Ben and Jerry Discuss Interest Rates, Jobs and Inflation
Federal Reserve Chair Jerome Powell reiterated today that the Fed is committed to bringing inflation down to its 2% target. Speaking at the “Perspectives on Monetary Policy” panel at the Thomas Laubach Research Conference, Powell said that the Fed will continue to raise interest rates until inflation is under control. The current Fed Chair shared the stage with former Fed Chair Ben Bernanke; the two more or less agreed, with Bernanke seeming a bit less optimistic.
The Panel Discussion
Powell acknowledged that the Fed’s actions to raise interest rates will likely slow economic growth. However, he said that the Fed is confident that it can bring inflation down without causing a recession.
“We understand that high inflation imposes significant hardship, especially on those least able to afford the higher costs of essentials like food, housing, and transportation,” Powell said and then emphasized, “we are strongly committed to returning inflation to our 2% objective.”
Powell reassured that the Fed is closely monitoring the labor market. The event is attended by experts in the field of monetary policy, including economists, central bankers, and other policymakers. It provides an opportunity for experts to share their views on the current state of the economy and the challenges facing central banks. Powell told the attendees that the Fed is committed to keeping the labor market strong but that it will not hesitate to take further action if needed to bring inflation down.
“The labor market is very strong, and we want to see that continue,” Powell said. “But we will take the necessary steps to bring inflation down,” he cautioned.
Ben Bernanke, the former Chair of the Federal Reserve, also spoke at the conference warning that the Fed is facing a difficult challenge in trying to bring inflation down without causing a recession. Bernanke said that the Fed will need to be very careful.
“The Fed is in a difficult spot,” Bernanke said. “It needs to bring inflation down, but it also doesn’t want to cause a recession. It will need to be very careful in its actions.”
Bernanke said that the Federal Reserve is facing a “new normal” in terms of inflation. He said that the Fed will need to be more aggressive in its use of monetary policy to bring down the pace of price increases. The former Fed chair said, “The Fed is going to have to be more aggressive in its use of monetary policy than it has been in the past,” He cautioned. “It’s going to need to raise interest rates more than once this year.”
Bernanke explained to listeners, “the Fed is not trying to cause a recession. But it is willing to risk a recession if it is necessary to bring inflation down.”
The comments from Powell and Bernanke took away any question whether the Fed is committed to bringing inflation down. Most listeners came away from this feeling the Fed is likely to continue to raise interest rates and to shrink its balance sheet in an effort to cool the economy and bring inflation down. However, attendees were also assured the Fed is keenly aware of the risks of a recession and is trying to avoid it.
What Does This Mean for the Economy?
The comments from Ben Bernanke and Jerome Powell suggest that the Fed is prepared to take aggressive action to bring inflation down. This could lead to higher interest rates and slower economic growth. However, the Fed is acting in a way it hopes leads to bringing down inflation without negative growth or a recession.
The bond markets had been pricing in an easing late in the year. US Treasury rates rose as the panel discussion got underway; this suggests that the tenor of some of the comments were unexpected. It is still too early to say what the impact of the Fed’s actions will be on the economy. However, it is clear that the Fed is taking inflation seriously and is willing to take steps to bring it down.
The next Federal Open Market Committee (FOMC) meeting will be held on June 13-14, 2023. The FOMC is the policymaking body of the Federal Reserve System. It meets every six weeks to discuss and set monetary policy, including the target for Fed Funds.
The next FOMC meeting is expected to be a critical one, as the committee will be making its decisions in the midst of sticky inflation, a troubled banking sector, and a slowing economy.
War Rooms and Bailouts: How Banks and the Fed are Preparing for a US Default – and the Chaos Expected to Follow
When you are the CEO responsible for a bank and all the related depositors and investors, you don’t take an “it’ll never happen” approach to the possibility of a U.S. debt default. The odds are it won’t happen, but if it does, being unprepared would be devastating. Banks of all sizes are getting their doomsday plans in place, and other industries are as well, but big banks, on many fronts would be most directly impacted. The following is an informative article on how banks are preparing. It’s authored by John W. Diamond the Director of the Center for Public Finance at the Baker Institute, Rice University, and republished with permission from The Conversation. – Paul Hoffman, Managing Editor, Channelchek
Convening war rooms, planning speedy bailouts and raising house-on-fire alarm bells: Those are a few of the ways the biggest banks and financial regulators are preparing for a potential default on U.S. debt.
“You hope it doesn’t happen, but hope is not a strategy – so you prepare for it,” Brian Moynihan, CEO of Bank of America, the nation’s second-biggest lender, said in a television interview.
The doomsday planning is a reaction to a lack of progress in talks between President Joe Biden and House Republicans over raising the US$31.4 trillion debt ceiling – another round of negotiations took place on May 16, 2023. Without an increase in the debt limit, the U.S. can’t borrow more money to cover its bills – all of which have already been agreed to by Congress – and in practical terms that means a default.
What happens if a default occurs is an open question, but economists – including me – generally expect financial chaos as access to credit dries up and borrowing costs rise quickly for companies and consumers. A severe and prolonged global economic recession would be all but guaranteed, and the reputation of the U.S. and the dollar as beacons of stability and safety would be further tarnished.
But how do you prepare for an event that many expect would trigger the worst global recession since the 1930s?
Preparing for Panic
Jamie Dimon, who runs JPMorgan Chase, the biggest U.S. bank, told Bloomberg he’s been convening a weekly war room to discuss a potential default and how the bank should respond. The meetings are likely to become more frequent as June 1 – the date on which the U.S. might run out of cash – nears.
Dimon described the wide range of economic and financial effects that the group must consider such as the impact on “contracts, collateral, clearing houses, clients” – basically every corner of the financial system – at home and abroad.
“I don’t think it’s going to happen — because it gets catastrophic, and the closer you get to it, you will have panic,” he said.
That’s when rational decision-making gives way to fear and irrationality. Markets overtaken by these emotions are chaotic and leave lasting economic scars.
Banks haven’t revealed many of the details of how they are responding, but we can glean some clues from how they’ve reacted to past crises, such as the financial crisis in 2008 or the debt ceiling showdowns of 2011 and 2013.
One important way banks can prepare is by reducing exposure to Treasury securities – some or all of which could be considered to be in default once the U.S. exhausts its ability to pay all of its bill. All U.S. debts are referred to as Treasury bills or bonds.
The value of Treasurys is likely to plunge in the case of a default, which could weaken bank balance sheets even more. The recent bank crisis, in fact, was prompted primarily by a drop in the market value of Treasurys due to the sharp rise in interest rates over the past year. And a default would only make that problem worse, with close to 190 banks at risk of failure as of March 2023.
Another strategy banks can use to hedge their exposure to a sell-off in Treasurys is to buy credit default swaps, financial instruments that allow an investor to offset credit risk. Data suggests this is already happening, as the cost to protect U.S. government debt from default is higher than that of Brazil, Greece and Mexico, all of which have defaulted multiple times and have much lower credit ratings.
