We saw a bit of a rotation in the equity markets this week with the growth names sagging a touch while the broader market pushed higher. Emerging was notably weak as well, as Chinese stocks in particular struggled. The bond markets were pretty quiet ahead of next week’s Fed meeting. Another quarter-point hike is widely expected, taking the Fed Funds rate up to between 5.25% and 5.5%. There’s some thought the Fed will signal that this is the last hike, but it seems more likely they will act coy and not pre-commit to any particular policy.
After all, trying to guess the direction of both growth and inflation isn’t an endeavor that economists distinguish themselves at. Take the debate about the U.S. consumer. In one camp you have those making the case that the consumer is on the cusp of disaster because all the excess cash built up during the COVID crisis is going to run out soon. The chart below captures the essence of the recession argument.
But there’s nuance to every debate. In the U.S., consumers have definitely drawn down their saving levels, but it’s important to keep things in perspective. The chart below shows savings levels around the world and where they stood at their COVID peak.
Globally, only the U.S. has spent down savings, but the level still stands at around 6% of GDP – that’s about $1.4 trillion, down from $2.3 trillion. That’s still a big number.
To quote MRB:
‘Based on current monthly income and consumption trends, the remaining excess savings will likely be completely drawn down by Q1 2024. In practice, this means that the total level of U.S. personal savings by the end of Q1 2024 will equal the level that would have prevailed had the pandemic never occurred, and if households had continued to earn and spend along pre-2020 trends between 2020 and Q1 2024.’
What they are saying is that the savings level is simply getting back to normal. Below is a longer-term view of savings in the U.S.
Another leg of the recession argument rests on the damage higher rates are having on consumers. But the counter argument is that consumers are also earning more on their cash balances. The chart below shows that those earnings actually modestly exceed the outflows (although the story would be very different if we broke out earnings and expenses at the various income levels).
This isn’t an argument for either booming growth or recession, only that the Fed will likely keep all their options open next week.
‘A Billion Here and a Billion There…
…and pretty soon you are talking real money.’ This quote is attributed to Senate minority leader Everett Dirksen, but there is no direct record of him saying it. But what he might have said in the 1960s would work just as well today, just increase the amounts by a factor of 10.
After all, fiscal policy is in a bull market, so to speak. The debt ceiling proved to be a ‘nothing burger’ as far as capping spending goes. And as a matter of fact, it put the whole debt ceiling issue on hold until 2025, meaning there’s no cap on spending over the next couple years (not that the debt ceiling proved to be much of a restraint).
And this is another reason forecasting both growth and inflation is proving so vexing for the economics profession. It’s been a long time since the fiscal side of things has been so stimulating. Take the recently passed legislation as noted by Alpine Macro:
‘The Biden administration has introduced several large-scale spending initiatives in a short period of time. They were presented as vital to U.S. competitiveness in a decoupling bipolar world beset by climate change. In theory, these programs will play out over the next decade. In reality, the impact will be frontloaded and they are already affecting economic and investor trends.’
The key details are as follows:
Inflation Reduction Act
$400bn in federal funding directed to clean energy initiatives.
Funding delivered through tax incentives ($216bn), grants ($82bn), and loan guarantees ($40bn).
$280bn in spending over ten years.
$200bn designated for scientific R&D and commercialization.
$52.7bn allocated for semiconductor manufacturing, R&D, and workforce development.
$24bn in tax credits.
Infrastructure Investment and Jobs Act
$550bn over five years.
$121bn for roads and bridges, $105bn for public transport, $42bn for airports and ports, and $15bn for EV charging infrastructure.
$284bn for core infrastructure which includes $73bn for the power network, $65bn for broadband, and $55bn for water infrastructure.
Based on the above, annual environmental spending alone in the U.S. is going to triple over the next ten years.
We aren’t arguing that this is good or bad, only that this burst of spending is unlike anything we’ve seen in a long time. And it also ties in with the geopolitical backdrop. For example, China dominates battery manufacturing, and billions are likely to be spent to reverse this.
Of course, the new spending is put on the national credit card. The deficit has widened recently due in part to higher interest costs, but also due to renewed spending.
The level of deficit spending today is something we usually only see during recessions. Deficit levels of 7% or 8% are usually associated with unemployment rates of 8% or more, not sub-4%, as you can see below.
How should the Fed set interest rate policy in this environment? Good question. They almost certainly don’t know, and this is before we even talk about the impact of AI on employment and productivity in the years to come.
(Other) Charts We Found Interesting
Every Wall Street strategist came into 2023 with subdued expectations, and many of them predicted lower prices. They are playing catch-up.
Interest costs now exceed defense spending.
But it’s worth looking at a longer-term chart of interest costs as a percent of GDP.
Another argument in favor of a resilient U.S. consumer – effective mortgage rates have hardly moved.
Tony Bennett in 1972 - Passing of another legend. The NYT’s obit had this gem – ‘With the possible exception of his former wives, everyone, it seemed, loved Tony Bennett.’
Have a good weekend
Chief Investment Officer
Gemmer Asset Management LLC
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