The 3rd quarter closed right on schedule despite the seeming surprise of its arrival among some newsmakers. Important updates in the week included the latest Personal Consumption Expenditures (PCE) data. Overall the Atlanta Fed GDPNow projection for annualized 3Q23 economic growth was unchanged at 4.9%.
The August PCE data from BEA (September 29) was mostly in-line with the critical monthly increase in core PCE higher by just 0.1%. In the nearby table I highlight the recent monthly series change in core PCE. The downward trend of the last 5 months to the August reading is just the sort of confirmation the Fed is seeking that their restrictive monetary policy is dampening inflation. Some simple math informs us the last 3-months annualized increase in core PCE is right at the long term 2% policy target.
I believe the core PCE data will be a critical measure that keeps the Fed on pause in the upcoming meetings. While the possibility of a tame September readings sets up another Fed pause in November, this should in no way change expectations, in my opinion, for the easing path next year. Remember the latest Summary of Economic Projections median Fed Funds estimate exiting 2024 is 5.1% or just ¼ point below the current effective rate.
As we get further data suggesting we have reached a terminal rate in the hiking cycle, I am spending more time thinking about potential credit costs increases over the next several quarters. With funding costs seeming to stabilize, I expect asset yields to steadily increase along with credit costs. The degree to which these 2 model drivers offset each other will likely determine the direction of bank industry earnings revisions.
Across mid-cap banks, industry EPS data peaked in 2022 as the benefits of higher asset yields, still low funding cost and lockdown related provision reversals boosted the bottom line by about 3% from 2021 results. Current expectations are for the group’s median EPS to fall -7% for the full year 2023 with higher funding cost being the largest driver. Consensus expectations are for median EPS to fall another -4% in 2024. To me, the greatest unknown variable in the income statement in 2024 will be credit costs.
While some CRE segments will likely become credit headaches next year, I expect the greatest loss severities to be found in C&I and Consumer portfolios. Historically, unsecured credit card debt has had some of the highest loss content in banking. This is to be expected as the yields in these portfolios are eye wateringly high even in the bad times. Using publicly available data from the Monthly Credit Card Master Trust as of August, we can observe in the nearby chart that charge offs and delinquencies in these portfolios have in some cases doubled since the 2021 trough. Still these rates are historically below trend. Further normalization will likely see charge offs move higher another 50% in the next several quarters. While this would increase credit cost over the portfolios, the net interest income from the remaining performing parts will likely still be additive to the bottom line. In my opinion, credit costs will need to spike well above historical levels before they overtake the growth in NIM that I would expect as positive slope returns to the yield curve.