Financial
Markets Update – Third Quarter 2024
I had a fantastic September
traveling to France and Luxembourg with my sisters. We joined my dear friend, Elisabeth, Thanks
GIs Association, and other American families for the dedication ceremony of a
new monument to the 11th Infantry Regiment, who fought in the
Dornot-Corny battle along the Moselle River in 1944 for their freedom. My Uncle, Stephen W. Jaworski, was killed in
action during these battles just south of Dornot. We spent quality time with our French friends/family. We joined Thanks GIs for lunch with the Mayor
of Noveant, who surprised us with a posthumous Medal of Honor award to Stephen
from the town. It was another emotional
day, and later we visited Stephen’s gravesite at the Luxembourg American
Cemetery to honor him. These were
powerful, emotional events and I will always be proud to represent Stephen, our
family hero.
Where is the Recession?
I’ll start this subject again
this quarter by saying I believed we would get recession by now; my timing has
been horribly early and wrong. All the
signals have been there for two years; the index of leading economic indicators
has been down 27 of the last 28 months, consumers are using borrowing to get
them through as inflation ravages household budgets, and an inverted yield
curve, which is generally a precursor of recession, lasted about two
years. Interestingly, the 10-year to
2-year Treasury spread, which was -37 basis points at June 30
th,
turned positive in September after 26 months and is now +23 basis points. The 10-year to 3-month Treasury spread is
still inverted, as short-term rates wait for more Fed action. The spread was -101 basis points at June 30
th
and is still widely negative at -81 points today. Remember, it is the re-steepening of the
yield curve after a prolonged period of inversion that heralds recession and
Fed easing.
You wouldn’t know we have
recession risk when stocks are rampaging; markets crashed for a day on August 5th
but recovered in mere days.
Year-to-date, the S&P 500 is up +21%, Nasdaq is up +23%, and the
DJIA is up +12%. But unemployment took a
turn for the worse with July’s numbers, reported in August and some economists point
to the Sahm Rule (recession occurs when the unemployment rate rises +.5% in a
short period), with the unemployment rate at 4.2% in August being +.8% over the
low in 2023 of 3.4% to say recession could be starting. I’ve been suspicious of the fictional payroll
numbers and equally unreal JOLTS report.
In August, the BLS announced that they would cut 818,000 jobs from the
payroll reports of the past 12 months as part of their benchmark revision
process. It’s the largest since
2009! The pool of available workers is
high again at 12.75 million persons and the unemployed now total 7.1
million. Full-time jobs are down
-1,021,000 in the past 12 months while part-time jobs, likely without benefits,
are up +1,055,000. Payroll and household
job growth has weakened considerably since July.
Gold is signaling concern as it
trades at new highs, currently $2,658 per ounce. Safe havens are not always bonds. Anticipated slowdowns in the economies of the
US, China, and Europe led to oil prices declining to $68.64 per barrel and gas
prices declining to $3.22 per gallon, according to AAA.
GDP
The latest Federal Reserve
projections from September for GDP are for +2% growth this year and next year,
despite 2Q24 GDP being +3.0% and the Atlanta Fed GDP Now being +2.9% for
3Q24. By the way, Chairman Powell called
2% GDP growth “solid.” It’s sad that we
have lowered our standards. The Fed and
many others believe (or maybe they hope) that we will have a soft landing. This is a familiar refrain. Before every recession since 1980, economists
and market participants believed the economy would have a soft landing; in
fact, the elusive soft landing was achieved only once since then- in 1996 by
Maestro Greenspan. More than likely, the
US will experience a weak recession…if the Fed keeps lowering rates.
The world’s best banker, Chase’s
Jamie Dimon, recently warned about a scenario that is worse than recession; he
says not to discount the possibility of stagflation like the 1970s, with slow
growth, rising inflation, and rising unemployment. I would add that we should not discount the
possibility of inflation falling far below Fed targets if they remain
stubbornly tight.
The Fed
I was not surprised at the 50
basis point cut in the Fed Funds rate in September. I’ve continually complained that the Fed
Funds rate was too high. I think it came
down to the Fed regretting that they did not cut rates in July (as all hell
broke loose with unemployment right after that), so they are playing
catch-up. But I ask, in what universe
does a 5% Fed Funds rate make sense?
Short-term Treasury yields and SOFR rates are all in the 4s, one-year to
10-year Treasuries all have 3 handles, and very long-term Treasuries are in the
low 4s. But a 5 handle on Fed
Funds? Even bankers disagree, as the FF
effective is 4.83%, toward the lower end of the 4.75% to 5.00% range. So yes, we’re happy with the first 50 basis
points two weeks ago, but there is a lot more work to do. I think the Fed will “catch up” again and do
50 basis points in November. That FOMC
meeting occurs after Election Day, so they won’t get any political
questions. And 2025? The Fed themselves project the rate cutting
phase will continue through the year.
