Inflation remains stickier than thought
US January CPI has come in on the high side of expectations with headline up 0.3% MoM versus the 0.2% consensus while core rose 0.4% MoM versus the 0.3% market expectations. This means the annual rate of headline inflation falls to 3.1% from 3.4% and core remains at 3.9%.
The details show the upside surprise coming from shelter, which increased 0.6% MoM, led by owners’ equivalent rent, which also increased 0.6%. Airline fares rose 1.4% MoM while medical care increased 0.5%, the same as recreation while education increased 0.4%. These last three are all the fastest rate of increase for a number of months.
We did get good news on vehicle prices, which were flat on the month for new cars and down 3.4% for used vehicles, but the report is undeniably disappointing overall.
Core CPI vs core PCE deflator, MoM%, 3M annualised and YoY%
Source: Macrobond, ING
When looking at the core PCE deflator, which is tracking considerably lower as a measure of inflation, it again underscores the mixed messaging we are getting from the US data. The left-hand chart is core CPI from today, the right-hand chart is the Fed’s favoured measure of core inflation, the core PCE deflator. What we want to see is the MoM% change (blue bars) to be below the black line (0.17% MoM) consistently to get inflation down to 2% year-on-year.
We aren’t close on CPI, but we are clearly there on the core PCE deflator. Likewise, the 3M annualised rate looks great on the PCE deflator and rather worrying on the CPI measure. (…)
Note that the PCE chart above does not include January, out at month end.
Sticky Sticky
The Atlanta Fed core sticky-price index (a weighted basket of items that change price relatively slowly, 64% weight) increased 6.8% (annualized) in January, its 3-month 6.3%. YoY: +6.5%.
Median CPI is trending up, sharply:
- Like the 16% Trimmed-Mean CPI (which excludes the biggest outliers in either direction and takes the average of the rest):
Goldman Sachs keeps explaining every little item, monthly…
The strength largely reflected start-of-year price increases for labor-reliant categories such as medical services (+0.7%), car insurance (+1.4%), car repair (+0.8%), personal care services (+0.7%), and daycare (+0.7%). Food away from home—which flows into the core PCE—was also strong at +0.5%.
We believe many of these increases reflect the lagged effect of strong wage growth in 2023, and we believe wage growth is now slowing.
However, despite a further slowdown in the rent category (+0.36% vs. +0.39% in December), the large and persistent owners’ equivalent rent category (OER) jumped to a 9-month high of +0.56% (largest gap vs. rent component since 1995). While the OER measure has been particularly volatile recently, we note the possibility that the January strength reflected the rebounding single-family housing market, which the OER sample was reweighted to emphasize starting last year.
Used car prices declined 3.4%, a larger drop than we expected, and we continue to expect further declines in February and beyond due to rising inventories and falling auction prices. Apparel (-0.7%) and prescription drug (-0.6%) prices also declined, in contrast to our expectations. Travel categories were strong (lodging +1.8%, airfares +1.4%), contributing to the jump in core services inflation excluding rent and OER to +0.85%, well above the prior six-month average of +0.37%.
… but its 6-month chart is worrisome:
July to October numbers were promising: core CPI was rising below 3% annualized. But November-January is back at 4%+. Is it a coincidence that consumer spending (demand) was quite strong at year-end?
Services inflation (61% of CPI, 76% of core CPI) is particularly sticky, +6.5% annualized in the past 3 months. It’s not only shelter, also up 6.5% a.r. since November, Services less shelter rose 0.6% in January and is up 6.1% a.r. in the last 3 months.
Meanwhile, core goods prices perked up 0.1% in January (ex-cars), not much but it broke a long deflationary trend linked to easing supply chains and overstocked merchants, two things of the past now.
