Morning Briefing | Explaining a 'Broken' Economy and Truflation
Tesla's EV deliveries decline for the first time in more than a year – Tesla (TSLA) saw global electric-vehicle ("EV") deliveries drop during the third quarter as the carmaker prepared factories for new production. The figure dropped to 435,059 vehicles, coming in below Wall Street expectations, and was down from the 466,140 vehicles delivered in the second quarter. Despite the dip in deliveries, the company is still on track to produce and sell more than 1.8 million vehicles in 2023. Tesla has maintained its sales by reducing car prices throughout the year. The company will likely reveal more details during its quarterly earnings report scheduled for October 18.
Multiple rate hikes still needed to lower inflation, says Fed's Bowman – Federal Reserve Governor Michelle Bowman reiterated that the central bank may need several interest-rate hikes to reach its 2% inflation target. Her comments come despite some of the biggest price slumps seen in three years, according to data from August. Bowman is concerned that high energy prices could erase the Fed's progress in recent months. She remains skeptical that the trend is sustainable and believes the headway made on inflation will probably slow, given the recent rate-hike pause.
U.S. manufacturing sees slowest decline in nearly a year – The Institute for Supply Management's ("ISM") Manufacturing Purchasing Managers' Index ("PMI") rose nearly 3 points from August to a reading of 49 in September. The recent data marks the slowest contraction (i.e., a reading below 50) in factory activity since November 2022. Increased employment and the strongest production growth since last July boosted the index. The improvement suggests that the worst may be behind American manufacturers as they inch toward the contraction/expansion threshold.
Bill Ackman says Fed tightening is over, U.S. economy weakening – The era of monetary tightening is likely over, according to the billionaire hedge-fund manager of Pershing Square. Ackman says economic cracks are forming thanks to an overzealous Fed. High mortgage and credit-card rates are key factors slowing the "still solid" but "definitely weakening" economy. Ackman also predicts a rocky future for commercial real estate investors as their debt will be repriced to align with the current climate.
Nearly 70% of investors believe U.S. office prices will crash – According to Bloomberg's Markets Live Pulse survey, the majority of respondents (nearly 70%) think it'll take a "severe crash" for the commercial real estate market to recover. Even more, roughly 44% of respondents believe the bottom won't come until midway through 2024. Extreme rate hikes, courtesy of the Fed, have continued to wreak havoc on the sector by drastically increasing the cost of financing. Lenders are also having more trouble offloading their commitments since most buyers don't think the market is close to bottoming out. However, according to a Barclay's analyst, a serious downturn in commercial real estate won't likely affect overall market stability because the debt is spread out across a wide array of investors to absorb losses.
Bank of England's Mann suggests higher rates despite last month's pause – Bank of England ("BOE") member Catherine Mann cautioned against easing up on the fight against inflation. She firmly believes that the central bank forecasts a "fundamentally different" future from the ones she considers likely. She also emphasized that her forecast is on the upper end of the BOE's projections. Mann argued that tighter monetary policy is needed to fight more frequent inflation shocks and to rein in stubbornly high demand and price pressures.
In this week's "mailbag" issue, we're highlighting several questions and comments from our readers over the past several weeks.
First, we have a question from Jeffrey in response to our recent issue, 'Gradually, Then Suddenly'... a Recession Is Here...
What do you mean exactly by something "will break"?
Kevin's response:
A few weeks ago, I wrote to you about the Federal Reserve's latest policy decision, where it decided to pause rate hikes for the second time this year and keep the benchmark at 5.5%.
As I explained, this was pretty much what everyone was expecting. In fact, investors were more focused on Fed Chair Jerome Powell's post-meeting comments and the central bank's quarterly Summary of Economic Projections.
Ultimately, the Fed stood by its "higher for longer" mantra. But Powell also finally admitted that a soft landing is basically off the table.
On top of that, the central bank delayed the first projected rate cut in June 2024 to September 2024. That means it'll be about a year until homebuyers, consumer debt, and banks' balance sheets see any sort of relief...
As I said in that issue (and what Jeffrey is referring to)...
