On the macro front, this week is all about the juxtaposition between the Fed’s senior loan officer survey, to be released on Monday, and an update on US inflation due Wednesday.
The survey will almost surely suggest credit conditions tightened further in the face of the worst banking sector stress since Lehman, while April’s CPI figures are expected to betray another month of stubborn core inflation.
The tension between a constrained credit impulse and recalcitrant price growth is at the heart of the Fed’s policy dilemma. Ostensibly, this is straightforward. The drag from 500bps of policy tightening combined with the aftershocks of SVB’s failure should ensure growth remains below-trend, helping to moderate demand and balance the labor market on the way to disinflation. So far, though, there’s little evidence that inflation intends to cooperate.
Core prices probably rose 0.3% last month from March, economists reckon, leaving the YoY rate at 5.5%. With apologies, there’s been scant progress on core inflation. That’s not to say it won’t eventually recede, it’s just to acknowledge reality.
“Special attention has been paid to the fluctuations in auto prices [and] given the weighting of housing (OER/rent), March’s more modest shelter costs point toward the beginning of the long-awaited moderation in the sector driven by higher mortgage rates and declining prices,” BMO’s Ian Lyngen and Ben Jeffery remarked, noting that core services ex-housing, which hasn’t moderated, will be scrutinized for any sign that the CPI version of Jerome Powell’s preferred barometer of underlying price trends is cooling.
Recent data on wage formation suggests no room for complacency. Although ADP’s “pay insights” figures showed wage growth moderating, and the latest JOLTS report was broadly constructive, ECI, ULC+ and AHE all indicated upward pressure on wages and compensation, which in turn suggests businesses will pass along elevated labor bills to consumers in the form of higher prices. You can call that whatever you like — “Greedflation,” profiteering or just running a business — but it’s not going to stop until consumers push back. Put differently, as long as companies have pricing power, they’ll wield it.
Corporates pursuing a so-called “price-over-volume” strategy have been rewarded by investors. “A basket of companies pursuing PoV shows how successful the strategy has been recently — and just how attuned investors seem to have become to it,” Bloomberg’s Tracy Alloway wrote last week, flagging Wingstop and Pepsi as “posterchildren.” “The price-over-volume dynamic has arguably helped all kinds of companies boost profits since the pandemic set off a wave of supply shocks, giving them de facto monopoly power,” she added, citing Samuel Rines, a podcast guest and a strategist at Corbu LLC.
All of that to say market pricing for Fed cuts in the back half of 2023 only makes sense when you conceive of it as one bet on an abrupt turn for the worst, not as a series of incremental 25bps cuts. “As the US regional bank ‘profitability crisis’ is claiming more victims with each passing week, we see the probability distribution shift towards an even deeper ‘Fed-forced-to-cut’ path,” Nomura’s Charlie McElligott said. “In layman’s terms, this is saying that if the Fed were indeed forced to cut due to building pressures with regional banks, it most likely would not occur in the form of ‘baby-steps’ spread into the end of year, despite the implied pricing giving you a kinda false optic of three Fed cuts priced in by December.”
McElligott’s point (and I elaborated on this last week+) is key. The odds of a succession of small rate cuts (so, the onset of a mini easing cycle or a carefully considered “mid-cycle adjustment”) this year are probably low. Indeed, as Goldman recently showed+, even when inflation is contained, it’s exceedingly rare for the Fed to cut rates in the six-month period following a pause when the labor market is tight.
I do realize it’s tempting to adopt the view of Jeff Gundlach (for example) and other “name brands” who’ve recently suggested the Fed will be cutting later this year, but the nuance really is important. Powell isn’t likely to embark on a measured easing cycle with the labor market tight and inflation elevated, because a couple of calm, 25bps cuts wouldn’t do anything to help in the event the bank crisis worsens materially.
For now, anyway, this looks pretty binary: It’s either higher for longer or it’s an about-face to acknowledge the severity of banking stress and expectations for an acute credit crunch.
Also on the US docket this week: NFIB (markets will be watching for further signs that small businesses are facing more onerous credit conditions), PPI and the first read on University of Michigan sentiment for May. Elsewhere, the BoE is likely to hike 25bps and trade data out of China will be eyed closely for clues both on global and domestic demand.
