Discover President Lagarde's Vision for Continued Central Bank Action
Embark on the ECB's Rate Hiking Journey
The Fed last week executed what looks to be the final rate hike of the current cycle. Powell emphasized in the presser that this is not necessarily a pause, but I think it would take a pretty significant uptick in the inflation-linked data to warrant a course reversal. In some ways, it mimics the path taken by the Reserve Bank of Australia, which paused in April but made another hike in May citing inflation as being too high (although I’m not sure what they expected to change in just one month). I don’t think the Fed is considering another rate hike at this point in 2023, but I don’t think we’re looking at rate cuts later this year either (Powell pretty much said to expect none for the foreseeable future). With banking stress still elevated and jobless claims creeping higher, there’s no advantage to risk overtightening here with the data already trending in the direction the Fed wants. The headline unemployment rate tends to be slow to turn, but current rate policy needs time to run its course.
If you’re looking for a catalyst for a recession or the next bear market, the commercial real estate sector is probably it. The latest Senior Loan Officer Opinion Survey that’s created by the Fed shows that the credit contraction has already begun. The net percent of respondents reporting stronger demand for commercial & industrial loans is at -55.6%, the worst reading since the financial crisis and the 3rd worst reading in the past 30 years. Higher lending rates were a big reason, but respondents also cited a more uncertain economic outlook, reduced tolerance for risk, deterioration in collateral values, and concerns about banks' funding costs and liquidity positions. We’re seeing a lot of those risks showing up in lumber prices, which are all the way back to COVID recession levels. Some investors may be using the recent uptick in home prices and new homes sold as reasons for hope in the housing market (and REIT prices have been outperforming the S&P 500 over the past month and a half), but the larger, longer-term macro outlook still looks very poor here. Office space vacancy rates are only the most visible part of the issue. We’re seeing weakness across the board in both the commercial and residential real estate spaces, new construction spending and contract cancellation rates. As long as banking sector stresses remain, the situation is very unlikely to improve any time soon.
We’re a mere three weeks away from the drop dead date where the government would run out of cash unless the debt ceiling is addressed. We’re still at the point in the process where investors are aware of the issues at hand, but not so concerned that they feel the need to adjust portfolio strategies. In another week or two (if the 2011 timeline is repeated) would be the point where investors are likely to consider hedging their bets “just in case”. That’s probably the point also where stock prices would, in theory, decline and Treasuries would rally if no solution is in sight. Regardless of how the debt ceiling is resolved, whether it’s a bill with some spending cuts or even the 14th amendment, I think we also need to carefully consider the potential outcomes beyond just the June 1st deadline. If the debt ceiling is raised without any strings attached, we continue down the path of spiraling debt with trillion dollar budget deficits that keeps us moving down the road to calamity. If the debt ceiling is raised with spending cuts, you remove a key piece of the economic growth engine that could further push the U.S. economy towards recession in the near-term or put us on track for a low- or zero-growth decade ahead. If the government defaults, we’ll have bigger issues to worry about than our portfolios. Either way, what happens in the next few weeks will dominate the media, but the long-term implications could spell the end of the current economic expansion.
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