This week Tom Fitzgerald from our Strategy group sits down with Joe Keating, Co-Chief Investment Officer of NBC Securities. Joe is a frequent guest on the podcast and gives us his take on where the Fed will go next and his outlook for the broader economy.


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.

SouthState Bank, N.A. – Member FDIC


Hello and welcome to the community bank podcast thanks for joining us today for another episode today we are turning our attention back to the economy Tom Fitzgerald sat down with Joe Keating one of our most frequent guests on this podcast to talk about Joe’s outlook for the economy for core CPI or what might be the federal reserve’s next rate hike whether or not we can achieve a soft landing with all this what does the aftermath of SVB mean for the economy all those things Tom and Joe dive into in today’s episode before we get there we’ve mentioned this a number of Times Now before each show but we would love to see you down at the Ritz Carlton Amelia Island this July July 6th through the 9th for our annual bank management conference we’re going to be featuring Kirk cousins our keynote speaker quarterback for the Minnesota Vikings as well as James Olsen a former CIA agent who tracked Vladimir Putin back in the 80s so not your typical banking conference we will talk about banking as well Chris Nichols will be talking all about strategy as usual we’ll be talking about the bond portfolio I’ve got a session on taking your banks marketing to the next level so we would love to see you this July at the Ritz Carlton in Amelia Island Florida for our annual bank management conference to register to view the agenda just click the link in the show notes of this episode and you can view our agenda and register on our website and with that here is Tom Fitzgerald and Joe Keating well Jill welcome back I know you’re our most frequent guest on on our podcast and so we do appreciate your time and we hope you’ve been doing well since we last talked hey Tom good to hear from you yeah everything’s great and I appreciate the opportunity to get together with you yeah it seems like forever I know last time we met it was February we typically try to kind of get you in every quarter but things things seem to be happening faster and faster to the point where you know we’ve got we could talk for an hour and not cover everything and and Caleb likes to keep this to about 30 minutes so I’ll just jump right into it if you don’t mind that sounds great OK like I said the you know last time we got together was early February and your take then as I recall was that we would probably fall somewhere between a soft landing and a mild recession for this year now obviously in March we had the two well publicized failures of some regional banks Silicon Valley on Signature Bank the other expectations coming out of that our banks are going to be tightening lending standards kind of hanging on us and their excess liquidity how do you view the odds of of a recession as far as those events and kind of where you stand now versus where you stood then well I I think the the odds of recession have increased slightly and I emphasize I think it would be a mild recession but one needs to consider the fact that you know with the tightening of lending standard that’s going on right now in the banking system that may actually lead to the Fed raising rates less than what they might have been inclined to do if we went back to early March so the the stress in the banking system related to fears about deposit flight you know we’ll have a disinflationary possibly deflationary impact on the economy as credit conditions look to tighten more rapidly banks and in particular regional and community banks will be forced to raise their lending standards and less credit will be available for credit will be available for households and businesses consumers will turn more cautious and hold off on large purchases while businesses will defer capital outlays and we focus a reference finances business surveys are are already signaling that companies are finding it more difficult to obtain credit and the federal reserve’s Beige Book which came out yesterday which is a review of economic activity across the 12 Federal Reserve districts confirm that quote UN quote lending volumes and loan demand generally declined across the consumer and business loan types as banks tighten their lending standards certain sectors of the economy as we talked about before are currently in recession manufacturing sector and that was reinforced by a big drop in the Philadelphia fed manufacturing index falling further this month and in and it’s been a negative negative territory for eight months business capital spending on structures particularly office construction and housing outside of Florida although some signs of stabilization in the housing market are developing largely because the US is short somewhere in the area of five to seven million housing units over the last decade and a half and the supply of existing homes for sale is restricted by low mortgage rates on the vast majority of homes locking homeowners into their current homes so you know both the supply and demand of existing homes for sale and and our purchase is highly sensitive to mortgage rates the service sector appears to be finally cooling a touch