September 2022

As of late, there has been little for the Fed to celebrate.  The all-important employment report has been relegated to second tier status as the Producer and Consumer inflation measures take center stage as the most important measure of the Fed’s success.  With the release of the September report, the Fed’s efforts this year represent a distinct failure.  Both measures came in above expectations and didn’t really offer any indication that the rate hikes to date have been successful.  The markets reacted mostly as expected.  The 30-year bond, after a brief short covering rally on the day of the CPI release is trading just above 4.00%.  Similarly, the 2-year note is trading just below 4.50%.  Fed Fund futures reset materially higher, with the May 2023 contract indicating a peak Fed Funds rate of 4.93%.

The equity market staged a similar short covering rally on the day of the CPI release, initially punching through the low of 2023 before staging a blistering rally to end the day close to the session high.  Investors should be cautious of that market action as we enter the earnings season in earnest.

The earnings parade kicked off with J.P. Morgan posting record net interest income and besting expectations, despite a sequential decline in net income compared to the same quarter last year.  Bank of America, Morgan Stanley and Citibank also beat expectations but also saw a decline in year over year earnings.  The message from Morgan Stanley was most ominous as they communicated that jobs cuts are on the horizon.

Mid-month will provide an updated glimpse of the state of the housing industry, which is not likely to be a pretty one.  With the latest uptick in interest rates, conventional 30-year mortgages have topped 7%, driving home buying affordability out of the reach of most perspective buyers.  The standard refrain is that buyers will wait until interest rates fall, then they’ll make their move.  Home sales are a significant driver of economic activity, as the new homeowner outfits their abode with new furniture, drapes, carpeting and all of the creature comforts that make a house a home.   On the other hand, refinancing of existing home mortgages has been a source of income for homeowners, as the monthly payment is adjusted downward, and a liquidity event for those doing a cash out refinancing.  When interest rates troughed in the summer of 2020, mortgages were being refinanced at the 2.50% level.  It’s safe to say that the homeowner that refinanced at 2.50% is not going to deliberately increase their month mortgage expense by refinancing at 7.0%.

Despite the unaffordability of home buying, the Fed is expected to raise the overnight Fed Funds rate by 75 basis points at each FOMC meetings in November and December.  Should that forecast come to pass, Fed Funds will close out the year at 4.75%.  What remains to be seen is how consumers react to that rising cost of capital.  We’re only a few weeks away from the start of the holiday selling season and retailers seem to be flush with inventory, unlike last year’s shortages.  Will the inventory build prove to be detrimental to profitability, especially if consumers pull back?  Our guess is as long as the employment picture stays rosy, that’s unlikely to happen.

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