Ketu Desai
By Ketu Desai
What a difference a few weeks make! We came into March with the growth and inflation data firming up. In early March, Chair Powell had his semi-annual Congressional testimony. The theme was clear, higher rates for a lot longer than expected. Markets were priced in a 6 percent Fed Funds terminal rate. Within days, the whole narrative changed. We went from inflation concerns to deflationary bust concerns. The Fed hiked another 25bps during the month.
The market is now pricing in that they have one more hike left and then they start cutting. The regional banking crisis will certainly dampen lending and growth. Barring contagion, the regional banking crisis will be a slow grind as loans mature and new regulations are passed. Banks have been tightening credit before the crisis, with loan growth running at just 1.45 percent. There are other pockets of capital that can certainly step up at a price. Most notably there has been $1.4 trillion in private credit that has been raised and approximately $3.5 trillion of global private capital dry powder. For now, at least, the economic data continues to point toward growth, led by strength in the employment market.
The most real-time measure of unemployment is initial jobless claims, and they remain near all-time lows. Consumers are still sitting on nearly $1 trillion in excess savings. Most homeowners are generating a positive carry on these savings, which could be stimulative. PMIs look to be bottoming and alternative data such as truck tonnage is rebounding. Atlanta Fed’s GDPNow shows 2.5 percent growth for the first quarter.
Inflation still remains a risk, the inflation data has greatly benefited from lower natural gas and oil prices. Energy prices have moved lower because of high Russian supply, massive SPR releases, China still in the initial stages of re-opening, and a massive unwind from financial market participants, most notably CTAs and macro funds. All of these factors look to reverse as we progress through the year. Oil has been cut in half and natural gas down 70 percent, and we have only been able to get CPI to 6 percent. Perhaps the UK’s experience could be instructive. The UK had its own financial system crisis last fall. Monetary policy makers reacted to the crisis and proposed fiscal policy was abandoned. The UK’s latest inflation data came in above 10 percent and the BoE hiked again. The regional banking crisis certainly hampers the Fed’s ability to aggressively hike, which could exacerbate the inflation problem, especially if energy prices start to turn up.
In the short-term, inflation will be driven by energy prices, housing, and the magnitude of the regional banking crisis and monetary policy will reduce demand. The longer-term inflation problem is supply related. Supply related to infrastructure, labor, and commodities. The inflation reduction act and the infrastructure bill combined are approximately $2 trillion that will command these resources that are in short supply. The combination of the regional banking crisis and higher rates will make funding these long-term supply investments more challenging. The net impact will be near term disinflation, settling at a higher steady state level of inflation. From a markets’ perspective, the way to invest depends on your horizon. In the short-term, while we are in this disinflation period, the leadership will continue to be large cap technology, growth, bonds, and gold. Investors can take more risk in growth tech trades, because they can barbell cash/bonds (and make a yield) and take more risk in their equity books.
The rally in technology has been purely multiple driven with the forward P/E up 30 percent since October. This is not sustainable long-term. For those with a longer-term horizon the opportunity is in cheap areas of the market that will benefit from inflation including energy, materials, and industrials. Many commodities also look compelling. As these sectors have sold off it might make sense to start building positions. Just in case we find out that we are not too different from the UK and inflation is stickier.
Looking forward, the market will focus on the regional banking crisis, first quarter earnings, and the economic data.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
