Thursday, March 21, 2024

Guest Post: Financial Markets and Economic Update - First Quarter 2024

Four Years Ago

It was on March 11th, four years ago in 2020, that the WHO declared a global pandemic due to the Covid virus threat that originated in China.  Our lives changed forever from this whole experience of the government’s declaration of a national emergency, leading to forced shutdowns of businesses and schools, mandated mask wearing, forcing 6-foot distances between people, travel restrictions, fear mongering with case and death counts, and forced vaccines/boosters.  No one who lived through this will ever forget what this time was like. 

In the markets, we watched helplessly as real GDP plummeted -5% in 1Q20 and -31% in 2Q20 before rebounding by +33% in 3Q20.  No one will forget how quickly stocks plunged and recovered.  Interest rates fell to incredible lows, forced there by the Federal Reserve’s rate and bond buying policies.  No one will forget the inflation that followed in 2021 to 2023, started first by supply chain issues, but then fueled by the Fed’s purchases and the obscene amount of cash handed out by the federal government.  M2 growth was out of control at over 20%.  Initially individuals and businesses saved their cash, but then as the pandemic eased, they spent with abandon, pushing up demand on everything from food, autos, clothing, travel, and entertainment to home goods and service-related businesses, such as restaurants.  It was not until May 11, 2023, that the US national emergency was lifted, but sadly, the free cash handouts continue.

The Fed and Inflation

The Fed raised rates by 5.25% between March of 2022 and July of 2023 to try to crush inflation.  I’m sure they are surprised that we did not get a recession yet, but more on that later.  The Fed Funds rate stands at 5.50%, compared to its starting point of .25% in 1Q22.  Although they are willing to admit that they will lower rates, they are not willing to admit that they are too high.  When Fed Funds exceeds inflation, the positive spread between the two creates a “real” rate and indicates tight policy.  Fed Funds minus CPI (3.2%) is 2.30%, Fed Funds minus PCE (1.8% 4Q) is 3.70%, and Fed Funds minus core PCE (2.1% 4Q) is 3.40%.  Are they tight enough?  Yes, absolutely!

Inflation relief may come from an unlikely source- China.  I’ve previously theorized that China would try to reclaim its global market share lost during the pandemic by flooding the markets with cheaper goods.  According to a Wall Street Journal article on March 3rd, this time has come.  This development could give us good news on inflation.  China, however, is struggling with their economy, too much debt, $4 trillion in real estate losses, and a shaky stock market, so these goods may be slow to arrive.  By the way, China is about to get an inverted yield curve.

Since tight policy has a detrimental effect on GDP growth, the Fed usually lowers rates when nominal GDP falls below Fed Funds.  Since Volcker’s reign, 14 of 18 easing campaigns started with Fed Funds above nominal GDP.  Nominal GDP for 4Q23 was +4.8% (real was +3.2%) and nominal GDP for 3Q23 was +8.2% (real was +4.9%); the latter was clearly too high to start easing, but the 4Q23 nominal rate fell substantially, creating a spread below Fed Funds of .70%. 

Nominal GDP is not the only consideration, but it’s a pretty important one.  Other factors include PCE inflation, M2 growth (or lack of it), consumer spending levels, the dollar, employment, and the real Fed Funds rate.  If the Atlanta Fed’s current GDPNow projection for 1Q24 GDP of +2.1% comes true and the implicit price deflator is 2%, the Fed Funds minus nominal GDP spread will be 1.0% or more.   It’s my thought that the Fed is waiting for 1Q24 GDP to check the spread.  Then they can have more confidence to lower rates in May or June, given that the unemployment rate has been rising slightly recently.  Should they lower rates at that point?  Yes!

I say “yes” for two reasons.  M2 year-over-year growth continues its unprecedented decline that began in December, 2022.  We have not seen a contraction in M2 since the 1930s.  January’s M2 y-o-y was -2.0%, December was -2.4%, and November was -3.0%.  Declining M2 is pulling inflation down.  Paired with a velocity of money that is low, at 1.35 in 4Q23, and projected to fall, there will be downward pressure on GDP.  Look at this equation and think.  GDP= M * V.

The second reason is something I always harp on- the lags in monetary policy- generally 6 to 9 months but they can obviously be longer.  Fed Chairman Powell even acknowledged, as did several of his Governors, that the Fed should begin to ease when inflation is headed to their target, NOT when inflation hits the target due to the risk of overshooting and inflation that turns into deflation.  And don’t forget QT; the Fed continues to let $100 billion per month mature off its balance sheet, further contributing to tighter conditions.  So, why not lower rates now?  Mark Zandi of Moody’s just discussed that a major risk to the markets and the economy is the Fed holding rates too high for too long.

Government Debt

Our government’s debt is now over $34.5 trillion, or 124% of GDP.  Weakness in GDP is a general rule after extended periods of the debt/GDP ratio exceeding 90%.  High debt levels continue to harm GDP as the US Treasury issues new debt with abandon and the politicians hand out money like candy.  It is mismanagement of the worst kind as budget deficits explode; the fiscal year 2023 deficit was -$1.7 trillion, following 2022’s deficit of -$1.4 trillion.  2024 could exceed -$2.0 trillion.