But buying credit default swaps at ever-higher prices limits a third key preventive measure for banks: keeping their cash balances as high as possible so they’re able and ready to deal with whatever happens in a default.
Keeping the Financial Plumbing Working
Financial industry groups and financial regulators have also gamed out a potential default with an eye toward keeping the financial system running as best they can.
The Securities Industry and Financial Markets Association, for example, has been updating its playbook to dictate how players in the Treasurys market will communicate in case of a default.
And the Federal Reserve, which is broadly responsible for ensuring financial stability, has been pondering a U.S. default for over a decade. One such instance came in 2013, when Republicans demanded the elimination of the Affordable Care Act in exchange for raising the debt ceiling. Ultimately, Republicans capitulated and raised the limit one day before the U.S. was expected to run out of cash.
One of the biggest concerns Fed officials had at the time, according to a meeting transcript recently made public, is that the U.S. Treasury would no longer be able to access financial markets to “roll over” maturing debt. While hitting the current ceiling prevents the U.S. from issuing new debt that exceeds $31.4 trillion, the government still has to roll existing debt into new debt as it comes due. On May 15, 2023, for example, the government issued just under $100 billion in notes and bonds to replace maturing debt and raise cash.
The risk is that there would be too few buyers at one of the government’s daily debt auctions – at which investors from around the world bid to buy Treasury bills and bonds. If that happens, the government would have to use its cash on hand to pay back investors who hold maturing debt.
That would further reduce the amount of cash available for Social Security payments, federal employees wages and countless other items the government spent over $6 trillion on in 2022. This would be nothing short of apocalyptic if the Fed could not save the day.
To mitigate that risk, the Fed said it could immediately step in as a buyer of last resort for Treasurys, quickly lower its lending rates and provide whatever funding is needed in an attempt to prevent financial contagion and collapse. The Fed is likely having the same conversations and preparing similar actions today.
A Self-Imposed Catastrophe
Ultimately, I hope that Congress does what it has done in every previous debt ceiling scare: raise the limit.
These contentious debates over lifting it have become too commonplace, even as lawmakers on both sides of the aisle express concerns about the growing federal debt and the need to rein in government spending. Even when these debates result in some bipartisan effort to rein in spending, as they did in 2011, history shows they fail, as energy analyst Autumn Engebretson and I recently explained in a review of that episode.
That’s why one of the most important ways banks are preparing for such an outcome is by speaking out about the serious damage not raising the ceiling is likely to inflict on not only their companies but everyone else, too. This increases the pressure on political leaders to reach a deal.
Going back to my original question, how do you prepare for such a self-imposed catastrophe? The answer is, no one should have to.
The Market Will Experience a Barrage of Appearances by Fed Officials
This will be another week of various regional Fed Presidents speaking and setting expectations of potential adjustments to monetary policy; this includes Jerome Powell and Former Fed Chair Ben Bernanke. Retail and consumer health could come into sharper focus during the week as major retailers report earnings and April retail sales are reported early in the week. The initial results for the Russell Reconstitution of its main indexes will be released after the close of trading on Friday. Also, late week, Fed Chair Jay Powell will make an appearance on a panel with Ben Bernanke.
Monday 5/15
8:30 AM ET, The Empire State Manufacturing Index for May is expected to fall back to negative territory at minus 2.0 after April’s 35-point surge into positive ground at 10.8. This monthly survey of manufacturers in New York State is seldom market moving, but combined with other reports helps draw a picture of economic health within the region and more broadly.
8:45 AM ET, Ralph Bostic, the CEO of the Atlanta Federal Reserve, will be speaking.
9:15 AM ET, Neel Nashkari, the President of the Minneapolis Federal Reserve, will be speaking.
12:30 PM ET, Thomas Barkin, the President of the Richmond Federal Reserve, will be speaking.
Tuesday 5/16
8:15 AM ET, Loretta Mester, CEO of the Federal Reserve Bank of Cleveland, will be speaking.
8:30 AM ET, April Retail Sales are expected to rise 0.7 percent versus March’s 1.0 percent decline that, much of the earlier decline was led by declines in car sales and gasoline.
8:55 AM ET, Raphael Bostic will be speaking. Bostic is the CEO of the Atlanta Fed.
9:15 AM ET, Industrial Production is expected to be unchanged in April after March’s 0.4 percent increase that was boosted by utilities output. Manufacturing output is seen as up 0.1 percent after falling 0.5 percent in March.
10:00 AM ET, Business Inventories in March are expected to remain unchanged following a 0.2 percent build in February.
10:00 AM ET, the Housing Market Index has not been experiencing the steep declines witnessed last year. After April’s previously reported 1-point gain to 45, May’s consensus is no change at 45.
12:15 PM ET, John Williams, the President of the New York Federal Reserve, will be speaking.
3:15 PM ET, Lorrie Logan is the President of the Federal Reserve Dallas, she will be speaking.
7:00 PM ET, Raphael Bostic, will be speaking. Bostic is the CEO of the Atlanta Fed.
Wednesday 5/17
7:30 AM ET, Mortgage Applications, compiled by the Mortgage Bankers’ Association will be released. compiles various mortgage loan indexes. The index measures applications at mortgage lenders. This is a leading indicator for single-family home sales and housing construction.
8:30 AM ET, Housing Starts and Permits during March edged lower to a 1.420 million annualized rate; April is expected to slip further to 1.405 million. Permits, at 1.413 million in March and, though lower than expected, very near the starts rate, is expected to rise to 1.430 million.
10:30 AM ET, The Energy Information Administration (EIA) provides weekly information on petroleum inventories in the U.S., whether produced here or abroad. The level of inventories helps determine prices for petroleum products.
Thursday 5/18
8:30 AM ET, Jobless Claims Jobless claims for weekly period ended May 13 are expected to fall back to 255,000 after rising a steep 22,000 to 264,000 in the prior week.
10:00 AM ET, Philadelphia Fed Manufacturing Index, The Philadelphia Fed manufacturing index has been in contraction the last nine reports and very deeply so in April at minus 31.3. May’s contraction is seen at minus 20.0.
9:05 AM ET, Lorrie Logan, President of the Dallas Fed is scheduled to speak.
10:00 AM, Ecommerce Retail Sales, are sales of goods and services where an order is placed by the buyer or where price and terms of sale are negotiated over the Internet, an extranet, Electronic Data Interchange (EDI) network, or other online system.
10:00 AM, The Index of Leading Economic indicators, had plunged 1.2 percent in March, it is expected to fall a further 0.6 percent in April. This index has been in sharp decline and has long been signaling a pending recession.
10:30 AM, The Energy Information Administration (EIA) provides weekly information on natural gas stocks in underground storage for the U.S. and five regions of the country. The level of inventories helps determine prices for natural gas products.
Friday 5/19
8:30 PM ET, Import/Export Prices. Import Prices, an inflation harbinger is expected to rise 0.3 percent for April, this would end nine straight declines. Export prices are expected to rise 0.2 percent.
8:45 AM, John Williams, the President of the New York Federal Reserve, will be speaking.
10:00 PM ET, Consumer Sentiment looking at the first indication for May, which in April fell 1.5 points to 63.5, is expected to fall another half point to 63.0.
