A Slower Economy, Lower Inflation; June Rate Cut Odds Significant

During the last week in March, there were several significant foreclosures (hundreds of millions of dollars per property). They included properties in San Francisco and Mountain View, CA, a large complex in Washington, D.C., and a medical office building (still under construction) in the southern part of Florida.

Leveraged loan delinquencies now exceed 6% (normal is <3%). This level is approaching the levels seen in the ’01, ’08, and ’20 Recessions. According to Moody’s, office vacancies are at record highs. Commercial Real Estate (CRE) prices are in freefall. According to Rosenberg Research, 29% of all CRE, and 56% of office loans now have negative equity. Retail malls are struggling, and the multi-family space is overbuilt (falling rents). It will be informative to see the additions to their loan loss reserves as banks post their Q1 results in April.

Equity Markets

Yet, despite the growing problems in the CRE sector and cracks appearing in the economic landscape, equity prices continue to scale new heights. The S&P 500 and the DJIA both hit record closing highs on Thursday (March 28), with the Nasdaq a hair’s breadth away from its record closing high of March 22nd. The equity market continues to be driven by momentum, and traditional valuation metrics, like the PE (Price/Earnings) Ratio are significantly above their median values (see chart below).

Cracks in the Foundation

Meanwhile, over the past quarter or so, we’ve seen flat to falling Industrial Production, lower retail sales volumes, shrinking exports, flat to negative capital spending, and a net loss of full-time jobs (being replaced by part-time ones). Yet, in the face of this data, both the Atlanta and St. Louis Federal Reserve District Banks are forecasting a stunning +2.3% growth rate for Q1 GDP. This appears to be extremely optimistic. In addition, the media is still touting “the economy is strong” mantra. We think the growth is much lower, as do many research houses. Rosenberg Research, for example, is projecting -0.5% Q1 GDP growth based on the trends in the following data over the past three months:

• Industrial Production (-2,7% Annual Rate (ARAR))
• Retail Sales volume (-5.3% AR)
• CoreCORE Capex Orders (-0.9% AR)
• Exports (-1.1% AR)
• Full-Time employment (-5.2% AR)

In addition, Rosenberg reports that same store sale have contracted in dollar terms (-0.2% year over year). Worse, when adjusted for inflation (i.e. looking at volumes), that number becomes a negative (-1.3%) and has been negative for five quarters in a row. That was last seen in the Great Recession (see chart below).

Furthermore, if we look at Wall Street’s earnings growth estimates for Q2, these are flat as a pancake, and we have the major retailers (TGT, HD, LOW, WMT) all commenting in their Q4 earnings calls that consumers have tightened their purse strings. The latest retail reports from the likes of Lululemon and NikeNKE were also downbeat as both reported disappointing sales, softening demand, and slower traffic.

In past blogs, we’ve commented on the rapid rise in credit card balances. That’s because personal savings have been depleted. And now we are seeing rapidly rising credit card, auto loan, and other consumer loan delinquencies.

Home Prices and the “Wealth Effect”

Rising home prices often lead to what economists call the “wealth effect.” That is, when home prices rise, homeowners tend to spend more because they feel they can afford higher consumption as their “wealth” is higher. That particular effect is now waning. Both the Case-Shiller and the FHFA Home Price Indexes are displaying steep negative slopes with the FHFA Index already in negative territory. The housing boom may very well be ending.

The Conference Board’s Consumer Confidence Index fell in March with the Future Expectations sub-index now at a six-month low. Less than 15% of those surveyed see the economy improving in the next six-months, while plans to purchase a car or major home appliance were the weakest since July ’22, and September ’11 before that.

Growth Forecasts

While the mothership Fed recently raised its GDP growth forecast for 2024 from 1.4% to 2.1% and lowered its U3 Unemployment Level at year’s end to 4.0% from 4.1%, reports from the Fed’s Regional District Banks aren’t as sanguine.

• The Dallas Fed’s Manufacturing Index showed up as -14.4 in March, even lower than February’s -11.3. Production, New Orders, and Shipments were negative and the workweek contracted. The Dallas Fed’s Services Index was also weak at -5.0; again lower than in February (-3.9).
• The Philly Fed’s Non-Manufacturing Index, at -18.3 in March, has now shown contraction for three months in a row. New Orders, Backlogs, and Inventories all shrank. And full-time job growth was the lowest since last June.
• The Richmond Fed’s Manufacturing Index was also negative in March (-11), and, again, worse than the -5 reading in February. This marked the sixth month in a row of contraction. Negatives were seen in in the indexes for New Orders, Capacity Utilization, and Backlogs. In addition, Business Spending was the most contractionary since July ’20.
• The chart shows the Chicago Fed’s National Activity Index. This comprehensive index has been in negative terrain since Q4 ’22.

The Fed and Interest Rates

Chairman Powell and other FOMC members continue to insist that they need to see more “good” inflation data before embarking on a lowering rate agenda. We had some bumps in the road on the disinflation path in January and February. At his recent press conference after the Fed’s latest meeting, the Chairman eased market angst, saying that the Fed would not overreact to the hotter than anticipated January and February inflation data.

On Friday (March 29^th), the Fed’s favorite measure of inflation, the Personal Consumption Expenditure Index (PCE) printed a +0.3% number (+0.332% to the third decimal), down slightly from January’s +0.4% (+0.376%). Nevertheless, due to “base effects,” the year over year rate (2.45%) ticked up slightly from January’s 2.43%, the first uptick in quite some time, but ever so slight. As inflation falls to target, statistically, such deviations can be expected.

The core PCE measure, which excludes the volatile food and energy sectors, also rose 0.3% in February, and 2.8% on the year over year measure, down slightly from 2.9% in January. The PCE report won’t do anything to change FOMC views that the last part of the inflation fight will take a little longer.

As seen from the chart below, the Core PCE Price Deflator is lower than the Core CPI Index. That’s good news as that is the index to which the Fed reacts.