Breaking down the sector into shelter (whose measurement grows ever more controversial as it accounts for a bigger share of overall inflation), and the Federal Reserve’s so-called “supercore” measure of services excluding shelter, we find that the supercore is rising, while the disinflation of shelter (which should be in full swing now, to judge from real-time indexes of new leases being signed) is proceeding slowly:
Supercore matters to the Fed because it is particularly sensitive to wages. The salary bill is a large part of a service company’s budget, much of it paid to relatively lowly paid workers. The concern as inflation took hold in 2021 was that the fast inflation of the goods that people needed to buy would prompt stronger wage demands. That would push services inflation upward, and risk embedding higher expectations. The January numbers suggest that that’s exactly what is now happening. (…)
On these figures, it would be foolish to cut. The Personal Consumption Expenditure number, separately calculated and not yet available for January, suggests price rises are lower, particularly in services, and implies that cuts might already be possible.
Further hikes are hard to imagine unless the PCE shifts hard upward, but the risk of overheating or “no landing” (in which the economy carries on strong and eventually forces the Fed to tighten until it forces a recession) looks significant. “Is the Fed too tight?” asks Steven Blitz of TS Lombard. “Current data say no, future data are unclear. Hedging their bet, the Fed holds back on cutting and communicates easing. Inflation lurks.”
BTW, here’s the Supercore monthly:
One could simply dismiss the CPI and hang his hat (or set monetary policy) on the recent PCE inflation numbers, but that would be dangerous given their past relationship …
… and the fact that monthly data has been unusually favorable to PCE lately, something that can reverse quickly:
This next chart highlights how subdued monthly PCE inflation has been compared to CPI inflation since last summer …
… giving these diverging trends:
Small Business Owners Expectations for Higher Sales Declined in January
The NFIB Small Business Optimism Index decreased two points in January to 89.9, marking the 25th consecutive month below the 50-year average of 98. The net percent of owners who expect real sales to be higher declined 12 points from December to a net negative 16% (seasonally adjusted), a very negative shift in expectations.
@RBAdvisors
State of the Credit Markets 2024
The most striking thing on the opportunistic credit side is the sheer enormity of the market right now. We think about the addressable market for opportunistic credit in four buckets: high yield bonds, BBB-rated bonds, leveraged loans, and private credit. The size of those four categories just prior to the financial crisis was about $3 trillion. Today, it stands at roughly $13 trillion, so that’s a 4x increase – staggering growth in those categories. (…)
Spreads have been a little bit tighter in the last three or four months. But with base rates where they are, private credit firms can potentially earn 11.5% or 12.0% coupons while lending to multibillion-dollar businesses, in situations where a private equity sponsor is writing a multibillion dollar check, usually to the tune of about 60-70% of the total capital needed to buy the company. That’s a very attractive risk-adjusted return.
Maturities are going to start to ramp up over the next several years in a very meaningful fashion. You have over $800 billion of U.S. high yield bond and leveraged loan debt that is coming due in 2024, 2025, and 2026 – and roughly $1.4 trillion globally.
All that debt needs to be refinanced in some way. Historically, the easiest way to do that has been by using the syndicated market. However, the syndicated market has become increasingly selective about which borrowers it will support. We can all look at credit spreads and say those are well within historical norms, but those credit spreads are available only to the best borrowers.
More and more, there are a lot of companies being left out that are looking for alternative solutions. Without those solutions, most of these companies will end up in a restructuring.
Clearly, the most acute area of risk right now is commercial real estate. That’s because the maturity wall is already upon us and it’s not going to abate for several years.
There’s a need for capital, especially for office properties where there are vacancies, rental growth hasn’t materialized, or the rate of borrowing has gone up materially over the last three years. This capital may or may not be readily available, and for certain types of office properties, it absolutely isn’t available.
As we roll forward in time, different pockets of risk – or different dimensions of risk – may develop. We’re probably at the beginning of a cyclical downturn, so we don’t believe it’s a good time to go heavy into cyclicals or interest-rate-sensitive asset classes, like, for example, homebuilding and building products.
