Economic Perspectives: Federal Debt: A Fiscal Year End Update
FAQs on the Markets and Economy
How hawkish was the Fed at its recent meeting?
The Feds new motto seems to be: Supersize it!
The Fed has made a very hawkish move. It has barreled ahead with the third hike of 75 bps. Its plan for the rest of the year implies another 75-bps hike at the next meeting in November and a 50-bp hike at December's meeting. It was just a few months ago that rate increases of this magnitude would be shocking, but they are now becoming routine.
The Fed continues to believe it will be able to arrange a soft landing for the economy. But it will be a bumpier ride than previously thought. The growth rate should crater this year at 0.2%. However, the Fed expects the pace next year to pick back up to 1.2%. This is despite the significant jump in financing costs for households and businesses and a higher unemployment rate.
There were some modest revisions to the overall economic forecast. They reflect slower growth, higher unemployment, higher inflation, and higher federal funds. That is consistent with the trend so far this year.
Are the higher mortgage rates starting to impact the price of homes?
With mortgage rates currently above 7.0%, well above the 3.0% rate of a year ago, the affordability of homes has significantly plummeted.
It has reduced demand for homes, which is being reflected in the price. The pace of price increases has slowed considerably since mortgage rates started to increase this past spring.
The recent peak in the yearly change of home prices occurred back in March at 20.8% YoY. That change has now shifted down to 15.8%. The more recent price movement shows the pace of weakness intensifying; for the past three months, prices have been up just at a 7.9% annualized rate (see chart). For some perspective, the long-term average of price gains is about 5.0%.
With recession risk increasing, how is the High Yield bond market responding?
In light of higher interest rates and the increased probability of a recession, credit stress is strangely absent.
The base case remains that defaults will normalize toward long-term averages of 4%, up from the current level of 1.5%, as inflation slows and the Fed moves interest rates quickly.
Jerome Powell has spoken multiple times about the economic pain likely to come from policy tightening, and the committee’s growth and unemployment forecasts were recently revised in a more pessimistic direction.
Corporate fundamentals remain strong. However, GDP growth in advanced economies is set to contract next year, driven by a European recession. Central banks are expected to keep tightening for the rest of 2022, given high inflation and tight labor markets. 2023 may prove to be a difficult year driven by a more challenging macroeconomic backdrop for U.S. corporations, pressuring fundamentals that have provided support for credit markets.
Corporate leverage has held steady in recent quarters, although consensus estimates continue to point toward significant deleveraging, which means better margins and less debt. But the margin equation is tricky and had declined by 0.9%. For retail companies, inventories are also a problem as sales growth is slowing.
Given CNR’s outlook for "Higher for Longer" interest rates, coupled with ongoing elevated levels of market volatility, we continue to remain neutral to respective benchmarks in our total return strategies. The time for more material over-/underweight allocations will come, but more clarity is needed from markets and the Fed.
Important Disclosures
The information presented does not involve the rendering of personalized investment, financial, legal or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell, any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial infor-mation. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been inde-pendently verified, and its accuracy or completeness cannot be guaranteed.
Any opinions, projections, forecasts and forward-looking statements presented herein are valid as of the date of this document and are subject to change.
There are inherent risks with equity investing. These include, but are not limited to, stock market, manager or investment style risks. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.
Investing in international markets carries risks such as currency fluctuation, regulatory risks and economic and political instability.
There are inherent risks with fixed income investing. These may include, but are not limited to, interest rate, call, credit, market, inflation, government policy, liquidity or junk bond risks. When interest rates rise, bond prices fall. This risk is heightened with in-vestments in longer-duration fixed income securities and during periods when prevailing interest rates are low or negative.
Investing involves risk, including the loss of principal.
As with any investment strategy, there is no guarantee that investment objectives will be met, and investors may lose money.
Past performance is no guarantee of future performance.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment advisor and a wholly-owned subsidiary of City National Bank. City National Bank provides investment management services through its sub-advisory relationship with City National Rochdale.
