Joe Keating’s Economic Outlook for Q4 and Beyond
This we sit down with one of our regular guests, Joe Keating, to get his thoughts on recent GDP data, inflation, and the outlook for Q4. Joe serves as Co-Chief Investment Officer of NBC Securities.
The views, information, or opinions expressed during this show are solely those of the participants involved and do not necessarily represent those of SouthState Bank and its employees.
Intro: Helping community bankers grow themselves, their team and their profits. This is The Community Bank Podcast.
Erik Bagwell: Welcome to the Community Bank Podcast. I’m Eric Bagwell, Director of Sales and Marketing for the Correspondent Division of South State Bank. Joining me is Tom Fitzgerald, Director of Strategy and Research for the Correspondent Division. Tom, how are you?
Tom Fitzgerald: Eric? I’m doing fine. I’m just glad that we’re back together. It’s been a while.
Erik Bagwell: It has. We have not sat behind the microphone together for a while and we’ve got a great show today and glad you guys have tuned into it. Tom is going to get, or has gotten with Joe Keating. Joe’s with NBC Securities and a frequent guest on the show. He’s probably our number one guest as far as appearance.
Tom Fitzgerald: I would have to guess he is. Yeah.
Erik Bagwell: Yeah and you guys are going to sit down and you talked about the economy, what’s going on. I know GDP number has come out and you guys are going to talk about that. Talk also real quickly about your Bond Accounting Report that we have available for folks. They can actually get that thing for free and download it. Talk about where to get it and what it encompasses.
Tom Fitzgerald: Yeah Eric. It’s a report I put out every quarter and we Bond Account for about 130 mostly community banks and so what I do is kind of take a look at those banks and aggregate as a single portfolio. It’s probably about $13 billion in par value. We take a look at all the parameters of the performance, book yields, durations, unrealized gain or loss and just trying to take a look at what they were purchasing over the last quarter. So that report, it’s a short two pager, so it’s a quick read and it’s very, I think it’s a lot of valuable information. You always want to kind of compare yourself to what your peers are doing and this report can do that for you.
Our listeners can find that at southstatecorrespondent.com/bondreport and they just fill out some information and that will be coming straight to their email box.
Erik Bagwell: Good deal. We’ve mentioned this quite a few times on the podcast and always have quite a few folks reach out and request the report. So listen, we are glad you guys have tuned into the podcast. We enjoy doing this and we appreciate all the feedback you guys are giving us. There’s a lot of folks listening around the country and we greatly appreciate it. So let’s go straight to Tom’s interview with Joe Keating right now.
Tom Fitzgerald: Well Joe, welcome back. I think you’re one of our most frequent guests on the show and it seems like every time you’re here, we have a ton to talk about, and I guess this session is not going to be any different. So, how are you doing since the last time we spoke?
Joe Keating: You know Tom, everything is really good. Thank you for asking.
Tom Fitzgerald: Yeah, we were just talking before, we’re sort of recording this in the middle of the World Series with the Braves there and we’re looking forward to a weekend of some winning ball games. So, hopefully that’ll follow through and by the time everybody reads this, it will be the Atlanta Braves World Series Champions.
Joe Keating: There you go.
Tom Fitzgerald: So, anyway let’s turn our attention to the subject at hand, the economy and you know, as we record this also, we had a pretty big number come out this morning. A big report, I should say. The number itself wasn’t so big, but it was Third Quarter GDP came out at 2%. The market was looking for about a 2.6 and just to compare the second quarter and the first quarter had six handles on them. So obviously a big slowdown in consumption. That was to be expected but I did want to get your thoughts on the report itself and is this sort going to be an outlier report or do you see this sort of a start of a slowing trend that we’re going to see continue into the fourth and into next year?
Joe Keating: Sure. Well, so Tom, we view the Third Quarter Real GDP Report as an outlier. Largely brought about by a stall in the reopening of the economy during August. You know, right there in Atlanta, the Atlanta Fed does a really good job of publishing a quarterly forecast number and if you go back to June 30, the forecast out of the Atlanta Fed for the third quarter was around 6%. Last week, that number was all the way down to half of 1% to less than half of 1%. So clearly some things went on during the quarter that led to this 2% growth rate. You know, in many ways, 2021 has been a bit of a roller coaster. If you think about the first six months of the year, the widespread distribution of vaccines led the seven day moving average of new cases of the virus to plummet from almost 254,000 back in January to under 14,000 by June 30. So a market drop.