The cash continues to fuel the economy temporarily and then it’s gone.  Some of the infrastructure projects are admittedly investments but many are not.  Real GDP was +3.2% in 4Q23, of which .73% was government spending; the 3Q23 real GDP was +4.9%, of which government was 1.0% of that.  Trillions of dollars of subsidies on “green” BS projects, electric vehicles no one wants, tax credits, debt forgiveness, and free money all fuel demand and contribute to inflation.  I’m surprised no one ever talks about maybe the Fed is keeping rates too high to fight the inflation caused by our own federal government crowding out the private sector. 

Where is the Recession?

I have spoken continuously about a recession coming, so where is it?  Why can’t we see it?  I was taught to watch specific indicators that are extremely efficient in forewarning about recession.  The inverted yield curve persists and is at record times- 10s to 2s since July, 2022 and 10s to 3 months since October, 2022.  Most recessions occur within 14 to 18 months following inversion, especially of both yield curve measures.   

ISMs and regional Fed surveys have been mostly negative for months on end.  Inventory has been building in the second half of 2023, with +$63 billion in 3Q23 and +$5 billion in 4Q23.  GDP shows up as weak every other quarter.  Stocks had their big selloff in 2022 and no recession followed.  In fact, stocks are now at new highs this quarter, led mostly by the Magnificent 7- MSFT, AMZN, NVDA, TSLA, AAPL, GOOG, and META- so there is no recession signal from stocks.  I think stocks are up on the potential of AI to massively increase productivity.

Leading economic indicators, or “LEI,” continues its long stretch of negative readings with January at -.4% and December at -.2% and is now down -3.0% for the past six months annualized.  The LEI index has now fallen 23 months in a row and is the lowest since April, 2020.  Even with the continued dire condition of this index and its trend, the Conference Board gleefully announced that they do not see a recession.  Oh, brother!  It sounds like 2007 all over again, when people got tired of looking at LEI and then in 2008, all hell broke loose.  Remember, hope does not stop recession.

CBS News just released a report saying that the average family is spending $11,434 more per year today than at the end of 2020 to maintain their standard of living.  Tell me that that’s not a bad sign.  JP Morgan Chase estimates that 80% of consumers have depleted their Covid savings, so they have no real extra cash.  Credit card and auto delinquencies have risen above pre-pandemic levels.  Insurance costs have been soaring.  CRE and its depleted value are a problem for many banks, not just NYCB, as vacancy rates for offices top 19% and 190 million square feet of office space is available for sale, lease, or sublease.  These are all signs of recession.

The Fed is holding interest rates too high, creating real spreads to inflation and to nominal GDP.  At this point, I can only say that I believe that recession will come, but I hope there will not be a major shock to cause it.  Of course, if the Fed eases enough soon, we can avoid bad outcomes.

The Employment Report

In my mind, I find that the monthly BLS report has lost some of its credibility.  February’s report showed payroll growth of +275,000 but restated growth in December and January by -167,000.  Challenger layoffs ran above 80,000 for both January and February, but they never seemed to show up in the numbers.  Unemployed persons rose by 300,000 to 6,488,000.  Household employment fell by -184,000, exactly the opposite of payroll growth once again.  The unemployment rate, which has been below 4% for 2 years now, rose by .2% to 3.9%.  The household report and resultant rise in the unemployment rate contrast with the sweet story of ever growing, then constantly restated downward, payrolls making headlines every month.

Here's a rant.  Every time the JOLTs report is issued, headlines say how “tight” the labor market is.  The JOLTS report for January showed 8,863,000 job openings and unemployed persons were 6,488,000 in February.  That’s 1.4 jobs for everyone looking for a job, right?  NO!  Maestro Greenspan taught me many things, including that the supply of labor is measured as the pool of available workers, which is the sum of unemployed persons AND those not in the labor force but want a job.  That number has been rising and is now at 12,130,000.  There are not enough job openings, or .7, for the supply of labor.  Why does everyone ignore the pool of available workers?  One ratio they do follow is the quits rate, which is a leading indicator of the jobs market; the rate was 2.1% in January, which is getting low, as people hold onto their jobs, at which they have to work longer and harder to beat inflation.

Wage growth was 4.3% year-over-year in February, which is not that far above Fed “targets.”  Their inflation target of 2.0% can be added to average historical productivity of 1.5%, which creates a “target” of 3.5%.  Productivity in 4Q23 was twice the historical average at +3.2% and very helpful to offset wage costs.  Greenspan also taught me this.  And a word about Fed targets.  Chairman Powell testified last week to Congress for two days and stated that their 2% target is based on PCE.  So let’s clear up any misconception that they target CPI, which traditionally runs higher based on its different construction.  CPI can be acceptable at 2.5% when PCE is at 2.0%.


In the past 18 years, I’ve written over 70 quarterly newsletters and plan to keep them going, as long as I have the energy and desire to rant and to try to make sense of things that just don’t make sense.  I retired in November of 2023, after 49 years in banking and I can tell you it is hard to walk away from something you loved.  When Jason Kelce announced his retirement from the Eagles on March 4th after 13 years, I truly understood why it was so emotional for him.  And yes, I cried every time he did.  So soon I’ll be off to watch the solar eclipse in totality in NY and I’ll be tending to tulips soon thereafter.  Retirement does have its benefits.

Thanks for reading!  DLJ 03/15/24

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.