along with the jobs market the credit crunch will deliver the finishing touches to the tightening of policy by the Federal Reserve over the past year and as I mentioned at the beginning tighter lending standards will substitute for additional rate hikes that could have happened the current stall in the economy could track closer to a mild recession given the tightening of credit conditions following the heightened stress in the banking system financial crisis is result in demand destruction which will arrive on top of the demand destruction that has already occurred and is continuing to develop from the tightening of monetary policy you know and I’ll show you saw this time it it’s also interesting that the minutes from the March FMC meeting which were released last week indicated that the Federal Reserve staff anticipates that the cumulative impact of the rate hikes since March of last year and the stress in the banking system will will lead to a mild recession this year so in terms of the way the data will play out on a quarterly basis for 2023 when we get the first quarter data next week I think the the growth rate for the entire economy will be around 2% largely due to consumer spending growing at about a 4% rate and all of that occurred during January consumer spending actually trailed off in February and March and the January uptick in spending as we talked about is was really due to weather we think some falls faulty seasonals and a very large Social Security cost of living increase in the second to fourth quarters of the year we think that the numbers the growth rates are going to track around zero with with a biased to small negatives with flat consumer spending weaker capital spending and weak residential construction and that’s where we we see the economy tracking towards this you know mild recession if you will with the data for the next three quarters after the first quarter you know tracking closest to zero with a slightly negative bias and I recall too back in February you you know you did feel like if we did kind of dip into a recession that it would not be deep and prolonged it would be sort of a kind of a fairly short and shallow and I kind of sounds like hearing anything different that you think that that sort of still how the recession if we were to get into one that’s is going to play out is that is that correct you know that’s that’s right Tom and I’ll I’ll mention two things in support of that one coming from the the financial markets and that you know I think the support for our position that the economy will will track closer to a mild recession but not a serious recession can be found in the credit markets once fixed income investors sense a recession is ahead even a mild recession the extra yield required on both investment grade and non investment grade corporate debt to compensate investors for the default risk which comes with corporate debt increases you know prior to the collapse of Silicon Valley bank the yield spread on investment grade corporate debt to treasury securities was 124 basis points compared to an average yield spread since December of 1996 of 152 basis points the yield spread has risen modestly to 137 basis points but still slightly below its average yield spread the yield spread on non investment grade corporate debt was 397 basis points on March 6th compared to the average yield spread since December 1996 of 542 basis points currently the yield spread has increased to 437 basis points which is still below the average yield spread to us the financial markets are saying that this points to the higher likelihood at worst of a mild recession additionally rate hikes have already painlessly reduced labor demand by reducing the number of job openings in the economy without raising the unemployment rate this is a dramatic departure from the usual historical pattern open positions fell by 632,000 in February and have fallen by more than two million since the peak of 12 million in March of 2022 employer who responds to pull back in demand by not filling currently open positions avoids the economic harm that layoffs caused through the loss of income and household spending power so again we think a key element that is pointing to a not serious recession deep and prolonged recession ahead of us and I’m sure you saw this morning as we as we record this on a on a Thursday you mentioned that the the Philly business outlook was was fairly negative and you know worse than expectations the jobless claims number came in a little bit worse than expectations the continuing claims number I think is the highest since November of 21 when I go back to the data and so like he said that you know the labor market certainly came into these rate hikes with the with the strong amount of momentum but it does seem like the Fed is sort of getting their way to gradually kind of cutting back some of that strength in the labor market which should kind of like you said kind of roll into sort of a softer softer demand cycle and then you know eventually kind of curb the inflationary impulses that they’re trying to deal with nice scenario is played out that way Tom is is you and I expect yeah just you know once these trends get established sometimes they sort of snowball on you and you know whether it’s jobless claims or the other you know it just you know it’s