Equity and Credit Markets Show No Pressing Need for Fed Rate Cut
Markets shrug off FOMC’s hawkish turn on economy and inflation …
The FOMC’s latest set of median projections for 2024’s final quarter were revised upward for economic growth and core consumer price inflation. Moreover, the FOMC’s median projected unemployment rate for Q4-2024 was lowered.
Ordinarily, these restated forecasts would be accompanied by an upward revision of the median projection for the federal funds rate. Instead, the FOMC’s median forecast for year-end 2024's federal funds rate was unchanged at 4.6%.
By leaving year-end 2024’s projection for fed funds at 4.6% despite the more upbeat outlook for the economy and upwardly revised view of core inflation, the FOMC implicitly recognizes the still ample downside risks facing the U.S. economy.
The FOMC’s median projections included upwardly revised estimates for the yearly increase by Q4-2024’s real GDP from December 2023’s 1.4% to a now 2.1% and for Q4-2024’s annual rate of core PCE price index inflation from December 2023’s 2.4% to a restated 2.6%.
Also, the median of the FOMC’s unemployment rate forecasts for 2024’s fourth quarter dipped from December 2023’s 4.1% to March’s 4.0%.
Notwithstanding the FOMC’s upwardly revised estimates for economic growth and core PCE price index inflation, as well as a marginally more positive outlook for the labor market, the median forecast for year-end 2024’s federal funds rate was unchanged at the 4.6% of December 2023.
Because of the unchanged outlook for year end 2024’s federal funds rate, the FOMC’s somewhat hawkish revisions did not prevent an increase by the implied probability of a June 12 Fed rate cut from 64% prior to the release of the FOMC’s March projections to a recent 72%.
Moreover, the 2-year Treasury yield dipped from 4.68% to 4.65% and the 10-year Treasury yield eased from 4.30% to 4.26%. Nevertheless, a destructive spike by Treasury bond yields might yet arise from Washington’s massive borrowing needs.
No progress will be made at reducing the federal budget deficit until the US government’s mammoth debt finally crushes both the US economy and financial markets.
In the past, households and businesses eventually paid a heavy price for being overly leveraged. Eventually the same painful fate will follow from Washington’s nearly 17-year borrowing binge.
FOMC will key on labor market conditions …
In its policy statement, the FOMC emphasized the labor market’s critical importance at providing guidance to the direction of monetary policy. It’s hard to imagine the Fed cutting rates if the average monthly addition to payrolls does not sink from the 252,000 of January-February 2024 to a pace no greater than 150,000 jobs per month. In addition, the unemployment rate needs to break above 4% to open the way for a rate cut.
During the mid-1990s soft landing – the only time since WWII, the US did not slip into recession following an extended series of Fed rate hikes – the unemployment rate averaged 5.5% and the average hourly wage rose by only 2.7% annually. By contrast, February 2024 showed a 3.9% jobless rate and a 4.3% annual rate of wage inflation. Put simply, 1994-1995’s soft landing showed much more room for noninflationary economic growth than is the case today.
The US labor market remains tight according to the merely 209,000 first-time jobless claims filed during the week-ended March 9. In all likelihood, the labor market has yet to soften by enough to make room for even one Fed rate cut. But financial markets don’t seem to care.
Good news on headline inflation may not return soon ...
The price of gasoline was up from the prior week for eight of the nine weeks ended March 18, 2024 for a cumulative gain of 12.3%. The recent 22% yearly increase by the price of WTI crude oil will affect a broad array of prices outside of transportation if only because of how petroleum is an important feedstock for many industrial processes.
Also, higher oil prices tend to increase geopolitical risk by boosting the coffers of unfriendly regimes in Russia and Iran. Climate change zealots frequently underestimate the importance of petroleum products to living standards and global stability.
Equity rally weakens the case for a Fed rate cut …
The rally by equities following the FOMC’s March 20 meeting weakens the case for a Fed rate cut. Massive additions to wealth supplied by high share prices and home price appreciation might yet help to stoke another upturn by price inflation.
Towards the end of 2023, the US common equity market received extraordinary support from a pronounced upturn by the moving 4-quarter sum of the net equity buybacks of US nonfinancial corporations from the $420 billion of the year-ended Q3-2023 and calendar-year 2022’s $536 billion to the $612 billion of calendar-year 2023. The latter was the biggest 4-quarter sum since the record-high $641 billion of the 4-quarters-ended Q1-2019. Nothing like adding fuel to the fire of what was already a sizzling equity rally.
Abundant balance sheet cash helped to fund 2023’s near record surge in the net equity buybacks of nonfinancial corporations. Fourth-quarter 2023’s record-high $3.8 trillion of highly liquid assets held by US nonfinancial corporations grew by a rapid 11.1% annualized, on average, compared to Q4-2019’s estimate. Over the same four-year span, the pretax profits of nonfinancial corporations soared higher at an annualized pace of 17.3% to $2.5 trillion, which also well outran the accompanying 5.8% average annualized growth of nonfinancial corporate debt to Q4-2023’s $13.6 trillion.
