October 2023: Market Commentary - The Fed and Debt
“Higher for longer.” That has been the mantra the Federal Reserve has been preaching all year, but it appears that investors are finally believing the Fed’s rhetoric. At its latest meeting, the central bank did not raise rates but did indicate that one more rate hike by year end is in the cards. They also indicated that rates will probably stay above 5% through the end of next year, squashing investors’ hope for a rate cut occurring early in 2024. In the post-meeting press conference, Federal Reserve Chair Jerome Powell admitted that the Fed’s inflation fight is only getting more difficult as wages, oil, housing, and most services continue to rise, which could require another tap on the breaks by the Fed.
Bottom Line: This realization by investors that rates will remain higher for longer caused stocks to fall to their lowest level since June, the dollar to rise, and Treasury yields reaching a 16-year high. It’s important to note that while higher rates have been a boom for investors, who can finally earn a decent return on their cash, it’s not been a great time for debtors, who face significantly higher interest costs. As corporate, government, and individual debt is paid, refinanced, or newly issued, the impact of these higher rates is going to be felt, most likely through lower corporate profits and reduced consumer spending. See below.
Debt – One of Those Four Letter Words
While debt, when used in moderation and for productive purposes, can be a good thing; oftentimes, that’s not the case. In simplest terms, debt pulls ahead sales as consumers buy goods today with money they don’t have. This, in turn, means that they now have to spend their money paying back banks rather than making new purchases that would drive growth. It also encourages savings, as consumers realize working to pay debts is no way to live and puts unneeded stress on their lives. For companies, excess debt robs them of funds needed to invest in their businesses, whether for factories, innovative technologies, or research and development. And let’s not forget the largest debtor, the U.S. government, who has continuously relied on deficit spending to keep the government running. For over a decade, the Fed had suppressed interest rates, flooding the market with cheap money. Now with the federal funds rate over 5%, that is no longer the case. With global debt at an all-time high and interest rates at the highest rate since the mid-2000s, let’s look at the latest figures:
- U.S. mortgage debt stands at $12 trillion; student loan debt is $1.57 trillion; auto debt is right behind at $1.56 trillion; credit card debt just went over $1 trillion for the first time in our nation's history. According to the Federal Reserve Bank of New York, the median U.S. household has $7,300 of credit card debt versus $5,300 in savings. With the average interest rate on credit cards now at 24% and over 10% for a used car, it’s not surprising that default rates on credit cards and auto loans continue to move higher.
- Per Moody’s Investors Services and Janus Henderson, non-financial corporate debt stood at $7.8 trillion at the end of the second quarter. More disturbing is the fact that in the first half of 2023, corporate debt defaults have already blown past 2022’s total. While larger companies, such as Bed Bath and Beyond, Party City, and trucking company, Yellow, garner most of the headlines, there have been about 400 other bankruptcies this year by companies you’ve never heard of. The substantial increase in interest rates starting in 2022 is causing stress for many companies, as corporate default rates have nearly tripled over the last year and a half, and most investors are not paying attention. Historically, default rates typically accelerate once a recession has started and don’t peak until after it has ended.
- Total U.S. government debt is up $10 trillion since 2020. The national debt currently stands at $33 trillion and our nation’s daily interest on these loans is over $2 billion a day. We now spend more on interest payments then we do for our country’s defense. To make matters worse, the average interest rate for this debt is only 2.76%. Over the next three years, half of this debt is going to be refinanced, presumably at much higher rates. Our deficit spending has become so large that the U.S. is issuing $2 trillion in bonds over the next six months. Very soon, our interest expense will exceed a trillion dollars!
- According to the Kobeissi Letter, nearly 700 banks now exceed the 2006 Commercial Real Estate (CRE) loan concentration guidance. The CRE guidance was established by the FDIC for the amount of exposure that small banks should have to commercial real estate loans. Currently, small banks hold over 70% of CRE loans totaling $2 trillion. Approximately $1.5 trillion of those loans are scheduled to be refinanced at higher rates by 2025. With office vacancies at historic highs and commercial real estate prices for those offices declining, this bears close watching.
- Housing affordability is at an all-time low. The average interest rate on a 30-year mortgage is about 7.5%, its highest since December 2000. With the Fed signaling interest rates will remain high, it’s only a matter of time before we see an 8% mortgage rate. It’s no wonder Fannie Mae, the government-sponsored mortgage company, estimates that the housing market is headed for the largest sales slowdown since 2011 (The Great Recession). This past week, the Census Bureau reported that August sales of new single-family homes fell 8.7%, hurt by higher rates and a low supply of homes for sale.
Bottom Line: There is no such thing as a “free lunch.” Or put another way, “Free money is never free.” Consumers are now paying the price of money printing through higher inflation and interest costs. According to the Kobeissi Letter, since 2020, the U.S. has printed 80% of all U.S. dollars in circulation (M2 money supply). At the start of 2020, we had approximately $4 trillion in circulation. Today, there is nearly $19 trillion, a 375% increase in three years! This, along with supply issues, is what caused inflation to hit a 40-year high last year. Many of the items people use every day are still seeing inflation rates well above 5%. This has started to affect consumer confidence and spending habits, as consumers are trying to “stretch” a dollar. The longer rates remain high, the greater the chance of economic growth slowing down. In other words, the longer rates stay high, the less likely a soft landing becomes. So, buckle up, THE FED’S JOB IS NOT DONE.
Quarterly thought…Deficit spending
“To contract new debts is not the way to pay old ones.”
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*The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
* The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.