Good morning. Jay Powell struck a hawkish tone in a speech yesterday. Bond yields only ticked up a bit in response, and stocks kept their composure. It seems that markets had already discounted what the Fed chair had to say. Sometimes markets follow policy and sometimes policy follows markets. The trick is to know which times you are living in. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.
The inflation narrative could flip fast
Jay Powell is worried about inflation again. Here he was yesterday:
We’ve said at the [Federal Open Market Committee] that we’ll need greater confidence that inflation is moving sustainably toward 2 per cent before it would be appropriate to ease policy . . .
The recent data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence.
The bond market had already freaked out last week, after March’s third-in-a-row hot consumer price inflation report, though long yields did close at 2024 highs on Tuesday. Overall, Powell’s comments and the rise in yields add to growing evidence of a vibe shift (ahem, sentiment reversal) that’s taken place over the past month, as we noted yesterday.
But it’s good to remind ourselves that Powell is a lagging indicator. He and his colleagues are committed to “data-dependence”, meaning they are led wherever the latest inflation numbers take them. To give just one example, less than a month ago he waved away hot January and February inflation reports, saying they “haven’t really changed the overall story”. March’s numbers have changed his tune for now. But Powell’s stern sounds yesterday could easily turn serene tomorrow.
We think the chance of an inflation narrative volte-face in the next few months is particularly high because of the dominance of shelter inflation. Shelter has long been the most important inflation category, but its salience has kept rising as non-shelter prices have settled down. In the consumer price index, most of the remaining inflation overshoot is in two categories: auto insurance and shelter. In the personal consumption expenditure index, which the Fed targets, it’s just housing; core PCE ex-housing is running at 2.1 per cent.
Remember the story in shelter inflation. The official data captures paid leases, including both newly signed and existing ones. This makes for a better cost-of-living measure but a worse barometer of live market conditions; conversely, rental data from private providers like Zillow captures newly signed leases, and so are more timely. Because rent inflation on new leases has looked relatively benign, many expect the official data will converge after a lag. Initially, that lag was supposed to be about nine to 12 months, but that hasn’t happened:
Why it’s taking so long is unclear. Some argue that it’s just noise: Zillow and other new-lease data have short histories and their relationship to CPI is poorly understood. Others say it’s signal: unaffordable house prices, expensive mortgages, low unemployment and/or higher immigration are keeping the rental market hot.
We’d split the difference: the rental market is somewhat strong, but not CPI shelter at 5 per cent annualised strong. Using month-over-month rates is helpful for comparisons here. In the latest March 2024 CPI report, shelter inflation rose 0.42 per cent, in line with where it’s been since March 2023. In normal times (including in strong rental markets), monthly shelter rates usually oscillate between 0.2 per cent and 0.3 per cent; in 2017-19, the average was 0.26 per cent.
In short, there’s (still) compelling reason to think shelter inflation will fall further. Though it hasn’t happened yet, we could turn a corner at any moment.
What would happen to broader inflation if it did? One way to visualise it is looking at the past three months of too-hot CPI data, which was driven not just by shelter but also roaring price increases in auto and hospital services. Even then, more normal shelter inflation would’ve offset gains elsewhere. The chart below simulates the past three core CPI reports under different assumptions for monthly shelter inflation:
We are not totally calm about inflation. PCE supercore prices (ie, ex-housing core services) have risen 5 per cent in the past three months, and 4 per cent in the past six. That is too high for the Fed, probably reflecting wage growth that has normalised slower than the overall labour market. But wage growth is indeed falling. With that in place, all that’s needed for the inflation narrative to go from “stubborn” to “gradually descending” is the long-awaited shift in shelter. (Ethan Wu)
Bank earnings
Banks are the most economically sensitive of businesses. They earn a spread by acquiring money at a lower price and lending it at a higher one. The biggest risk to that model is that borrowers don’t pay back their loans, a risk amplified by the fact that banks are highly leveraged. The rate at which borrowers renege is a function of macroeconomic conditions. So, if you are wondering whether the economy is improving or degrading, look at bank results, particularly credit quality.
It’s been a little odd, then, listening to banks talk about their first-quarter results over the past few days. Neither the monster national players (JPMorgan Chase, Bank of America, Wells Fargo, Citigroup) nor the regionals (PNC, M&T, et al) have had much to say about the economy’s effect on credit quality. Neither have analysts asked many questions about it.
Mostly this reflects the fact that the US economy is, in aggregate, very healthy. These are few disasters to talk about, other than office real estate, and that disaster is moving at a politely glacial pace. That frees the analysts to ask about their two present preoccupations, both of them technical and fiddly: when will the increase in deposit costs, driven by depositors slowly realising that they don’t have to accept zero interest rates, peak? And, for the biggest banks, will they be able to release capital and use it to buy back shares when the latest version of the Basel rules are finalised?
The banks’ answers to these questions are, roughly: we don’t really know, but maybe later this year; and we just plain do not know. The uncertainty about deposit costs, in particular, has been expressed in the banks’ conservative outlooks for 2024 lending profits, leading to some bad performance in bank shares. The market is being characteristically short- sighted here. Over time, a higher rates plateau will make banks more profitable. It’s just that the timing of profits is a little tricky in the transition.
Listening closely, however, several of the banks did nod to the fact (much discussed by Unhedged) that low-end consumers — those with more debt than assets — have been pinched by the increase in rates. It’s the well-to-do that are keeping the economy growing. Here is JPMorgan chief executive Jamie Dimon:
Consumer customers are fine. Unemployment is very low. Home prices are up. Stock prices are up. The amount of income they need to service their debt is still kind of low, but the extra money of the lower-income folks is running out — not running out, but normalising, and you see credit normalising a little bit. And of course, higher-income folks still have more money, they’re still spending it.
“Normalising” is a word several of the banks have been kicking around to describe the fact that loan delinquencies, write-offs and reserves have all been ticking up. Here, for example, are the levels of balances in delinquency in Bank of America’s credit card business:
Notice that we have surpassed the pre-pandemic levels of late 2019 (the same is true if you look at the delinquencies as a percentage of total loans).
Unhedged is not going to make the mistake of predicting whether the problems at the low end of the credit spectrum presage weakening further up the scale. Economic inflection points are impossible to time. The point, instead, is that we can see by looking at the low end that the economy is still processing the jump in rates that began two years ago, and the infusion of fiscal support that proceeded it. The economy is strong in aggregate, and its biggest post-pandemic paradoxes have disappeared. But the situation is still dynamic. Strong consumer spending, as Dimon points out, has been driven by wealthy consumers who have benefited hugely from an asset price rally. That rally might be stalling now.
Bank earnings season has been boring so far. But don’t let that fool you. We’re still living in interesting times.
One good read
American big-box store sells lots and lots of small bits of metal.
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