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Markets currently believe that the US economy remains resilient, a recession can be avoided and that means interest rates will stay high and for far longer than previously thought. However, there is increasing evidence that a US recession is imminent, if so then interest rates have peaked and should come down rapidly.
Federal Reserve Chair Jerome Powell has previously stated that monetary policy involves “long and variable lags” an expression first used by Milton Friedman the founder of modern monetarist economic theory.
When exactly does the interest rate pain hit “Main Street? Based on history It should be about now.
Thus, the talk of US interest rates staying high and for longer is simply reflecting a US economy that seems to be ignoring this monetary policy pain, for now. The commentators and even the Fed themselves seem to be keeping their options open with such statements.
However, if the US economy doesn’t slowdown and soon then economics is wrong.
Meanwhile Joe Biden is desperately hoping that it isn’t, the Presidential Primaries begin in February. With US inflation falling back to target he will soon start to pressurise the Fed into acting. The Thanksgiving to February period will be critical for the Democrats. The inflation problem is rapidly passing on both sides of the Atlantic. In the UK both energy prices and now food inflation are falling.
As we stated in an earlier newsletter, panic food supply contracts signed post Ukraine are now expiring. For once the Bank of England seems to be ahead of the curve and again, as we have highlighted before, the UK economy is actually doing very well.
They have been reluctant followers of the Fed, their decision to hold rates was a pleasant surprise and Gilts actually went up on the news.
Europe is also trying very hard not to increase rates. Germany is already in recession and the rest of Eurozone will probably follow in the next quarter.
Europe is increasingly tied to China and the delay of major post-Covid stimulus whilst the property sector is sorted isn’t helping. Currently the markets have bought in to the “higher for longer” narrative.
This, based on history, shouldn’t be the base case for the markets; interest rates peaking around here and cuts next year should be. The markets, however, need the data to deteriorate to change their present view.
US Recession Watch
US Consumer Spending Annual Change
Source: Citicorp
This first chart shows the number of news articles mentioning “soft landing”. As we know the media is rarely right on economic matters and this chart is a clear reflection of this fact. The current peak looks very similar to the prior patterns.
The scale reflects the extra number of “news” platforms. This is yet another pointer towards an imminent recession and that the market’s narrative of higher for longer has a high probability of being wrong.
The second chart shows that US consumer spending is falling sharply, the majority of US households have spent their Covid savings, indeed they are now poorer than before Covid.
These are recession type numbers. Market strategists have also pointed out that US consumer spending has also been heavily distorted by big one-off events. Must-see concerts by Beyonce and Taylor Swift have been of such a scale that they have distorted the GDP of the world’s largest economy.
Similarly two block buster movies Barbie and Oppenheimer have soaked up consumer spending. From here on this will make next year’s GDP/Consumer spending numbers automatically start to look bad (which is good for the Fed).
With no savings to fall back on most US consumers are likely to be far more prudent this Thanksgiving/Christmas season.
A further factor that will hit the US economy this quarter is that Joe Biden suspended Student Loan repayments during Covid, this moratorium has now expired, another big hit to the US consumer. Strikes are unsurprisingly back in the US.
From actors, screenwriters and now the autoworkers, the economic pain is starting to become real and all with the Presidential election next year. We would expect the political pressure on the Fed to start building very soon.
US Bank Lending
Obesity and Healthcare Stocks
Airlines are, however, perceived to be beneficiaries with millions saved in fuel costs if the average weight of the passengers drops even marginally. For heavily indebted governments that are subsiding or spending heavily on prescription drugs and medical treatments these drugs potentially offer a way to reduce demand and overall cost of medical services. Markets can and do get carried away with such “silver bullet” stories but there does appear to be a large willing market from both users and from service providers for these treatments.
Markets
October generally marks the beginning of positive seasonality, but it can also be the most volatile month, Black Monday 1987 was in October.
Coincidentally, there are many parallels between 1987 and now, interest rates were rising and the Fed was very “hawkish”.
However, whilst the impetus for that crash was interest rates the magnitude was actually due to a collapse in trading systems.
Less than a year later markets were higher, an important point to note for long term investors. Markets remain in this unclear period of will the US and thus the global economy fall into the recession that the markets have been predicting since the Russian invasion of Ukraine. History and economics tells us that it should and soon. There are political forces in play that also need it to happen soon.
The Fed is presently “talking up “ the possibility of “higher for longer” (they always do at this point in the cycle) at least until the unemployment and other economic statistics tells it that it can declare victory over inflation and start cutting.
No-one can be certain when this will be, but in theory it should be soon. However, if the Fed pushes the rhetoric too hard, then markets will in the short term run scared, but then, that in turn would allow the Fed to cut sooner and faster.
We are now entering positive seasonality and we are doing so with pessimism as the dominant emotion. Markets in the short term are very oversold but these points in the cycle are always hugely volatile.
For long term investors the “ducks continue to line up nicely”. Markets are just waiting for the bad economic news.
October 2023
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This information is not intended to be personal financial advice and is for general information only. Past performance is not a reliable indicator of future results.