it’s like you said it’s hard to it’s hard to kind of put a governor on those kinds of things so let’s hope they you know let’s hope they do that so anyway let’s kind of move into that this is sort of kind of moving into that fed policy you know views and and that obviously you know they’re getting close to a terminal rate you know you don’t probably hike 25 basis points in their may meeting that’s pretty much where the the market is giving them that so I’m sure they’ll take it the difference is where the market thinks the Fed funds will be at the end of the year you know a month ago the market was looking at 100 basis points of rate cuts now they’ve dialed that back to about 50 but that’s still 50 more than the Fed thinks and the fed’s been pretty strong you know jawboning the market that you know we want to stay you know higher for longer we’re not cutting in 23 kind of gets into your thoughts on kind of where where do you see the Fed kind of moving as we move through 23 and and into 24 as far as the the the policy rates well you know as you stated time so you know let’s start with the futures market it has the Fed cutting cutting rates in November following a rate hike at the Maya FMC meeting which would take that the target rate for the funds rate to five to five and a quarter you know I think the decision to raise rates are not at the may meeting is largely a call on the FMC committees confidence in the safety and soundness of the banking system which I think so they’re feeling fairly good about right now and any reassessment of the committee’s estimate of the degree to which potential credit tightening is ahead and the implications for growth you know in in many ways I think a may hike would largely be for for show to basically reinforce to the markets that the Fed is really really focused on getting the inflation rate down to their 2% target as you said despite chair Powell saying at the March FMC meeting that rate cuts are not in our base case for the remainder of 2023 the market is pricing in two rate cuts by year end somewhat in line with the yields on treasury securities currently I think the expectation of rate cuts is likely based on the thought that a credit crunch will lower the neutral rate the level at which monetary policy is neither stimulating nor restraining the economy’s growth rate holding rates steady while the neutral rate falls would actually make policy incrementally tighter you’re going back to that March FMC meeting for a minute the policy statement in the press conference showed a much more cautious central bank than the one that aggressively raised rates in 2022 the fragility of the banking system with huge unrealized losses in banks bond portfolios combined with the risk of deposit runs and the tighter credit conditions that are on the horizon are clearly weighing on the FOMC committee members this initial crack in the banking system the recessionary conditions and certain sectors of the economy and the current looming progress on cooling inflationary pressures indicate that the year long tightening of policy by the Federal Reserve is now having they pronounced effect and and we think the odds are really high that the rate hikes will soon be finished so in terms of whether or not we get rate cuts here in 2023 I think it it all depends upon what happens to the the economic data the high frequency data in particular will will guide things in the near term and then what happens to to the labor market so I guess my bottom line would be that they’re they’re going to the feds and try and hang in there as long as they can at the five to five and a quarter funds rate uh but but because they’ve become a little bit more cautious I think that the initial signs of that that things might be getting worse than than than we’re all anticipating for 2023 I think that at that point you you will see them begin to cut rates again yeah and you mentioned it kind of just drove my memory as you were talking that you you mentioned that the Fed Beige Book did talk about kind of anecdotal information about tightening credit conditions and of course the big survey and that is the you know the the senior you know officers you know lending survey that’s going to come out unfortunately right after the the may meeting and that will kind of give us a better look at how how institutions are tightening down you know they’re underwriting and credit criteria and that could like you said that could go a long way towards you know the the Fed staying at that five to five and a quarter and then maybe possibly if if conditions tightened up you know excessively then you know we’re looking at you know rate cuts closer to what the market is is calling for but of course that’s that’s still to be decided so we’ll just see how that plays out I’m talking about inflation right now the the you know it’s it’s a really tricky and there’s definitely conflicting signals you’ve got the core CPI kind of sticky as they call it at about 5.6 year over year rate in the most recent report while the overall inflation rate is moderating in a fairly consistent manner you’ve got CPI rising only 110th in March and then you look at PPI and core PPI rising 2.7 and 3.4% respectively year over year through March and on that that that 2.7 overall PPI number I look it was a year ago it was 11.7 so tremendous