August 11th, 2023
It is not often one gets to use a rating agency pun for a headline two weeks in a row, but here you have it. This week it was Moody’s who made news by downgrading the U.S. regional banking sector. On Tuesday, the credit agency explicitly downgraded 10 banks while placing another 11 on negative credit watch. The move comes on the heels of Fitch having downgraded the U.S. government’s credit rating from AAA to AA+ just last week. In issuing its downgrade, Moody’s cited the higher interest rate exposure regional banks have relative to their larger bank brethren and their concern that regional bank asset-liability management risks may compound should the Fed keep rates “higher for longer” as many Fed officials have repeatedly suggested. The U.S. banking sector – and its equities in particular – had been on a tear recently, having seen their deposits stabilize in Q2 following the collapse of Silicon Valley Bank and Signature Bank in March. The latest ratings downgrade served as a reminder to investors of the threat that still lies ahead with $1.5 trillion of real estate debt needing to be refinanced between now and 2025. Regional banks are heavily exposed to real estate, and the combination of higher rates, falling asset valuations, and lower lending liquidity could result in regional banks facing a slew of workouts and outright defaults in the years ahead. The untimed nature of Moody’s downgrade took markets by surprise, but July’s better-than-expected CPI print helped counterbalance investors’ mood – pun intended. Thursday’s positive CPI report was followed by Friday’s negative PPI report, which showed indications of reinflation at the producer level that investors worried could lead to higher future inflation at the consumer level. Markets see-sawed throughout the week’s session with the Dow ultimately netting 0.62% for its effort.
For the first time in 12 months, headline inflation accelerated in July, rising 3.20%. July’s reading was below consensus estimates of 3.30%, but still represented an increase over June’s 3.00% annual rate. An increase in the cost of goods and core services was responsible for the increase relative to the year-ago level. Food prices rose 4.90% year-over-year (yoy) overall with the “food away from home” subcomponent increasing 7.10% as more consumers frequented establishments amid their summer vacations. A significant drop in energy prices helped contain topline inflation, however. Energy prices were down -12.50% from the year ago period with gasoline prices declining -19.90% from last year’s levels. Surprisingly, despite the extreme temperatures, electricity costs only registered a 3.00% increase from a year ago. Core CPI, however, remained a thorn for both consumers and the Fed’s interest rate policy, rising 4.70% yoy. Inflation was broad-based with prices rising for new vehicles, apparel, and medical care commodities (medicinal drugs and medical equipment and supplies). Core services remains particularly high, increasing 6.10% from the year ago period. While the CPI report showed that there remain certain areas that are continuing to exhibit high inflation, the month-to-month, U.S. City Average CPI – both for all items and for core – only grew at 0.2% (2.4%, last month annualized). This was below the 0.3% recorded in June, which had investors sighing with relief that perhaps the Fed’s work is done. Friday’s producer price report, however, stoked concerns over that interpretation as wholesale prices rose 0.30% in July, higher than expected. July’s monthly gain was the biggest monthly gain since January, and it is a sharp rebound from an unchanged reading in June. Year-over-year, however, producer prices were only higher by 0.80%, but investors couldn’t help but wonder if July’s monthly headline PPI reading was simply an outlier or reason for concern. The core PPI, which excludes food, energy, and trade, rose 2.70% yoy, but increased 0.30% month-to month (3.6% monthly annualized). Like the headline PPI figure, this was a significant countertrend move that easily erased the -0.10% drop in June that investors had cheered. Investors’ initial elation over Thursday’s CPI reading was soon replaced by bewilderment once Friday’s PPI report dropped.
High Interest Rates Crimp Global Demand
Global trade continued to slow amid high borrowing costs and weakening consumer demand. The U.S. trade deficit narrowed sharply in June as businesses cut back on purchases of foreign-made goods, resulting in imports falling to their lowest level in more than 1-1/2 years. Imports of goods and services fell -1.00% to $313 billion while exports dipped -0.10% to $247.5 billion. The drop comes as businesses are seeking to manage inventories more carefully on the expectation that demand will soften and rates will remain elevated. China trade figures punctuated these expectations. China’s imports fell -12.40% yoy in July, much worse than the forecast for a -5.00% decline. China’s exports, a proxy for global demand, contracted even more sharply, down -14.50% compared to the -12.50% estimate. China’s figures not only point to a significant deceleration within the world’s second largest economy, but it also points to a chilling in global demand for goods.