Higher for longer is my guess; need more stuff broken (which is not fair to many, but that’s life right?)
It’s all about the rebalancing. In my view, the fomc has overtightened and forget the soft landing. Real time pricing of goods and the yield curve suggest a hard landing. But others see services prices and employment holding up. I suspect inflation numbers are going much lower very soon which will cause the Fed to cut within 6 months or less. 2-3% inflation and 5% Fed fund rates indicate extremely tight monetary policy, not to mention the very unwise shrinking of the Fed’s balance sheet in the midst of a banking credit shock. Commercial real estate is the next shoe to drop.
American investors, it seems to me, have even more of a bias towards greed than even the companies in which they invest do, and very short attention spans to boot. After COVID has ravished us to the tune of a million dead, we soon started to hear the brand names in many areas proclaiming that enough sacrifice is enough. We’re bored, let’s get back to normal ….
Here’s the chain. As posted here in the previous post, seven firms have accounted for 110% of all stock returns this year. All the other companies lost a collective 10% of their value. If that’s really the case, as it seems to be, growth has to fall. Eventually, sooner than later, so do the magnificent seven. On the other side, many business firms have been waiting 20 years to have this much built-in pricing power and I don’t see them wanting to give it up without hard pushback. Somehow, elasticity seems to have switched its basic nature and is allowing the price-volume tradeoff to be quite favorable for many goods. The summer will be a real canary in the mine indicating just how strong these relationships will stay.
My daughter and son-in-law are both out of work from their nice six-figure tech jobs. Together, they paid more tax than I did for ’22, but after a few months off they seem far more interested it going to my grandson’s myriad sporting events than going back to work. They have been collectively busting their butts for nearly 50 years with maybe four weeks of total vacation time and they are tired and behind at home. I spent 21 straight years in school, followed by over 40years of work. In spite of all that, I was born to retire. I pre-retired after 35 years and quit after forty. Never missed it. Between the narrow market, the pressure from the Fed and the banks they have messed up, I can’t see any up before lots of down, especially if people like my kids aren’t in a hurry to get a new job. The Fed and the Treasury want to see inflation whipped. They are right. What they don’t know is actually how to accomplish this.
As a kid, I had a memorable experience I still can’t get out of my head. I was about 12 and my dad and I were downtown headed for our weekly Saturday haircut. We were on a tight side street with a lot of traffic when around the corner comes this big wagon driven by two Amish teens hauling that week’s eggs to the market. That wagon contained many thousands of eggs and it was a very hot July day. As the wagon got about 100 feet into the busy street the kids lost control of the horses, they reared-up fast and in the blink of an eye the work of more than 1000 chickens was on the very warm street. The horses came down and ran a bit before they were pulled up. Everyone on the street stopped to look and it was very quiet. Soon the contents of all the broken eggs began to coalesce just like a giant fried egg. The yolk was 15-20′ across and the white part probably 50′. What a sight to behold! Just one tiny mistake and all that work, along with a whole week’s collective takings was erased. Sound familiar?
Thank you Mr. L for a nice story and maybe a lesson!
Mr Lucky — your point is well-taken about businesses being reluctant to surrender or holster pricing power now that they feel they’ve got it again. But how do you think these businesses’ reclaimed pricing power compares to those of wage earners? Especially at the lower end, where now distant rumors of a $0.50/hr increase in the Federal minimum wage was going to lead to mass layoffs, robots and skyrocketing prices at the register. (Nice call). Instead, we have some states at nearly twice the federal minimum wage with some businesses adding fringes or other benefits and still looking for enough workers. Something tells me employees don’t want to surrender pricing power either. They are not merely reclaiming it, but experiencing it for the first time in their lives in many cases.
And seperately, re interest rates, I have no real personal insight or even prediction except for this — if the Fed reacts under duress and delivers a 75 bp emergency cut before the year’s out, the analysts/pundits now calling for a a series of course-correcting 25 bp moves will proudly declare they nailed the call on the Fed pivot. But this post is a good reminder that the journey is often more important than the destination.
Really good art for the article cover. Kudos to the AI I suppose