For US nonfinancial corporations, the ratios of debt to cash and debt to pretax profits have dropped to historically low levels. For example, the ratio of debt to cash fell from Q4-2022’s 3.9:1 to Q4-2023’s 3.6:1. The latter also was under its ratios of 4.4:1 for Q4-2019, 2017-2019’s 4.9:1 average, and 4.95:1 for calendar-year 2007.
The chart below shows how a historically low ratio of corporate debt to cash complements a now historically thin high-yield bond spread. Not to be overlooked is how ample corporate cash will facilitate the purchase of business assets from financially stressed high-yield companies.
In addition, the ratio of nonfinancial-corporate debt to unadjusted pretax profits eased from Q4-2022’s 5.52:1 to Q4-2023’s 5.48:1. Though the latter was well under both Q4-2019’s 8.58:1 and 2017-2019’s average of 7.76:1, it was slightly above the 5.41:1 average of calendar-year 2007.
Calendar-year (CY) 2023’s surge by net equity buybacks was not mostly funded with debt. CY 2023’s $286 billion of net borrowing by nonfinancial corporations was down from the (i) $354 billion of the 4-quarters-ended Q3-2023, (ii) the $702 billion of CY 2022, and (iii) the $505 billion of the 4-quarters-ended Q1-2019.
Fourth-quarter 2023’s $13.6 trillion of outstanding US nonfinancial corporate debt rose by merely 1.5% from a year earlier for the smallest yearly percent change since the -0.6% annual contraction of 2011’s first quarter. Just prior to the arrival of the Great Recession, Q4-2007’s outstandings of US nonfinancial corporate debt increased by 11.7% annually to $6.6 trillion.
Not many firms are starving for cash despite the lifting of fed funds from February 2022’s 0.13% to the now 5.38% and the climb by the 10-year Treasury yield from June 2020’s month-long average low of 0.62% to a recent 4.26%. An unprecedented shrinkage by the M2 measure of the money supply has yet to manifest itself in terms of a crippling dearth of liquidity.
Ratio of debt to cash also declines for unincorporated businesses …
Since Q4-2019, the cash holdings of unincorporated nonfinancial businesses grew by a rapid 8.7% annualized to Q4-2023’s record $2.23 trillion. The slower 5.8% average annualized growth rate of unincorporated nonfinancial business debt to Q4-2023’s $7.49 trillion lowered the ratio of debt to cash for unincorporated businesses from Q4-2019’s 3.77:1 to the 3.35:1 of Q4-2023.
However, the aggregate balance sheet of unincorporated businesses was not without an ominous development. Fourth quarter 2023’s -3.0% yearly drop was the fourth straight year-on-year decline by proprietors’ equity in unincorporated nonfinancial businesses. Proprietors’ equity in unincorporated businesses last entered into a series of yearly setbacks at the start of 2008-2009’s Great Recession.
Corporate borrowing sizzles during early 2024 …
Corporate borrowing was very lively during 2024’s first two months. The issuance of investment-grade corporate bonds advanced by 27% year-on-year to $393 billion during January-February 2024, which was a record high for the two-month span. Investment-grade corporate bond issuance grew sharply despite a rise by the average investment-grade corporate bond yield from January-February 2023’s 5.24% to January-February 2024’s 5.32%, wherein Bloomberg/Barclays’ average Baa-grade investment-grade bond yield barely rose from 5.42% to 5.48%.
The same serial comparison showed a 68% annual jump by high-yield corporate bond offerings to $61 billion for the best January-February total since the $94 billion of January-February 2021. Coincident with the rebound by high-yield bond issuance was a stimulatory drop by a composite junk bond yield from 8.44% to 7.85% that was more than accounted for by an accompanying narrowing of the high-yield bond spread from 465 basis points (bp) to 364 bp.
Meanwhile, leveraged loan issuance soared higher by 142% year-on-year to the $101 billion of January-February 2024 for its best start since the $111 billion of January-February 2021. The surge by leveraged loan issuance owed much to a narrowing of the leveraged loan spread from January-February 2023’s 511 bp average to the 452 bp of 2024’s first two months.
Because of the refinancing of outstanding debt, an elevated level of corporate borrowing does not necessarily equate to a much faster rate of growth for outstanding corporate debt. For example, 2023’s $1,442 billion gross issuance of corporate bonds towered over the $319 billion net issuance of corporate bonds. In other words, despite 2023’s $1.44 trillion of corporate bond offerings, the outstandings of US corporate bonds rose by a much smaller $319 billion.