The simplest explanation for market movements isn’t always the most complete one
A version of this article first appeared on TKer.co
When it comes to understanding new developments in the economy or the markets, the obvious and simplest explanations aren’t always the correct or complete ones.
Consider the impact of higher interest rates. Higher rates are bad, right?
Two years ago, the Federal Reserve began hiking interest rates aggressively in its effort to cool inflation by slowing the economy. Sure, inflation rates have come way down and many economic metrics reflect decelerating growth. But the impact of higher rates has been far less severe than many expected, as reflected by upward revisions to 2023 and 2024 GDP growth forecasts. There were even economists warning of recessions that never came.
That’s because higher rates aren’t only bad. There’s also a brighter side of higher interest rates.
Households and businesses have been earning more interest income on their cash and new bond holdings. From The Wall Street Journal on Wednesday:
Washington has pumped out trillions of dollars in recent years for pandemic relief, clean-energy projects and more, selling Treasurys to finance soaring budget deficits. The snowballing debt, coupled with the highest rates in more than two decades, pushed government interest expenses to a seasonally adjusted annual rate of nearly $1.1 trillion, according to first-quarter figures from the Commerce Department.
That is income for cash-rich companies or Americans who park savings in money-market funds, where 5% annual returns can turn into a surprise five figures…
Andy Constan, chief executive of the investment consulting firm Damped Spring Advisors, said the higher government-bond payouts likely boosted Americans’ overall spending.
According to previous reporting by the WSJ’s Gunjan Banerji, “Investors parking cash in money-market funds [in 2023] reaped around $300 billion in interest income — more than in the prior decade combined.”
Of course, this financial tailwind mostly applies to those with a lot of cash and not too much debt.
In a research note published on Wednesday, JPMorgan’s Michael Feroli cautioned against jumping to the conclusion that higher rates are an obvious net benefit for economic activity: “[I]nterest income effects are only meaningful when the marginal propensity to consume of interest receivers is materially different from that of interest payers.”
Still, he concluded that “interest income flows may boost aggregate demand by a tenth or two of GDP.”
In other words, it’s possible higher interest rates have indeed been a tailwind — not a headwind — for the economy. Or as Yahoo Finance’s Myles Udland characterized it: a “backward problem” for the Fed.
A low saving rate isn’t necessarily a bad thing
While we’re on the subject of household finances, we should talk about the personal saving rate (i.e., the percent of income left after spending money and paying taxes), which at 3.6% is down from its highs and is trending below prepandemic levels.
A low saving rate intuitively sounds less than great. It sounds like people aren’t earning enough to save, or maybe they’re spending increasingly irresponsibly.
Or maybe it’s neither of those explanations.
Keep in mind that the personal saving rate reflects a snapshot of monthly behavior. So its decline doesn’t tell us much about cumulative savings.
According to Federal Reserve data released Friday, households have over $4 trillion in checkable deposits sitting in bank accounts, which is about quadruple prepandemic levels.
And for households, it’s not just cash in the bank. Record high stock prices and higher home prices have helped fuel household net worth to record highs.
If you’re sitting on a ton of wealth, do you really need to be putting away more money?
“Elevated net worth supports a low saving rate,” Deutsche Bank’s Matthew Luzzetti wrote on Monday.
TKer subscribers first read about this relationship last September when Renaissance Macro’s Neil Dutta explored this phenomenon.
“When you are ‘loaded,’ you have less reason to save,” Dutta wrote. “If my stock portfolio is rising and home prices are climbing, I don’t feel like I need to be saving as much.”
Zooming out
All of this speaks to TKer’s rule No. 1 of analyzing the economy: Don’t count on the signal of a single metric.
We’re lucky to have so many angles on the economy. Almost every day, we get periodic updates on things like jobs, manufacturing activity, housing, income, spending, sentiment, and so on. The confluence of these macro crosscurrents make for a rich mosaic on the economy.
Despite months and years of rising interest rates and falling saving rates, the bulk of the economic data has overwhelmingly confirmed consumer spending has been increasing, business investment has been rising, and aggregate wealth has been growing.
Keep this in mind as fear mongers and ill-informed commentators cherrypick data and mischaracterize it to suit their own interests.
Reviewing the macro crosscurrents
There were a few notable data points and macroeconomic developments from last week to consider:
The labor market continues to add jobs. According to the BLS’s Employment Situation report, U.S. employers added 272,000 jobs in May. It was the 40th straight month of gains, reaffirming an economy with robust demand for labor.
Total payroll employment is at a record 158.54 million jobs, up 6.23 million from the prepandemic high.
The unemployment rate — that is, the number of workers who identify as unemployed as a percentage of the civilian labor force — rose to 4% during the month. While it’s above its cycle low of 3.4%, it continues to hover near 50-year lows.
Wage growth ticks up. Average hourly earnings rose by 0.4% month-over-month in May, up from the 0.2% pace in April. On a year-over-year basis, this metric is up 4.1%.
Job switchers still get better pay. According to ADP, which tracks private payrolls and employs a different methodology than the BLS, annual pay growth in May for people who changed jobs was up 7.8% from a year ago. For those who stayed at their job, pay growth was 5%.
Job openings decline. According to the BLS’s Job Openings and Labor Turnover Survey, employers had 8.06 million job openings in April, down from 8.35 million in March. While this remains elevated above prepandemic levels, it’s down from the March 2022 high of 12.18 million.
During the period, there were 6.49 million unemployed people — meaning there were 1.24 job openings per unemployed person. This continues to be one of the most obvious signs of excess demand for labor.
Layoffs remain depressed, hiring remains firm. Employers laid off 1.51 million people in April. While challenging for all those affected, this figure represents just 1.0% of total employment. This metric continues to trend below pre-pandemic levels.