Frankly, with rates this high in these economic conditions, something is bound to "break" sooner than later. And it could all happen "gradually, then suddenly."
Whenever someone says that the economy will "break," they mean that the economy will be in a period of distress for a good amount of time. One or more sectors may collapse, and the broader economy may see a sizable decline or correction as a result. For example, in 2008, the financial sector "broke" along with the housing market. This eventually caused an overall economic breakdown, otherwise known as the Great Recession.
Today, insanely high interest rates have sounded the alarm for a major debt and credit bubble...
Approximately 30% of total outstanding U.S. debt is scheduled to reach maturity within the next 12 months. Around 52% of this debt is set to mature within the next 36 months and will need to be refinanced. However, debt-servicing costs have risen since the last time this debt was refinanced, from 1.5% to 3.0%. That means maintaining this debt has become twice as expensive.
In the banking sector, things haven't improved as much as folks had hoped they would since the regional banking crisis in March...
Banks' unrealized losses on investment securities are skyrocketing. As of the second quarter of 2023, there were about $558 billion in unrealized losses. To put this into perspective, that's about 26% of all banks' equity capital.
Take a look...
If banks have to boost their liquidity, they would be forced to do so at a tremendous loss. Tightening credit conditions and the potential for the Fed to impose stricter capital reserve requirements mean that banks would need to "cash out" of these investments to maintain liquidity.
Essentially, banks would need to sell their investments for less than they bought them for.
This is a serious trend we need to watch into 2024.
And it's why I think something is bound to "break." Certain parts of the economy are clearly on an unsustainable trajectory and will likely see a correction soon.
Now, let's move on to our next question, from Steve G...
I'd be interested in Kevin's take on Truflation... which presents a lower "true" inflation figure than the CPI. They contend that the old metrics, established over a century ago, are outdated – with the last update being in 1999, before we had electric cars, smart phones, or e-commerce. They claim to have developed a more cutting edge and accurate measurement methodology. Do you believe that the government should modernize its inflation measurement methodology to reflect the different world we live in today? Would it make any difference to policy decisions?
Kevin's response:
I have to admit that this question made me do a Tiger Woods-style fist pump.
I love to see readers researching alternative avenues of financial and economic measures that are independent from the government.
And I have indeed heard of Truflation before, Steve.
For those of you who haven't, Truflation is a blockchain-powered data aggregator that provides daily, unbiased, real-market inflation and economic data. According to its website, it has a set of independent inflation indexes which draw on as many as 30 data sources and more than 10 million product prices at the country level.
It's privately-owned, and it claims to provide more up-to-date and accurate information on inflation than the U.S. Bureau of Labor Statistics.
While I do appreciate the want for a more transparent view of inflation, and as much as I say to stay skeptical of government statistics, I would say the same for private ones.
Currently, Truflation puts the annual U.S. inflation rate at 2.44% compared with the official government-reported Consumer Price Index ("CPI") figure of 3.7%.
Take a look at how the two compare over the past year...
As you can see, there's more volatility in the Truflation figure. That's to be expected, as it recalculates figures on a daily basis among a larger selection of goods and services. But it's not terribly different from the government's official CPI readings.
Could the government update and modernize their methodology to include more data points and produce more time-relevant statistics? Sure. Should they? Probably. Will they? Doubtful.
But, more importantly, I don't think a more updated version of the CPI would drastically change any monetary policy decisions.
So, while I do think it's an interesting idea to look at Truflation's data in conjunction with the official CPI figure, I wouldn't call it the end-all, be-all of modern inflation.
Before I sign off, I'd like to share a couple musings from readers...
Bank of America says we won't have a recession? Apparently they don't read the morning briefing! – Gary A.
Concerning the low unemployment figures going forward: the massive baby boomer bubble started popping during Covid with boomers deciding to retire rather than go back to the employment pool... Therefore, we may not have a traditional [rise] in unemployment levels similar to the past. – Ted B.
As always, thanks for the great questions and comments!
Remember, whether you're writing in about a past essay, asking us a question, or even responding to another reader's question... we want to hear from you! As always, send your questions and comments to new@stansberryresearch.com.
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