Weekly Review & Outlook: April 15, 2024

Inflation stays hot in March pushing out monetary easing expectations. Very small sample set bank earnings are highlighted by earnings per share (EPS) beats relative to expectations.

BLS released the March Consumer Price Index (CPI) report (April 10) which found both headline and core consumer inflation prices rose 0.4% from February. The unwanted “hot” inflation findings highlighted monthly price increases for shelter, car insurance, health care and clothing.

Last 6-months annualized trends look ominous relative to the inflation fight. Core CPI on this basis is now running at 4.1% more than double the 2% long term target rate. The analysis also highlights the strong rise from 2.8% in November.

Consumer inflation’s reacceleration is again seeping into consumer expectations. The most recent University of Michigan Surveys of Consumers (April 12) found “year-ahead inflation expectations ticked up from 2.9% last month to 3.1% this month, lifting just above the 2.3-3.0% range seen in the two years prior to the pandemic. Long-run inflation expectations also edged up, from 2.8% last month to 3.0% this month.” This shift higher in consumer inflation expectations is a direct challenge to the Fed’s 2% anchoring goal.

For those of us that want to reconcile accelerating inflation in the context of restrictive monetary policy, a good starting point is examination of fiscal policy. The U.S. is now in the 5th year of historically high fiscal stimulus with cumulative deficits of more than $10T including current fiscal deficit of $1.1T just half way through the year. Common sense seems to dictate that large deficit spending will lead to currency devaluation, aka inflation.

There is an evolving economic theory called the fiscal theory of the price level (FTPL) which is being developed by economists such as John Cochrane. As noted in Chicago Booth Review, December 2019, How Fiscal Policy Drives Inflation, “Cochrane finds that a monetary-policy shock—in the form of an interest-rate increase unaccompanied by changes in the fiscal surplus or growth—led to an immediate and persistent increase in inflation. Meanwhile, a negative fiscal-policy shock, or a decline in surpluses, also resulted in persistent inflation, about half of which was offset by changes in the discount rate.” Cochrane’s revised paper The Fiscal Roots of Inflation is linked for a deeper dive. My takeaway is that restrictive monetary policy is unlikely to tame inflation while fiscal policy remains stimulative.

Turning to early 1st quarter bank results, EPS are generally topping expectations due to lower credit cost and higher non-interest income. Other early trends are lower loan balances, lower Net Interest Margin and Net Interest Income. We’ll have a much broader data set to digest over the next 2 weeks.

From the JPM call CEO Dimon and CFO Barnum provided various comments which I found noteworthy. Starting with their observations on Commercial Real Estate which seems to be everyone’s priority. Dimon commented,

“So I’ll put it into 2 buckets. First of all, we’re fine. We’ve got good reserves against office. We think the multifamily is fine. Jeremy can give you more detail on that if you want.

But if you think of real estate, there’s 2 pieces. If rates go up, think of the yield curve, the whole yield curve, not Fed funds, but the 10-year bond rate, it goes up 2%. All assets, all assets, every asset on the planet, including real estate, is worth 20% less. Well obviously, that creates a little bit of stress and strain, and people have to roll those over and finance it more. But it’s not just true for real estate, it’s true for everybody. And that happens, leveraged loans, real estate will have some effect.

The second thing is the why does that happen? If that happens because we have a strong economy, well, that’s not so bad for real estate because people will be hiring and filling things out. And other financial assets.

If that happens because we have stagflation, well, that’s the worst case. All of a sudden, you are going to have more vacancies. You are going to have more companies cutting back. You are going to have less leases. It will affect — including multifamily, that will filter through the whole economy in a way that people haven’t really experienced since 2010.

So I’d just put in the back of your mind, the why is important, the interest rates are important, the recession is important. If things stay where they are today, we have kind of the soft landing that seems to be embedded in the marketplace, everyone — the real estate will muddle through.

Obviously, it’d be idiosyncratic if you’re in different cities and different types and B versus A buildings and all that, but people will muddle through. They won’t muddle through under higher rates with the recession. That would be tougher on a lot of folks, and not just real estate, if in fact that happens.”

With respect to 1Q24 and current year renewals, it seems a lot of refinancing was completed in the quarter. CFO Barnum commented,

“we caution a little bit there about pull-forward, which is even more acute, I think, on the Debt Capital Markets side, given that quite a high percentage of the total amount of debt that needed to be refinanced this year has gotten done in the first quarter.”

I end with Dimon’s comments on the environment and expectations for the full year (my emphasis),

“So I would say consumer customers are fine. The unemployment is very low. Home price are up, stock price 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 normalizing. And you see credit normalizing a little bit.

And of course, higher-income folks still have more money. They’re still spending it. So whatever happens, the customer’s in pretty good shape. And they’re — if you go into a recession, they’d be in pretty good shape. Businesses are in good shape. If you look at it today, their confidence is up, their order books are up, their profits are up.

But what I caution people, these are all the same results of a lot of fiscal spending, a lot of QE, et cetera. And so we don’t really know what’s going to happen. And I also want to look at the year, look at 2 years or 3 years, all the geopolitical effects and oil and gas and how much fiscal spending will actually take place, our elections, et cetera.

So we’re in good — we’re okay right now. It does not mean we’re okay down the road. And if you look at any inflection point, being okay in the current time is always true. That was true in ’72, it was true in any time you’ve had it. So I’m just on the more cautious side than how people feel, the confidence levels and all that, that doesn’t necessarily stop you from having an inflection point. And so everything is okay today, but you’ve got to be prepared for a range of outcomes, which we are.

And the other thing I want to point out because all of these questions about interest rates and yield curves and NII and credit losses, one thing you projected today based on what — not what we think in economic scenarios, but the generally accepted economic scenario, which is the generally accepted rate cuts of the Fed. But these numbers have always been wrong. You have to ask the question, what if other things happen? Like higher rates with this modest recession, et cetera, then all these numbers change. I just don’t think any of us should be surprised if and when that happens.

And I just think the chance of that happen is higher than other people. I don’t know the outcome. We don’t want to guess the outcome. I’ve never seen anyone actually positively predict a big inflection point in the economy literally in my life or in history.”