In response, the pace of economic activity rose really briskly, with the economy growing at rates of over 6% during the first two quarters of the year. However, the surge in the Delta Variant COVID-19 cases all the way back up to almost 162,000 by September 1, caused the reopening of the economy to stall. Highlighted by the slowdown in the economy’s growth rate to that 2% number that we talked about for the third quarter. The stall in the economy was evident across all sectors of the economy. Consumer spending slowed all the way down to the 1.6% compared to 12% at an annual rate in the second quarter. The expected shift that we talked about in the past from spending on goods to spending on services by consumers did take place.
We saw outlays on goods fall at a 9.2% annualized rate, all the way down from 13% in the second quarter. While service outlays grew 7.9%, although that was slightly lower than the 11 1/2% rise during the second quarter. Of course, supply chain disruptions and product shortages also contributed to the decline in spending on goods. As we could see in durable good outlays declining at more than a 26% annualized rate led by almost a 54% decline in motor vehicle outlays and that’s the sharpest monthly or quarterly decline in motor vehicle outlays in more than forty years. And a little bit more than 10% rate of decline in purchases of furniture and appliances.
Residential construction outlays fell for the second consecutive quarter. Declining at a 7.7% pace. Demand for housing from what we can tell remained strong, but a record surge in prices. Material shortages are rising from supply chain issues and labor shortages arising from COVID-19 concerns and unusually high jobless benefits held back construction activity. Turning over to the business side, business capital spending also slowed. Advancing at a 1.8% pace compared to 9.2% in the second quarter. Outlays for intellectual property products led the way at a pace a little bit in excess of 12%. Inventories fell at a $77 billion rate last quarter, the third consecutive quarter of an inventory drawdown.
Due to the ongoing supply chain disruptions and product and labor shortages, businesses had to dip into their inventories to meet demand. However, this is interesting from a math perspective. Since inventories were liquidated at a slower pace than the $168 billion pace in the second quarter, inventories actually contributed 2.1 percentage points to the economies 2% growth rate in the third quarter. Net exports subtracted 1.1 percentage points from the third quarter growth rate with imports growing while exports fell as the U S continues to recover at a faster pace than the rest of the world. And some good news, the high frequency data for September points to a rebound in consumer spending.
Solid growth in the service sector and in the manufacturing sector, continued strong activity in the single family housing market and a constructive rebound in consumer sentiment. Demand for labor remained strong with initial unemployment claims reaching a new pandemic low over the last couple of weeks. It appears that economic growth accelerated even further during October with the improvement being broad based and across categories. So bottom line is we do not see a recession on the horizon and see the economic expansion becoming self-sustaining and self-reinforcing. It returned to above trend growth in the current quarter and I’ll define that as something in the 5 to 6% range and for all of 2022. And I’ll peg that at somewhere in 3 1/2 to 4% range, driven by healthy household balance sheets.
Very low debt burdens, high savings rates along with strong income growth from healthy job gains and wage hikes is on the horizon. Consumer spending on services will lead the way at the expense of spending on goods. Outlays for equipment and software will lead business capital spending as businesses respond to ongoing labor shortages and the need to raise productivity levels. Given margin pressure from rising material prices and wage increases. Inventory rebuilding will drive manufacturing activities after drawing down, we saw the business sector draw down inventories in each of the past three quarters as surging demand collided with supply chain disruptions. And lastly, we think housing and construction activity will remain steady, but at a high level of activity.
Tom Fitzgerald: And I tend to agree with all of that. I think when I was looking at the numbers this morning and you kind of alluded to it. But you can really see the fingerprints of both the supply chain disruption on the good side of the market and then the virus cases, you know, the Delta variants rising during the quarter on the services side. It certainly played into suppressing some of that activity as well as obviously the semiconductor issue with the cars and you mentioned those numbers being way down from where they traditionally are. So I think you’re right that the seeds have been sewn, I think in the third quarter for a rebound into the fourth and probably carrying on into 22 as well.
Let’s move on to another topic that’s on everybody’s tongues, at least on investor’s tongues and consumers as well. Because they’ll tell you about it, the gas pump and at the grocery store and that’s inflation. As far as the inflation data that we have gotten lately, and we’ll get an updated PCE number tomorrow in the personal income and spending numbers, but what is your take on inflation and what is your outlook as we go through the fourth quarter and into next year?
