Inflation Cools As Equity Market Surges
While we continue to err on the side of caution, this week we are a little less pessimistic about the economy, inflation, and the fate of short-term interest rates. A surging equity market masks some real concerns about the state of the economy. Remember, a deeply inverted yield curve must be respected. Although many cheered the slowing inflation numbers, inflation is still stubbornly high and becoming more embedded. The US economy is mostly service-based, so as service sector wage inflation continues to climb, food and rent costs continue to rise. Bringing inflation down to the 2% target will take time and some tough decisions by the Fed. However, for now, the equity markets have discounted this bad news. Instead, they focus on the assumption the Fed will not move as aggressively as feared just a short time ago. The base case is now 50 bp hike in September (although I am still in the camp of getting the Fed’s fund rate up sooner than later, as this may cause some short-term pain but will more quickly kill inflation off). The odds of a 75 bp hike have come down to 33% from double those odds this time last week.
Overall, corporate earnings were better than expected but many companies are now reducing guidance. Revenue growth is misleading in a high inflationary environment, as much of its development is attributable to inflation, which also affects input costs and lowers profit margins. Additionally, the rate at which consumer credit card balances have escalated is worrisome. With wages not being able to sustain the cost of living, consumers seem to be dipping much deeper into savings and credit cards.
Now to some positives. Consumer confidence has perked up from last month. Mortgage rates have come down some with 30-year mortgage money options in the mid-4% range. Purchase volume in our primary market is improving, but make no mistake, applications are down overall. More niche lenders are coming into the market as well. This will be good for the higher-priced homes as a large percentage of buyers in the high-end space are self-employed or have more complicated financial structures. While it remains a rough game, our lending relationships are still making common sense decisions on complex loans, which is encouraging.