Weekly Review & Outlook: February 20, 2024

January consumer inflation data showed prices increasing more than expected while nominal January retail sales seasonally contracted. Bank industry news was more subdued than recent weeks.

The January Consumer Price Index (CPI) from BLS (February 13) found the consumer basket to continue to rise well ahead of the Federal Reserve’s annualized 2% target rate. While the price of all items increased 3.1% from the prior year, the core basket which is the greater focus for monetary policy path increased 0.4% from December. The report called out increases among housing, insurance and health care.

In thinking about future near term inflation for 1H24, the good news is that the 2023 roll months for core PCI are high with February 2023 at 0.5% and the following 3 months at 0.4%. This should set up for a steady decline from January’s reported 3.9% 1-year increase in core CPI. Similarly core Personal Consumption Expenditures monthly increases will also be rolling 4 months of 0.3%.

More challenging is the disturbing recent trend of accelerating core CPI inflation. When we evaluate the last 6-months annualized, the downward 2H23 trend troughed in November at 2.8% and has subsequently begun to slope positively to a 3.4% January reading. I think the Fed will be hard pressed to initiate rate cuts in a non-stressed environment without core CPI trends again trending lower on a monthly basis towards the 2% target rate.

I find the focus on Fed rate cuts within the context of banking industry net income drivers to be less clear cut than a surface analysis possibly suggest. I do not have a hard number but qualitatively I believe a larger number of banks have a higher net interest outlook in a Fed pause scenario than if short term rates were to follow the futures curve. Most banks remain asset sensitive and would see loans reprice lower more quickly than funding.

Bank equities positive response to potential rate cuts tells me that valuation decisions are prioritizing economic and credit risks over net interest income outlook. Bank credit would stand to benefit in a lower rate environment. For example, maturing Commercial Real Estate loans that would be criticized if renewing at current market rates, would see greater Debt Service Coverage Ratios if renewing at rates forecast by the forward curve. More broadly the inverted yield curve as future recession indicator continues to warn of economic risks. Lower short end rates could be very helpful in moving the curve towards positive slope.

Other macro news in the week included the Census Bureau’s January Retail Sales report (February 15) which showed seasonally adjusted contraction in total nominal sales of -0.8% from December. My thesis is that there are 2 categories of U.S. consumers, home owners and renters. Home owners more typically have locked in there housing cost. Even those with mortgages are more likely to have very low, fixed financing rates. Renters on the other hand have had to manage inflation across a greater portion of their non-discretionary purchase basket and are more likely to see inflation burdened budgets. Earlier this month, the New York Fed published their Quarterly Report on Household Debt and Credit (February 6). Among the many interesting data in the report, I highlight the delinquency chart by loan type. Credit card and auto loan delinquency rates continue to move higher. Residential real estate credit quality remains pristine. The tale of two consumers would seem to fit with this data. The report does not have cross tabs on renters and home owners, but it does segment by age group. Consumers under 29 would be expected to more likely be renters. This segment is experiencing the highest delinquency rates across age groups.