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Economic Momentum Perplexes Forecasters—interest Sensitive Sectors Defy Fed’s Rate Increases–consumer Spending Slowed After January—dwindling Excess Consumer Savings Clouds Holiday Spending— Encouraging Inflation Signs—could July Rate Hike Be The Peak?

Date Posted: July 11, 2023

Economic Momentum Perplexes Forecasters

The Covid Pandemic Caused, In Part, Disruptions And Accelerated Changes That Continue To Puzzle Economic Forecasters In The Current Economic Environment. A Clear Example Of This Can Be Seen In The Better Than Expected 2% Growth For The Final Estimate Of First Quarter’s Real Gdp Growth. However, The Growth Disparity Between Gdp And Gdi Rates Suggests That Economic Momentum May Not Be As Robust As Implied By Gdp Alone (See Figure 1.) That Disparity May Be Resolved In September With The Annual Benchmark Revisions. If The Revisions Tilt Towards Gdi Data, It Would Mean Slower Economic Momentum Than The Currently Estimated Gdp Growth.

Figure 1
First Quarter Real GDP/GDI Estimate Progression

GDP Plus

Source: Bureau of Economic Analysis, Federal Reserve Bank of Philadelphia

Consumer Spending Slowed After January Into Second Quarter

The Substantial 4.2% Growth In Personal Consumption Expenditures Greatly Influenced First Quarter Gdp Growth. Several Factors Such As Strong Labor Markets, Aggregate Excess Savings,
And The Eight Percent Increase In Social Security Payments Fueled Increased Consumer Spending. However, This Surge Came Primarily In The First Month Of The Quarter And Then Leveled
Off Through May (See Figure 2.) If Consumer Spending Continues At This Slow Pace, It May Be Necessary To Revise Gdp Growth Estimates For The Second Quarter.

Figure 2
Consumer Spending % Change by Month 2023

Source: Bureau Of Economic Analysis,

Dwindling Excess Savings And End Of Student Loan Forebearance Could Cloud Fourth Quarter Holiday Spending

The Record Breaking Federal Fiscal Stimulus Programs Propelled Current Economic Momentum By Generating Excess Savings. The San Francisco Fed Estimates These Programs Generated
Leftover Excess Savings Totaling About $500 Billion. They Expect This Current Level Of Excess Savings Will Diminish By Year-end. The Upcoming Termination Of Student Loan Forbearance Will
Likely Further Weaken Consumer Finances (See Figure 3.) Recent Observations Made By Consumer Package Goods Producers And Retailers Indicate Early Signs That Consumers May Be Reducing Their Discretionary Spending. Lower-income Consumers, Facing Tighter Budget Constraints, In Light Of Elevated Inflation, Appear To Be Seemingly Shifting To Lower-priced Products. If That Initial Indication Of Reduced Spending Expands, It Could Help Curb Inflation And Selectively Squeeze Profit Margins.

Figure 3
Student Loan Debt Balance ($tr) And Share By Age

Source: New York Fed Consumer Credit Panel/EquiFax, Moody’s Investors Service,

Interest Sensitive Sectors Defy Fed’s Rate Increases

Historically, When The Fed Raises Rates, Sectors Sensitive To Interest Rate Changes, Such As Autos And Housing, Tend To Enter A Cyclical Downturn. However, In This Cycle, Neither Sector Seems To Be Fully Playing Its Expected Role In Supporting The Fed’s Anti-inflationary Measures. The Auto Industry Experienced A Temporary Volume Slowdown Due To Parts Shortages But Quickly Recovered Even Before The Fed Hiked Rates. This Positive Trend Persisted Even After The Fed Increased Its Funds Rate Five Times (See Figure 4.) Recently, A Major Auto Data Provider Raised Its 2023 Sales Forecast To 15 Million Vehicles Representing Eight Percent Growth Over Last Year. Such Significant Auto Sales Growth Could Pose An Obstacle To The Fed’s Attempts To Slow The Economy And Moderate Inflation.

Figure 4
Sales of Automobiles and Light Trucks

Source: Autodata Corporation Via Haver Analytics

Fed Contributes To Its Own Housing Problem

The Fed May Face A Greater Challenge In The Housing Sector Which Shows A High Sensitivity To Significant Interest Rate Changes. Interestingly, The Fed Unintentionally Contributed To Its Own Housing Problem. The Rapid Increase In The Funds Rate Led Mortgage Rates To Rise From Sub-three Percent To Over Seven Percent Today. These High Mortgage Rates Prompted Homeowners  To Opt To Stay In Their Current Homes Benefitting From Their Low-rate Mortgages. Consequently, Their Decision Drove Existing Home Inventory Available For Sale To Multi-year Lows (See Figure 5.) Despite The More Than Doubling Of Mortgage Rates, The Scarcity Of Existing Inventory Spurred New Home Sales. Single Family Home Sales In May Reached 760,000 A Rise From 611,000 When The Fed First Started Raising Rates Last March (See Figure 6.) This Unexpected Strength In New Home Sales Counters The Fed’s Efforts To Slow The Economy To Achieve Its Inflation Target. As A Result, The Strong Performance Of The Housing And Auto Sectors Will Likely Contribute To The Fed Increasing The Funds Rate At Its Next Meeting.

