Weekly Wisdom- June 14, 2023

By Hightower Great Lakes on June 15, 2023

Consumer and Service Sectors Less Interest Rate Sensitive

While higher inflation and elevated interest rates make spending and borrowing more expensive, the U.S. consumer maintained a stockpile of excess savings from which it has drawn to the tune of $2 trillion. The consumer has achieved better wage growth, which has also supported healthy spending habits. Credit card delinquency has remained near pre-pandemic levels, despite the Fed’s actions to make borrowing more expensive.

Consumer confidence is improving, and the resilient housing market also emphasizes consumer strength with new home sales +12% y/y – back to levels seen in March 2022. While we expect the consumer remains cautious in pockets (goods vs. services) real consumer spending remains elevated.

Chart 1: Mortgage Applications Improved Since November ‘22[1]

Service sectors represent 70% of the U.S. economy and are less impacted by real interest rates. This is reflected in ISM Services PMI, which has expanded for 35 of the past 36 months. Consumer spending and prices remain elevated for services related to experiences, housing, health care, food and education.

Chart 2: Personal Consumption Expenditures for Services Continues to Grow[2]

Additional signs of strength include normal credit spreads and a spike in construction towards manufacturing – mostly tied to onshoring as companies bring supply chains back to the USA.

Chart 3: Credit Spreads in Line With Five Year Average[3]

Chart 4: Rising Construction Spend Towards U.S. Manufacturing[4]

Despite higher rates, tighter lending standards and higher input costs, there are many areas of positive economic growth – consumption, housing, pockets of manufacturing and industrial production. Interestingly, core banking loans are up 5% on an annualized basis – despite the bank issues back in March. There is no question that reserves will go higher within the banking system, but we are encouraged with the excess reserves and capital in the system – something that is much different than the 2008 Great Financial Crisis.

Latest Inflation Data is Good News

Headline consumer price inflation (CPI) increased 4% y/y vs. 8.9% y/y in May of last year – the slowest in two years. Headline producer price inflation (PPI) increased +1.1% y/y vs. 11.7% at the peak – the smallest gain since 2020. The issue is that core inflation on both the CPI and PPI remains elevated; the CPI core remains 5.3% and PPI core at 2.8%. The PCE core also remains high at 4.8%, and the expectations going forward are at 3.9% – again, higher than the 2% target rate.

Chart 5: Clear Slowdown in Pace of Inflation[5]

The important point: As the Fed continues to emphasize “higher for longer” monetary policy, we are likely near the end of its rate hiking regime, and after ten individual rate hikes in the past 18 months, the economy continues trucking along and potential for a soft landing is greater than where it was eight months ago.

Fed Pauses for Now… Expects More Hikes at Slower Pace

It was a confusing “hawkish pause” this afternoon. The Fed increased its GDP targets, lowered their expectations for unemployment and raised its target for inflation, suggesting they see a “soft landing” for the economy – at least in the shorter term. Yet the dot plots increased by 50 bps vs. 25 bps expected, and the terminal rate went to 5.6%.

Meaning, better growth, yet higher for longer interest rates. This raises the question as to why they paused on rate hikes this past meeting. Clearly there are many opinions and views at the Fed. But this last meeting had more puts/takes. Perhaps we are nearing the end of Fed hikes, but it seems like the Fed is nowhere near changing policy on lowering rates any time soon – consistent with our thoughts.

Chart 6: Fed Expectations for Unemployment is Tighter and GDP Growth Slower Than History[6]

Debt Ceiling Scenario Creates Abnormal Price Action at the Short-End of the Treasury Curve

The Treasury General Account (TGA) is the U.S. government’s operating account to handle daily public money transactions. Due to the government hitting the statutory debt limit earlier in the year, the TGA balance was used to fund the government, and balances fell well below normal levels (below $23 billion on June 1 vs. end-of-June targets of $425 billion).

In order to replenish the account, the U.S. government is increasing the pace of Treasury bill auctions but will also receive an influx of corporate tax receipts on June 15. The increased pace of bill issuance could further pressure front-end yields higher, where the 2/10 inversion currently stands at -80 bps.

Click here to read last week’s Weekly Wisdom (6/7).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

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This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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[1] Source: FactSet (chart). As of June 14, 2023.

[2] Source: FactSet (chart). As of June 14, 2023.

[3] Source: FactSet (chart). As of June 14, 2023.

[4] Source: St. Louis Federal Reserve. As of June 14, 2023.

[5] Source: FactSet (chart). As of June 14, 2023.

[6] Source: FactSet (chart). As of June 14, 2023.