Inflation
Everybody hates inflation! Thankfully, inflation continues to head down
toward Fed targets, albeit slowly for some measures. Fed targets are based on the BEA reported PCE
and core PCE numbers, published monthly and quarterly. The most recent monthly report for August had
PCE at +2.2% y-o-y and core PCE at +2.7% y-o-y.
From the GDP report, 2Q24 PCE was +2.5% and core PCE was 2.8%, both
y-o-y.
In terms of CPI, August was +2.5%
y-o-y and core CPI was +3.2% y-o-y.
Remember that CPI historically is higher than PCE by +.5%, so 2.5% would
be a good goal to have on CPI. Core CPI
is stubborn and declining more slowly than expected. Before we celebrate too much, can you say “supply
chain issues?” We have the threat of
dock workers going on strike October 1st at ports along the east
coast of the US and across the Gulf coast to Texas. What would this disruption mean especially since there is so much need in
states like Florida, North Carolina, and Tennessee after Hurricane Helene
destroyed so many communities with massive rain and flooding.
Chairman Powell stated that wage
growth is not contributing to inflation.
He also called the labor market “solid,” but we will forgive him for that
one. The figure was +3.8% y-o-y for
August. Remember that wages can increase
in a 2% inflation target environment and, if productivity is decent
(historically +1.5%), can grow +3.5% on average. 2Q24 productivity was +2.5% and 1Q24 was
+.4%, making the y-t-d average +1,5%, precipitating Powell’s comments. The wage growth percentage for August is
getting closer to this goal.
The inflation narrative really is
broken down into two parts: the level of
the inflation index and the marginal rate of change. The level of CPI is up +19.7% since the end
of 2020, including food +21.8%, shelter +22.7%, and energy +33.8%. It is the level of CPI, with no decline in
sight, that frustrates consumers the most.
Victory in getting the marginal change down to a low level does not
reduce their grocery, housing, utility, and energy bills. High prices have pushed consumers to turn to
credit cards to take care of everyday needs; credit card balances outstanding
have ballooned to $1.34 trillion with an average rate of 23%, and more telling,
a delinquency rate of 9%.
Restrictive Fed
Was Fed Funds at 5.5%
restrictive? Yes! Let’s have a look:
FF less CPI of 2.5%= 3.0%; FF
less core CPI of 3.2%= 2.3%; FF less PCE of 2.5%= 3.0%; FF less core PCE of 2.8%=
2.70%; FF less nominal GDP 2Q23 of 5.5%= 0.0%; 1Q24 of 4.6%= 0.9%; FF less
nominal GDP 4Q23 of 4.8%= 0.7%.
Not to be forgotten are two other
key elements in this tightening cycle- QT and M2. QT continues at a pace of $60 billion
sales or runoff per month from the Fed’s balance sheet. To date, the balance sheet is down $1.5
trillion from its peak. It’s hidden
tightening in that $1 trillion of QT is believed to be the equivalent of +100
basis points of tightening.
M2 continues its slight growth,
according to the H.6 Money Stock report.
In August, M2 grew by +2.0% y-o-y compared to July +1.3% y-o-y. Between December, 2022 and March, 2024, M2
declined on a y-o-y basis, which was the first time that has happened since
1931 to 1933. Don’t go there; I think
the Fed was trying to offset wild government spending but decided not to risk
it anymore. Milton Friedman suggested
that M2 growth should equate to output, or nominal GDP. That’s been 4% to 5%, so M2 is restrictive
and far away from equilibrium.
Speaking of government spending,
the deficits are out of control, at a projected -$1.9 trillion for fiscal 2024
compared to -$1.7 trillion in 2023. Debt
outstanding is $35.3 trillion, or 121.7% of GDP as of 2Q24; when the debt to
GDP ratio exceeds 90% for over five years, the negative effect on GDP is about
-33% of trend. Interest expense on debt
will now top $1 trillion per year, or $3 billion per day. Ridiculous!
Given the habit of our government of printing tons of money to hand out
like candy, I am afraid of what they’ll do when we have recession. Maybe Jamie will be right.
What does it all mean? Recession signals are around but not
impacting us yet. Stocks, bonds, and
data can all turn on a dime. Short-term
rates should continue to decline, with the Fed having some catch-up to do. Inflation is headed down, at least the
marginal change part. Long-term rates
have some room to decline, which includes mortgage rates, which are about to
drop below 6%- finally! No one will move
out of their home when they have a low-rate mortgage. The average mortgage rate in the US is 3.78%,
so don’t expect too much from housing.
Unemployment is the wild card. If
it keeps getting worse, the Fed will respond more aggressively. Those affected in many states by Hurricane
Helene will have a huge task in front of them to rebuild their homes, roads,
bridges, and communities after last week’s flooding and devastation. Give them the strength to do so.
I appreciate all of your
support! Thanks for reading! DLJ 09/30/24
Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy recently retired from Penn Community Bank where she worked since 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.
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