Brian Pietrangelo:
Welcome to the Key Wealth Matters weekly podcast, where we casually ramble on about important topics including the markets, the economy, human ingenuity, and almost anything under the sun, giving you the keys to unlock the mysteries of the markets and investing.
Today is Friday, September 15th, 2023. I'm Brian Pietrangelo, and welcome to the podcast. This past week I was on the road at a few client events providing economic updates. And in particular, was in New York for two of them. It was great to be with clients, and at the same time, I am vividly reminded of the tragic events that took place 22 years ago this week. So I'd like to pause for a moment to remember all of those that died, as well as those that continue to be affected. And certainly, all of the first responders that did everything they could to help. I invite you to join me in a moment of reflection and to never forget.
Well, thank you. And with me today, I would like to introduce our panel of investing experts here to share their insights on this week's market activity and more. George Mateyo, Chief Investment Officer, Cindy Honcharenko, Senior Fixed Income Portfolio Manager, and Connor Cloetingh, Senior Lead Equity Analyst. As a reminder, a lot of great content is available on key.com/wealthinsights, including updates from our Wealth Institute on many different subjects. And especially our Key Questions article series addressing a relevant topic for investors each Wednesday. In addition, if you have any questions or need more information, please reach out to your financial advisor.
Taking a look at this week's economic news, we've got four items to share with you this week. We'll start with the inflation read as measured by the Consumer Price Index, which came out on Wednesday from the Bureau of Labor Statistics. CPI, as it's known, actually increased on a year-over-year basis in August at 3.7%, up from 3.2% in July. However, in contrast to that, the core CPI, which excludes the volatile food and energy subcomponents, actually went down year-over-year in August at 4.3%, from 4.7% in July.
So what's the difference? The difference is the significant rise in overall energy prices recently that drove up the overall CPI but did not drive up the core CPI. And that's why we look at both indicators. In addition, the cost for shelter, otherwise known as the pseudonym for housing, we saw a little bit of a decline year-over-year down to 7.3% in August, from 7.7% in July. Which means that those elevated prices are still high, but are beginning to come down at a reasonable pace.
And second, overall retail sales for the United States economy came out yesterday as a report from the Census Bureau and showed that there was a .6% increase in August for overall retail sales. Which was a little bit above expectations, showing the consumer resiliency in the overall economy. However, some of that had to do with the increase in overall gasoline prices and energy prices, which drove some of the increase overall.
And third, also yesterday, the weekly initial unemployment claims data came out for the week-ending September 9th and it was at 220,000, which reflects a consistent number for the past few weeks where we're not seeing an increase. Which again, shows the resiliency in the overall labor market, as we continue to look at that going forward in the future.
And finally, just this morning, our fourth data point, which is somewhat lesser known, which is the industrial production figure that is produced by the Federal Reserve. We continue to look at it because we think it's important, and it was good news for the month of August in that industrial production continue to show an increase of 0.4% for the month. Which again, is important when we look at the overall manufacturing industry.
So taking all of those into consideration in addition to other thoughts that we might have, starting with George, around what's going on in the economy and what it might mean for the remainder of the year. So, George?
George Mateyo:
Well, I think, Brian, you could say that this week we saw further evidence that the economy is actually doing quite well. We've seen evidence that inflation has picked up a little bit, but the markets shrugged that off. We've actually had this rolling narrative right now where the market's been trying to figure out if we'd see a hard landing or maybe a soft landing. Meaning either you'd see a pretty big recession or maybe the Fed can land a plane softly and take the economy down ... take inflation down without taking the economy down, I should say.
And now it seems like the market's almost anticipating a perfect landing, right? Where we've got this narrative right now, where stocks are really doing quite well, year-to-date, anyway. I think they're a little weak this morning, but stocks, so far this year, are up about 15 to 16% versus bonds. The VIX, the volatility curve that we look at is actually quite low. Inside the market, you're seeing actually some cyclical performance relative to defensive performance, meaning some of the more economically sensitive companies have actually done better. And in the credit markets, high yield spreads are quite tight.
So the narrative right now has been shifting all the way around from hard landing to soft landing, to no landing to now a perfect landing. And I think that's notable in the sense that, that might be the case, we might actually see a perfect landing. But at the same time, there's still some things that probably have to be better understood before we can really declare victory. I think we're seeing this pronounced and lagging impact with spending. That's certainly the hangover from COVID-related times where things were really pulled forward in terms of overall demand for things. There was, of course, supply shortages and that really compounded this catch-up period of excess spending that we've seen for quite some time.
