The Fed (thinks it) has time on its side

Good morning. I’m old enough to remember when private equity liked to buy companies with steady, predictable cash flows that were ripe for cost cuts. Yesterday came the news that Apollo was interested in buying Paramount Global’s Hollywood studio. What is the movie business famous for? Lack of predictable profits and hatred for “suits” who come in to try to tell the insiders what to do. Perhaps a reader can explain how things have changed: robert.armstrong@ft.com.

The Fed

US inflation has been going sideways for several months, at a level that is above the Federal Reserve’s target and the country’s comfort zone. In response, the central bank announced yesterday that it would do nothing.

The Federal Open Market Committee’s plan of action — as expressed in the near-term rate projections of its members and in the tone of its chair’s press conference — is exactly as it was in December. Back then, the FOMC had enjoyed an almost uninterrupted six month run of good inflation news, and thought that its policy rate would be 4.6 per cent at the end of this year. It still thinks this, despite notably disappointing inflation reports in January and February. More importantly, Jay Powell’s language has retained its decidedly optimistic flavour:

As labour market tightness has eased and progress on inflation has continued . . . we believe that our policy rate is likely at its peak for this tightening cycle, and that if the economy evolves broadly as expected, it will probably be appropriate to begin dialling back policy restraint at some point this year . . . 

Wait wait wait, one wants to interrupt, progress on inflation has not continued. Here is the chart Unhedged used to make this point a week ago, after the February CPI numbers landed:

Here’s what Powell had to say about this:

. . . the January CPI and PCE numbers were quite high. There is reason to think there may be seasonal effects there, but nonetheless we don’t want to be completely dismissive of it. The February number was high, higher than our expectations, but we currently [expect] well below 30 basis points (0.3 per cent month-over-month) core PCE, which is not terribly high. So it’s not like the January number. I take the two of them together, and I think they haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes bumpy road towards 2 per cent.

The FOMC thinks that two months of bad data, even accompanied by remarkably resilient economic growth and some extra accommodation provided by exuberant markets, is not enough for it to change its stance. It may be right. It could be that seasonal factors, and the fact that falling market rents refuse to appear in housing services prices, mitigate the badness of the numbers. And maybe two months just isn’t all that much time. But make no mistake: the Fed has decided that the disinflation story is fully intact and their policy posture, solidly tilted towards rate cuts in the near future, is unchanged.

This plain fact might be obscured by changes in the committee’s longer-term economic projections. Since December, it has made non-trivial increases in its view of the appropriate policy rate for 2025 (3.6 per cent to 3.9 per cent) and 2026 (2.9 per cent to 3.1 per cent), and even nudged its view of the long-term neutral rate a tiny bit (2.5 per cent to 2.6 per cent). Estimates for economic growth in the out years were nudged up, too. The “dot plot” of individual members’ rate policy views showed a decided migration upwards.

This is hawkishness, surely? No, it is not. Remember that the committee members’ ability to forecast the behaviour of the economy more than a quarter or two in the future is no better than yours or mine. We can’t do it, and neither can they. They have decisions to make about what to do this year, and they have been clear where they stand on those decisions. They plan to cut. Their longer-term projections, by contrast, are not plans — they are expressions of an attitude, a commitment to professional seriousness. Yes, the projections say, we see the bad data. But it does not change our mind.

The low-end consumer revisited, redux 

Unhedged has been writing recently about various scraps of evidence suggesting that, even as the US economy as a whole hums along, there is significant stress among lower-income consumers. The hard data comes from car loan delinquency data. Card delinquency rates don’t look so great either, as my colleagues Stephen Gandel and Patrick Mathurin described in detail yesterday. The soft data comes from corporate executives discussing demand trends — a series of anecdotes that continues to accumulate, whether it be a Coca-Cola executive saying that while the American consumer overall is strong, “we all know that a lower-income consumer is under more pressure”, or the CEO of the high-gloss burger chain Shake Shack saying that “in times like this” lower-income consumers trade down to cheaper brands than his.

A reader suggested another bit of hard data: hardship withdrawals from 401k retirement accounts. Because such withdrawals are taxed, and deferring withdrawal until retirement avoids this, the trend is informative. Vanguard, one of the largest 401k providers, tracks this:

A 2019 law made it easier to take emergency withdrawals, which may account for some of this trend, but the 2023 jump is striking all the same.  

In the hope of getting a more detailed view of what is going on, I spoke to Jennifer Thomas, a portfolio manager at Loomis Sayles who specialises in asset-backed securities. She tracks consumer loans at a granular level, and agrees that there is a subset of consumers who are getting into trouble. Typically, these borrowers have missed a single loan payment and are unable to make it up. “When we talk to the loan issuers, they all say the same thing — borrowers have jobs, they just can’t catch up.” Interestingly, Thomas notes that the problems are particularly acute for the 2021 and 2022 loan vintages, when many subprime lenders relaxed credit standards because consumer balance sheets were so strong. Standards have since tightened up again. There is very little “deep” subprime lending currently and interest rates are high, now that stimulus checks are largely spent and student loan payments have been reinstated.

The big question is whether the stress at the low end is the leading edge of a weakening trend that will work its way further into the economy. Ian Shepherdson of Pantheon Macroeconomics thinks that it might be. His argument is that the excess savings built up during the pandemic acted as a wall separating the actions of the Fed from the private sector. Now that excess has been run down for all but the richest households, the wall is gone. Here is his chart of household liquidity, using inflation adjusted figures from the Fed’s distributional accounts:

This change in household balance sheets is visible in weak real retail sales, and small business is pinched, too — both by customers holding back and by expensive credit. Shepherdson sites National Federation of Independent Business net intention to hire survey, which is not showing an encouraging trend among small businesses:

Shepherdson is not confident that a recession is coming, but thinks we could see an abrupt slowdown in payroll numbers sometime soon — at which point the state of the economy will be a worry for everyone, not just those on low incomes.

One good read

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