Weekly Review & Outlook: February 5, 2024

“People are going to the store, and they’re paying much more for the basics of life than they were two years ago, three years ago. And they’re not happy about it.” – Jerome Powell

After lackluster bank quarterly reports, an incrementally hawkish Fed and strong jobs report combined with large provisions taken at New York Community Bank (NYCB) to knock bank equities lower to their worst weekly performance since June.

As expected, the Federal Reserve Open Market Committee (FOMC) left their target interest rate unchanged with an upper bound of 5.5% at their January 31 meeting. Comments in the implementation press conference, however, dampened odds that easing would begin at the next meeting in March. Fed Chairman Powell stated (my emphasis),We included that language in the statement to signal clearly that with strong growth, strong labor market, inflation coming down, the Committee intends to move carefully as we consider when to begin to dial back the restrictive stance that we have in place. So, if you take that to the current context, we’re going to be data-dependent. We’re going to be looking at this meeting by meeting. Based on the meeting today, I would tell you that I don’t think it’s likely that the Committee will reach a level of confidence by the time of the March meeting to identify March as the time to do that. But that’s to be seen. So, I wouldn’t call — you know, when you ask me about in the near term, I’m hearing that as March. I would say that’s probably not the most likely case or what we would call the base case.”

The statement and press conference also noted that balance sheet run-off or Quantitative Tightening (QT) will continue at its current pace. Tapering in QT will begin to take shape following FOMC discussion at the March meeting. Powell provided structure to the committee’s perspective stating, “we see those as independent tools. And so, for example, if you are normalizing policy, you might be reducing rates but continuing to run off the balance sheet. In both cases, that’s normalization, but from a strict monetary policy standpoint, you could say we’re loosening and tightening. So that could happen. It’s not something we’re planning or thinking about. But right now, we’re thinking about getting to a place where we’re going to see the balance sheet runoff to continue. We’re watching it carefully, and as I said, we’ll be looking into that as a Committee starting in March.”

Also last week, BLS released the January Employment Situation report (February 2) which found a surprisingly high 353k net jobs added in the month. The annual revision process for the Establishment survey was positively revised higher by 359k. The categories experiencing the highest growth in January were Health Care, Retail/Clerical, Administrative and Government. Looking back 1 year shows a stunted Goods-producing economy with jobs growth of just 1.2%. More revealing is Goods-producing less Construction added just 44k jobs from a year ago or +0.3%. Within the Banking industry, the late cycle report from NYCB served as a sector catalyst to refocus investors to real estate credit risks. The bank took a $552mm provision for credit losses mostly to build “reserves to address office sector weakness and an expected increase in criticized loans due to repricing risk in the multi-family portfolio.” I do not express opinions on specific stocks in this letter. We do that in the management of the Redwood Fund. So, I refrain from opining whether the -42% drop in NYCB stock seems appropriate to their announced results and outlook. I will note that the importance is that credit risks for the industry should be part to the sector valuation. The move from the dystopic view of “half the banks are insolvent” to an “immaculate landing” in the rate hike cycle seemed a bit bipolar to me. In my perspective recession risks remain elevated and equity premiums should be greater to justify investors owning risk assets. Credit should at least normalize further in 2024. The scope of a larger credit cycle being realized is still open for debate.