decrease in the wholesale pricing pressures it’s just it you know some of that pricing reduction is just not flowing through to the retail level as fast as as we would like as consumers some of that pricing power that that the retailers got they want to hang on to I think but what is your take with inflation do you think we kind of sticks near that 4% or is that the fed’s 2% target is that achievable by sometime next year you know I I think it is achievable the 2% sometime next year so so so let’s start by looking at inflation expectations in the treasury market and and let’s compare them to before the failure of Silicon Valley bank and if expectations have fallen 23 to 105 basis points compared to early March from one year out to 10 years bringing the inflation forecast to 2.6% for one year and two and a quarter to 2.4 out five to 10 years so there are several factors that point to lower inflation including slower wage growth the economy tracking closer to a mild recession as we’ve talked about slowing rent increases since summer 2022 goods deflation declining supplier delivery times and transportation costs supporting inflationary pressures are rising used car prices once again and the the tight labor market while the the CPI is still well above the feds 2% target at what did we say we said five point well 5% for the headline year on year through March it is showing continuing signs of of decelerating you know a a 6/10 of 1% increase in shelter costs was the smallest gain since November but still resulted in shelter costs rising an annual rate of 8.2% in the March reading increases in in rental leases have slowed sharply including some reports of rents falling since the third quarter of 2022 following their surging pace in 2021 and most of 2022 softening rents are not showing up in the consumer inflation reports in a meaningful way because the labor department’s measure of rents lags behind changes in rents for newly signed leases you know excluding shelter CPI was hired by 3.4% year on year through March and the slower pace of rent increases will pull consumer inflation lower later this year additionally the high inflation months of April to June from 2022 will be rolling off the year on year figures in coming months applying base effect downward pressure it’s interesting that 34 basis points of the 38 basis point increase in the core CPI in March came from rents and travel related services both of which will slow over the next few months so we do look for the inflation rate over the next year to be around 3% maybe a touch lower but to decline closer to the fed’s 2% target in 2024 in fact average hourly earnings in the March jobs report rose at a 3.2% annualized rate over the past three months and as we all know that’s a pace that is consistent with 2% inflation so we’re we’re hopeful and I think it’s the the the most likely outcome that we will get to that 2% number in 2024 I would and I would think so too I know and and and you know this Powell has kind of taken to calling this this super core index that basically takes takes the core services number which is X food and energy and then he also exes out the the housing component to kind of see where you know given the lagging nature of that that housing number as you as you talked about and it’s still been kind of a fairly it’s been a fairly sticky number you know with consumers now really moving into the service side of the economy you know with travel entertainment rush lot of the things they couldn’t do over the last few years with the pandemic they’ve kind of shifted into that service side but again you would think with the moderation in in in wages going forward that you know some of that will also start to to to kind of relax and and and kind of ease off so I I do I kind of agree with you I think it’s going to be it’s going to be a tough venture from say three down to two but I think you know I think we can eventually get there now let me kind of change just kind of summarizing some of this Joe when you kind of take your views on the economy on inflation fed policy what does this all say about yields on treasury securities well you know we we we just lived through time as you well know one of the most volatile months during March in terms of what treasury yields did you know in our lifetimes 2 year treasury yields peaked on March the 7th following up Powell’s very hawkish testimony before Congress and they peaked at 5.07% while the 10 year treasury you’ll hit 398 one of the highest readings since the recent peak back on October 24 at 4:24 with the inversion reaching 109 basis points versus 55 basis points of inversion at the end of 2022 well we are we know now that those treasury yields plunge following the closure to regional banks and chair Powell warning of a looming tightening of credit conditions as bank cut back banks cut back on lending to reduce their risk exposure with the developing stresses in the banking market so that the two year yield fell to 377 down 130 basis points in a couple weeks with the 10 year following to 337 a 61 basis point drop over a couple of weeks both really dramatic declines and that yield curve inversion collapsed from over 100 basis points to 40 basis points treasury yields firmed a bit as March ended as investors warmed to the idea that the that the liquidity measures put