And I still suggest that I think we're going to see some slowdown. We've seen numbers now that suggest that people are having to rebalance their budgets a little bit. Student loan repayments are setting up again. So I think we're going to start to see some slowdown in spending perhaps in the back half of this year. And then related to that has also been fiscal spending. Fiscal spending is something we don't talk a whole lot about, but the government's been spending at a pretty aggressive clip as well. And I would suggest that maybe at some point, that might actually have to come down a little bit too. So when these spending impulses start to moderate, I would think that the economy would also start to fade off a little bit and maybe trail back a little bit. And we'd see some of this momentum that we've seen so far this year fade at the margin.
So against this backdrop, I think it's notable that the Federal Reserve has been talking about unemployment coming up a little bit, perhaps. They've talked about wanting to get inflation down. I guess my first question for you, Cindy, is whether or not you think that the Fed can actually come out next week and declare victory and say that we're done raising interest rates. The ETB, oddly enough, actually did that very thing this week where they surprised the market and suggested despite the fact that inflation is still high, they're likely to go on pause and maybe even declare victory. Do you think, Cindy, the Fed here in the United States can declare victory when they get together next week?
Cynthia Honcharenko:
I don't think they will, George. If you recall at Jackson Hole, Fed Chair Powell made it clear about the 2% inflation target, that that's not up for debate and that the central bank will keep at it until the job's done. I think that pledge will follow through until inflation is back to their target. And I think that was a nod toward Paul Volcker, perhaps. And I think there's going to be some reluctance next week from Powell and the Fed officials to start doing a victory lap. I think they'll have a hawkish hold next week. I think they will keep rates unchanged, but there's going to be a bias toward possibly further tightening. And we may see that in the dot plot. It's probably going to show a 25 basis point hike, one more at least for 2023. And I know that's what the market's expecting. But I mean, if you look at historical interest rate projections, the market really hasn't gotten it right.
I think they'll continue to imply that there is 100 basis points of cuts in 2024. I think that's a little out of the realm, let's just say. I'm expecting that we're going to continue to see a slowdown in the economy, and that's going to filter through. And that may put their cuts on hold until 2025, but we will see. I think he will guide the committee to wait a little bit longer, and that they're going to assess the incoming data through the remainder of the year. I think he's going to also remind everybody that there's policy lags and those are still operative. And the effects of the past tightening are still in the pipeline, so we haven't really experienced those yet. And those effects will become more apparent, I think as we start to see excess savings run down.
Even some of the policy hawks, I think will appear more comfortable on taking a careful approach. Lorie Logan, on September 7th was in Dallas, and she said, "The traditional way to make sure a fire is out cold is to pour water on it. Lots of water, until you've eliminated every last bit of heat." That's a good way to put out campfires, but I will argue today that it's not a good way to put out inflation. So she said that, "The FOMC will need to keep the water bucket close at hand, and we must not hesitate to use it as necessary." I thought that was an interesting comment.
As far as the statement, I think they're going to maybe alter the phrasing. The economic activity has been expanding at a moderate pace, to language acknowledging a bit more of a pickup, as you mentioned, and that the committee will continue monitoring. I think they'll describe job gains as being robust and unemployment as having remained low. I expect them to continue assessing inflation as remaining elevated. Despite the core CPI inflation averaging .2% month-over-month over the last three months, I think the statement will hold short of formally acknowledging progress, as I mentioned at the beginning.
The September pause, I think will be more described as a risk management strategy, rather than a significant progress toward returning inflation to its 2% target. We are going to see some new faces next week. From what we saw ... excuse me. At the June meeting, Philip Jefferson and Adriana Kugler, they've been sworn in. We also have Jeffrey Schmidt, who replaced Esther George, and President Kathy O'Neill Paese ... I think I pronounced her name correctly. She will be submitting forecasts because James Bullard's seat still remains vacant, and that is protocol until that president seat is filled.
So the bottom line here is the Fed appears to be intent this year on not being surprised to the upside on inflation, and that seemed to be their theme in 2022 as well. As a result, I think that they will maintain the 2023 core inflation forecast that has been significantly likely to overshoot the realized data, which they've been doing up to this point. They did revise the PCE inflation to 3.9% from 3.6% in March. So while the headline inflation has been coming consistently down, core inflation has been a little stickier, with the one percentage point improvement in core PCE year-over-year since February 2022. Still decelerated to 4.2% year-over-year from 4.6 in April. It looks like we could see that closer to 3.3% by year-end.
So since the Fed is closer, I would say, to the end of the tightening cycle versus the beginning, if the Fed does in fact pause and the data comes out weaker than expected, and that's enough to stop a fourth quarter Fed rate hike, I think that the US front end rates will decline and the US treasury curve will steepen. And that'll be led by the lower front end rates, and those could back up five to 10 basis points, but getting the timing right is going to be really difficult. So I think favoring three year in end maturities rather than extending and going longer in duration, the principle and interest payments are actually going to be everyone's superpower at that point. And you'll be able to build duration and your ladder based on those P&I payments coming in, if you strategically put those to work.