Joe Keating: Well, and I agree, Tom, I’m looking forward tomorrow to seeing what that Core PCE Price Index Number is for September when it gets released tomorrow. So the inflation data remained well above the pre pandemic pace in the third quarter. But did cool a bit compared to the second quarter of 2021, which is a little bit of good news on inflation. The Gross Domestic Purchases Price Index rose at a 5.4% rate. Just a touch below the 5.8 in the second quarter and is higher by 4.2% year over year. The closely watched Core Personal Consumption Expenditures Price Index that we were just referring to for the whole quarter cool to 4 1/2% rate compared to 6.1 in the second quarter and is higher by 3.6% year over year.
The biggest concerns I think among investors and in business people and the most significantly risks to the economic expansion currently are inflation and the Federal Reserve managing the economic exit from the pandemic. You know, it’s safe to say that everyone was expecting a short lived spurt in inflationary pressures, as the economy reopened with the widespread distribution of vaccines. A one-time normalization of prices in the travel, leisure entertainment and hospitality industries. Those high context service sectors was sure to take place as a rebound from the depressed level of prices at the worst of the government mandated shutdown of the economy in 2020 occurred.
However, supply side constraints arising from disrupted supply chains and labor and material shortages were for the most part, largely unexpected and have become a second source of pricing and wage pressures in the economy over the past couple of months. It appears the risks in the short run are to longer and more persistent bottlenecks and higher prices for many goods and services. The supply constraints have run headlong into surging demand as rising vaccination rates and the nearly $2.8 trillion in fiscal relief approved since December of 2020 have produced a rebound in the economy that is clearly unprecedented. Rising wages have reinforced household demand.
When the pandemic soon becomes endemic and that’s defined as a manageable disease that does not cause undue burdens on hospitals or other healthcare resources, you know, like the seasonal flu. The process of eliminating supply disruptions, labor shortages, and pricing pressures arising from shortages will accelerate as supply conditions ease, and the pent up demand for goods ebbs with consumers shifting more towards spending on services with the economy reopening. The pressures pushing up good prices should ease as we move into 2022. Supply and demand are in the process of rebalancing, but the process will play out over several more months. Once the rebalancing is complete, good prices will stop rising and in certain categories could even fall back a bit.
Tom Fitzgerald: So that’s, I think good news for all of us consumers and for investors alike and I tend to agree. I think, like you said, most of these surges that we’ve seen have been from supply constraints meeting outsized demand and just the correction of that is obviously taking longer than certainly the Fed thought and most investors as well. I do think relief will be coming at some point in 22 and that’s, I think good to hear at least from a rates perspective and kind of how the Fed’s going to react to that as we move into 22. And speaking of the Fed, let’s talk about, you know, we talked about a lot of stuff going on as we talk today. As we’re recording this, there’ll be a Fed meeting next week, the November meeting and kind of widely reported or rumored that they’ll announce their tapering at that meeting and the schedule that’ll go with it.
Just give us some of your thoughts. What you think we’ll hear from the Fed next week and if they do a tapering, kind of what schedule do you think they’ll set out for us?
Joe Keating: Well, yeah, the big issue next week is going to be the FOMC meeting and we clearly expect the Central Bank to announce it will reduce its bond purchases by $15 billion per month starting that month. Starting in mid-November and that would neatly place the Federal Reserve on a schedule to end the current bond buying program in June of 2022. One thing to keep in mind as we watch what goes on with the Federal Reserve is that some changes to the makeup of the Board of Governors, other Federal Reserve are possible over the next few months. Jerome Powell’s term as Chair ends on February the fifth of next year and Vice Chair, Richard Clarida’s term as a Governor ends at the end of January.
While Randy Quarles’s term as a Governor extends all the way out to January of 2032. His term as Vice Chair for Supervision ended this month. There is also one vacancy currently on the board. So President Biden could and likely will alter the composition of the board in coming months, which could impact the timing of the next step, the first rate hike. Mr. Powell, a Republican has been the front runner to keep his job, just because we think that that would sit best with the financial markets. But we all know that this questionable trading activity by two Federal Reserve Bank Presidents, Dallas Federal Reserve Bank President, Robert Kaplan and Boston Federal Reserve Bank President, Eric Rosengren were seized upon by a vocal minority of Democrats who already opposed his nomination because they say he’s too friendly to Wall Street on bank regulation.
The conflict of interest controversy for the Federal Reserve has dented, but likely not derailed Mr. Powell’s chances for a second term and last week Mr. Powell did impose sweeping personal investing restrictions on Senior Federal Reserve Officials in a bid to address the controversy. So we’ll see how it plays out. I think both you and I, Tom, believe that Mr. Powell has done a really good job except, you know, back in 2018, when he went a little haywire in terms of raising rates, which they eventually had the back backtrack on. But other than that one episode, and particularly here during the pandemic, I think he’s done a terrific job managing monetary policy and I really hope that politics does not influence who’s the next Chair of the Fed and that Mr. Powell does in fact get reappointed.
