Liquidity is shrinking
Perils lurk but so does the potential for upside surprises.
So then, has the Fed done enough? Depends on when you ask. Rate-hike odds change with every data point, each seeming to send conflicting signals. For example, headline March CPI (more below) surprised, rising at its second-slowest pace in three years. (Time for a pause?) But the core rate rose. (Maybe not.) What is certain is the Fed’s historic hikes are starting to take a toll. Liquidity stresses are popping up all over. U.S. banks have seen $1 trillion of deposits flee since February. In Europe, interbank funding rates are at levels last seen during 2012’s euro crisis. In the U.S., an Empirical Research analysis found the number of leveraged-loan borrowers confronting potential troubles has spiked relative to the past 10 years. U.S. government debt servicing costs have soared 50% in just a year, and as they move into budget season, states with lofty January tax collection estimates are throwing them in the garbage—California’s projected surplus of nearly $100 billion has morphed into a $23+ billion deficit. The share of NFIB firms reporting credit hard to get in March nearly doubled in just a month to ’90s’ levels (more below). With year-to-date tax refunds running at their lowest level in more than 10 years and the average credit card rate its highest ever, consumers are feeling the pinch, too. The New York Fed’s March survey found 43% of households expect credit to tighten further vs. the pre-pandemic norm of 10%. It could get worse. Jefferies Group estimates the pending end to the student loan moratorium will represent an $18 billion monthly hit to incomes. That's 2% of personal consumption expenditures.
The Fed’s inflation fight may be a bigger threat to corporate profits than wages. With elevated jobs cushioning against a sharp weakening in demand, both the Fed and a Bloomberg survey of economists see the jobless rate rising from 3.5% now to 4.6% by year-end and holding through next year. That means if there is a recession, the 1.1 percentage point increase would be the smallest of the modern era. Even if the rate were to climb twice as much (2.2 points), it would still be well below its 6.2% average over the last 50 years. Consensus sees this labor strength preventing annualized wage growth from slowing beyond a still healthy 3.2% through 2024, and that’s the issue for companies. Short of massive layoffs, which could cause unemployment to rise faster and the economy to shrink more dramatically, Bank of America sees profit margins testing prior cycle lows and producing an even larger decline in profits. S&P 500 operating earnings already appear poised to drop a second quarter in a row—Refinitiv data suggest -5.2% in the Q1 earnings season just underway. It doesn’t help that Chair Powell’s inflation fighting is at war with the government’s inflation-linked automatic spending increases. A long list of spending programs getting 10%+ increases was a big factor in a March budget deficit that doubled to $376 billion vs. last year, with net interest costs as a percentage of tax revenues reaching a 23-year high.
Despite pockets of shrinking liquidity, bank deposits and M2 are a respective $2 trillion and $3 trillion above normal balances. “Excess savings” over and above 2019 levels owing to government largesse stood at $1.1 trillion in January, the Richmond Fed said. Lots of money still out there. And jobs. Payroll and household employment rose a respective 1 million and 1.6 million in the ’23’s first three months to record highs. We are mindful the job market is a lagging indicator. But the Conference Board’s help-wanted count among industries astounds (more below). Openings all over. Even with consistently stronger-than-expected economic data in the first quarter, cuts to consensus earnings continued. To Deutsche Bank, this sets up for its out-of-consensus call, a Q1 earnings season that surprises to the upside. It sees earnings negative on a y/y basis but up sequentially, with sales growth continuing to slow but margins ticking higher on the back of operating leverage with the pickup in real growth. Barclays chimes in that a final look at transcripts from Q4 ’22 earnings calls during Q1 reflected optimism about the general outlook despite cost concerns, and early reporters look quite healthy. Time for a pause? Maybe not.
- Pause? … March’s PPI was quite weak, with the headline contracting m/m and the preferred core metric (ex food, energy and trade services) eking out a 0.1% gain. The core PPI for unprocessed goods (a leading metric for earnings growth) fell 0.3% and was down sharply y/y. Also on a y/y basis, headline PPI fell to 2.7% from last year’s peak of 11%, with goods inflation dropping from above 17% to 2% and services inflation (which does not include rent) from about 9% to 2.8%. Elsewhere, both import and export prices contracted and are now running at a respective -4.6% and-4.7% y/y.
- The consumer is not going down without a fight While March headline retail sales disappointed, core sales that strip out volatile components surprised to the upside, declining less than expected on a big jump in ecommerce sales and increased spending at restaurants & drinking establishments. Core sales also were revised upward for February, capping a strong Q1 for consumers. Also, early April Michigan sentiment rebounded after March’s plunge, though year-ahead inflation expectations jumped.
- If everyone’s on one side of the boat Despite the year’s bullish start, the latest Investors Intelligence Bull/Bear reading hit new year-to-date highs. Sentiment has been consistently the most bullish component for stocks over the past year as investors generally remain steadfast to their bearish outlook.
- … maybe not Headline CPI’s rise moderated in March as energy prices declined and food price increases slowed, lowering y/y CPI to 5.0%— 4 percentage points below last June’s 9.1% peak. However, y/y core prices ticked up a tenth of a point to 5.6%, and core services ex shelter and medical services popped 0.6% m/m, lifting the 3-month y/y pace to 8.6%.
- Small businesses are a big deal The NFIB optimism index slipped amid broad softening in hiring plans, job openings, capital spending plans, sales expectations, expected credit conditions and plans for expansion. Businesses with fewer than 100 workers employ 35% of the private sector workforce, produce 25% of the nation’s gross output and rely disproportionately on small banks for loans.
- The inflation fight is global In the latest sign Europe has skirted recession, German exports advanced 4% and factory orders 4.8% in February, both representing the fourth increase in five months, and industrial production rose 2% (it rose 0.5% y/y in the U.S. on a surge in utilities as seasonal weather returned but manufacturing activity fell). Germany’s strength seems certain to keep the ECB on its tightening path as inflation across the pond remains sticky, particularly with oil breaking out above its multi-month range.
Deflation? U.S. online prices as measured by Adobe declined for a seventh month on annual basis. The company analyzes one trillion visits to retail sites and more than 100 million items across 18 product categories to track price changes.
Jobs all around The Conference Board’s help-wanted count among major industries in February found openings in professional & business services (1.8 million), health care & social assistance (1.7 million), leisure & hospitality (1.5 million), retail trade (829,000), state & local government ex-education (535,000), transportation, warehousing & utilities (488,000), financial activities (476,000), durable goods manufacturing (475,000) and construction (412,000).
Can Big Tech keep delivering? Consensus expects the sector to expand profit margins as much as 140 basis points next year, the largest projected increase of all sectors, putting it at all-time highs. The question is how much already is priced in? With the five biggest names up as much as 26% year-to-date, three-quarters of market gains this year stem from the sector. Three stocks, Apple, Nvidia and Microsoft, contributed to 54% of the Q1 gains in the S&P.