10:00 AM ET, Quarterly Services is expected is focuses on information and technology-related service industries. These include information; professional, scientific and technical services; administrative & support services; and waste management and remediation services. These sectors correspond to three NAICS sectors (51, 54, and 56). The Quarterly Services Survey produces estimates of total operating revenue and the percentage of revenue by class of customer.
11:00 AM, ET, Fed Chair Powell, is joined on a panel titled “Perspectives on Monetary Policy” by former Fed Chair Ben Bernanke.
4:00 PM ET, The FTSE Russell Index reports the first list of stocks leading to the Russell’s Reconstitution in 2023.
What Else
Investment roadshows are like getting a front-row seat to information direct from management’s mouth. The most useful investor information often comes from the unplanned responses to questions during the roadshow – either asked by you, or other interested investors.
Noble Capital Markets has an expanding and interesting calendar of roadshows during the week and month. Some are in cities that are paid less attention to than the major financial centers. This week CoCrystal (COCP) will be presenting at roadshows in Miami, and Boca Raton, FL. For more details, and a complete list of roadshows and cities, Click here.
US Debt Default Could Trigger Dollar’s Collapse – and Severely Erode America’s Political and Economic Might
Congressional leaders at loggerheads over a debt ceiling impasse sat down with President Joe Biden on May 9, 2023, as the clock ticks down to a potentially catastrophic default if nothing is done by the end of the month.
Republicans, who regained control of the House of Representatives in November 2022, are threatening not to allow an increase in the debt limit unless they get spending cuts and regulatory rollbacks in return, which they outlined in a bill passed in April 2023. In so doing, they risk pushing the U.S. government into default.
It feels a lot like a case of déjà vu all over again.
Brinkmanship over the debt ceiling has become a regular ritual – it happened under the Clinton administration in 1995, then again with Barack Obama as president in 2011, and more recently in 2021.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Michael Humphries, Deputy Chair of Business Administration, Touro University.
Image: An 11 year-old sampling of possibilities from the RPC (June 19, 2012)
As an economist, I know that defaulting on the national debt would have real-life consequences. Even the threat of pushing the U.S. into default has an economic impact. In August 2021, the mere prospect of a potential default led to an unprecedented downgrade of the the nation’s credit rating, hurting America’s financial prestige as well as countless individuals, including retirees.
And that was caused by the mere specter of default. An actual default would be far more damaging.
Dollar’s Collapse
Possibly the most serious consequence would be the collapse of the U.S. dollar and its replacement as global trade’s “unit of account.” That essentially means that it is widely used in global finance and trade.
Day to day, most Americans are likely unaware of the economic and political power that goes with being the world’s unit of account. Currently, more than half of world trade – from oil and gold to cars and smartphones – is in U.S. dollars, with the euro accounting for around 30% and all other currencies making up the balance.
As a result of this dominance, the U.S. is the only country on the planet that can pay its foreign debt in its own currency. This gives both the U.S. government and American companies tremendous leeway in international trade and finance.
No matter how much debt the U.S. government owes foreign investors, it can simply print the money needed to pay them back – although for economic reasons, it may not be wise to do so. Other countries must buy either the dollar or the euro to pay their foreign debt. And the only way for them to do so is to either to export more than they import or borrow more dollars or euros on the international market.
The U.S. is free from such constraints and can run up large trade deficits – that is, import more than it exports – for decades without the same consequences.
For American companies, the dominance of the dollar means they’re not as subject to the exchange rate risk as are their foreign competitors. Exchange rate risk refers to how changes in the relative value of currencies may affect a company’s profitability.
Since international trade is generally denominated in dollars, U.S. businesses can buy and sell in their own currency, something their foreign competitors cannot do as easily. As simple as this sounds, it gives American companies a tremendous competitive advantage.
If Republicans push the U.S. into default, the dollar would likely lose its position as the international unit of account, forcing the government and companies to pay their international bills in another currency.
Loss of Political Power Too
The dollar’s dominance means trade must go through an American bank at some point. This is one important way it gives the U.S. tremendous political power, especially to punish economic rivals and unfriendly governments.
For example, when former President Donald Trump imposed economic sanctions on Iran, he denied the country access to American banks and to the dollar. He also imposed secondary sanctions, which means that non-American companies trading with Iran were also sanctioned. Given a choice of access to the dollar or trading with Iran, most of the world economies chose access to the dollar and complied with the sanctions. As a result, Iran entered a deep recession, and its currency plummeted about 30%.
President Joe Biden did something similar against Russia in response to its invasion of Ukraine. Limiting Russia’s access to the dollar has helped push the country into a recession that’s bordering on a depression.
No other country today could unilaterally impose this level of economic pain on another country. And all an American president currently needs is a pen.
Rivals Rewarded
Another consequence of the dollar’s collapse would be enhancing the position of the U.S.‘s top rival for global influence: China.
While the euro would likely replace the dollar as the world’s primary unit of account, the Chinese yuan would move into second place.
If the yuan were to become a significant international unit of account, this would enhance China’s international position both economically and politically. As it is, China has been working with the other BRIC countries – Brazil, Russia and India – to accept the yuan as a unit of account. With the other three already resentful of U.S. economic and political dominance, a U.S. default would support that effort.
They may not be alone: Recently, Saudi Arabia suggested it was open to trading some of its oil in currencies other than the dollar – something that would change long-standing policy.
Severe Consequences
Beyond the impact on the dollar and the economic and political clout of the U.S., a default would be profoundly felt in many other ways and by countless people.
In the U.S., tens of millions of Americans and thousands of companies that depend on government support could suffer, and the economy would most likely sink into recession – or worse, given the U.S. is already expected to soon suffer a downturn. In addition, retirees could see the worth of their pensions dwindle.
The truth is, we really don’t know what will happen or how bad it will get. The scale of the damage caused by a U.S. default is hard to calculate in advance because it has never happened before.
But there’s one thing we can be certain of. If the threat of default is taken too far, the U.S. and Americans will suffer tremendously.
Even a Short-Lived Default Would Hurt Money Market Fund Investors
While the U.S. Treasury is now at the mercy of politicians negotiating, positioning, and stonewalling as they work to raise the debt ceiling to avoid an economic catastrophe, money kept on the sidelines may be at risk. Generally, when investors reduce their involvement in stocks and other “risk-on” trades, they will park assets in money market funds. These investment products are now paying the highest interest rates in 15 years, which has made the decision to “take money off the table” even easier for those involved in the markets.
But, are investors experiencing a false sense of security?
Background
Money Market Funds (MMF) are mutual funds that invest in top credit-tier (low-risk) debt securities with fewer than 397 days to maturity. The SEC requires at least 10% to be maturing daily and 30% to be liquid within seven days. The acceptable securities in a general MMF include Treasury bills, commercial paper, and even bank CDs. The sole purpose of a money market fund is to provide investors with a stable value investment option with a low level of risk.
