Normally we start with rates to understand the week we had, but it’s hard to understand the outcome without understanding the week itself. There were many events of the week that controlled the narrative…
Summary of the Week (July 31 – August 4)
Monday was the Senior Loan Officer Opinion Survey on Bank Lending Practices. Loans to businesses reflect tighter standards and weaker demand for commercial and industrial loans. Banks reported lending standards tightening across all categories of residential real estate. Banks also reported tighter standards and weaker demand for home equity line of credit (HELOC). Demand weakened for auto and other consumer loans, but credit card loans remain unchanged. Credit cards have unfortunately emerged as a pseudo-emergency fund for many Americans without an actual Emergency Fund savings account, so they’ll likely remain at normal levels through recessionary times.
So what can we expect over the next half of the year? If credit conditions loosened, that would indicate economic growth. But the banking outlook reports the opposite: “[F]or the second half of 2023, banks reported expecting to further tighten standards on all loan categories. Banks most frequently cited a less favorable or more uncertain economic outlook and expected deterioration in collateral values and the credit quality of loans as reasons for expecting to tighten lending standards further over the remainder of 2023.”
This means lower-income and lower-middle-class households will feel the effects of the recession even more deeply than they already do.
Tuesday brought news of Fitch’s downgrading of the US’s long-term credit rating from “AAA” to “AA+.” Fitch is one of the larger rating agencies, but in its higher class of rating agencies, it’s one of the lower ones. They identified key drivers of the rating downgrade, such as erosion of governance over the last 20 years, rising government deficits, unaddressed middle-term fiscal challenges, and several others. Yet despite these challenges, the US maintains exceptional strengths that make it a high-quality debt carrier. Fitch’s view is that governance standards have deteriorated, including the recent political standoff resulting in the last-minute raising of the debt ceiling. These conflicts have “eroded confidence in fiscal management,” and they also reference the absence of a medium-term fiscal framework that exacerbates issues like economic shocks, tax cuts, and new spending initiatives. Fitch identified medium-term challenges like rising social security and Medicare costs due to an aging population as inhibitors to our current structure. They also maintain some doubt in the US’s ability to withstand rising government deficits in the coming years; the debt-to-GDP ratio is becoming an increasingly significant issue. There was also a final mention of the high likelihood of another rate hike by the Fed by September.
Wednesday marked the release of the Quarterly Funding Statement from the US Treasury, which captures the data related to recent and future Treasury issuance.
Nominal Rates & the Fed
Money market rates and capital market rates all show minimal changes.
Total money market funds increased by $28.95 billion: retail grew by $17.43 billion and institutional rose by $11.52 billion.
September 20 is the next FOMC meeting and FedWatch shows a higher likelihood that the Fed will pause its next rate hike rather than raising interest rates another 25 basis points (bps). December projections show a high likelihood that no more rate increases will occur in 2023 (of course, these are just projections and not commitments).
Later this week, July CPI and PPI will be released, giving us a more updated picture of inflation, consumer spending, and producer spending. More on that next week!
Jobs Data
The Job Opening and Labor Turnover Survey (JOLTS Report) for June showed:
- 582 million Job Openings
- 772 million Quits
- 227,000 Initial Jobless Claims
- 7 million Continuing Jobless Claims
- 5 % Unemployment Rate
- 3 Average Working Hours (weekly)
- 416% Increase of Average Hourly Earnings
- 125% Increase of Average Weekly Earnings
- Heavier Reliance on Part-Time Employees
Real Rates, Federal Funds Rate, and TLT
Federal Fund Futures (FFF) are continuing to level out beginning around November and persisting through Q1 and Q2 of 2024. These projections may indicate rate cuts coming as early as Q3 of 2024, but this may still be optimistic.
TLT, our major long-term bond ETF, had a rough week last week.
Housing & OAS
The Primary Mortgage Market Survey shows 30-yr. Fixed Rate Mortgages (FRM) are up to 6.90% (up 9 bps from last week) and 15-yr. FRM are at 6.25% (up 14 bps from last week). And mortgage applications are down 3%, which isn’t surprising given the stagnant home buying market. Home builders collectively show slowing across the board; KB Homes was the only developer whose stock price reported breaking even for the week.
In looking at data surrounding REITs, take a look at Trepp, a company who provides valuable data and research to help navigate the volatile market forces. They provide a table (below) on Loans Disposed with a Loss in the last 12 months:
They also provide data on Commercial Mortgage-Backed Securities (CMBS) reporting a 4% delinquency rate in July 2023, meaning 4% of commercial businesses were not able to pay their July loan payment on time. The delinquency rates seem to be increasing mostly in lodging and office space, but retail seems to be maintaining its steady but high delinquency rate. This makes it easier to see which spaces are waning and at what pace; in the wake of COVID, market forces and expectations around employment are continuing to shift in new directions.
AI’s Influence on the Market
In Newsletters of weeks past and during Quarterly Reviews, we’ve mentioned the influence of AI and the effect it’s had on business valuations and shareholder sentiments. We’ve also mentioned how AI’s presence is chiefly responsible for almost all of this year’s growth in the S&P 500. Below is a graph measuring the S&P Analyst calls that mention AI at least once, as well as another graph measuring the average number of AI mentions per call:
You can easily see the spike in references to AI because it gained so much traction with investors and shareholders. Hearing “AI” in reference to any new service or product spiked consumer sentiment, plain and simple. And even though some companies have been implementing technologies for years that utilize algorithms, automation, and data analytics, incorrectly classifying them as “AI Technologies” provided a healthy boost to how a company is valued. And it’s paramount that prudent investors keep this in mind when evaluating companies individually or by sector; the AI factor may be valuable, but it could also provide some misleading information about how valuable and innovative a company really is.
This newsletter is a synopsis of a continual series of updates by a market analyst Mark Meldrum. Mark Meldrum is a CFA that provides weekly updates on the market, but they tend to be an hour long. Here is a synopsis of his video found here.
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