“Straddle the line in discord and rhyme” sang the recently inducted Rock n Roll Hall of Fame member Duran Duran in Hungry Like the Wolf and I think that line is exactly what the Fed is now dancing around with the fed funds rate taking another step closer to 5% today. //www.youtube.com/watch?v=oJL-lCzEXgI. I say this because of the size of the debt on which these rate increases are taking place against. You’ve heard me for a while now talk about the ticking time bomb that is floating rate debt for some, and I include two charts here. One is total business debt as a percent of GDP which is at 77%, a record high if we don’t include the Covid spike and the other from yesterday’s NFIB report that shows the average interest rate being paid by small business. That latter chart is predominantly floating rate debt being paid by mostly small and medium sized businesses tthat is resetting higher. We know many bigger companies are more insulated because they termed out their debt having access to the capital markets but when that debt comes due in coming years, higher rates for longer will have its sting.
Total Business Debt as % of GDP
NFIB’s Average Interest Rate Paid by Small Business on short term loans
Add this to my belief that while inflation will continue to fall sharply from here, the new normal after it settles out will be 3-4% for a variety of structural factors, particularly the end of cheap labor, the death of just in time inventory combined with the always persistent pace of services inflation. The days of 1-2% and deeply negative REAL interest rates is over, for a while at least.
In Howard Marks’ new letter out yesterday titled ‘Sea Change’ and what I just said is essentially some of the change, among many other factors he lists, he also gave a great analogy of how impactful the long period of low interest rates had on both the economy and markets.
He wrote, “At some airports, there’s a moving walkway, and standing on it makes life easier for the weary traveler. But if rather than stand still on it, you walk at your normal pace, you move ahead rapidly. That’s because your rate of travel over the ground is the sum of the speed at which you’re walking plus the speed at which the walkway is moving. That’s what I think happened to investors over the past 40 years. They enjoyed the growth of the economy and the companies they invested in, as well as the resulting increase in the value of their ownership stakes. But in addition, they were on a moving walkway, carried along by declining interest rates. The results have been great, but I doubt many people fully understand where they came from. It seems to me that a significant portion of all the money investors made over this period resulted from the tailwind generated by the massive drop in interest rates. I consider it nearly impossible to overstate the influence of declining rates over the last four decades.” The bold was Howard’s.
Now you can say ‘well rates are still historically low’ and yes, that is true but the rate changes are on a massive amount of debt, particularly on the Federal Government side. Just watch the debt clock to make yourself dizzy, //www.usdebtclock.org/ and understand that the US Government is headed for $1 Trillion per year of interest expense.
With respect to the consumer, we know what’s happened with the housing market and the impact from the sharp rise in mortgage rates has had. In the context of a savings rate that is at the 2nd lowest level since at least 1959, Bankrate.com’s average credit card rate is up to 19.4%, //www.bankrate.com/finance/credit-cards/current-interest-rates/
So the net result of not being in Kansas anymore is going to be a slower rate of economic growth and lower market multiples and while a mild recession is all we will see, it also implies that any recovery that follows is mild too. Remember, the sharper the recession, the quicker the bounceback.
For the Fed, the irony of yesterday’s weaker than expected CPI came with a 2% rally in the CRB index because any sign of the Fed slowing down their hikes will just weaken the dollar and create a rally in commodity prices. ‘Straddle the line…’
Cass Freight’s Transportation index came out yesterday for November and shipments fell .4% y/o/y and lower by 1.9% m/o/m. They said “After some noise in recent months related to comparisons and other temporary factors like repositioning mistimed inventory, and consumers getting ahead of rising interest rates, freight volumes settled back to a flattish level in November vs a year ago. Still a very stable environment overall, but still one with many headwinds.”
The implied freight rate continued to moderate with 5.1% y/o/y price growth vs 7.9% in October. “The supply/demand balance in US trucking markets has loosened significantly this year, and as a result freight rates are leveling off and set to soften further in the months to come.”
While JetBlue was a bit cautious in an 8k filing yesterday as we saw, Delta today said “Demand for air travel remains robust as we exit the year and Delta’s momentum is building.” I’ll say this, just wait for the Chinese consumer when they start flying internationally again after being essentially locked up for 3 years.
There was little change in the average 30 yr mortgage rate at 6.42% but mortgage apps did rise by 3.2% w/o/w. Purchases rose 4% w/o/w, though remain 38% below its yr ago pace. Refi’s were up 2.8% w/o/w while still down 85% y/o/y.
The day before the BoE is most likely going to hike rates by 50 bps to 3.5%, November UK CPI moderated to 10.7% from 11.1% and that was 2 tenths below expectations. The core rate was higher by 6.3% y/o/y vs 6.5% in October and also 2 tenths less than forecasted. Hopefully they have seen peak inflation too but energy prices will be the big swing factor. In response, the UK 10 yr inflation breakeven fell 5 bps to the lowest in 2 months.
UK CPI y/o/y