Unlike other mutual funds, money market funds are initially set and trade at a $1 price per share (NAV). As interest accrues, rather than the value of each share rising, investors are granted more shares (or fractional shares) at $1. However, the funds are marketed-to-market each day. Typically market prices don’t impact short-term debt securities at a rate above the daily interest accrual. But “typically” doesn’t mean always. Occasionally, asset values have dropped faster than the daily interest accrual. When this happens, the fund is worth less than $1 per share. It’s called “breaking the buck.”
When a money market fund “breaks the buck,” it means that the net asset value (NAV) per share of the fund falls below $1. In addition to quick valuation changes, it can also happen when the fund’s expense ratio exceeds its income. You may have gotten a notice during the extremely low interest period that your money market fund provider was absorbing expenses. This was to prevent it from breaking the buck.
Nothing is Risk Free
Just under $600 billion has moved into money-market funds in the past ten weeks. This is more than flowed into MM accounts after Lehman Brothers went belly up which set off panic and flights to safety. Currently, $5.3 trillion is invested in these funds; this is approaching an all-time record.
The Federal Reserve has been lifting interest rates at a record pace, the level they have the most control over is the bank overnight lending rate, or Fed Funds. This impacts short-term rates the most. Along with more attractive rates, stock market investors have become nervous. This is another reason asset levels in MMFs are so high – a high-yielding money-market fund that is viewed as risk-free looks attractive compared to the fear of getting caught in a stock market sell-off.
As discussed before, there are risks in money-market funds. And right now, the risks may be peaking. This is because government spending has exceeded the ability for the U.S. to borrow and pay for it under the current debt ceiling limit. The limit was actually reached last January when it was addressed by kicking the problem further down the road. Well, the road now ends sometime in June. In fact, U.S. Treasury Secretary Janet Yellen said the U.S. government may run out of cash by June 1 if Congress doesn’t act, and that economic chaos would ensue if the government couldn’t pay its obligations. Not paying obligations would include not paying interest on maturing U.S. Treasuries.
It isn’t a stretch to say the foundation of all other securities pricing is in relationship with the “risk-free” rate of U.S. debt. That is to say, price discovery has as its benchmark that which can be earned in U.S. debt which has been presumed to be without risk of non-payment.
What Happens to Money Market Funds in a Default?
In a default, the U.S. Treasury wouldn’t pay the full principle it owes on liabilities such as maturing Treasury debt – short term term government debt with extremely short average maturities is a staple of market funds. That is why the price of one-month Treasury debt has dropped recently, sending its yield up to above 5% from a 2023 low of about 3.3%. It has driven expected returns of MMFs up as well, but there is a risk that these short maturities may not get fully paid on time. Many fund providers’ money market funds would then break the $1 share price.
Breaking the buck can have significant consequences for investors, particularly those who rely on money market funds for their cash reserves. Because money market funds are considered a low-risk investment, investors may not expect to lose money on their investment. If a money market fund breaks the buck, it would diminish investor confidence in the stability of these funds, leading to a potential run on the fund and broader implications for the financial system.
Likelihood of Breaking the Buck
Money market funds breaking the buck is a relatively rare occurrence. According to the Securities and Exchange Commission (SEC), there have been only a few instances where MMFs have broken the buck in the history of the industry. The most significant of these occurred in 2008 during the financial crisis when one of the oldest money market funds, Reserve Primary Fund, dropped below $1 due to losses on its holdings of Lehman Brothers debt securities. This event led to a run on many money market funds creating significant instability in the financial system.
Since the Reserve Primary Fund incident, regulatory changes have been implemented to strengthen the money market fund industry and reduce the risk of funds breaking the buck. These changes include requirements for funds to maintain a minimum level of liquidity, hold more diversified portfolios, and limit their exposure to certain types of securities.
Take Away
Nothing is risk-free. Banks such as Silicon Valley Bank found that out when their investment portfolio, largely low credit risk, normally stable securities, wasn’t valued at what they needed it to be worth to fund large withdrawals.
Stock market investors that were drawn in invest in to rising bond yields also found that when yields keep rising, the values of their portfolios can drop just as quickly as if they were invested in stocks during a sell-off. While no one truly expects the current tug-of-war over debt levels in Washington to lead to a U.S. default, one can’t be sure at a time when there have been many firsts that we thought could never happen in America.
Inflation in Argentina so far in 2023 is running at 126.4%. Meanwhile, its GDP has declined by 3.1%. This certainly meets the definition of hyperinflation. Can this situation occur in the U.S. economy? Hyperinflation is when prices of goods and services in the economy run up rapidly; at the same time, it causes the value of the nation’s currency to fall rapidly. It’s a devastating phenomenon that has serious consequences for businesses, investors, and households. Below we explore the causes of hyperinflation, its effects on the economy, and some ways to protect investable assets against it.
Causes of Hyperinflation
Hyperinflation can be caused by a variety of factors, but one ingredient that is most common is excessive money printing by the country’s central bank. When a central bank allows excessive cash in circulation, especially if it is during a period of low or negative growth, natural economic forces that occur when there is an abundance of currency chasing the same or fewer goods, serves to drive up prices and down currency values. This inflation can quickly spiral out of control, leading to hyperinflation. Other causes could include shortages of goods or services driving prices up as demand outstrips available supply.
Effects on the Economy
Excessive inflation is not good for anyone that holds the impacted currency. Businesses can command higher prices, but they will also be paying higher prices to run their business and receiving payment with notes with far less purchasing power. This is because hyperinflation increases costs for labor and raw materials, weighing down profit margins. Less obvious, but certainly adding to the hardship, is that businesses may have trouble securing financing and loans during hyperinflation; this can limit their ability to function or grow.
For households and individuals, hyperinflation also rapidly decreases purchasing power, as prices for goods and services jump up. This lowers living standards in the country as people are forced to pay more for the same goods and services. Additionally, hyperinflation can lead to a loss of confidence in the currency. Behavior including the belief that items should be purchased now because they will be more expensive tomorrow leads to hoarding and other actions that create shortages and drives up prices even further.
How Some Prepare for Hyperinflation
Hyperinflation is rare, yet, once the wheels start turning, such as they did in Venezuela in 2016, or Germany in 1923, it is important for businesses and individuals to take steps to prepare for the possibility. Here are ways that people have prepared for excessive inflation in their native currency.
Diversify Your Investments: While some believe it is always prudent to stay widely diversified, it may offer even more protection when the economy goes through the turmoil of excessive inflation. Preparing in this way means spreading your investments across a variety of asset classes, such as stocks, bonds, real estate, and commodities. This will help by avoiding any one particular asset class that gets hit hard. Keep in mind, stocks are often a good hedge against moderate inflation, and precious metals have historically been looked to for protection in times of extreme inflation. Earnings of companies that export are not expected to suffer as much as importers.
Hold Some Assets Denominated in Other Currencies: This can include established digital currencies, foreign stocks, bonds, that are not denominated in your own home currency. By holding assets denominated in other currencies, you can protect yourself from its devaluation versus others.
Invest in Hard Assets: Hard assets, such as gold and silver, land, and even tools can be a good way to protect yourself or your business from hyperinflation. These assets have intrinsic value and can retain their value even if the currency they are denominated in loses value. Remember that if inflation remains, it is likely to cost more in the coming months for the same piece of office equipment that helps your business run more efficiently.
