If we open a quarrel between the past and the present, we shall find that we have lost the future. – Winston Churchill
“The flash crash” on the 5th of August is likely the event during the month that most investors deem as most
memorable but perhaps it is the dramatic revision to the reported number of jobs created by the US economy that will
be the most important. On August 21st The Washington Post headlined “Labor Market Was Weaker Than Previously
Reported in Big Fix to Data” with the second sentence of the accompanying article reading “The government reported
Wednesday that the economy created 818,000 fewer jobs from April 2023 through March 2024 in the biggest revision
to federal jobs data in 15 years, according to the Bureau of Labor Statistics.”
In recent months commentators have been wrestling with the apparent disconnect between the reported robust
condition of the US economy and the increasing negativity of the US population’s attitude towards that same
economy. As the rate of inflation declined and the US economy provided ample opportunities for employment the
University of Michigan’s Current Economic Conditions Index had risen by March 2024 to 82.5. In the following five
months it has fallen to 61.30, a decline of 25%. Almost half of those in the workforce work for small businesses with
fewer than five hundred employees. Larger businesses obtain their capital in the bond market for longer terms and
have been significantly protected from rising interest rates. Small businesses though borrow predominantly from
regional banks at current interest rates. Those borrowing rates are now near 8%. A result is that there has been no
increase in bank loans to businesses year over year. Small businesses with fewer than fifty employees have
experienced a zero-growth rate in employment on a year over year basis and the rate of new business formations
has declined 51%. Possibly a number of widely held assumptions about the true state of our economy are on the
cusp of being significantly altered.
In the pre-pandemic world of the 2010’s the 10 Year US Treasury rate averaged 2.41%, the Fed Funds Rate 0.75%
and the US Consumer Price Index 1.78%. Most expected that to be a state of reality likely to persist. Then there was
the federal government’s public policy response to the pandemic resulting in inflation levels reaching 9% in June
2022 and the Federal Reserve’s hiking interest rates to 5.50% in July 2023 where they currently rest. In the past
three months the Core CPI Rate, which excludes food and energy because of the volatility of those specific inputs,
has fallen to an annualized rate of 1.60%, below the Fed’s 2% target.
The US Federal Reserve has what is referred to as a twin mandate; to maintain an inflation rate of 2% and a level of
economic activity sufficient to support the full employment of the US workforce. The Fed Funds rate is the interest
rate that it uses to influence the rate of economic activity. The “neutral” Fed Funds Rate is thought by many
economists to be 2.75%. Right now, the rate is 5.50%. If the economy is no longer at full employment and the
inflation rate is finding its way to 2% then that rate should find its way to 2.75% and possibly a great deal sooner than
most expect. So far this part of the picture is reasonably clear but there is another part that seems to not being
actively considered. The current Ten-Year US Treasury rate is 3.84%. The break-even rate, as identified by the
Treasury Inflation Protected Security (TIPS) market, is 2.15%, close to the pre-pandemic rate. Let’s propose a
possible scenario. We are returning to our pre-pandemic world with a Fed Funds rate of 0.75%, a CPI rate of 1.78%-
and 10-Year US Treasury rates of 2.41%. For those arguing that this is not possible a reasonable response would be
to ask what has changed that would keep it from becoming so?
With the Federal Reserve poised to take its foot off the brake that is negatively impacting half of our national
economy, the effect of materially lower interest rates could be significantly more positive than is widely assumed. The
news could be especially good for prospective home buyers. Historically, the yield spread between thirty-year fixed
rate mortgages and the Ten-Year US Treasury rate is 1.50%. That spread is currently at 2.50%. With mortgage rates
currently at 6.50% it may be that 5% rates could be in our not-too-distant future. Stock market investors may also be
hearted by the prospects of rising valuations due to lower interest rates and an economy that starts to regain its
stride with borrowing rates that become increasingly affordable.
Recovering nicely from “the flash crash” of August 5th the S&P 500 was +2.43% for the month and +19.52 year to
date but it was a very different market with “the Magnificent 7” stocks -.70% for the month with defensive sectors of
the market such as Consumer Staples, Real Estate, Utilities and Health Care posting returns twice that of the index.
MidCap stocks were flat and SmallCap was-1.44%. Foreign Developed Markets matched the S&P with European
Stocks and Latin American stocks performing particularly well. The curious disconnect between gold and
cybercurrencies continues with gold +2.31% and Bitcoin -8.84%. The 60/40 portfolio returned 1.12% for the month
with the 60% equity share returning 2.35% and the 40% fixed income share flat with portfolio returns now +13.2% ytd.
Mark H. Tekamp/August 31, 2024