This week on “Inside the Economy”, we discuss banking and inflation. Money market funds have seen large inflows over the past 2 months following the issues in the banking industry, but with the Fed’s balance sheet growing as well, what does this mean for the economy going forward? Inflation continues to soften with lower rents and supply chain procedures getting back to pre-pandemic levels. Tune in to learn about this and more!
- Q4 2022 GDP estimate 2.6%
- Oil prices bump over $80
- Unemployment remains at 3.6%
Welcome to another edition of Inside the Economy! My name is Cody Campbell. I’ll be filling in for our beloved Larry Howes as he’s gallivanting across East Asia, hopefully enjoying the cherry blossoms, wonderful cuisine, and everything else that part of the world has to offer. Speaking of cherry blossoms, spring has sprung, at least in Denver. And for those of you who do not know what spring in Denver means, it’s remarkably similar to the stock market volatile, sporadic, and can’t make up its mind.
Last weekend it was 70 degrees. By Tuesday, it’ll be in the chance of snow later in this week. So now that the weather has been addressed, we can move on to the important matters at hand real quick. Just a reminder to check out my colleague Brad Conover’s Q1 2023 recap of the markets on our website. Or, if you are an SHJ client, you can access the video within our quarterly letter. Okay, let’s get into technicalities!
ISM Manufacturing came in this morning at 49.2, starting to find out its equilibrium again. Non-manufacturing ISM won’t come out until this airs. The third revision of GDP in Q4 was 2.6%. No real update on jobless claims or unemployment. We did see oil spike over the weekend as OPEC announced surprise cuts of over 1 million barrels per day, almost half coming from Saudi Arabia. This sent WTI crude above $80 this morning.
The yield curve stayed steady over the last two weeks, even with the quarter-percent increase from the Federal Reserve. The most notable move was in the two year treasury trying to find its footing. It was 5% in early March, dropped to about three and a half percent in a few weeks with the banking news, and is hovering around 4% today.
After the banking fiasco, which I will touch on in a minute, the bond market is pointing to rate cuts prior to the end of the year. In my humble opinion, the Fed should be around 4% or maybe a touch lower. I don’t think there’s any need to raise rates higher, break more things and then have to come and do damage control. We can wait it out at about 4%.
Consumers can carry us through. Inflation will come down. But either way, I do believe the Fed is doing a pretty decent job. Let’s touch real quick on the banking crisis first. A major catalyst to what’s going on, or rather what has happened, is represented by this chart here tracking inflows to money market funds. Money market funds are yielding over 4% right now and are liquid in one trading day.
The funds are made up of mostly short-term government paper. If my regional bank or credit union couldn’t offer me 4%, I’d think about moving my money, too. And this logical thinking and the combination of technology has created a run on banks across the nation and the issue at hand. Many of these banks have mismanaged risk in their bond portfolios and have unrealized losses. And when they have net outflows, they have to sell bonds, which results in trouble, Silicon Valley Bank as an example.
So the Fed has stepped in, opening the Discount Window and Bank Term Funding Program, or BTFP, to help these banks stay afloat while depositors move their cash around. So in the last few weeks, we saw the Fed’s balance sheet increase about 300 billion because of this. Now, just looking at this chart, you could say, well, hasn’t this undone tightening the Fed’s been doing? Will this not contribute to future inflation? Did we turn on the money printing machine again? I completely understand why these questions are coming up. However, let me break it down this way.
The Fed is essentially allowing banks to collateralize or exchange their Treasuries and other government debt that is worth, call it, 90 cents for par value today. Or in other words, banks have a bond worth 90 cents today, but in the future, it will be worth a dollar. Therefore the Fed is saying; I’ll give you the dollar today; give me the bond. And we’ll calm the fears of depositors here in the banking system.
Was there any new money created or issued? And you got to love financial media. This from Bloomberg playing on fears saying discount window borrowing reaches all-time highs surpassing 2008 crisis. What’s the pattern on this chart? Flatline, blip back to flatline. This should play out the same this time around the Fed’s balance sheet. It should come back down in do time. All else equal, the Fed has indicated they are still taking measures to reduce their balance sheet, which they did over $9 billion worth of Treasuries and MBSs on March 15.
Now that we all agree the Fed’s balance sheet increase is not inflationary let’s take a look at inflation. Looking at the supply side, global container costs have started to normalize, easing some stress on the supply chain. Even though oil is back on the rise, most commodities have come back down to earth from last year’s peak, including natural gas. And for all you gold bugs out there, gold has rallied year to date up about 8%. Silver had a double-digit run in March, and precious metals have ticked up a bit.
Shelter, this is where I think the stickiest, gooiest gummiest part of CPI has been, and this is no secret. The two lines in an uptrend owner’s equivalent, rent and rent of primary residence, make up a big component of the CPI waiting for shelter. The data, like most economic data, is so lagging, like slower than a month of Sundays, that if you look at the other surveys on this chart, the Zillow Rent Index and the Apartment list, you would have optimism that shelter inflation will continue to come down once the data catches up.
Switching to the demand side, consumer confidence increased a tiny bit in March, even in the midst of a banking crisis and all the fear in the media. PCE, as mentioned earlier, came in at 4.6%, which is now below the Fed funds rate, and depending on policy over the next six months, it’s not a stretch if the labor market remains resilient, that the consumer could carry us through this period of slow growth and elevated inflation.
Now, I do like to get ahead of things, and I have seen a lot of headlines around de-dollarization, so I thought I’d speak to it briefly before the media’s fear-mongering tactics reach your screen. De-dollarization is the concept that the almighty US. The dollar is becoming less important in global trade. News of Brazil and China agreeing to come up with an alternative to trading in dollars. The UAE and India exploring other options are just a few of the recent headlines.
Now the US Dollar’s global status as the reserve currency has a strong foothold. About 60% of foreign exchange reserves are dollars. Over the last two decades, countries have continued to try and become less dollar dependent. But for now, I don’t see this as a risk or accelerating rapidly. Oil is still mainly traded in dollars. As long as we have a trade deficit, more dollars are being used globally. All in all, the dollar strength could weaken, and that would actually bode well for almost everyone, especially international investments, which have greatly underperformed since the financial crisis of 2008 comparatively to the US.
Without preaching too much, my hope is our nation realizes the power of being the world’s reserve currency and the power we have as the issuer of that currency. And if we could only shift our thinking a bit, we could bring prosperity to so many people in the US. as well as globally. Alright, wrapping it up here. We’ve seen an up and down market in 2023. January was great. February, not so much. End of March pretty decent.
Looking at this chart, same old story here. The top eight stocks in the S&P 500 are carrying the returns year to date. The other 492 companies are actually down slightly at the end of March. The top eight companies in the S&P, naturally being more technology-oriented, have had a great run this year. Maybe some speculation on the Fed lowering rates into the end of the year and getting us through to the next cycle. As always, if you have questions, email email@example.com. My name is Cody Campbell. I appreciate you tuning in. Take care!