But we’ll see and we’ll find that out relatively quickly because his term, as I said, is up on February the fifth and there needs to be the whole Senate confirmation hearing process. So in order to get that started, Mr. Biden is going to have to make a decision on the next Chair of the Fed relatively soon.
Tom Fitzgerald: Yeah. He’s been pretty quiet on that. They’ve obviously been asked the question, but he hasn’t come out forcefully in favor of Powell or denounced. To me there he’s been pretty mom on it, but I do know that Janet Yellen is certainly in his corner and so that’s a pretty powerful sponsor to have in front of the President. So, like you, I kind of think he will be reappointed. I don’t know that the administration wants to get into a protracted kind of controversy over this. Given, they’re still trying to get that budget bill through and I think once that is done in some form or fashion, then the attention will turn to the Fed membership and hopefully, like you said, we’ll get some hearings and get the reappointment of Powell.
Because I think he’s been a steady hand at the tiller and I’d like to see that continue at least personally. We can’t let you go Joe, until we get your thoughts on, everybody’s kind of wants to sit there and listening to what does Joe think about rates? And so as you look today in your crystal ball, you know, let’s talk about longer data treasuries first. Obviously begin with the Fed meeting next week, you know, and you talked in July when we met about the taper tantrum had already happened. So I guess you feel like these backup in yields that we’ve seen in the last couple of months may be what we are going to see at least for the time being, but give us your view. Where you think rates are going to go and especially in light of what the Fed will be doing in the tapering front.
Joe Keating: Yeah, well, we all know that the peak in the ten-year treasury yield during 2021 was back on March the 31st at 1.75% and then we did see the yield fall into a low in late July where the yield on the tenure actually got under 120. And I think that was all related to the Delta Variant and people extrapolating what that would do to the economic reopening, the reopening of the economy and they were correct as we now know, from looking at the data that there clearly was a stalling in the economy during August. And that probably carried over into say the middle of September. Since that, we have now seen rates or yields rise in August, September, and again here in October.
Although the October rise is fairly modest. The ten-year treasury today is trading 157, 158, something like that. That’s up just modestly from what we saw at the end of September, which was 149. So, and that’s with basically everyone acknowledging that the Fed will begin tapering during the month of November. So, you know, as we talked about back in July, we think that the taper tantrum occurred already from the low end ten-year treasury yields back on August the fourth of a year ago at 50 basis points up to that 175 peak that we saw recently on March 31st. You know, it’s interesting, the rise in yields I think is partly because of a reacceleration in the economy that we’ve already talked about during September and into October, but also that inflation expectations have picked up a bit.
You know, we all follow the implied inflation outlook in some maturity of the treasury securities and I tend to focus on the tenure and it’s risen up to 2.65% from 229 back on September the 21st, and is now above the previous 2021 high of 258 back on May the 12th. So, we have seen inflation expectations rise a bit, which I think is an acknowledgement of the supply chain issues and shortages of supply and labor that are giving us a little bit of a further boost in the inflation data. But you know, 265 is not 3 or 4% either. So I do think that there’s some good news in terms of what it is investors are looking at. They’re looking at a little bit more sustained inflation, but clearly not runaway inflation.
So it’s interesting that the futures market is pricing in about a 75% probability of at least two rate hikes by the end of next year and with this relatively modest move higher in ten-year treasury yields during the month of October. We think the Central Bank is building some credibility for not being soft on inflation by starting to taper a little earlier than previously expected. And that particularly, you take a look at the comments that Mr. Powell has made in the last press conference that the Federal Reserve is retaining its focus on keeping inflation and inflation expectations under control.
So [24:03: inaudible] first will turn out to be the high yield for this cycle [24:14: inaudible], but we continue to expect that even if longer data treasury yields make another run at 2% with the economy reopening, the rise and ten-year treasury yields will be contained as inflationary pressures ease as 2021 rolls into 2022. So we expect the yield on the 10-year treasury note to trade within a 1.6 to let’s say 1.8 range for the next couple of months and it would not surprise us at all if the 175 that we saw back on March 31st does turn out to be the high for this cycle.