Cryptocurrencies: Keeping within the guidelines of diversification, more established tokens such as bitcoin and ether are considered by some to help protect from hyperinflation. A word of caution, cryptocurrencies have little history against currency devaluation and inflation. The theory however is these digital currencies are decentralized and not subject to the same inflationary pressures as fiat currencies.
Take Away
In 2018 inflation in Venezuela exceeded 1,000,000%, proving, when the recipe for higher prices is in place, the unimaginable can happen.
While there is no consumer or investor that can proactively impact a rising price freight train, if hyperinflation is expected, there are steps one can take to reduce the negative impacts. These financial steps can be as simple as buying things today that you expect to need later, and more substantially diversifying your portfolio toward hard assets, companies that export to countries not experiencing inflation, and even bonds with either short maturities or an inflation factor as part of the return.
The Market is Deciding if the Fed is Finished or Not, Here’s How this Week Will Help
Two key inflation reports and quite a few Fed governors are coming out of the blackout period, removing the gag and sharing their thoughts on the state of the economy and monetary policy. Last Friday’s strong US Jobs report has left many market participants looking for a clearer sign that the Fed will take a neutral stance. The two inflation reports and Fed governor addresses may help make clear the Fed’s next “data dependent” step.
Monday 5/8
• 10:00 AM ET, Wholesale Inventories (preliminary), this is the second estimate for March wholesale inventories. It is expected to print at a 0.1 percent build-up, unchanged from the first estimate. The report measures the dollar value of sales made and inventories held by wholesalers.
Tuesday 5/9
• House Speaker Kevin McCarthy will meet with President Joe Biden to discuss the debt limit. The meeting comes three weeks before the U.S. is projected to run out of money to pay its bills.
• 6:00 AM ET, The Small Business Optimism Index has been below, at times deeply below, the historical average of 98. The April consensus is 89.7 versus 90.1 in March.
• 8:30 AM ET, Phillip Jefferson took office as a member of the Board of Governors of the Federal Reserve System in May 2022. While he is relatively unknown, he may begin to play a larger part as he is considered a favorite for Fed Vice Chair, with Biden set to nominate Jefferson for the seat vacated by Lael Brainard seat.
• 12:05 AM ET, John Williams is the President of the New York Federal Reserve. The New York Fed President takes the role of Vice Chair of the FOMC, the seat is a permanent voting member (outside the rotation).
Wednesday 5/10
• 8:30 AM ET, Consumer Price Index (CPI) for April is expected to show that core prices are continuing at the same pace of a monthly increase of 0.4 percent. The headline number is also expected to rise 0.4 percent after March’s 0.1 percent increase, which was below expectations – remember, energy prices spiked last month. Annual rates, which in March were 5.0 percent headline and 5.6 percent for the core, are expected at 5.0 and 5.5 percent, showing little or no improvement.
• 2:00 PM, the Treasury Statement for April is expected to show a $410.0 billion surplus. That would compare with a $308.2 billion surplus in April a year-ago and a deficit in March this year of $378.1 billion. April, tax month, is the seventh month of the government’s fiscal year.
Thursday 5/11
• 8:30 AM ET, the Producer Price Index (PPI), after falling 0.5 percent in March, is expected to rise 0.3 percent in April. The annual rate ending April is forecast to be 2.5 percent, down slightly from March’s 2.7 percent. April’s ex-food ex-energy rate is seen at 0.2 percent on the month and 3.3 percent on the year versus March’s monthly 0.1 percent decline and plus 3.4 percent yearly rate.
• 7:45 AM ET, Christopher Waller is a member of the St. Louis Federal Reserve Board of Governors. He is a CBDC advocate. Along with Bullard and Mester, Waller is considered to be among the Fed hawks.
• 4:30 AM ET, The Fed’s balance sheet is a weekly report presenting a consolidated balance sheet for all 12 Reserve Banks. It lists factors supplying reserves into the banking system and factors absorbing reserves from the system. The official name for the report is Factors Affecting Reserve Balances, otherwise known as the “H.4.1” report. This report has taken on renewed interest as it is the only place to get information on quantitative tightening moves, and the impact of new measures taken to secure troubled banks.
Friday 5/12
• 8:30 PM ET, Import/Export Prices. Import Prices, an inflation harbinger is expected to rise 0.3 percent for April, this would end nine straight declines. Export prices are expected to rise 0.2 percent.
• 10:00 PM ET, Consumer Sentiment looking at the first indication for May, which in April fell 1.5 points to 63.5, is expected to fall another half point to 63.0.
• 7:45 PM ET, a late day address by St. Louis Fed Chair James Bullard.
What Else
Investment roadshows are like getting a front-row seat to information direct from management’s mouth. The most useful investor information often comes from the unplanned responses to questions during the roadshow – either asked by you, or other interested investors.
Noble Capital Markets has a growing, interesting calendar of roadshows during the week and month. Some are in cities that are paid less attention to. These include Entravision in Kansas City, MO, on May 9 (lunch). Entravision will again be presenting on May 10 in ST. Louis (lunch). Also on May 10, Salem Media will be in New York (lunch). For more details, and a complete list of roadshows and cities, Click here.
Can Biden and McCarthy Avert a Calamitous Debt Default? Three Evidence-Backed Leadership Strategies that Might Help
The U.S. is teetering toward an unprecedented debt default that could come as soon as June 1, 2023.
In order for the U.S. to borrow more money, Congress needs to raise the debt ceiling – currently $31.4 trillion. President Joe Biden has refused to negotiate with House Republicans over spending, demanding instead that Congress pass a stand-alone bill to increase the debt limit. House Speaker Kevin McCarthy won a small victory on April 26 by narrowly passing a more complex bill with GOP support that would raise the debt ceiling but also slash spending and roll back Biden’s policy agenda.
Biden recently invited congressional leaders, including GOP leader McCarthy, to the White House on May 9 to discuss the situation but insisted he isn’t willing to negotiate.
Rather than leading the nation, Biden and McCarthy seem to be waging a partisan political war. Biden likely doesn’t want to be seen as giving in to Repubicans’ demands and diminishing legislative wins for his liberal constituency. McCarthy, with his slim majority in the House, needs to appease even the most hard-line members of his party.
This article was republished with permission from The Conversation, a news site dedicated to sharing ideas from academic experts. It represents the research-based findings and thoughts of, Wendy K. Smith, Professor of Business and Leadership, University of Delaware.
Having studied leadership for over 25 years, I would suggest that their leadership styles are polarized, oppositional, short-term and highly ineffective. Such combative leadership risks a debt default that could send the U.S. into recession and potentially lead to a global economic and financial crisis.
While it may seem almost impossible in the current political climate, Biden and McCarthy have an opportunity to turn around this crisis and leave a positive and lasting legacy of courageous leadership. To do so, they need to put aside partisanship and adopt a different approach. Here are a few evidence-backed strategies to get them started.
