As we have mentioned repeatedly in this weekly post, the resilience of the U.S. stock market considering aggressive interest rate hikes from the FED has been quite impressive. The driving force behind this strength could be a combination of a number of things. Left over cash balances from the ridiculous blizzard of money creation the Fed embarked upon after Covid could be one thing. The continual progression of technologies that are making businesses more efficient could be another. The idea that America is doomed and China is the preeminent world power is clearly fading – so that seems to be supporting our asset markets. There could be factors that we have no awareness of getting priced into the markets. Time will tell…
All of that considered, looking forward we are starting to get concerned. The lag time between the Fed raising interest rates and the corresponding affects on the economy is generally considered to be about 18 months. If that is accurate, then we are just now getting to the slowdown that the Federal Reserve was attempting to engender with higher rates. They started raising rates in the spring of 2022. Clearly things are slowing down now – the million-dollar question is how much and will it spill over into a recession.
The yield curve has been inverted for about a year now – historically that has resulted in a recession – however the timing is never exact. The Fed has officially paused its hiking of interest rates but they may increase again at their next meeting. They are continuing to read from a faulty playbook. Their number one error is one we have mentioned before – that higher interest rates equal lower consumer prices – or lower inflation. That is an obvious fallacy as higher interest rates discourage investment in production resulting HIGHER consumer prices. Also, interest payments are part of the cost of production – when those rates are higher, producers have to pass costs on to consumers or go out of business.
The second misstep of the Fed is their focus on employment numbers. Employment is a lagging indicator number one, but more importantly, post Covid the labor force is smaller. Looking at disability claims from insurance companies, disability rates have skyrocketed. https://www.westernstandard.news/news/expert-tells-nci-us-death-and-disability-up-40-for-adults-under-65/article_2810b2f6-eac6-11ed-8c44-4335ce522654.html
This explains a lot of the tightening in the labor market – so it is not a situation where the economy is so strong that it is supporting extra workers and needs to be cooled
So, if the Fed is so wrong and we are so right – then how does this get reconciled? We think there is at least a significant possibility that the economy continues to deteriorate and the Fed is forced to lower interest rates. Sadly, our guess is that something will have to break (more than the banking problems we have already had) for the Fed to lower rates. Here are some of the indicators to watch going forward…
- The continued deterioration of the commercial real estate situation. Vacant office spaces are piling up all around the country, but one example is in San Francisco where a Coldwell Banker report had office vacancies at an all-time record rate of 29.4%.
- Banks borrowing from the Fed’s emergency bank term funding program facility. Currently the facility has loaned out $102 billion. Continued increase would be an indicator of continued erosion in banking system conditions due to higher interest rates.
- Global Purchasing manager indexes – especially in Europe – have clearly shown a decline in manufacturing activity. The U.S. continues to be the bright spot, but no one knows how long that can continue.
Consumer strength and resilience in the U.S. has maintained well since Covid, but cracks are appearing in the dam. Don’t forget that student loan payments resume in a few months and personal savings rates look terrible back at the 2007-08 levels…
Our concerns our growing that the economic slowdown could accelerate due to the higher interest rates finally taking effect on consumer spending. Keep in mind that doesn’t mean we should sell all our stocks and run for the hills– because we have been through several iterations historically of bad economic news being good news for asset markets. Traders may assume that interest rates will be lower and continue buying stocks and bonds. That being said, we are instituting more caution – and you can get decent interest rates while you cautiously wait.
As we frequently end with…don’t sell your gold!
Regards and good investing!