in place by the banking regulators regulators had lowered the risk of contagion in the banking systems related to deposit flight and a bit further here in April largely due to the CPI report which as we talked about before showed core CPI up 5.6% year on year in February with the two year now at 416 still well below the 507 on March 7 but above the 377 low on March 24 likewise the 10 year treasury is at 353 again well below the 398 on March 7 or the 4/24 of October 24 but above the 337 of March 24 and that inversion is now at 63 basis points so we think the actions of the treasury market over the last month and a half are very consistent with the economy tracking closer to a mild recession year this year with some question about how sticky inflation will turn out to be and rate cuts being brought forward the looming credit crunch will have a widespread impact on the economy and deliver the final blow to the forces slowing the economy and inflation in 2023 so we expect that yields on both two year and 10 year treasury securities should trade down towards 3% over the course of the year as the Federal Reserve eventually cuts rates either late this year or in early 2024 with growth and inflation moving lower so so that implies that we’ll see more of a decline on the two year treasury than we will on the 10 year treasury and hopefully some of that decline will help some of the positions are clients have in their portfolios with sitting on unrealized losses that are you know well too too high to mention in this in this program but hopefully any any rally in the in the treasury market I think would be well you know would be well welcomed um to try to ease some of those you know some of those losses again that you know almost every bank is sitting on right now right Joe I can’t let you get out of here without again kind of ticking in one look at common stocks and how you view you know investments in that area through the balance of this year given all the outlook we’ve discussed this today yeah well the the stock market was very volatile both our positive manner and a negative manner during the first quarter of the year but I I do think it’s interesting to note that the S&P 500 is up about 15% versus the October 12 low and I’m not sure everyone really appreciates that and compared to the volatile trading during the first three months of the year April so far has been a fairly calm month as traders and investors vacillated between earnings worries rising from weaker growth and recession and the possibility of the Federal Reserve pausing rate hikes following the may 2-3 FMC meeting and then eventually cutting rates as the economy tracks closer to a mild recession which will help to lower inflationary pressures so while the outlook for 2023 has gotten a touch worse following the collapse of Silicon Valley bank and the looming credit crunch the outlook for 2024 has brightened as inflationary pressures are likely to ease considerably over the next six months and the Federal Reserve is likely to cut rates before year end during early 2024 and the banking crisis in March had not occurred rates would likely have peaked at a higher level and remained high for a longer period of time the Federal Reserve cutting rates will allow investors to look forward to the next upturn in the economy and earnings you could think about it as you know being able to look across the valley with the S&P 500 still 14% below its peak reached on January the third of 2022 it appears the market has gone a long way towards pricing in the economy tracking toward a mild recession this year the stock market tends the bottom before a recession ends if the October 12 2022 low holds at which point the S&P 500 was more than 25% below its peak the stock market would have bottomed this time before the recession even started however the housing market business capital spending on structures as we talked about in the manufacturing sectors all did fall into recession last year nothing about the economic cycle inflation and the financial markets have been normal over the past couple of years as the distortions created by the pandemic and the policy response have been substantial conditions will normalize as the pandemic recedes further in the rearview mirror but likely only after the economy tracks closer into a mild recession in the months ahead eventually all bear market downturns are completely erased by a bull market rally that will be the fate of the 2022 bear market at some point in the future let’s just hope that point comes sooner rather than later right yes we all do sometimes you gotta take the pain with the you know with the upside but right now you know that pain like you said been going on for a couple of years so we’re looking for that that bull market rally for sure but anyway Joe I want to thank you again for your time today and and and for all of the time that we’ve been able to talk to you in in prior meetings and I’m sure we’ll probably circle back again sometime around june to kind of see where you know where we stand for the second half of of of 23 and and kind of kind of map out that the strategies from there so again thank you again joe for for your time and for your all of your information you’re entirely welcome tom and thank you for everything


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