Non Deposit Investment Products are: Not FDIC Insured, Not Bank Guaranteed, May Lose Value
The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Readers are cautioned that such forward-looking statements are not a guarantee of future results, involve risks and uncertainties, and actual results may differ materially from those statement. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.
Past performance or performance based upon assumptions is no guarantee of future results.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.
Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.
All investing is subject to risk, including the possible loss of the money you invest. As with any investment strategy, there is no guarantee that investment objectives will be met and investors may lose money. Diversification does not ensure a profit or protect against a loss in a declining market. Past performance is no guarantee of future performance.
This material is available to advisory and sub-advised clients, as well as financial professionals working with City National Rochdale, a registered investment adviser and a wholly-owned subsidiary of City National Bank. City National Bank provides investment management services through its sub-advisory relationship with City National Rochdale.
INDEX DEFINITIONS
S&P 500 Index: The S&P 500 Index, or Standard & Poor’s 500 Index, is a market-capitalization-weighted index of 500 leading pub-licly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria that the index includes.
Muni Bond: A municipal bond is a debt security issued by a state, municipality or county to finance its capital expenditures, including the construction of highways, bridges or schools. These bonds can be thought of as loans that investors make to local govern-ments.
Bloomberg Barclays U.S. Corporate High Yield Bond Index: measures the USD denominated, high-yield, fixed-rate corporate bond market.
Dow Jones Select Dividend Index: The Dow Jones U.S. Select Dividend Index looks to target 100 dividend-paying stocks screened for factors that include the dividend growth rate, the dividend payout ratio and the trading volume. The components are then weighted by the dividend yield.
CBO: A collateralized bond obligation (CBO) is a type of structured debt security that has investment-grade bonds as the underlying assets backed by the receivables on high-yield or junk bonds.
Moody’s: Moody’s Corporation (MCO) is the holding company that owns both Moody’s Investors Service, which rates fixed income debt securities, and Moody’s Analytics, which provides software and research for economic analysis and risk management. Moody’s assigns ratings on the basis of assessed risk and the borrower’s ability to make interest payments, and its ratings are closely watched by many investors.
Penn Wharton Budget Model: Penn Wharton Budget Model’s (PWBM) tax policy simulator allows policymakers, members of the media, and the general public (“users”) to see the impact that potential reforms to tax policy will have on many the economy and the federal budget.
NDMC: National Drought Mitigation Center (NDMC) The National Drought Mitigation Center’s mission is to reduce the effects of drought on people, the environment and the economy by researching the science of drought monitoring and the practice of drought planning.
NOAA: The National Oceanic and Atmospheric Administration (NOAA) is an American scientific and regulatory agency within the United States Department of Commerce that forecasts weather, monitors oceanic and atmospheric conditions, charts the seas, conducts deep sea exploration, and manages fishing and protection of marine mammals and endangered species in the U.S. exclusive economic zone.
USDA: The United States Department of Agriculture (USDA) is the federal executive department responsible for developing and executing federal laws related to farming, forestry, rural economic development, and food.
The SIFMA Municipal Swap Index: The Securities Industry and Financial Markets Association Municipal Swap Index is a 7-day high-grade market index comprised of tax-exempt Variable Rate Demand Obli-gations (VRDOs) with certain characteristics. The Index is calculated and published by Bloomberg. The Index is overseen by SIFMA’s Municipal Swap Index Committee.
CalPERS: The California Public Employees’ Retirement System, also known as CalPERS, is an organization that provides numerous benefits to its 2 million members, of which 38% are school members, 31% public agency members, and 31% state members.
4Ps: The 4P analysis is a proprietary framework for global equity allocation. Country rankings are derived from a subjective metrics system that combines the economic data for such countries with other factors including fiscal policies, demographics, innovative growth and corporate growth. These rankings are subjective and may be derived from data that contain inherent limitations.
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