This week was one of those weeks where we are incredibly grateful to not be a financial news journalist. Imagine having to produce a 2000-word piece on the week’s main news item – the CPI report. The report gets released on Thursday. The headline reading was better than expected. Check. The all items and core readings both looked really good on a monthly basis. Check and check. Now for the headline, “Inflation Beaten, Fed’s Job Done.” With that in hand, all that is left to do is reference the trusty rolodex (we’re dating ourselves) and proceed to spend the rest of the day collecting savory sound bites from industry pundits and polishing the piece up for a Friday AM release. Then comes the Friday PPI report, which blows a hole in the primary thesis, but it’s too late…. the story has dropped. If you were up early this morning, you probably saw a steady stream of “Fed victory” articles flowing from dawn until 9 AM, when someone finally broke a broom handle and jammed it into the printing press upon realizing that the CPI and PPI reports don’t jive. We’re not criticizing. We’re sympathizing. We’ve written many a piece, only to be forced to reevaluate our initial position when new data is released on a Friday morning. In our case, we can simply extend our own deadline, but we’re not having to navigate the complexities and demands of the corporate juggernauts that distribute the majority of what we all read on a daily basis. Still, you can’t help but smile when the totality of data doesn’t match the conviction of the headline. This was just one of those types of weeks. Inflation was this week’s main event, and while the news media and markets want to claim victory, that determination is still inconclusive. The most you can say is this week’s reports show that progress is being made, but there are still a number of elements that need monitoring. Furthermore, there is a nuance that is being missed in the inflation and interest rate debate and one that Moody’s is rightfully pointing out. Markets believe that their interest rate “problem” is entirely a function of inflation. It is true, inflation and the entire yield curve have been tightly tethered to the Fed during this tightening cycle. It is possible, however, that inflation and short-term rates uncouple from intermediate and long-term rates once inflation regresses to norms. One scenario is that the Fed lowers rates once they are satisfied that inflation has returned to normal, reducing short-term rates, while the long end of the curve simply stays where it is. This scenario could happen under a classic growth expectation for the economy. The other option is that the Fed simply chooses not to lower rates once inflation is over. Low rates are a modern phenomenon. The Fed might prefer to have some firepower to help the economy in the event of a crisis, particularly if the economy shows that it can sustain itself while doing so. Higher rates may cause some dislocations but so long as the broader economy can remain healthy, higher rates should be welcomed by markets and investors alike. That is not what markets are conditioned to, however. For markets, lower inflation is synonymous with lower rates, and having been juiced by cheap money over the past fifteen years, investors are craving a pivot by the Fed. This week’s CPI and PPI reports, on balance, might move the Fed closer to a pause, but investors might soon realize that inflation may be a waning factor for rates longer term.
The Week Ahead
It’s the summer of Barbenheimer (Barbie and Openheimer), Taylor Swift, and Beyonce. Collectively the quad has raked in $2.1 billion in ticket sales and given local economies a much needed boost as consumers frequent restaurants and hotels as part of the movie and concert-going experience. July retail sales should see a pop from strong consumer demand. Housing also comes under the spotlight as high interest rates and tight existing home sales inventory push homebuyers into the new homes sales market. The trend is set to continue as builders release housing start and permits figures.
Will(ful) Neglect: Majority of Americans Do Not Have an Estate Plan
A study released earlier this week showed that 60% of Americans do not have an estate plan. The publication of this study encouraged us to revisit this topic in this week’s market commentary because this statistic has remained consistently high historically, and it continues to be a cause for concern, particularly when considering that other research has shown this percentage to be as high as 67%. The study also showed that 58% of respondents reported either experiencing conflict themselves or knowing someone who has experienced conflict due to the absence of an estate plan or will. Additionally, 37% of adult children who know their parents have a will would not know where to find their parent’s will. Lastly, more than one third of respondents shared that there are surprises for their beneficiaries in their wills.
There are many potential consequences of not having an estate plan, and while the complexity of an estate plan may vary from individual to individual, everyone needs a plan and a strategy for managing and protecting their estate. Your “estate” includes all the assets you have accumulated during your lifetime – typically including savings, stocks, bonds, your home, 401ks, real estate, business interests, life insurance, and personal effects. If you are just starting out, an estate plan may simply focus on who will receive your assets after your death and who should manage your estate, pay your final expenses, and handle the distribution of your assets. Parents with young children should have an estate plan to ensure their children will be cared for financially and be placed with an appropriate guardian. Individuals with larger estates can use estate planning to identify various ways of preserving assets for beneficiaries and reducing or postponing estate taxes. Perhaps most importantly, having an estate plan in place prevents your assets from going to people you didn’t intend them to and can reduce or minimize conflict among your heirs by clearly outlining your wishes. Furthermore, having an estate plan in place can avoid probate which is a lengthy, costly, and public court process.
Estate planning can help accomplish the following:
- Designate beneficiaries for your assets
- Establish trusts to ensure that your assets are managed for the benefit of your heirs and according to your wishes
- Determine how and by whom your assets will be managed during your lifetime if you ever become unable to manage them yourself
- Protect minor children from court-imposed guardianships and protect and provide for special needs dependents
- Minimize gift and estate taxes to preserve more of your assets for your heirs
- Reduce the cost of attorney’s fees, probate fees, and executor’s commissions
Similar to a financial plan, estate plans should be reviewed and updated regularly, and particularly around major life events or changes. If you have any questions about estate planning or financial planning, please do not hesitate to contact one of our advisors at (214) 891-8131.