As expected, consumer prices rose in August, rising more than consensus expectation. The year-over-year measure of CPI registered 3.7%, up from 3.2% last month, but the core CPI for the same period fell from 4.7% to 4.3%. That’s far from the Fed’s 2% target but the anecdotal slowing in the economy is likely enough to keep the Fed on the sidelines at the September 20th FOMC meeting, but not enough call the current monetary policy the peak.
There’s a lively debate between those that believe that economic growth is slowing and those that believe it’s reaccelerating. The actual outcome will have a marked impact on the progress made to date on inflation. Clearly, employment growth has slowed from the torrid pace witnessed earlier this year. The July nonfarm payroll report registered the first back-to-back sub-200,000 growth since December 2020. Similarly, the jobs availability measure (JOLTS) has contracted to less than 10 million from the 12 million touched earlier this year. But with 9.5 million unfilled jobs still available it seems unlikely that the economy is on the verge of a significant stumble. On the other hand, retail sales for July paint a picture of a confident consumer seemingly unworried about income and willing to spend. That creates a conundrum for economists. Clearly certain industries, namely housing and autos, have slowed down or are in outright recession, but that has failed to impact consumption.
The June payroll gain was the slowest in 30 months, coming in at 209,000 new jobs versus the 230,000 consensus expectation. That disappointment was offset by a greater than expected jump in average hourly wages. The wage measure came in at a 4.4% annualized rate versus the 4.2% expectation. The unemployment rate ticked down to 3.6%. A loosely interpreted rule of thumb is that the economy will continue to grow when more than 200,000 jobs are added per month. The BLS report was especially disappointing when compared to the private ADP jobs measure released on Thursday that showed a whopping gain of 497,000 new jobs. As we have cautioned in the past, seasonal adjustments applied to the BLS measure cause the two reports to deviate from time to time. Also of note, the revision to the previous two months was 110,000 jobs lower.
The Fed paused! Following ten consecutive rate hikes, the FOMC refrained from raising the federal funds rate at the June meeting. The summary of economic projections of the committee members offers some insight into their thinking. Despite leaving the overnight rate unchanged, the committee raised its Fed Fund forecast for the end of this year to 5.4% – 5.6%, an indication that they believe additional hikes will be warranted. What likely drove that decision was the lowered forecast for the unemployment rate from 4.5% to 4.1% and the forecast for real GDP revised for this year from 0.4% up to 1.0%.
With volatility still at a heightened level from the failure of Silicon Valley Bank, Signature Bank, and First Republic, we thought it would be an opportune time to discuss how we’ve positioned our Reserve Cash Management strategy (RCM). As the name implies, the RCM is a separately managed account strategy designed to generate returns in excess of the money market universe with a somewhat similar risk profile.
The short-maturity fixed income landscape is vastly different than last year. Namely, the overnight lending rate corridor is 5.0% to 5.25% and we’re likely at the peak of that rate for this cycle. Moreover, the Fed Funds futures market is anticipating that the Fed will cut the overnight rate later this year and will ultimately take the Fed Funds rate below 3.00%.
Following the Federal Reserve-induced banking crisis that gripped the capital markets last month, much debate has focused on the next course of action. Clearly, the Fed’s sharp and relentless rise in interest rates, and negligence of its regulatory responsibility contributed to the demise of Silicon Valley Bank and Signature Bank. From that, an argument can be made that they should pause from any additional rate hikes to evaluate their action to date. If for no reason other than to let any banks that extended duration too soon generate some net interest income. However, an equally persuasive argument is that the inflation mentality is starting to become entrenched.
With the events of the last few days, February seems like a distant memory. More importantly, it was yet another test of the integrity of the Reserve Cash Management strategy, and it performed as designed. As we have espoused, the emphasis of the RCM is broad diversification and an emphasis on liquidity, and that has served our investors well during the crisis. We’ve emphasized that to keep any more than $250,000 in a bank account is to make an unsecured loan to that institution. The RCM is a strategy that holds the securities in the name of the client, in a separately managed account, at a qualified custodian, thereby eliminating counterparty risk.
January was a peculiar month in that the New Year kicked off with a general feeling of malaise in terms of market sentiment stemming from what proved to be a disappointing holiday selling season. The stock market commenced the year trading at the December low as economic data continued to disappoint. The Fed, reacting to the string of weak Q4 economic reports and continued stubborn inflation readings, communicated that they would reduce the magnitude of rate hikes again from 50- to 25-basis points. In holding to their word, they did so at their February 1st meeting. Moreover, the committee members loosely suggested that the peak of the rate would reach 5% and not the 5.25% to 5.50% they communicated just 3 months earlier. That change in messaging succeeded in boosting investor concerns as witnessed in both stock prices and bond yields. The 30-year kicked off 2023 yielding 3.96%, only to close the month at 3.63%, as investors fretted that the economy was on the verge of recession and the Fed would be forced to cut rates later this year. Paradoxically, equity indices rallied for the same reason. The S&P 500 gained more than 6% for the month. While still more than 15% below the all-time high touched in December 2021, the index has rallied nearly 20% off of the 2022 low touched last October.
We’re delighted to communicate that the Halyard Reserve Cash Management (RCM) composite generated a positive net return of 0.72% for 2022. During a year in which nearly every risk asset fell in value, we are delighted with that outcome. That’s not to say that the composite didn’t suffer some interim mark-to-market losses as the Federal Reserve defied expectations and raised the overnight lending rate by 400 basis points. The composite endured an unprecedented six mark-to-market losing months last year despite the Halyard team’s highly conservative duration management.
Judging by the November Consumer Price Index, the Fed’s harsh medicine of higher interest rates is starting to work. While year-over-year CPI still rose 7.1% last month, that’s down from 7.7% in October, and the 0.1% month-over-month increase is exactly what the Fed has been expecting. While the November Producer Price index came in higher than expected, that measure of inflation takes a back seat to CPI in that some of those price pressures can be absorbed by margin compression at the corporate level. The CPI, on the other hand, directly impacts consumers and risks the spiral effect in which consumers expect prices to continue to rise into the foreseeable future.