What's next for the U.S. economy? 'The extent of these effects is uncertain.'
A version of post was originally published on TKer.co
After a volatile couple of days, stocks ended higher last week, with the S&P 500 climbing 1.4%. The index is now up 3.4% year to date, up 11% from its October 12 closing low of 3,577.03, and down 17.2% from its January 3, 2022 closing high of 4,796.56.
Turmoil in the banking system has made for a murkier outlook for the economy.
“Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation,” the Federal Open Market Committee (FOMC) said in its monetary policy statement on Wednesday. “The extent of these effects is uncertain.” (Emphasis added.)
In other words, the odds of getting turned down for a loan may have gone up by an uncertain amount as banks assess the uncertain outlook for their deposits and regulation.
“Such a tightening in financial conditions would work in the same direction as rate tightening,” Fed Chair Jerome Powell explained during the post-FOMC meeting a press conference. "In principle as a matter of fact, you can think of it as being the equivalent of a rate hike or perhaps more than that, of course it's not possible to make that assessment today with any precision whatsoever.”
While the woes in the banking sector may not have been intended, their effect on financial conditions are generally in line with what the central bank has been aiming for in its ongoing effort to bring down inflation.
In financial markets, uncertainty puts downward pressure on stock prices as investors demand more return for their capital. Though, this uncertainty premium also helps explain why returns tend to be relatively high in the stock market.
While nothing is ever really certain, the quotes above suggest Fed officials are particularly uncertain about what comes next.
“The future depends on two hard-to-predict behaviors,” UBS economist Paul Donovan wrote on Friday. “Will bank investors and depositors keep moving their money? And if they do, will loan officers respond by tightening lending standards?”
To recap: This whole thing began when wary Silicon Valley Bank depositors quickly withdrew their cash in a run on the bank. In response, the Federal Reserve, Treasury, and FDIC announced that all of the bank’s depositors, including uninsured depositors, would be made whole — essentially signaling to every American bank depositor that all their cash is safe.
While policy makers sound pretty serious about the safety of everyone’s deposits, who knows what people will do upon hearing about turmoil in the banking system? Sure, overhauling how you manage your cash is time-consuming. Still, that won’t stop at least some people from taking their cash and moving it elsewhere. If enough people do this, the result would be more financial instability.
All eyes on the Fed’s H.8 report
According to the Federal Reserve’s H.8 report published Friday, bank deposits fell by $98.4 billion to $17.5 trillion in the week ending March 15, the largest one-week decline since April 2022.
From Bloomberg: "The decline was entirely due to a record plunge in deposits at smaller institutions… Deposits at small banks slumped $120 billion, while those for 25 largest firms rose almost $67 billion. So-called “other” deposits, which exclude accounts with maturity dates such as certificates of deposit, declined by $78.2 billion to $15.7 trillion. Compared with a year ago, these more liquid deposits such as savings and checking accounts have declined by 6.1%, the most in data back to the early 1970s."
So it appears that at least some people moved their deposit from smaller banks to larger banks.
That leads us to lending. With uncertainty regarding deposits, banks seem likely to be more cautious in their lending. And tighter lending standards are a headwind to economic growth.
During the week ending March 15, bank lending jumped by $63.4 billion to $12.2 trillion.
“Of course, it’s too early to see any potential effect on credit supply, but both large and small banks saw decent gains in loans (though there could be some tapping of credit lines in anticipation of tighter credit conditions later on, something that occurred early in the GFC),” JPMorgan economist Michael Feroli wrote on Friday.
It’s unclear what to make of any of this as it’s one week’s worth of data. But it’s possible that the worst is behind us.
“One thing that seems more unambiguously positive was Powell’s remark on March 22, a week after the reference date on this report, that ‘Deposit flows in the banking system have stabilized over the last week,’” Feroli noted.
At least we’re talking about it
If there’s a silver lining, it’s that everyone’s now got banking turmoil on their minds.
According to Bank of America’s March Global Fund Manager Survey, “systemic credit event” — which is just a fancy way of saying “big problems at the banks” — has overtaken “inflation stays high” as the top risk.
And recall TKer Truth No. 8: “The most destabilizing risks are the ones people aren’t talking about.“
Before a few weeks ago, few were concerned about a systemic credit event. Now, many are concerned. And as we discussed recently on TKer, markets will go haywire when a little-known risk suddenly emerges as traders and investors scramble to price in the downside.
Now that we’ve had a few weeks to price in a lot of concerns, we have to consider the possibility that things turn out better than what may now be priced into the markets.
This story is still unfolding, so unfortunately, it may be weeks or months before we can see things more clearly in hindsight.
Related from TKer:
The complicated mess of the markets and economy, explained 🧩
Reviewing the macro crosscurrents 🔀
There were a few notable data points from last week to consider:
🏛️ The Fed hikes rates
On Wednesday, Fed Chair Powell reiterated the central bank’s commitment to bring down inflation with increasingly tight monetary policy.
“My colleagues and I understand the hardship that high inflation is causing, and we remain strongly committed to bringing inflation back down to our 2% goal,” Powell said during its post-FOMC meeting press conference.
“Price stability is the responsibility of the Federal Reserve. Without price stability, the economy does not work for anyone. In particular, without price stability, we will not achieve a sustained period of strong labor market conditions that benefit all.”
Powell made these comments after announcing another 25 basis point interest rate hike, a move that surprised some Fed watchers who expected the central bank to pause amid turmoil in the banking sector. It was a unanimous decision by the Fed’s 11-member FOMC.