George Mateyo:
So speaking of superpowers, Cindy, I think that's an [inaudible 00:13:31] metaphor. Connor, if I turn to you on the equity market, the equity market, the stock market seems to have superpowers too, in the sense that we've had a lot of news to confront this past week. News out of China continues to be a topic of concern to some, higher inflation, potentially, interest rates moving up a little bit. And as Cindy mentioned, maybe the Federal Reserve is likely to keep active in terms of maybe taking inflation down.
What's your take on the stock market these days? And it seems very resilient of late. Would you characterize it the same way or something different, perhaps?
Connor Cloetingh:
No, I would agree with you there, George. I mean, I think basically the market had a little bit of a sell off here recently. But as the economic data that we've been speaking about has come out, it seems like the idea that this soft landing can be stuck is coming more true by the weeks and the months. So I think while it's not going to be a perfectly soft landing and there may be some bumps along the road, but it feels like the economy is still in a pretty good place, and that's being reflected by the equity markets. I think the broad indices are up about a percent this week. So a little bit of a rally here.
George Mateyo:
So what else are you watching these days, Connor? I mean, there's a lot of other things that are around the equity market that are probably a topic of concern. What are you paying attention to mostly?
Connor Cloetingh:
Yeah. So actually being based out of Michigan, I think maybe I hear about this a little bit more than most. But with the strike against the big three automakers by the UAW, them walking off the job at midnight last night, could have some implications for the economy overall, near term and longer term. But initial thoughts with that are maybe not quite as big of an impact to the automakers as investors we're expecting, given that it's only one plant each for the big three automakers in the US.
So one thing, near term, I think the knock-on effect of that could be a reduction in auto production. Which could continue to help see elevated inflation in new and used car pricing, which would make the Fed's job a little bit harder. But then I think the longer term is where we're maybe a little more focused. And that's just the resurgence we've seen in organized labor this year has ... may be a cause for concern on the labor costs having to get pushed along and further price increases over years of these new contracts that we're seeing.
And not only ... well, the contracts aren't there yet for autos. But what we've seen in some logistics companies and what they're trying to still negotiate in Hollywood could cause companies to have reduced margin outlooks in future years because of this increase in labor costs. Or on the other hand, it could cause them to push prices even further, further causing inflation. So it could go one of two ways there, but overall, that's where we're focusing our attention these days.
Brian Pietrangelo:
Hey, Connor, what's the main issue for our listeners? What's the main issue at debate here and what's the possibility for resolution?
Connor Cloetingh:
Yeah. So the main issue with the automakers specifically is that the UAW is trying to go down to a four-day work week. It's trying to have ... roughly, it would double the costs for the hourly workers for the big three automakers. And so while there's been some good faith offers placed by the automakers, it's only halfway to what the UAW demands are. So while the strikes are limited to three plants, as I mentioned today, they could expand and then that could be a larger hit to US GDP in the back quarter of the year. So still remains to be seen.
Brian Pietrangelo:
Well, thanks for the explanation, Connor. And George, any final thoughts for today?
George Mateyo:
Yeah. I think given all these cross currents, Brian, I think we just want to remind our listeners to really faithfully diversify, right? There's a lot of noise and we're going to probably going to have to, I guess, confront the fact that things will slow down at some point. We've had a good burst here of activity throughout the summer into the early fall, and the market has done quite well. So I think we need to recognize the fact that maybe as things start to play out from here, when some of these higher interest rates start to take hold, once some of these wage pressures that Connor referenced inside the conversations in the auto sector, I think these things will take the economy down a gear.
I don't think a recession ... we're definitely not in a recession right now, that's for sure. But we've seen a big spending impulse both from the consumer and also from, frankly, the fiscal government that I think at some point will fade. So for that reason, I think the stance we want to continue to take is really being balanced towards risk, being fully diversified, and we also want to emphasize quality throughout our portfolios.
Brian Pietrangelo:
Well, thanks for the conversation today, George, Cindy and Connor, we appreciate your insights. And thanks to our listeners for joining us today. Be sure to subscribe to the Key Wealth Matters podcast through your favorite podcast app.
As always, past performance is no guarantee of future results, and we know your financial situation is personal to you. So reach out to your relationship manager, portfolio strategist, or financial advisor for more information. And we'll catch up with you next week to see how the world and the markets have changed and provide those keys to help you achieve your financial success.
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