Fed has it wrong intentionally? Housing & Autos
Struthers Report V29 # 6.7
The Fed has it wrong, but intentionally?
It appears that the market is at quite the odds with the Fed, but there is method to the Fed madness.
As most of you know, I am predicting a recession in 2023 likely in the 2nd half. That said, the economy has remained resilient so far. According to St. Louis Fed President James Bullard, recession fears are exaggerated. He cites a (“very, very”) strong labor market and resilient consumer consumption as reasons for his dissent. Bank of America’s earnings support Bullard’s comments. The bank is more consumer orientated than some other big banks and said its customers increased spending by 8% in Q1 from a year earlier. I believe the Fed will tighten and raise rates too high, but intentionally to cause a severe recession.
Markets are pricing in 3 rate drops for later in 2023, but I don't think they know how stubborn the Fed will be. In their last meeting, the Fed did not say it would pause and pivot, but this is an ongoing process and will be data dependent. They have the recent jobs report and will get the May report before next Fed June 14th meeting. Also today's inflation report and one more report by June 14th. Powell said inflation is still job 1 and still targeting 2% inflation. He only said they are closer to the end than beginning with rates. Will there be another rate increase? Powell does not know yet if rates are high enough. Powell says a June rate increase is on the table. Will inflation take a big dip by June 14th? Will the job market weaken?
The April inflation number was expected to show little if any progress, with economists expecting the headline CPI number to rise 0.4% in April (Y/Y basis of 5.0%, up from the 0.1% increase in March. Core CPI, which excludes the volatile food and energy sectors, is also expected to increase 0.4%, unchanged from the March M/M increase (with a rise of 5.5% Y/Y vs. the March print of 5.6%).
Today that is what we got with CPI up 0.4% for a 4.9% yearly rate and core CPI up 5.5% on the year.
Unless inflation and jobs tank in the May data, we might see another 1/4 point rise. I believe the Fed wants to error on the side of too much tightening. The only way that the Western debt laden countries can continue with all this debt is with interest rates of 0% to 1%. The only way that can happen is with a severe recession and a banking crisis that will go along with it. That will give the Fed market support to lower those rates way down. And they also have to ensure that the inflation beast has been tamed.
As I have mentioned, I watch housing and auto sales data closely to watch for recession signals.
The housing market still looks like the coyote suspended in mid air off the cliff. The market is in limbo with fewer wanting to buy or sell. US new home listings in April were down more than 20% from a year ago and homeowners are increasingly staying put with low mortgage rates locked in, rather than trying to secure a new home at a higher rates. Inventory is low, holding prices up or more stable while sidelining would-be buyers looking to upgrade their homes.
Data from Realtor.com showed that 392,016 homes were listed for sale in April, below the 497,844 from the same month in 2022, and even further from the 552,082 listed in April 2019. The situation is similar in Canada. I believe it will be the coming recession that triggers the next down wave in housing.
Auto sales have also been resilient. New vehicle sales of 1,357,125 units for April are down 2.0% from March 2023 but up 7.7% from a year ago. You can see on the chart that there is no sign of significant weakness. We see the typical spring buying.
The markets don't get how stubborn the Fed and the consumer are. It cannot continue, but longer than markets think. Revolving credit outstanding rose $17.6 billion in March with consumer borrowing the most in four months and more than expected. It comes on one of the largest credit card spikes in history. Total credit increased $26.5 billion after a gain of $15 billion in February data. I would bet April numbers are higher still. However, consumer sentiment is at levels you see in a recession. I believe the continued spending and credit explosion is either a matter of expanding credit to hang on or a denial that the current economic situation will continue or get worse.
Total US retail sales for the January 2023 through March 2023 period were up 5.4 percent (±0.4 percent) from the same period a year ago. Energy prices have now come down so I cannot blame the increase on higher energy sales. Consumers look pretty tough or perhaps they are still in a party and spending mode after lock downs lifted?
I also follow the Atlanta Fed now prediction on GDP. They are still well above market consensus as was the case in Q1. And the Atlanta Fed turned out to be way more accurate than the market consensus in Q1. Is the market just wishing for a slight recession so rates will come down?
Conclusion
Gold is still in my trading range and equity markets are going sideways. Equity markets may continue sideways until the fall when the scary months of September and October arrive. The equity markets believe in Goldilocks and think there will be a soft landing with interest rates coming down. The market is predicting rates will be far lower in 6 months (yield curve inverted). I don't believe the market is predicting a severe recession I see as necessary and a continued banking crisis.
In recent updates I have highlighted the contraction with the M2 money supply and the last time that happened was in 1930. Something is brewing that is far worse than the markets are pricing in. Negative swap yields indicate bank balance sheets are declining which will mean less money making it into the economy. The Fed is now the major player in money market funds, offering risk free 5% rates. There has been so much flowing there (over $2 trillion), going from around $3 trillion in 2019 to around $5 trillion today. It has crowded out private investment. Why loan to a business and take risk?
The Banking crisis is not over and the Fed will reverse too late, well at least according to what markets want. Bond traders looking at the collapse in US regional bank shares, are betting the Fed is likely to reverse the recent 25bps hike by July. Equity markets are already pricing this in. Tech stocks have been flying in this bear rally, but the rally is narrow with too much concentration. A good sign that this is a bear rally is when the same stocks that created the blow off top are leading the bear rally.
Further crowding the money markets will be government debt. The budget deficit, in the first 6 months of the fiscal year (Oct. to Oct.) is $480 billion above last years level. Revenues fell 3% and things are on course for a structural $2 trillion deficit, expected with falling tax receipts. The Fed is tightening and raising rates, how will the deficit be covered? In the end it will be with massive QE, but things will get much worse before that arrives. The Fed always acts too late, only this time, it might be more intentional.
I am afraid the equity market is going to get a taste of Goldilocks burning porridge and I expect new bear market lows. I am watching a number of recession proof stocks but I find you always get to buy them lower in a market sell off. I am just looking for the right timing on some Put Options, so stay tuned.
When I put all the markets in context, they are saying we are heading to a bad crash. Best is to have good levels of cash and some gold. Energy and defense stocks could be among the better choices in equities. Energy stocks are very cheap and the governments transition policy to green energy will end up in disaster causing energy shortages. War will continue and has high odds of escalating, plus war is always used as blame for things that go wrong.
Sorry to be so negative and I know this does not make me very popular. That said, I have always called it as I see it and do not sugar coat. It might be bitter medicine, but some day we will be at a bottom and looking up to better days.