As expected, the Fed remained unchanged on interest rates at its recently concluded March meeting. What's more interesting is that the “dot plot,” a picture of the FOMC's thinking on interest rates over the next two years, remained at three cuts for 2024. Looking at the chart (the 2024 column), the middle point is 4.625%. This represents a difference of 75 basis points from today's rate of 5.375%, or three rate cuts of 25 basis points each by the end of 2024.
The Fed's March dot plot
Yahoo! Finance
A change of mind to a higher year-end number by two participants would bring the median to 4.875% and represent only two cuts. Markets were concerned ahead of the meeting that this might be the case, due to hawkish public statements from several FOMC members. But that didn't happen. Note that the points are tilted much more towards the hawkish (higher) side. There are only two points that indicate the FOMC's opinion that interest rates will be below the median through the end of 2024, while nine points indicate a higher value. In December it was five points below the median. So it appears that the better-than-expected CPI and PPI numbers in January and February have caused the FOMC to become even more hawkish than in December.
However, be aware of the changes planned for 2025, 2026 and beyond. The median rate for 2025 is 3.75%. In December it was 3.5%. This means one less rate cut for 2025. In 2026, the median is 3.125%, down from 2.875% in December. Another cut less. We don't place too much emphasis on these longer-term issues. A lot can and will change by then. Also note that after 2024 the points become much more moderate: the middle point has fewer compatriots and the points have a much larger spread.
Because Chairman Powell wasn't as hawkish at the press conference as markets had feared, stocks rose to record highs. In the press conference, Powell noted that the elevated inflation readings in January and February were likely just “bumps” and the path to 2% inflation is still intact. He also noted that wage growth slowed satisfactorily, eliminating any lingering concerns about a 1970s-style wage-price spiral.
It appears that the reason for the lower number of rate cuts in the dot plot is at least partly due to a more optimistic view of the economy. The 2024 GDP forecast was raised from 1.4% to 2.1%, the U3 unemployment rate was reduced from 4.1% to 4.0% and the core inflation rate was reduced to 2.6% from 2.4% in December % raised. The latter implies that the FOMC now sees a much slower path to the 2% inflation target than it did three months ago. So while Powell said that the rise in inflation in January/February was “just a bump in the road,” in the eyes of the FOMC, that bump has apparently slowed the journey!
Money supply (M2)
Universal value advisors
In addition to the hawkish tone of the meeting, the Fed further reduced its securities holdings (Quantitative Tightening (QT)). Powell hinted at this in the press conference. The result, as shown in the right part of the M2 chart, is a continuation of the decline in the money supply that is now more than a year old. Monetary economists of the Milton Friedman school would cite this as a reason for disinflation. Furthermore, prolonged periods of money supply shortages have always been associated with recessions.
Financial markets: The DJIA and S&P500 set records on Thursday (March 21) (S&P500: 5,241.33; DJIA: 39,781.37), but fell slightly on Friday. The Nasdaq, however still driven by AI mania, continued its record run on Friday, rising to 16,428.82. For the week, the DJIA gained 1.97%, the S&P500 gained 2.29% and the Nasdaq gained 2.85%.
Selling existing homes
Universal value advisors
Housing
Existing home sales rose +9.5% in February. As a single data point, this looks pretty impressive. But a look at the graph shows a different story. Despite the recent increase, sales are still at Great Recession levels. There are various reasons. First and foremost, there is a lack of inventory. Most existing homeowners have low mortgage rates because they purchased before the Fed's recent tightening. Today's high mortgage rates are a major disincentive for existing homeowners to sell. Even a sideways move is likely to nearly double your monthly mortgage payment. Additionally, the Fed's “higher for longer” policy has pushed interest rates higher since December, as the chart of the 10-year Treasury yield shows.
Yield on 10-year government bonds
Universal value advisors
A weakening financial system
A year ago (March 23) there was a mini-meltdown at the regional bank. Several banks, including Silicon Valley Bank (SVBVB) and Signature BankSBNY, failed. This was due to unrecognized losses in their Held to Maturity (HTM) bond portfolios. According to banks' accounting regulations, a bond in the HTM account does not have to be valued at market price. However, if a single bond in this HTM account is sold before maturity, the entire HTM account must be marked to market. When SVB and others had deposit flows, they had to sell from their HTM accounts to cover the deposit outflow. This resulted in all bonds being valued at market value. Because interest rates had risen so quickly, any bonds purchased before the Fed's rate hike cycle were at significant discounts to the purchase price. The loss recognition was large enough to consume the bank's entire capital.
One of the measures the Fed used was to set up a credit facility so that the Fed would lend money to banks at the face value of the bond rather than its market value. Thus, any additional deposit runs could be covered by taking out loans using the face value of these bonds as collateral. Notable: This month the Fed closed this facility!!
The chart below shows the weakness in commercial real estate (CRE) prices. The banking system holds $2.7 trillion in CRE loans, about 30% from regional banks, only 6% from money center banks, leaving more than 60% in the hands of small banks. We recently reported on the troubles at New York Community BankNYCB (Symbol: NYCB), where an expected Q4 profit of +$200 million turned into -$200 million due to commercial real estate write-offs. Since then, former Treasury Secretary Mnuchin has assembled a group of investors to inject capital.
Commercial property prices
Universal value advisors
The “work from home” trend that began with the pandemic continues to have a major impact on office building rents. We recently reported that the mortgage on a New York office building (360 Park Avenue) was sold by a Canadian pension fund for $1. (see grafic).
Defaults on commercial real estate loans
Universal value advisors
The Kansas City Fed's CRE index falls. It seems inevitable that CRE problems will soon begin wreaking havoc on the banking system. We wonder how many banks will be able to raise additional capital if this becomes a trend.
Commercial real estate index
Universal value advisors
Final thoughts
The economy continues to show mixed (conflicting) signals, such as large positive non-farm employment numbers but negative job creation in the sister household survey. While existing home sales appeared to rise a whopping +9.5% in February, a closer look shows that these sales are still at Great Recession levels – although +9.5% is a good start!
We remain concerned about CRE's values. They continue to sink. Small and regional banks appear to be most at risk. We do not believe this issue will go away and expect some impact this year.
The Fed told us via its dot plot that it is serious about higher for longer. They are based on a “strong” economy. As discussed in our blogs, we see emerging weakness. Perhaps the Fed's opinion is based too heavily on lagging indicators (like the unemployment rate). The manufacturing sector already appears to be in recession as industrial production and capacity utilization fall. Not a single full-time job has been created online for over a year. In our opinion, it would be wise for the Fed to start cutting rates sooner rather than later.
(Joshua Barone and Eugene Hoover contributed to this blog.)
Follow me up Twitter. Checkout my website.
Robert Barone, Ph.D. is a Georgetown-educated economist. He is co-portfolio manager of UVA's Fixed Income ETF (Symbol: FFIU). Robert is also a Managing Director and Financial Advisor at Farther Finance Advisors, LLC (“Go Farther!”). Known nationally for his writings, Robert's storied career includes serving as a professor of finance, CEO of a community bank, director and chairman of the Federal Home Loan Bank of San Francisco, director and chairman of CSAA Insurance Company (the AAA brand), and Director of the AAA Auto Club of Northern California, Nevada and Utah Robert is currently a director of Allied Mineral Products (Columbus, OH), America's leading refractory company.
Read moreRead less
Comments are closed.