Weekly Review & Outlook: August 21, 2023

Another light volume trading week saw bank stocks consolidate lower to various bank sector indices’ 50 day moving averages. Better than expected economic data along with another rating agency warning, consensus declaration to hawkish Fed minutes and negative China headlines all contributed to trading weakness.

In evaluating the July FOMC minutes (August 16), I find this to be the latest battle of man v. machine. Headlines declared the minutes hawkish citing Natural Language Processing (NLP) models which attribute and count the binary assigned references according to computer code. When I read the minutes focused on risk management details, I find the introduction of “two sided” risks as important. Here is the specific paragraph with my emphasis noted.

“Participants discussed several risk-management considerations that could bear on future policy decisions. With inflation still well above the Committee’s longer-run goal and the labor market remaining tight, most participants continued to see significant upside risks to inflation, which could require further tightening of monetary policy. Some participants commented that even though economic activity had been resilient and the labor market had remained strong, there continued to be downside risks to economic activity and upside risks to the unemployment rate; these included the possibility that the macroeconomic effects of the tightening in financial conditions since the beginning of last year could prove more substantial than anticipated. A number of participants judged that, with the stance of monetary policy in restrictive territory, risks to the achievement of the Committee’s goals had become more two sided, and it was important that the Committee’s decisions balance the risk of an inadvertent overtightening of policy against the cost of an insufficient tightening.”

In my opinion, since the rate hike cycle began in March 2022, the price stability aspect of the Fed mandate was almost exclusively prioritized. With rates now at a restrictive level, the maximum employment mandate should begin to receive more attention. In this context, the July minutes are more neutral than broadly portrayed.

A key element to the future monetary policy path is the uncertainty to which already implemented tightening measures lag and to what degree. The San Francisco Fed published research on the state of consumer savings provocatively titled Excess No More? Dwindling Pandemic Savings (August 16). In the nearby chart, the red area shows “updated estimate for cumulative drawdowns, which reached more than $1.9 trillion as of June 2023. This implies that there is less than $190 billion of excess savings remaining in the aggregate economy. Should the recent pace of drawdowns persist—for example, at average rates from the past 3, 6, or 12 months—aggregate excess savings would likely be depleted in the third quarter of 2023.”

If the report’s analysis is correct, consumer resilience of the past few years may be about to lose another leg of support. Student loan deferment and expanded lockdown era social benefits have already lapsed. Consumers as a whole may soon be facing even greater challenges meeting household budgets that are more than 17% higher from February 2020. The proverbial “long and variable lags” of monetary policy are real and are likely still substantially ahead of us.