Figure 5
Nar Us Existing Home Inventory (Mm)

Source: National Association Of Realtors, The Daily Shot

Figure 6
New One Family House Sales

Source: Census, HUD

Encouraging Inflation Signs

Figures 7 And 8 Show The Recently Reported Personal Consumption Expenditures (Pce) Price Index. Despite Modest Decreases For Both Year-over-year And Month-to-month Rates, Core Pce
Inflation Remains Elevated At Roughly The Same Level Since November 2021 (See Figure 10-the Blue Line.) Encouragingly, For The First Time Since The Current Inflationary Cycle Began, Median Pce Inflation Shows A Potential Initial Downward Bend (See Figure 9-the Orange Line.) The Significance Of This Can Be Drawn From The Conclusion Of The Cleveland Fed’s Center For Inflation Research Which States That, “The Median Pce Inflation Rate Can Be Useful For Estimating The Underlying Trend In Inflation And Forecasting Future Inflation.”

Figure 7
PCE Price Index % Change Past Month

Source: Federal Reserve Bank of Cleveland

Figure 8
PCE Price Index % Change Past 12 Months

Source: Federal Reserve Bank of Cleveland

Figure 9
Median Personal Consumption Expenditures Inflation

Source: Federal Reserve Bank of Cleveland, Bureau of Economic Analysis, Haver Analytics

Shelter Costs Should Reduce Inflationary Pressures Later In The Second Half

Shelter Costs Comprise A Significant Share Of The Core Consumer Price Index {42%) And An Important 20% Share In The Fed’s Key Measure Of Inflation, The Core Pce Price Index. Research
Conducted By The Richmond Fed Suggests That Changes In Shelter Indices Typically Lag Market Rent Changes By Roughly A Year. According To The Corelogic Single-family Rent Index {sfri),
April Rents Experienced A 3.7% Increase Marking A Sharp Decline From The 14% Increase Last Year (See Figure 10.) The Combination Of Lower Rent Increases And The Lag Effect May Result In
Decreased Pressure On The Shelter Cost Indices Starting Sometime In The Second Half Of This Year.

Figure 10
National SingleFamily Rent IndexY/Y % Change by Price Tier

Source: CoreLogic SingleFamily Rent Index, April 2023

Investment Conclusions

Peak Funds Rate: In Its June Minutes, The Federal Open Market Committee Reaffirmed Its Strong Commitment To Returning Inflation To Their 2 Percent Objective. To Make That Even Clearer, Chair Powell, Emphasized That 2 Percent Objective Seventeen Times During His Subsequent Press Conference. In Response, The Futures Markets Postponed The Likelihood Of Rate Cuts Out To 2024. However, The Fed’s Data-dependent Approach May Not Effectively Capture Inflection Points In The Economy. Initial Indications, Such As The Improving Median Pce Price Index, Reduced Shelter Inflation Pressures, And Recent Cautious Business Commentary, Suggests The Possibility Of A Slowing Economy. If These Early Signs Prove Correct And The Fed Hikes The Funds Rate In July, We Believe There Will Be A Pause In September. The Pause Will Allow The Fed To Evaluate The Further Impact Of Their Rate Hikes On The Economy. If Growing Signs Of An Economic Slowdown Start Increasing, Then The July Funds Rate Could Potentially Be The Peak.

Equities: As We Enter The Second Half Of 2023, Long-term Investors Should Broaden Their Focus Beyond Just This Year To Capitalize On Current Investment Opportunities Created By The Pandemic. Additionally, Investors Should Consider The Potential Investment Opportunities
Resulting From The Federal Government’s Greater Focus On Developing Industrial Policies To Direct Capital Investment Within This Country. To Identify Such Growth Prospects, Investors Should Venture Beyond The Usual Growth Names That Dominated The Previous Decade. Prioritizing High- Quality Companies With The Potential For Sustained Future Free Cash Flow And Dividend Growth Driven By Above Average Returns On Capital Will Prove Crucial.

Fixed Income: As 2023 Progresses And The Fed Approaches Its Peak Funds Rate, Extending Bond Duration Will Likely Prove Increasingly Attractive. Alternative Investments Can Also Be Used For That Portion Of The Portfolio Historically Committed To Fixed Income; As They Tend To Be Less Correlated With Stocks And Bonds. That Diversification Will Also Prove Particularly Valuable In The Face Of Current Investment Uncertainties.