The level marks the short-term battleground between the bulls and the bears.
With a deluge of economic data hitting the wire this week and earnings season underway, sentiment should be tested as the fundamentals remain problematic. Moreover, while we’ve warned repeatedly that a cash-rich U.S. consumer is bullish for the FFR, Bank of America CEO Brian Moynihan – who runs the second-largest U.S. bank – said on Jan. 17:
“The consumers are spending, their wages are growing and frankly, there's still a lot of stimulus…. The money in their accounts continues to be solid.”
As a result:
“[The FOMC] may leave [rates] higher for longer just to make sure they squeeze out that services-side inflation.”
He also said during the Q4 earnings call on Jan. 13:
“Consumer deposit balances continue to show strong liquidity, with the lower cohorts of our consumers continue to hold several multiples of balances they have as the pandemic began. These balances are drifting down, but they still have plenty of cushion left.”
Furthermore, the bank’s delinquency data highlights why the average consumer remains in a strong position, and the resiliency is bullish for the FFR.
Please see below:
Source: Bank of America
To explain, the consumer charge-off rate (percentage of debt unlikely to be collected) has averaged 1.6% since 2004 and was 3.6% during the GFC (peaked at 6% in Q3 2009). In contrast, the blue line on the right side of the chart shows that the current charge-off rate is 0.5%, which is even less than the 0.8% realized pre-pandemic.
As such, the Fed’s 2022 rate hikes have not led to widespread defaults, and it’s an indicator of why the demand destruction that often coincides with dovish pivots is not present now.
As further evidence, the average credit card interest rate hit a nearly 30-year high of 19.07% in November. Yet, credit card charge-offs are still materially below their 4.7% average since 2004.
Please see below:
Source: Bank of America
To explain, the blue line on the right side of the chart above shows that the current credit card charge-off rate is 1.7%, which is nowhere near the GFC average of 8.3%, and is also below the pre-pandemic average of 3%.
As a result, when you combine these metrics with ~40-year high core inflation, a ~50-year low unemployment rate, and record-high household checkable deposits, the 2023 rate cuts priced in by investors contrast fundamental reality.
To that point, with their misguided optimism only pushing asset prices further from their fundamental values, the crowd erodes the Fed’s progress with each bullish celebration.
Please see below:
To explain, the blue bars above track the monthly change in the Goldman Sachs Financial Conditions Index (FCI). If you analyze the right side of the chart, you can see that the recent drops were the sharpest since November 2020.
Although, lower interest rates, a weaker U.S. dollar, higher stock prices, and narrower credit spreads only support more inflation; and with the Atlanta Fed’s Sticky CPIs already hitting new highs, the crowd is digging a deeper hole.
Furthermore, with the crude oil price rallying sharply in recent days, it closed above $80 on Jan. 17. So, the sharp month-over-month (MoM) drop in energy prices that hurt the headline CPI in December could reverse in January if the momentum continues.
Please see below:
Source: Cleveland Fed
To explain, the Cleveland Fed expects the headline and core CPIs to increase by 0.50% and 0.48% MoM, respectively, in January; and if the predictions prove prescient, these annualize to 6.2% and 5.9% YoY. Therefore, the inflation battle is far from over in our view, and investors have not priced in the ramifications.
Overall, risk assets look shaky, as bearish S&P 500 seasonality has arrived. Moreover, with sentiment indicators near their 2022 peaks, the risk-reward is highly unattractive. As such, we see storm clouds from short and medium-term perspectives.
What’s your opinion of the economic outlook? Is the U.S. economy stronger than the consensus thinks, or is a 2023 pivot inevitable? How soon will inflation dissipate?
Alex Demolitor
Precious Metals Strategist