August 28, 2018

It’s all but a foregone conclusion that the Fed will raise short-term interest rates by a quarter-point at the next FOMC meeting in late September. The Fed Watch Target Rate Probability tool is currently showing a 96% probability of the Fed Funds moving up to 2.00%-2.25% at the September 26 meeting and a 62.1% chance of another hike at the December 19 FOMC meeting (charted below). However, there is growing evidence that the Fed might find it harder to justify the December rate increase – or any rate hikes in 2019.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

If the Fed doesn’t act in December, there is currently a 60.7% chance that they will raise rates in January 2019. However, if the auto and housing markets continue to show signs of further softening, the Fed will likely step to the sidelines after the September rate increase. Recent auto and housing totals are down:

Domestic auto sales for July decreased to a seasonally adjusted annual rate (SAAR) of 3.93 million from a SAAR of 3.95 million in June. The July sales rate was 12.7% below the year-ago period. Domestic truck sales decreased by 3.5% to 9.14 million SAAR in July, down from 9.47 million SAAR in June.

Looking at the July data (year-over-year) for each major auto company, most company sales were down:

  • BMW -0.3%
  • Fiat Chrysler +5.8%
  • Ford -3.3%
  • GM (estimated) -3.0%
  • Honda -8.2%
  • Hyundai-Kia -5.1%
  • Mercedes-Benz USA -20.1%
  • Nissan North America -15.2%
  • Subaru +6.7%
  • Toyota Motor -6.0%
  • VW Group of America +7.9%

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

On the housing front, there are several variables that together are negatively impacting recent data. The key takeaway from last week’s July Existing Home Sales report is that supply constraints continue acting as a drag on overall sales. Lower inventory, higher mortgage interest rates, and higher prices on available inventory are crimping affordability, especially for first-time buyers. All prospective buyers are facing affordability pressures resulting from home prices increasing at a faster pace than income.

With that said, there are a couple of notable changes in the underlying trends. While supply is tight at 4.3 months, it is well up from March’s 3.5 months’ supply. Additionally, during this same time frame, the year-over-year median price increases have declined from 5.6% in March to 4.6% in July. This implies a positive trend and not some one-off or seasonal situation, as some economists have suggested.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

New Home Sales for July didn’t fare any better, decreasing by 1.7%, led by a stunning -52.3% decline for the Northeast region. The July Building Permits report revealed that single-family housing starts rose just 0.9% to 862,000, a modest pace that reflects the headwinds builders are facing with higher costs for materials, labor, and land. Regardless of the fact that there is an affordable housing shortage, especially for first-time home buyers, builders are not stepping up the pace of permits to build low-cost housing. The profit margins just aren’t there to offset the aforementioned rising costs.

More “Buy Now, Pay Later” Showing Up in the Data

Even while auto and home sales declined, retail sales ex-auto rose 0.6% in July, implying that spending on small ticket items is robust. The Thomson Reuters Same Store Sales Index is now looking at 3.3% Q2 2018 growth, up from 1.2% in Q2 2017. All sectors are expected to post stronger comps this year.

So, if wage growth is nominal and the cost of housing, medical, travel, entertainment, education, elder care, food, and gas is up across the board year-over-year, what accounts for the rise in discretionary spending? Answer: Credit card debt soared to an all-time record high of about $1.04 trillion in June.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The benefits of tax reform are clearly seen in the rise of the U.S. stock market averages, but this newfound optimism has also spurred consumers to spend more. The percentage of U.S. households revolving their credit card debt from month to month has been rising recently to 38% in 2018 after steadily falling from 41% since 2010, while delinquencies are starting to rise, primarily among the small community banks, according to the National Foundation for Credit Counseling. Add in record student loans of $1.5 trillion and record auto loans owed of over $1.1 trillion and it gets the Fed’s attention. I leave out the $15 trillion in mortgage debt outstanding because, barring a repeat of 2008, real estate is an appreciating asset.

Americans are in a borrowing mood, and their total tab for consumer debt could reach a record $4 trillion by the end of 2018, according to Lending Tree, which analyzed data from the Federal Reserve on non-mortgage debts, including credit cards, auto, personal, and student loans. Americans owe more than 26% of their annual income to these forms of debt, up from 22% in 2010.

What this tells me is that these trends, while still manageable for consumers in the aggregate, should give the Fed pause in considering any future rate hikes after September. A further pop in short-term rates could really move the needle in the debt-to-household-income ratio. But given what the data is already showing us, the Fed is already repositioning its posture from that of being hawkish to that of being more neutral.

If at any point after the September FOMC meeting the Fed signals a no-go on a December rate hike, U.S. stocks should rally and thus remain the center of global investing attention. And if the market gets a real whiff of the Fed standing pat on any further rate hikes, dividend growth stocks should lead the year-end rally, with the retail sector not too far behind. Leave no doubt. America does love to shop.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license.


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