Moving From a Zero-Sum Game to a More Holistic Approach
Political leaders often risk being hijacked by members of their own party. McCarthy faces a direct threat by hard-line conservative members of his coalition.
For example, back in January, McCarthy agreed to let a single lawmaker force a vote for his ouster to win enough votes from ultraconservative lawmakers to become speaker. That and other concessions give the most extreme members of his party a lot of control over his agenda and limit McCarthy’s ability to make a compromise deal with the president.
Biden, who just announced he’s running for reelection in 2024, is betting his first-term accomplishments – such as unprecedented climate investments and student loan forgiveness – will help him keep the White House. Negotiating any of that away could cost him the support of key parts of his base.
My research partner Marianne W. Lewis and I label this kind of short-term, one-sided leadership as “either/or” thinking. That is, this approach assumes that leadership decisions are a zero-sum game – every inch you give is a loss to your side. We argue that this kind of leadership is limited at best and detrimental at worst.
Instead, we find that great leadership involves what we call “both/and” thinking, which involves seeking integration and unity across opposing perspectives. History offers examples of how this more holistic leadership style has achieved substantial achievements.
President Lyndon B. Johnson and fellow Democrats were struggling to get a Senate vote on the Civil Rights Act of 1964 and needed Republican support. Despite his initial opposition, Republican Sen. Everett McKinley Dirksen – then the minority leader and a staunch conservative – led colleagues in crossing party lines and joining Democrats to pass the historic legislation.
Another example came in 1990, when South Africa’s then-President Frederik Willem de Klerk freed opponent Nelson Mandela from prison. The two erstwhile political enemies agreed to a deal that ended apartheid and paved the way for a democratic government – which won them both the Nobel Peace Prize. Mandela became president four years later.
This integrative leadership approach starts with a shift of mindset that moves away from seeing opposing sides as conflicting and instead values them as generative of new possibilities. So in the case of the debt ceiling situation, holistic leadership means, at the least, Biden would not simply put up his hands and refuse to negotiate over spending. He could acknowledge that Republicans have a point about the nation’s soaring debt load. McCarthy and his party might recognize they cannot just slash spending. Together they could achieve greater success by developing an integrative plan that cuts costs, increases taxes and raises the debt ceiling.
Champion a Long-Term Vision Over Short-Term Goals
What we call “short-termism” plagues America’s politics. Leaders face pressure to demonstrate immediate results to voters. Biden and McCarthy both have strong incentives to focus on a short-term victory for their side with the presidential and congressional elections coming soon. Instead, long-term thinking can help leaders with competing agendas.
In a 2015 study, Natalie Slawinski and Pratima Bansal studied executives at five Canadian oil companies who were dealing with tensions between keeping costs low in the short term while making investments that could mitigate their industry’s environmental impact over the long run. The two scholars found that those who focused on the short term struggled to reconcile the two competing forces, while long-term thinkers managed to find more creative solutions that kept costs down but also allowed them to do more to fight climate change.
Likewise, if Biden and McCarthy want to avert a financial crisis and leave a lasting legacy, they would benefit from focusing on the long term. Finding points of connection in this shared long-term goal, rather than stressing their significant differences about how to get there, can help shift away from their standoff and toward a solution.
Be Adaptive, Not Assured
Voters often praise political leaders who act swiftly and with confidence and self-assurance, particularly at a moment of economic uncertainty.
Yet finding a creative solution to America’s greatest challenges often requires leaders to put aside the swagger and adapt, meaning they take small steps to listen to one another, experiment with solutions, evaluate these outcomes and adjust their approach as needed.
In a study of business decisions at a Fortune 500 technology company, I spent a year following the senior management teams in charge of six units – each of which had revenues of over $1 billion. I found that the team leaders who were most innovative tended to be good at adaptation. They constantly explored whether they had made the right investment and made changes if needed.
Small steps are also necessary to build unlikely relationships with political foes. In his 2017 book, “Collaborating With the Enemy,” organizational consultant Adam Kahane describes how he facilitated workshops to help former enemies take small steps toward reconciliation, such as in South Africa at the end of apartheid and in Colombia amid the drug wars. Such efforts helped South Africa become a successful multiracial democracy and Colombia end decades of war with a guerrilla insurgency.
This kind of leadership requires small steps toward connection rather than large political leaps. It also requires that both sides let go of their positions and consider where they are willing to compromise.
Biden and McCarthy could learn from two former Tennessee governors, Democrat Phil Bredesen and Republican Bill Haslam. Though they oppose each other on almost every political issue, including gun control, the two former leaders have built a constructive relationship over the years. Rather than tackle the big divisive issues, they started with identifying the small points where they agreed with each other. Doing so led them to build greater trust and continue to look for connections.
So when a gunman killed six people at a school in Nashville recently, the two former governors were able to move beyond political finger-pointing and focus on how their respective parties could work together on meaningful gun reform.
Of course, it’s easier to do this once you’re out of office and the pressure from voters and parties goes away. And although current Tennessee Gov. Bill Lee agreed on the need for gun reform, his fellow Republicans in the state Legislature balked.
A Long Shot, But …
And that’s why I know this is a long shot. The two main political parties are as polarized as ever. The odds of a breakthrough that leads to anything more than a last-second deal that kicks the debt ceiling can down the road remain pretty low – and even that seems in doubt.
But this is about more than the debt ceiling. The U.S. faces a long list of problems big and small, from high inflation and a banking crisis to the war in Ukraine and climate change.
Americans need and deserve leaders who will tackle these issues by working together toward a more creative outcomes.
The FOMC May Now Apply Less Brake Pedal to the Economy
The Federal Open Market Committee (FOMC) voted to raise overnight interest rates from a target of 4.75% – 5.00%. to the new target of 5.00% – 5.25%. This 25bp move was announced at the conclusion of the Committee’s May 2023 meeting. The monetary policy shift in bank lending rates had been expected but concerns of the impact of tightening on some economic sectors, including banking, had been called into question and left Fed-watchers unsure if the Fed would clearly indicate a pause in the tightening cycle. Inflation which had been easing somewhat going into the last FOMC held in March has since reversed direction and remains elevated.
As for the U.S. banking system, which is part of the Federal Reserves responsibility, the FOMC statement reads, “The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.”
As for inflation which is hovering at more than twice the Fed’s target, the post FOMC statement reads, “The Committee remains highly attentive to inflation risks.” Both of these quotes can be viewed as not trying to panic markets in either direction.
There were few clues given in the statement about any next move, causing some to believe that the Fed is now going to take a wait-and-see position as previous rate hikes play out in the economy. The statement was shorter than previous releases following a two-day FOMC meeting, but it ended with the following forward-looking actions:
“In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.”
Fed Chair Powell generally shares more thoughts on the matter during a press conference beginning at 2:30 after the statement.
The US debt limit is the total amount of money the United States government is authorized to borrow to meet its existing obligations. These include interest on debt, Social Security, military costs, government payroll, utilities, tax refunds, and all costs associated with running the country.