“We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound,” Powell said. “In addition, we are committed to learning the lessons from this episode and to work to prevent events like this from happening again.“
While reiterating that the disinflationary process is underway, with inflation significantly off its highs, Powell said that the inflation rate was nevertheless still too high.
And so the Fed-sponsored market beatings continue.
🏛️ The Fed also signals right hikes could be coming to an end
While the Fed is currently maintaining a hawkish stance in regards to monetary policy, it also signaled that interest rate hikes could be over. Consider this line from the March 22 FOMC statement (emphasis added):
“The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2% over time.“
And compare it to the language used in the February 1 FOMC statement (emphasis added):
“The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time.“
JPMorgan’s Michael Feroli characterized the change as “less hawkish and less committal.“
“That leaves a hike on the table, but it is less obvious it comes at the next meeting,“ Neil Dutta, head of economics at Renaissance Macro, wrote on Wednesday.
The Fed’s updated Summary of Economic Projections released Wednesday suggested that the central bank saw one more 25 basis point rate hike some time this year before hitting its peak target rate. It’s another sign that the Fed’s campaign of rate hikes could pause and may soon be over.
💳 Consumers seem unaffected by banking turmoil
While credit card data suggests the economy continues to cool, there’s little indication that the recent banking turmoil has had a material effect on spending.
From Bank of America: “Total card spending per [household] fell by 0.4% y/y in the week ending Mar 18 according to [Bank of America] aggregated credit and debit card data. Card spending has been slowing since Jan. At the national level, it has not been clearly impacted by regional banking stress."
And from JPMorgan (h/t Carl Quintanilla): “Recent bank failures in the US have raised questions about the consequences for consumers. … our Chase consumer card transactions data (credit and debit) through March 19 do not show a meaningful impact on spending in the first week after the event.“
💼 Unemployment claims remain low
Initial claims for unemployment benefits — the most up-to-date of the major labor market stats — fell to 191,000 during the week ending March 18, down from 192,000 the week prior. While the number is up from its six-decade low of 166,000 in March 2022, it remains near levels seen during periods of economic expansion.
For more on low unemployment, read: The labor market is simultaneously hot 🔥, cooling 🧊, and kinda problematic 😵💫.
👍 Businesses are investing
Orders for nondefense capital goods excluding aircraft — a.k.a. core capex or business investment — climbed 0.2% to a near-record $75.2 billion in February.
The backlog of unfilled core capex orders was at $266.9 billion during the month.
For more on this massive economic tailwind, read: 9 reasons to be optimistic about the economy and markets 💪
🏚 Home sales jump
Sales of previously owned homes jumped 14.5% in February to an annualized rate of 4.58 million units. From NAR Chief Economist Lawrence Yun: “Conscious of changing mortgage rates, home buyers are taking advantage of any rate declines. Moreover, we're seeing stronger sales gains in areas where home prices are decreasing and the local economies are adding jobs.“
💸 Home prices are cooling
From the NAR: “The median existing-home price for all housing types in January was $363,000, a decline of 0.2% from February 2022 ($363,700), as prices climbed in the Midwest and South yet waned in the Northeast and West.“
📈 New home sales are up
Sales of newly built homes rose 1.1% in February to an annualized rate of 640,000 units.
👍 Surveys suggest things are getting better. According to the S&P Global Flash U.S. Composite PMI, private sector activity “grew at a solid pace that was the fastest since May 2022 as demand conditions improved and new order growth returned. Manufacturers and service providers alike registered upturns in output, with service sector firms driving the increase.”
With surveys, remember: What businesses do > what businesses say 🙊
📈 Near-term GDP growth estimates remain rosy. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.2% rate in Q1. This is up considerably from its initial estimate of 0.7% growth as of January 27.
💸 Stock buybacks are off their highs
According to data from S&P Dow Jones Indices (SPDJI), S&P 500 companies bought back $211.2 billion worth of stock in Q4 2022, up from $210.8 billion in Q3 and down from $270.1 billion in the prior year.
And while it’s true that the dollar value of buybacks has generally trended higher over the years, it’s not true that this activity is becoming a growing share of the market. See chart below.
“Buybacks as a percentage of market value decreased to 0.66% in Q4 2022 from 0.70% in Q3 2022 (Q4 2021 was 0.67%); the historical average is 0.65%“ Howard Silverblatt, senior index analyst at SPDJI, wrote in an email on Tuesday.
For more on buybacks, read: The record-high stock buybacks aren't as wild as they seems 🧐
Putting it all together
Despite recent banking tumult, we’re getting a lot of evidence that we could see a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
The Federal Reserve recently adopted a less hawkish tone, acknowledging on February 1 that “for the first time that the disinflationary process has started.“ And on March 22, the Fed signaled that the end of interest rate hikes is near.
In any case, inflation still has to come down more before the Fed is comfortable with price levels. So we should expect the central bank to keep monetary policy tight, which means we should be prepared for tighter financial conditions (e.g. higher interest rates, tighter lending standards, and lower stock valuations).
All of this means the market beatings may continue for the time being, and the risk the economy sinks into a recession will be relatively elevated. In fact, recession risks intensified recently with bank failures sparking concerns about financial stability.
However, it’s important to remember that while recession risks are elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs. Those with jobs are getting raises. And many still have excess savings to tap into. Indeed, strong spending data confirms this financial resilience. So it’s too early to sound the alarm from a consumption perspective.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have had a pretty rough couple of years, the long-run outlook for stocks remains positive.
A version of post was originally published on TKer.co
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