Tom Fitzgerald: Yeah. And I also, you know, talking about going back to the Fed meeting and the taper announcement that’s probably coming. I’m wondering too, like you mentioned the market has basically priced in two Fed hikes in 22, which is a little more aggressive than what the Fed had projected at their September meeting. They were sort of half and half on just one rate hike in 22 and then a couple more in 23. So I’ll be interested to hear if Powell has anything to say to that. Speak to that at the press conference if he pushes back on that or if he’s going to just accept that as that could be where we are and when we get to the middle of June after the end of tapering. So that’s again some, I’m sure he’ll get asked about that at the press conference. So I’ll be interested to see what his answer is in that regards.
Joe Keating: Agreed.
Tom Fitzgerald: Yeah. Anyway, let’s wrap it up. Everybody has got their 401ks out and they’re staring at them. So, you know, with stock market trading at near highs, even despite what’s going on with inflation and what’s going on with softer GDP number. What do you see in store for us as we kind of wind up the year and into 22 with the stock market?
Joe Keating: Well, you know, stock prices have advanced fairly smartly so far here in 2021. Depending upon what market measure you look at through last night, stock prices are up on the order of 14% to 21%. The S and P 500 did fall 5.1% during September. The first decline of more than 5% since October of last year, but the S and P 500 has gained 6.3% since the recent low back on October the fourth. It seems that investors have turned their attention to a reacceleration in the pace of the reopening of the economy after the August stall and the first wave of Third Quarter 2021 Earnings Reports, which have been on average better than expected. You know, strong earnings growth has certainly been the major positive for common stocks this year.
Operating earnings of the S and P 500 companies rose 143% year over year in the first quarter. Now, I acknowledged that was compared to trough earnings during 2020, but 143% still pretty good number and then they were higher by 94% in the second quarter. With year over year comparisons becoming a bit steeper as the year goes on third quarter 2021 operating earnings are on track to advance 31% over the third quarter of 2020 with 26% of the company’s reporting so far. Additionally, of the companies that have posted earnings so far, 81% have exceeded Analyst Earnings Forecasts, according to Bloomberg.
Reflecting on last month’s economic data updates and earnings reports, we are left with the view that the reopening the economy has accelerated and remains on solid footing. As vaccination rates continue to rise, new COVID-19 cases are on the decline. We are also encouraged, and we’ve kind of mentioned this already, that the Federal Reserve is poised to begin removing monetary accommodation. Company fundamentals are sound and still improving and we view common stocks as attractive relative to other assets. So as already stated, our fundamental thesis of no recession on the horizon and the economic expansion becoming self-sustaining and self-reinforcing remains unchanged, and we look for common stock prices to be higher a year for now.
I don’t look for the S and P to gain 21%, in 2022, like we’ve seen so far here in 2021, you know, but something on the order of a high single digit number is fairly likely. The current worries that are out there and here’s one that I’m probably most worried about, but I don’t hear many people talking about it. You know, these rising tensions between China and Taiwan, all the way over to supply chain disruptions and labor shortages to pricing pressures, to operating margin pressures are all legitimate concerns. However, we think these issues appear to be adequately reflected in the market, particularly so when the S and P 500 declined by that 5.1% pace during September. One thing we know for sure is that 12 months from now, those worries will have been replaced by a new set of worries. It’s just the way the world turns.
So we remain inclined to buy stocks on the pullback, as we’ve done all year, when our clients had fresh cash to put to work. As we look for further gains and earnings, coupled with significant returns of capital to investors in the form of dividend payments and share repurchases. So our advice remains the same. Stay invested in high quality companies which will benefit from the economy returning to an adapted normal that will turn out to be surprisingly similar to the old normal. With the economy’s growth rate remaining strong over the next few quarters.
Tom Fitzgerald: Well Joe, I want to thank you for all the insights that you’ve given us today and all of the material that we covered. I’m sure our listeners are thankful for it as well. I want to, you know, when you look out over the near term horizon, you’ve got the FOMC meeting next week with the tapering announcement, most likely, and then December is another meeting before the end of the year and then, you know, obviously year end always brings certain challenges to the market. So I’m already penciling you in for a January revisit to the show. So we can kind of go over what happened between now and the end of the year, and kind of set our sights on what’s going to happen in 22.
So, I hope you will accept our invitation because we certainly would love to get you back in as soon as we can once the calendar turns to 22. So again, thank you so much Joe for your time and your insights,
Joe Keating: Tom, that would be terrific and I look forward to it and to everyone out there, enjoy the upcoming holiday season. Take care.
Tom Fitzgerald: Thank you Joe.
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