The debt limit is not designed to authorize new spending commitments. Its purpose is to provide adequate financing for existing obligations that Congress, through the years, has approved. While taxes provide revenue to the US Treasury Department, taxation has not been adequate since the mid-1990s to satisfy US spending. This borrowing cap, the so-called debt ceiling, is the maximum congressional representatives have deemed prudent each year, and has always been raised to avert lost faith in the US and its currency.
Failing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations – which has never happened before. Default would bring about another financial crisis and threaten the financial well-being of American citizens. Since a default would be much more costly than Congress meeting to approve a bump up in the borrowing limit, which the President could then sign, it is likely that any stand-offf will be resolved on time.
Congress has always acted when called upon to raise the debt limit. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt.
How Does this Apply Today?
According to the Congressional Budget Office, tax receipts through April have been less than the CBO anticipated in February. The Budget Office now estimates that there is a significantly elevated risk that the US Treasury will run out of funds in early June 2023. The US Treasury Secretary has even warned that after June 1, the US will have trouble meeting its obligations. The implications could include a credit rating downgrade in US debt which could translate to higher interest rates. If US Treasury obligations, the so-called “risk free” investments, does not pay bondholders on time (interest), then the entire underpinning of an economy that relies on the faith in its economic system, could quickly unravel.
What Took Us Here?
On January 19, 2023, the statutory limit on the amount of debt that the Department of the Treasury could issue was reached. At that time, the Treasury announced a “debt issuance suspension period” during which, under the law, can take “extraordinary measures” to borrow additional funds without breaching the debt ceiling.
The Treasury Dept. and the CBO projected that the measures would likely be exhausted between July and September 2023. They warned that the projections were uncertain, especially since tax receipts in April were a wildcard.
It’s now known that receipts from income tax payments processed in April were less than anticipated. Making matters more difficult, the Internal Revenue Service (IRS) is quickly processing tax return payments.
If the debt limit is not raised or suspended before the extraordinary measures are exhausted, the government will ultimately be unable to pay its obligations fully. As a result, the government will have to delay making payments for some activities, default on its debt obligations, or both.
What Now?
The House of Representatives passed a package to raise the debt ceiling by $1.5 trillion in late April. The bill, includes spending cuts, additional work requirements in safety net programs, and other measures that are unpopular with Democrats. To pass, the Senate, which has a Democratic majority, would have to pass it. Democratic Senator Chuck Schumer described the chances as “dead on arrival.”
House Speaker McCarthy has accepted an invitation from President Biden to meet on May 9 to discuss debt ceiling limits. The position the White House is maintaining is that it will not negotiate over the debt ceiling. The President’s party is looking for a much higher debt ceiling that allows for greater borrowing powers.
In the past, debt ceiling negotiations have often gone into the night on the last day and have suddenly been resolved in the nick of time. Treasury Secretary Yellen made mention of this and warned that past debt limit impasses have shown that waiting until the last minute can cause serious harm, including damage to business and consumer confidence as well as increased short-term borrowing costs for taxpayers. She added that it also makes the US vulnerable in terms of national security.
Expect volatility in all markets as open discussions and likely disappointments will heat up beginning at the May 9th meeting between McCarthy and Biden.
The taming of monetary policy necessary to slow price inflation has triggered a corrective trend in the valuation of financial instruments. Many big banks in the United States have substantially increased their use of an accounting technique that allows them to avoid marking certain assets at their current market value, instead using the face value in their balance sheet calculations. This accounting technique consists of announcing that they intend to hold such assets to maturity.
As of the end of 2022, the bank with the largest amount of assets marked as “held to maturity” relative to capital was Charles Schwab. Apart from being structured as a bank, Charles Schwab is a prominent stockbroker and owns TD Ameritrade, another prominent stockbroker. Charles Schwab had over $173 billion in assets marked as “held to maturity.” Its capital (assets minus liabilities) stood at under $37 billion. At that time, the difference between the market value and face value of assets held to maturity was over $14 billion.
If the accounting technique had not been used the capital would have stood at around $23 billion. This amount is under half the $56 billion Charles Schwab had in capital at the end of 2021. This is also under 15 percent of the amount of assets held to maturity, under 10 percent of securities, and under 5 percent of total assets. An asset ten years from maturity is reduced in present value by 15 percent with a 3 percent increase in the interest rate. An asset twenty years from maturity is reduced in present value by 15 percent with a 1.5 percent increase in the interest rate.
The interest rates for long-term financial instruments have remained relatively stable throughout the first quarter of 2023, but this may be subject to change as many of the long-term assets of recently failed Silicon Valley Bank and Signature Bank must be sold off for the Federal Deposit Insurance Corporation to replenish its liquidity. The long-term interest rate is also heavily dependent on inflation expectations, as with higher inflation a higher nominal rate is necessary to obtain the same real rate. It is also important to remember that the US Congress has persisted in not raising the debt ceiling for the government, which is currently projected to not be able to meet all its obligations by August. This could impact the value of treasuries held by the banks.
Other banks that may be close to an effective insolvency include the Bank of Hawaii and the Banco Popular de Puerto Rico (BPPR). The Bank of Hawaii’s hypothetical shortfall as of the end of 2022 already exceeded 60 percent of its capital. The BPPR has over double its capital in assets held to maturity. All three banks—Bank of Hawaii, BPPR, and Charles Schwab—have lost between one-third and one-half of their market capitalization over the last month.
It is difficult to say with certainty whether they are indeed secretly close to insolvency as they may have some form of insurance that could absorb some of the impact from a loss of value in their assets, but if this were the case it is not clear why they would need to employ this questionable accounting technique so heavily. The risk of insolvency is currently the highest it’s been in over a decade.
Central banks can solve liquidity problems while continuing to raise interest rates and fight price inflation, but they cannot solve solvency problems without pivoting monetary policy or through blatant bailouts, which could increase inflation expectations, exacerbating the problem of decreasing valuations of long-term assets. In the end, the Federal Reserve might find that the most effective way to preserve the entire system is to let the weakest fail.
Stock Market Performance – Looking Back at April, Forward to May
Will the hawks at the Federal Reserve find their perch following the May FOMC meeting? After an aggressive year of tightening, many expect Powell will now signal a pause while the Fed keeps a sharp eye on inflation and other pests that thrive in an overly stimulated economy. Bearish investors that have pulled back are now beginning to have reasons to change their sentiment – their lack of aggressiveness or risk aversion during a solid stock market showing in April may turn their JOMO (joy of missing out) to FOMO (fear of missing out) in the coming weeks.
For a while, the markets have been paddling upstream, navigating a shaky economy with poor visibility. Once the FOMC meeting is in its wake, the stock market should have more visibility from which to make decisions.
Out of the Woods Yet?
The next scheduled FOMC meeting is May 2-3. The expectation is that they will decide to raise Fed Funds another 25bp and then just observe as higher interest rates and all-around tighter money play out in the U.S. economy. Investors will know during the first week of the month if this is what they can expect as Fed Chair Powell will offer guidance at his press conference on May 3.
If the barrage of rate hikes is over, investors will turn their focus toward other factors. These could include the U.S. debt ceiling which is expected to be reached in June, a weakening dollar which benefits U.S. exports, and whether the stock market, which has been pricing itself for a recession may have gone too far with the fear trade.