Another area where we see risk increasing is among floating-rate borrowers broadly, specifically those that took on debt in 2018-21 when base rates were zero and the cost of borrowing was 5-7%. The costs for those same borrowers are now more like 11-13%.
Generally speaking, when these companies took on this debt, the sponsors and borrowers assumed that they would see synergies or increased growth and cash flows. Most of this hasn’t materialized. Some businesses have grown, but they typically haven’t grown to the level that they or their owners thought they would.
Therefore, in addition to seeing a meaningful escalation in their cost of borrowing, these floating-rate borrowers have also been negatively impacted by the economy and therefore haven’t been able to grow into their capital structures.
(…) what you’re going to see over the next three years is an unprecedented wave of liability management driven by the really poor debt documents that were written over the last five years. That is a big risk that I don’t think the market fully appreciates.
Those structures are perfectly positioned for predatory sponsor action, more commonly known as “creditor-on-creditor violence.” If you’re in those structures and you’re not aware of what’s going to happen, you’re likely going to have a rude awakening.
We’ve seen this trend emerge to a very limited degree in 2023. But it’s likely going to tick up in 2024, precisely because maturities are going to start to ramp up, and borrowers aren’t going to have the ability to address them through the syndicated market. Sponsors who are backed into a corner are likely going to try everything at their disposal to save their equity. The easiest way to do that is to pit creditors against each other and to advantage a certain set of those creditors to create liquidity for the company.
This is not like the distressed market we saw in 2007, where you could go out and buy a loan and expect to get the same treatment that you would in a normal bankruptcy or restructuring process. These sponsors will act. There are few sponsors who are going to be above aggressive liability management, so you should be ready for that. (…)
Moving forward, we believe we’re going to test the domestic market for treasuries. I would pay close attention to Treasury auctions. How do they go? How well do they clear? How do new Treasurys get placed, and who is buying those Treasurys? The foreign buyers of Treasurys, which were the largest owners in prior years, may be tapped out.
Given the quantum of debt the U.S holds and the budget deficit that is upon us, it’s hard to imagine a scenario where the dollar value of Treasurys that need to be rolled every quarter or every month would actually decline. Thus, we’re somewhat concerned about where the 10-year Treasury yield goes from here, given supply and demand imbalances.
Some really poorly underwritten debt was issued over the five years leading up to 2022. A lot of it found its way into the banking sector. A lot of those banks, including both regional and large banks, are sitting with big embedded losses on their balance sheets. These losses might not have to be recognized immediately, but the people running the risk books for those banks probably feel pretty uncomfortable. They’ll likely look to shed that risk.
They can shed it directly through loan portfolio sales. After the financial crisis, Oaktree’s Opportunities group bought roughly 60 different pools of non-performing loans involving over $2 billion of equity capital deployment. We may not see an opportunity of that size this time around, but there will be pools for sale out there.
A more elegant way to reduce risk is risk transfer. We’re seeing an increase in the number of banks interested in talking to us about risk transfer involving high-quality assets that are simply mispriced – they were just purchased in an era that doesn’t exist right now. We’re very excited about this growing opportunity. (…)
CFOs typically begin seeking refinancing solutions at least a year in advance of maturities. As we flip the calendar to 2024, a lot of people are going to start looking at 2025 maturities and are going to be trying to find ways to address them. Thus, we expect to see a big uptick in the demand for rescue capital, especially once CFOs start to focus on 2026 maturities.
Supply of capital is very constrained right now. Many of the LPs that would typically provide capital to the sector are currently restrained by legacy portfolio issues and the fact that they’re not getting the distributions they anticipated. So we except the supply of capital in this area to remain very constrained, creating attractive competitive dynamics for us. (…)
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Commercial-property pain is still far from the levels of the 2008-9 financial crisis. In the second quarter of 2010, the industry was swamped with a record $194.8 billion in distress, $109 billion more than at the end of 2023, according to MSCI.
