Contributors
Madison Faller
Global Investment Strategist
Sarah Stillpass
Global Investment Strategist
Forgive the cliché, but it’s an apt one. Goldilocks had another visit with the three bears this week and some things have changed since their last meeting. A strong economy is emerging alongside lingering risks, while stock markets power higher. How do onlookers make sense of the outlook? So far, here’s what we’re seeing:
- Still too hot: Inflation above the Federal Reserve’s target
- Still too cold: Big borrowers feeling the pinch
- What’s just right: Corporate profits finding their sweet spot
In all, the rest of 2024’s story will be told based on whether – and how – Goldilocks finds that “just right” balance for the economy. We think that’s possible, marking a constructive backdrop for investors. Meanwhile, opportunities are unfolding to meet the hot and cold challenges along the way.
Still too hot: Inflation
Goldilocks probably felt some relief as U.S. inflation cooled for the first time this year. After a hot first quarter, the April Consumer Price Index (CPI) revealed a slight slowdown, with headline prices clocking in at a 3.4% annual pace, down from March’s 3.5%. Even the core measure, stripping out volatile food and energy components, ticked lower to 3.6%, down from 3.8%.
The progress is evident: More than 55% of the items in the CPI basket are now running at a rate below the Fed’s 2% target. A year ago, more than half were clipping an above 4% pace.
Over half of consumer inflation items are below the Fed’s 2% target
Share of U.S. CPI components within year-over-year growth ranges, percentage
This chart shows the share of U.S. CPI components within year-over-year growth ranges, in percentage terms.
- In January 2019, the percentage of CPI components that were below a 2% rate stood at 65%; 30% were between 2% and 4%, and 4% were greater than a 4% pace.
- By December 2020, the percentage of CPI components that were below 2% had more than halved to 30%. 44% were between 2% and 4%, and 26% were greater than 4%.
- For August 2021, the portion of the CPI components that had a growth rate of 2% or less was about 21.7% while the portion of the CPI components with a growth rate between 2 - 4% was about 30.4% and the portion of CPI components that increased by greater than 4% was about 47.8%.
- Then in August 2022, the percentage of CPI components running at a below 2% pace was 4% - a series low. There were just 4% of components between 2% and 4%, while the remaining 92% were greater than 4%.
- In March 2023, that had changed to 17% being below 2%, and the same amount being between 2% and 4%. 65% were greater than 4%.
- Finally, in April 2024, the percentage of CPI components that were below 2% stood at 57%, 13% were between 2% and 4%, and 30% were greater than 4%.
Source: Bureau of Labor Statistics, Haver Analytics. Data as of April 30, 2024.
But the bears are still lurking: That cooldown still doesn’t pass the Fed’s 2% temperature check. Shelter inflation remains stubborn – decelerating tick by tick – and services are sticky amid a rebalancing labor market. Meanwhile, goods prices can only drop so much, and commodity prices remain elevated.
The balance of evidence signals progress to come, with inflation continuing to decelerate from here. But it may only go so far. A stronger economy likely dictates higher inflation and higher policy rates than the last cycle. That has consequences, both good and bad.
Still too cold: Big borrowers
Heading into 2024, economists and investors alike expected a wave of rate cuts. Some central banks, like in Latin America and Europe, are now on their way. But too hot inflation is forcing the Fed to hold rates higher for longer.
Most segments of the economy have proven resilient in the face of that pressure. But for some, high rates mean cold porridge. Borrowing, for both consumers and corporations, simply becomes more expensive.
Consider this: The start of the year was marked by record new bond issuance, as high quality companies capitalized on a fall in rates that has since reversed. Many weaker borrowers missed the window and now face higher costs compared to their original debt agreements. That could spur pockets of stress to broaden beyond well-known trouble spots like commercial real estate and squeeze the likes of small and medium-sized businesses, who tend to incur more debt. Their ability to repay interest obligations is now below pre-COVID levels.
Those companies also employ about three-quarters of the private sector, and consumer spending has been under a microscope. This week’s retail sales gauge stagnated (albeit off a strong Q1 run) and the New York Fed’s latest summary on household debt showed more borrowers are falling delinquent on credit card and auto loan payments. Again, that doesn’t mean the consumer is in trouble: mortgages, which represent about 70% of all U.S. household debt, aren’t seeing the same stress, with delinquency rates well below levels seen during the Global Financial Crisis. High and stable wages also support income power, and in turn spending. But points of stress are nonetheless important to monitor.
Some borrowers are falling behind on their debt payments
U.S. serious delinquency transition rates (90 days or more delinquent), percentage debt balances, annualized
This chart shows U.S. serious delinquency transition rates, which are 90 days or more delinquent, as a percentage of debt balances. It examines debt dynamics across credit cards, auto loans, and mortgages over the last 20 years. The rates are annualized.
- In Q1 2004, delinquency transition rates for consumer credit cards stood at 8%, auto loans at 2%, and mortgages at 1%.
- From there, the values rise to their series peak by the end of 2009. In Q4 2009, the delinquency transition rate for consumer credit cards stood at 11%, auto loans at 3%, and mortgages at 8%.
- By Q1 2011, the measure for consumer credit cards was 8%, auto loans at 2%, and mortgages at 5%.
- Then in Q3 2020, the measure for consumer credit cards had fallen to 5%, auto loans at 2%, and mortgages at 1%.
- Finally, in Q1 2024, the gauge for consumer credit cards jumped to almost 7%, auto loans just under 3%, and mortgages remained near 1%
Source: FRBNY Consumer Credit Panel, Equifax, Haver Analytics. Data as of March 31, 2024. Rates represent annualized shares of balances transitioning into delinquency.
What’s just right: Corporate profits
Corporate America has been signaling good things ahead, defying too hot and too cold challenges. As we recently shared what we’ve heard on the Street this earnings season, S&P 500 companies look to have grown profits by more than 5% year-over-year in Q1. What’s more, all sectors are beating estimates, protecting (and growing) their margins by passing on higher costs to still solid consumers.
With that increased confidence, more companies are rewarding their shareholders by boosting share buybacks by the most in years. They’re also telegraphing big spending plans to invest in the future. Artificial Intelligence (AI) is commanding attention, while capital expenditure plans are also broadening beyond just big tech players. Focus on infrastructure, security and supply chain resiliency is likewise boosting investment in the “traditional” economy.
To us, that means that stocks maintain their role of long-term return generators in portfolios, powering through higher growth, inflation and interest rates.
The takeaway: On balance, this week brought Goldilocks closer to a “just right” temperature for the economy, with inflation cooling and growth settling. That creates a constructive backdrop for multi-asset investors. Yet, still too hot inflation and the cold pinch of tighter credit highlight challenges that are worth monitoring. As the year unfolds, investors can confront those challenges with a toolkit prepared for the spectrum of potential scenarios. For instance, equities and real assets can hedge against too hot inflation, while private lenders can help navigate strain in credit markets. The rate reset comes with costs, but we also believe it comes with potential.
All market and economic data as of 05/17/2024 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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