Digest readers know that for months, we’ve been running a “commercial real estate watch” segment to monitor this critically-important sector of the U.S. economy.The same factors that resulted in a handful of banking failures this spring are creating cracks in the foundation of the $20-trillion commercial real estate sector. If defaults snowball, it will have an enormous impact on the U.S. economy.On Monday, Goldman Sachs CEO David Soloman echoed our oft-repeated warning:
There’s no question that the real estate market, and in particular commercial real estate, has come under pressure.You’ll see some impairments in the lending that would flow through our wholesale provision.
And here’s additional broad context from CNBC:
After years of low interest rates and lofty valuations for office buildings, the industry is in the throes of a painful adjustment to higher borrowing costs and lower occupancy rates due to the shift to remote work. Some property owners have walked away from holdings rather than refinancing their loans.Defaults have just begun to show up in banks’ results. Goldman posted almost $400 million in first-quarter impairments on real estate loans, according to Solomon.
Moving elsewhere in the economy, have you noticed the inconsistent messaging surrounding oil?
The growing market narrative is that we’re going to dodge a recession and enjoy a Goldilocks economic environment. Given this, it’s interesting that we don’t see/hear this manifested when the spotlight turns to the oil sector.Here’s Bloomberg from earlier in the month, just before OPEC+’s meeting:
…Global oil inventories are shrinking as the alliance’s latest production cuts take effect. On the other, disappointing Chinese economic indicators and fears of a US recession have emboldened bearish speculators.
And here’s FX Empire from a couple days ago:
WTI oil is moving lower as traders remain worried about the strength of the oil demand in summer. The recent announcements from OPEC+ did not provide material support to the market…Brent oil is also moving lower amid a broad pullback in the oil markets. Recession worries remain an important negative catalyst for Brent oil.
Bottom line, when we talk stocks, the overall idea seems to be that the economy is going to tiptoe around a recession and achieve a soft landing. But when we talk oil, the economy is headed into a recession. I don’t have a crystal ball to know which perspective is correct, but you don’t need a crystal ball to see the inconsistency.
Finally, don’t miss what’s happening over in the junk bond sector
A “junk” bond originates from a company with a higher risk of defaulting on its loan payments than a company offering an “investment grade” bond.In exchange for this higher default risk, the company has to pay investors a higher yield.Despite the negative name, the $1.4 trillion junk bond sector is very important for the U.S. economy because it’s a critical source of financing for many companies with less-than-perfect credit.Yesterday, we learned that junk bond defaults are surging. In fact, the number of defaults only halfway through 2023 has now surpassed the numbers for 2021 and 2022 combined.The Financial Times reports that there were 18 debt defaults in the U.S. loan market between January and the end of May. Together, these defaults totaled $21 billion. And nearly $8 billion of those defaults came from May alone, suggesting an acceleration.From Lotfi Karoui, the Chief Credit Strategist at Goldman Sachs:
There is a payment shock unfolding among the weakest issuers in the loan market.[The combination of excessive leverage and the Fed’s rate hikes is] really problematic for companies that have a big chunk of their liabilities in floating-rate form.
Meanwhile, the head of European and U.S. Credit Strategy at Deutsche Bank said “We are lining up here for a pretty meaningful default cycle.”Despite this, here we are today with the stock market growing increasingly bullish. You have to wonder if Wall Street is gazing far enough out on the horizon.
On that note, a reminder to let us know your thoughts
What will happen with rates here in 2023? And have we just begun a new, long-term bull market?Reply to today’s Digest to let us know you’re sizing up the market.Have a good evening,Jeff Remsburg
