Stressing Over Stress Tests

Banks are bracing for the latest results in the Fed’s assessment of financial institutional stability, which could bolster the call for further regulatory oversight and higher capital requirements in the aftermath of the collapse of four regional banks earlier this year.

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Of course, not all Fed officials are on board for a blanket increase in requirements. According to Fed Governor Michelle Bowman, new capital requirements for financial institutions could unnecessarily hinder bank lending and diminish competition. Speaking on Sunday at a financial seminar in Salzburg, Bowman said,?“When policymakers raise capital requirements, the tendency can be to singularly focus on the perceived benefits—higher capital implies greater resiliency of the banking system,”?she said.?“But there’s a tradeoff. Resiliency, in terms of higher capital, comes at a cost—namely, decreased credit availability and increased cost of credit in normal times—and can have broad impacts on banks, the broader financial system, and the economy.”

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That being said, her remarks should not be taken as an outright rejection or dismissal of the need for more oversight. Rather, her conclusion is that any reform efforts should be taken in the context of whether or not examiners themselves have the?“appropriate tools and support to identify important issues and demand prompt remediation.”

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According to industry experts, the 23 lenders being tested are expected to show capital in excess of current regulatory minimums.

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As we noted yesterday, central bank officials have descended upon Sintra, Portugal for the ECB's annual retreat on central banking. Recession, price stability, stubbornly elevated inflation – these are but a few of the topics policy makers will discuss. Following Fed Chairman Jerome Powell’s testimony last week indicating further rate hikes would be necessary, commentary from his counterparts in Europe, the U.K. and Japan will be closely scrutinized for similar sentiment.

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This morning, Chair Powell spoke at the ECB retreat in Portugal, reiterating the need for the Committee to remain committed to taming inflation. Powell said consecutive rate hikes were not off the table.?“I wouldn’t take, you know, moving at consecutive meetings off the table,”?he said.

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On the economic calendar yesterday, durable goods orders unexpectedly rose 1.7% in May following a 1.2% gain in April. According to the median estimate on?Bloomberg, durable goods orders were expected to decline 0.9%. Year-over-year, headline orders rose 4.2% in May, up from the 4.1% annual increase the month prior.

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Transportation orders rose 3.9% following a 4.8% gain the month prior, due to a 32.5% gain in civilian aircraft orders and a 2.2% increase in vehicle and parts orders. Excluding transportation, durable goods orders rose 0.6% in May, but fell 0.3% over the past 12 months.

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Capital goods orders rose 2.8% in May. Nondefense capital goods orders, meanwhile, gained 6.7% following a 0.1% increase in April. Capital goods orders excluding aircraft?and?defense – a proxy for business investment – rose 0.7% in May following a 0.6% rise the month prior. Year-over-year, business investment increased 2.1%, up from the 1.8% annual gain in April.

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In other details, electrical equipment orders gained 1.7%, machinery orders rose 1.0%, and primary metals orders gained 0.5%. Also, computers and electronics orders rose 0.3%, while fabricated metals orders were flat in May.

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Bottom Line:?The headline rise in May orders was stronger than expected. The majority of the strength, however, was seemingly isolated to aircraft orders, masking a growing crack in corporate expenditures. While still positive, core orders have softened, suggesting businesses are already feeling the pinch of higher borrowing costs, albeit to a lesser degree than previously expected. Going forward, as the Fed presumably continues to raise rates and financial institutions impose tighter credit standards, businesses’ ability to spend and invest will expectedly be further restrained.?

The S&P Case Shiller 20-City Home Price Index rose 0.91% in April following a 0.42% gain the month prior. According to the median estimate on?Bloomberg, the 20-city index was expected to rise 0.40%.?Year-over-year, however, the 20-city index dropped 1.7% following a 1.12% decline the month prior. The National Home Price Index, meanwhile, rose 0.53% in April and declined 0.24% over the past 12 months.

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The FHFA Home Price Index increased 0.7% in April, more than the 0.5% gain expected and following a 0.6% increase the month prior.

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Additionally, yesterday, new home sales unexpectedly jumped 12.2% from 680k to 763k in May, the highest since February 2022. According to the median estimate on?Bloomberg, new home sales were expected to decline 1.2% in May. Over the past 12 months, meanwhile, sales jumped 20.0%, following a 11.3% gain the month prior. Due to a rise in sales, the months’ supply of new homes ticked down from 7.6 months to 6.7 months, the lowest since February 2022. From a price standpoint, the median cost of a newly constructed home rose 3.5% from the month prior to $416k. Year-over-year, however, new home prices decreased 7.6% in May following a 12.2% drop in April.

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Also, yesterday, the Conference Board Consumer Confidence Index rose to 109.7 in June from 102.5 in May, surpassing the expected gain to 104.0 and the highest reading since January 2022.?In the details of the report, a gauge of current conditions gained from 148.9 to 155.3, the highest readings since July 2021, and a gauge of future expectations rose from 71.5 to 79.3 in June, a nine-month low.

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Finally yesterday, the Richmond Fed Manufacturing Index rose from -15 to -7 in June, a three-month high but still marking the sixth consecutive month of a negative print.?According to the median estimate on?Bloomberg, the index was expected to rise three points to a reading of -12.

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In the details of the report, new order volume rose from -29 to a reading of -15, order backlogs ticked up from -32 to -25, and shipments rose from -13 to -5, a three-month high. Also, capacity utilization increased from -15 to -2 in June. On the other hand, the number of employees declined three points to a reading of 2, a two-month low.

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This morning, MBA mortgage applications rose 3.0% in the week ending June 23 following a 0.5% gain the week prior. The 30-year mortgage rate, meanwhile, rose 2bps to 6.75%.

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Also this morning, wholesale inventories declined 0.1% in May, as expected and following a 0.4% decrease the month prior.

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Tomorrow, the third revision to Q1 GDP will be released. In the second round revision, GDP and consumer spending was surprisingly revised higher. GDP was revised up by two-tenths of a percentage point to a 1.3% gain on an annualized basis, following a 2.6% gain in the fourth quarter. Personal consumption was revised up a tenth of a percentage point to a 3.8% gain in the second-round Q1 report, following a 1.0% rise in Q4.

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Arguably most important, however, along with the latest consumer spending data, is an updated read on the PCE, the Fed’s preferred measure of inflation, on Friday. The headline PCE is expected to show further improvement in May, potentially dropping below 4% on an annual basis for the first time since the spring of 2021.?The core, however, which excludes food and energy, remains stubbornly elevated and is expected to remain well above 4.5%, perpetuating the Fed’s need for further action.?

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?-Lindsey Piegza, Ph.D., Chief Economist?

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