The Fed will be in Jackson Hole next week, where Chairman Jay Powell is expected to speak following the inflation read last week: CPI registered 3.2% through July, and was up a modest .2% from last month, though core inflation is still elevated in the high 4s. Many believe the moderation has validated the Fed’s posture. Continued U.S. economic strength extending into Q3, however, adds further uncertainty to their future course. While the surprising resilience of the U.S. economy, with low unemployment and consumer confidence holding up, has many believing there is room for a soft landing, it has also complicated the Fed’s job. The Fed has made it clear they need to see wage and price pressures subsiding, which could translate into keeping rates higher for longer. Nevertheless, there are cracks in the consumer story beginning to materialize, as we’ve discussed here.
Deutsche Bank’s Chief US Economist, Matthew Luzzetti, says he still expects a mild recession, despite a Q3 re-acceleration, which he says could be above 3% despite tighter bank lending standards. Luzzetti believes the Fed lag, credit tightening, and rising delinquency rates will take its toll, and expects a hawkish message out of Jackson Hole. Rising credit card balances, rising delinquencies, and slowing student loan repayments — down $7 billion — are also on his radar. As excess savings is being drawn down by consumers, there are also signs they are making trade-offs (services v. durable goods currently). So far, however, the U.S. consumer is hanging there.
We thought we’d mention two ratings downgrades that occurred recently. The first was by Fitch, which moved US Treasury debt lower by one level earlier this month. Fitch downgraded US sovereign rating from the top-ranked AAA to AA+ as a result of the government’s fiscal deterioration, following up one day later with a downgrade to the credit ratings of Fannie Mae and Freddie Mac.
Fitch cited as an example a “marked increase in general government debt …due to a failure to address medium-term public spending and revenue challenges” “Over the next decade,” the Fitch report said, “higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms.”
This is only the second time U.S. debt has been downgraded, the first occurring in 2011 by Standard and Poor’s also after a debt ceiling negotiation. Republican Budget Committee members have been highly critical of Democrats on this score — saying they have only occurred under Presidents Obama and Biden — and arguing that this is a wake up call to address fiscal issues that have been glossed over in the debt-ceiling debates. In a statement, the Majority said if not addressed, the downgrades will affect the U.S.’s ability to “absorb a major financial shock in the future; and if we don’t change course, the U.S. will not only incur another credit downgrade, we will undermine the dollar as the global reserve currency.”
Alexandra Wilson-Elizondo of Goldman Sachs said this week she did not believe, at this point, the Fitch downgrades would have long term effects but in the nearer term it could cause an elevated debt burden to crowd out private investment and that’s that’s not good for long-term productivity of the economy.
In a move that brings regional banks and CRE back into focus, Moody’s cut the credit ratings of several small to mid-sized U.S. banks Monday and said it may downgrade some of the nation’s biggest lenders. They downgraded 10 banks by one level and placed six large banks, including Bank of New York Mellon, US Bancorp, State Street, and Truist Financial on review for potential downgrades. Moody’s said the sector’s credit strength is likely be tested by funding risks and weaker profitability.
Goldman Sach’s Ashish Shah said the Moody’s downgrade is “reflective of the information we learned in March… the challenges to regional banks business model” and the fact that the commercial real estate (CRE) stress is at a real issue. CRE “continues to be a real thing that is playing out,” Shah agued. Shah added, however, that he does not believe the issue of asset valuation in CRE necessarily bleeds into the real economy, though it creates risk.