Hiring activity continues to be much higher than layoff activity. During the month, employers hired 5.64 million people.
People are quitting less. In April, 3.51 million workers quit their jobs. This represents 2.2% of the workforce, which matches the lowest level since September 2020 and below the prepandemic trend.
A low quits rate could mean a number of things: more people are satisfied with their job; workers have fewer outside job opportunities; cooling wage growth; productivity will improve as fewer people are entering new unfamiliar roles.
Unemployment claims tick higher. Initial claims for unemployment benefits rose to 229,000 during the week ending June 1, up from 221,000 the week prior. While this is above the September 2022 low of 187,000, it continues to trend at levels historically associated with economic growth.
People are traveling. From Apollo Global’s Torsten Slok: “The TSA has daily data for the number of people scanning their boarding pass with a TSA agent, and it continues to show no signs of the economy slowing down…”
Card spending is holding up. From JPMorgan: “As of 30 May 2024, our Chase Consumer Card spending data (unadjusted) was 0.7% below the same day last year. Based on the Chase Consumer Card data through 30 May 2024, our estimate of the U.S. Census May control measure of retail sales m/m is 0.47%.”
From Bank of America: “Total card spending per HH was down 0.4% y/y in the week ending Jun 1, according to BAC aggregated credit & debit card data. Retail ex auto spending per HH came in at -1.9% y/y in the week ending Jun 1. Y/y spending growth in many categories was likely impacted by the shift in Memorial Day observance (5/27/24 vs. 5/29/23).”
Used car prices are cooling. From Manheim: “Wholesale used-vehicle prices (on a mix, mileage, and seasonally adjusted basis) were down in May compared to April. The Manheim Used Vehicle Value Index fell to 197.3, a decline of 12.1% from a year ago.”
Gas prices fall. From AAA: “Gasoline prices took another trip south this week, falling eight cents since last Thursday to $3.48. It marks the largest weekly drop of the year. … According to new data from the Energy Information Administration (EIA), gas demand dipped from 9.14 b/d to 8.94 last week. Meanwhile, total domestic gasoline stocks jumped from 228.8 to 230.9 million bbl. Tepid gasoline demand, increasing supply, and falling oil costs will likely lead to falling pump prices.”
Mortgage rates tick lower. According to Freddie Mac, the average 30-year fixed-rate mortgage declined to 6.99% from 7.03% the week prior. From Freddie Mac: “Mortgage rates retreated this week given incoming data showing slower growth. Rates are just shy of seven percent, and we expect them to modestly decline over the remainder of 2024. If a potential buyer is looking to buy a home this year, waiting for lower rates may result in small savings, but shopping around for the best rate remains tremendously beneficial.”
There are 146 million housing units in the U.S., of which 86 million are owner-occupied. 39% are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged. All of this is to say: Most homeowners are not particularly sensitive to movements in home prices or mortgage rates.
Services surveys signal growth is heating up. From S&P Global’s May U.S. Services PMI: “A return to growth of new business following April’s blip supported a marked strengthening of growth in the US service sector in May. … It was not all positive in May, however, with services employment down for the second month running as firms wait to see whether the renewed rise in new business will be sustained before committing to new hires.”
The ISM’s May Services PMI also signaled growth in the sector.
Manufacturing surveys mixed. S&P Global’s May U.S. Manufacturing PMI improved from the prior month. From the report: “It was pleasing to see new orders return to growth in May following a blip in April. Although modest, the expansion in new work bodes well for production in the coming months. In fact, manufacturers cited confidence in the future as a factor contributing to increases in employment, purchasing activity and finished goods stocks.”
The ISM’s May Manufacturing PMI, meanwhile, signaled contraction in the industry.
It’s worth remembering that soft data like the PMI surveys don’t necessarily reflect what’s actually going on in the economy.
Construction spending ticks lower. Construction spending declined 0.1% to an annual rate of $2.099 trillion in April.
Near-term GDP growth estimates look good. The Atlanta Fed’s GDPNow model sees real GDP growth climbing at a 3.1% rate in Q2.
Putting it all together
We continue to get evidence that we are experiencing a bullish “Goldilocks” soft landing scenario where inflation cools to manageable levels without the economy having to sink into recession.
This comes as the Federal Reserve continues to employ very tight monetary policy in its ongoing effort to get inflation under control. While it’s true that the Fed has taken a less hawkish tone in 2023 and 2024 than in 2022, and that most economists agree that the final interest rate hike of the cycle has either already happened, inflation still has to stay cool for a little while before the central bank is comfortable with price stability.
So we should expect the central bank to keep monetary policy tight, which means we should be prepared for relatively tight financial conditions (e.g., higher interest rates, tighter lending standards, and lower stock valuations) to linger. All this means monetary policy will be unfriendly to markets for the time being, and the risk the economy slips into a recession will be relatively elevated.
At the same time, we also know that stocks are discounting mechanisms — meaning that prices will have bottomed before the Fed signals a major dovish turn in monetary policy.
Also, it’s important to remember that while recession risks may be elevated, consumers are coming from a very strong financial position. Unemployed people are getting jobs, and those with jobs are getting raises.
Similarly, business finances are healthy as many corporations locked in low interest rates on their debt in recent years. Even as the threat of higher debt servicing costs looms, elevated profit margins give corporations room to absorb higher costs.
At this point, any downturn is unlikely to turn into economic calamity given that the financial health of consumers and businesses remains very strong.
And as always, long-term investors should remember that recessions and bear markets are just part of the deal when you enter the stock market with the aim of generating long-term returns. While markets have recently had some bumpy years, the long-run outlook for stocks remains positive.
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