Inflation’s Sticky Path

Issue 343

By Jeffrey Trusheim, Chief Financial Officer, Mortgage Solutions of Colorado, LLC DBA, Mortgage Solutions Financial.

Mortgage Solutions presents Issue 343 of Market Pulse. This commentary will provide Trusheim's perspective of the economic, political, and technical considerations that will have an impact on the global & domestic financial marketplace. The report will provide a recap of the previous week's activity as well as a look at the important market-moving factors in the week ahead.

The CPI and PPI inflation reports both showed that inflation eased a bit last month, but continues to be “sticky” and well above the Fed’s target. The Department of Labor said that headline CPI inflation slowed to 3.3% y/y in May from 3.4% y/y in April. The core CPI rate (ex. food and energy) dipped to 3.4% y/y in May from 3.6% y/y in April. PPI fell to 2.2% from 2.3% y/y in April, with core PPI at 2.3% in May versus 2.5% y/y in April.? Both of these inflation measures indicate that inflation is moderating, however CPI is still more than 50% higher than the Fed’s 2% goal. This report could possibly be an outlier caused by a sharp drop in energy prices and transportation costs.?

FOMC

And then there was one! In January, there was an expectation that the Fed would cut interest rates as much as seven times this year. At the March FOMC meeting, the Fed knocked that expectation down from seven to just three. Well, at last week’s FOMC meeting, the Fed kept interest rates unchanged at a 23-year high (5.25%-5.50%), and signaled an expectation of only one 25 basis point cut in 2024.

Fed Chair Powell said, “We’re looking for something that gives us confidence that inflation is moving sustainably down.” Powell used the word “confident” or “confidence” 20 times during his press conference. Powell remained noncommittal on rate cuts, saying that the monetary policy committee was looking at a “range of plausible outcomes.” FOMC members emphasized that they require several consecutive months of declining price pressures before contemplating rate cuts, particularly in light of the latest payrolls report.?

In the SEP (Summary of Economic Projections) report, or “Dot Plot” as some call it, the new economic projections showed 15 of 19 voting and nonvoting committee members expect the Fed will reduce rates this year, with that group roughly split between one or two rate cuts. The medium, or midpoint, of those projections reflected expectations on just one reduction in rates this year.?

Current rate cut probabilities for the remainder of this year: July - 14%, September - 71%, November - 82%, December (2nd cut) - 76%. The Fed’s “terminal rate” for 2024 is 5.1%, for 2025 is 4.1%, and for 2026 is 3.1%. And let’s hope that such aggressive rate reductions through 2026…are for the right reasons!

HOME EQUITY

Home equity is near all-time highs. Total home equity for U.S. mortgage holders rose to more than $17 trillion in the first quarter of 2024. Average equity per borrower increased $28k - to about $305k - from a year earlier. That’s up almost 70% from $182k before the pandemic. Total home equity for U.S. homeowners with (60%) and without (40%) a mortgage is $34 trillion.

Mortgage applications for home purchase in the U.S. rose for the first time in five weeks as rates eased closer to 7%. The Mortgage Bankers Association’s index of mortgage applications to buy a home increased 8.6% in the week ended June 7th to 143.7, the highest since May 3rd.?

TROUBLES IN FRANCE

There are quite a few elections (around the world) taking place this year, and the outcomes could change the global geopolitical and economic landscape for years ahead. Keep your eye on the French elections in particular. A coalition of France’s left-wing parties presented a manifesto to pick apart most of President Macron’s seven years of economic reforms and set the country on a collision course with the European Union over fiscal policy. Macron just last week called for a snap legislative election - and this group wants to reverse the government’s pension reform, reinstate the right to retire at age 60, raise the minimum wage, and impose an extra tax on the profits of certain firms. “We will finance all of this very ambitious project by taking from the pockets of those who have the means to give,” Socialist Party head Oliver Faure said.?

THE STOCK MARKET

We have four major stock market indices in the U.S., and they all seem to be dancing to the beat of different drummers. The S&P 500 had a four-consecutive-day new high winning streak last week, marking its 30th record high of the year. It finished at 5431, up 85 points on the week, and up 13.9% year-to-date. The NASDAQ had a five-day new high win streak, gaining 3.5% for the week, and is now up 16.8% for the year. The DOW finished the week on a four-day losing streak and has posted losses in three of the last four weeks. The small-cap Russell 2000 (IWM) has yet to join the party, and has posted losses for the last two weeks.?

The obvious difference is that the S&P 500 and NASDAQ have the mega-cap technology stocks in their index, whereas the DOW and the IWM do not. The composite earnings of these six mega-cap stocks (Microsoft MSFT, Apple AAPL, Google GOOG, Meta META, Amazon AMZN, and Nvidia NVDA) are on pace to climb over 50% year-over-year. Compare that to the other 494 stocks in the S&P 500, which have flat earnings growth year-over-year.?

This bifurcated market has a lot a negative divergences and technical weakness under the surface. The evidence pointing to a major top continues to build. Confirmation will come if/when an impulsive five wave decline develops that trades below previous support levels, starting at 5340, with follow-through below 5190. Until that happens, patience is required. The next upside Fibonacci targets are in the 5450-5500 region.?

THE BOND MARKET

The 10-year Treasury continued with its whipsaw trading pattern last week, with the yield plummeting from 4.47% on Monday to a low of 4.18% on Friday, before closing at 4.21%, down 22 basis points. It appears that bond traders are a bit confused about the Fed’s next move. I thought Fed Chair Powell was clearly leaning more hawkish with the “dot plots” and at his press conference. However, last week’s bond rally could also be attributed to safe haven buying, fueled by the turmoil in the Eurozone, especially France.?

Despite the fact that the FOMC is forecasting only one rate cut this year, the market ended the week pricing a 4.83% fed funds policy rate at the Fed’s December 18th meeting - or two full rate cuts.?

I am not giving up on the inverted yield curve, and its predictive value as a recession indicator. It continues to remain severely inverted, at -94 basis points. The current streak of inversions was at 375 days, as of last Friday’s close, which is double the length of the next longest streak in 2007. However, it terms of calendar days, the yield curve first inverted 561 days ago, which is still 17 days less that the 589 average number of days that have historically elapsed between the first inversion and the start of a recession. Many analysts are now writing off the inverted yield curve as a relic of another economic era…not me, and I don’t think it will be different this time.?

It would be very remiss of me if I didn’t acknowledge the latest milestone that our elected officials are about to cross. Soon the number will flip above $35 trillion, as the quantity of U.S. government debt spirals to a new record. The trajectory of America’s debt burden is unsustainable, and IMHO no amount of spending cuts or tax increases will be able to avoid the inevitable default. Whether it’s 5 years or 25 years from now…The Great Reset is coming.?

Have a great week!

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Jeff Trusheim is the CFO of Mortgage Solutions Financial. Jeff is a 30+ year veteran in the Wall Street arena, with a background in economics, risk assessment and finance (banking and mortgage). He has previously worked in Fortune 500 companies in growing their portfolio and economic footprint.?