Not shown in these charts is performance since Silicon Valley Bank was closed (March 12). One might expect that this would have caused investors to run to the sidelines. Instead, the S&P 500 rose 8% since March 10. It may be that the event has served as a turning point.
Look Back
Three of four broad stock market indices (Dow 30, S&P 500, Nasdaq 100, and Russell 2000) were positive in April. The Russell Small-cap index demonstrates the caution that investors were still taking. In theory, small-cap stocks that have traditionally outperformed over longer periods, should make up for some of this lost ground at some point, and reward investors. April was not a month where the risk-on trade made this happen.
The Dow industrials, considered a more conservative index, was up nearly 2.50% during the month. The S&P 500 index was lower at nearly 1.50%, and the Nasdaq 100 rose nearly .50%.
Market Sector Lookback
Of the 5 top performing S&P market sectors (SPDR) all exceeded a 5% return on the month. Top on this list was communications stocks in the XLC SPDR; it returned 7.21%. Real Estate rallied in the XLRE to return 7.03% in April, this marks a big turnaround after months of real estate weakness.
One might think that the markets are irrational when they see the financial stocks in the XLF is the third best performer. But the index which includes large banks such as JP Morgan Chase, and Wells Fargo benefitted from investors that quickly decided that the Silicon Valley Bank failure brought financial stocks below where they should be valued.
Energy, as benchmarked by the XLE SPDR rallied as the price of oil began rising after an OPEC decision last month. The price of oil carried energy stocks with it. Lastly, consumer staples indicated by XLP moved up to perform slightly better than the overall S&P 500 Index (SPX).
Of the bottom 5, or lowest performing SPDR benchmark ETFs, all were positive performers. The worst of which is Industrials (XLI) returning 1.81%. Second from the bottom was the materials sector shown as XLB, this returned 3.60%. Consumer discretionary companies, or XLY, includes companies like Starbucks, Home Depot, and Nike. This index was third worst, but still approached the average of the full S&P 500 at 4.35%.
XLU are utilities, since utilities usually attract dividend investors, rising rates can weigh on these companies. Many utilities also find their costs increase as energy prices rise. However, the 4.59% increase in the index ETF was part of a broad-based upward move in stocks last month.
The best of the worst was the technology sector or XLK. The return of 4.63% during April shows that big tech was not favored last month. Investors have learned how this sector can roar up and also roar down, this may be causing some to diversify more broadly.
Should the Fed indicate they are going to pause the tightening cycle, the yield curve may take its more natural upward slope. Fear of recession may be replaced with greater inflation fears with the Fed standing aside. This would cause market factors to reshape the longer end of rates. A positive sloping yield curve would be a positive for the earnings of lending institutions.
Rates in the very short end may begin to spike as no investor wants to be holding a maturing U.S. Treasury if the U.S. doesn’t raise the debt ceiling. This would only impact T-Bills and T-Notes coming due in weeks and months.
Will bearish sentiment turn to bullishness? Those not in the market missed a rally across all industries. This suggests that there was money flowing in as experienced investors and traders know to buy when there is a “sale,” not after the prices have already been jacked up.
Does this mean the risk-on trade is getting started? The broad S&P 500 rising in every industry could demonstrate that fears over a recession, the banking crisis, the war in Europe, and other “hide under your covers” events, were more than priced in. If that is true, strength will continue. With that strength, investors will begin to look for areas that have not participated in the rally. Perhaps this is when small-cap stocks will retake their position as the better performers.
Take-Away
The market has been given a lot to think about recently. First Republic Bank and a forced FDIC take-over, inflation trending up, debt ceiling fears, unexciting earnings, and the realization that higher interest rates on bonds does not mean total return on a bond portfolio can’t be negative. So the “guaranteed return trade” isn’t guaranteed to have a positive return.
The stock market reacts before there is complete clarity. In fact, traders don’t want complete clarity, it’s when a positive economic outlook is most certain is often when the market has peaked. The current lack of sure visibility may now be handing us the opposite effect.
The FOMC Meeting is the Big Story this Week, But First Republic Will Steal Headlines
In a week full of economic releases, the markets will be most obsessed with two events.
First, the FOMC meeting on May 2-3 is expected to result in the Fed raising the Fed Funds rate by 25 basis points. Market watchers will be looking for signs the FOMC will pause. This could be conveyed in the wording of the statement from the Fed at 2pm on May 3, or during the press conference, Fed Chair Powell is expected to hold at 2:30 on the same day.
Second, inflation information will also keep some investors on edge. A few vocal Fed governors continue to signal that they believe that wage growth and other non-housing inflation warrants continued vigilance. This makes the April Employment Report of particular concern. It is not expected to change the story about a strong labor market. There may be a few more signs of the imbalances in labor supply and demand resolving, but many businesses are still hiring, and relatively few are laying off workers.
Monday 5/1
• 9:45 AM ET, Purchasing Managers Index (PMI) for April is expected to come in at 50.4, unchanged from the mid-month flash to indicate marginal economic expansion relative to March.
• 10:00 AM, The ISM Manufacturing Index has been contracting during the last five months. April’s consensus is for slight growth of 46.8 versus March’s 46.3.
Tuesday 5/2
• 9:00 AM ET, The monetary policy-setting arm of the Federal Reserve will begin a two-day meeting that will end with an announcement of any adjustments to policy.
• 10:00 AM ET, Construction Spending for March is expected to have increased at a barely detectable .1% after falling .1% the previous month.
• 9:00 AM ET, Factory Orders is an important leading indicator of economic activity. The consensus forecast for March is a solid increase of 1.2%. This follows a decline the previous month of .7%.
Wednesday 5/3
• 10:00 AM ET, Institute for Supply Management (ISM) surveys non-manufacturing (or services) firms’ purchasing and supply executives. The services report measures business activity for the overall economy; above 50 indicates growth, while below 50 indicates contraction. The number for April is expected to be above 50 at 52%.
• 2:00 PM, the Fed statement following the FOMC meeting will be released.
• 2:30 PM, Fed Chair Jay Powell will answer questions on economic policy in a post FOMC meeting press conference.
Thursday 5/4
• 8:30 AM ET, Initial Jobless Claims for the week ended April 29 is expected to be higher at 240,000 than the prior week, where it stood at 230,000 individuals claiming unemployment.
Friday 5/5
• 8:30 PM ET, the U.S. Employment Report is chocked full of data that could cause a late-week shift in inflation expectations. The survey provides estimates for nonfarm payrolls, average weekly hours worked, and average hourly and weekly earnings. For April compared to March the economy is expected to have added 180,000 new jobs versus 236,000have an unemployment rate of 3.6% versus 3.5%, hourly wages are forecast to have a second month of increases averaging .3%, and an average year-over-year hourly wage increase equalling 4.2%.
What Else
There is more concern being created in the banking sector as the FDIC is said to be preparing to take First Republic Bank into receivership until they find a suitor. The bidding process among large banks is likely to be headline news before and after.
