Seesaw
Ummet Ozcan is known for throaty Mongolian techno music. As the mesmerizing synthesizer and bass of his song “Seesaw” excite audiophiles, the lyrics deserve attention too: “Up and down, we go up and down the seesaw, ‘til we are in free fall.’” Sounds a bit like the American consumer, who, according to last week’s releases from the Bureau of Economic Analysis, is showing signs of both strength and weakness.
On the positive side, personal income and spending both beat survey estimates, with each recording impressive 0.7% monthly gains for May. Stock market prices hit new highs as well.
On the negative side, consumer sentiment is at all-time lows, according to the University of Michigan’s latest survey. Meanwhile, the Personal Consumption Expenditures (PCE) price index revealed that inflation accelerated to a 4.1% annual pace, well above the 2% target of the Federal Reserve (Figure 1). And while we have a ceasefire of sorts in the Iran war, the details are still to be finalized and remain contentious. Both the positive and negative news, in short, make rate cuts harder to implement—and rate hikes easier to imagine, at least at the margin.
Given the sharp drop in oil prices, “it is highly likely that inflation peaked in May,” wrote Joe Brusuelas, chief economist at RSM US. It’s not just oil, though. The gains in the PCE were largely concentrated in the services sector, including portfolio management fees, air transportation, and healthcare.
Looking forward, these subindices may not buoy pricing pressures as much. Portfolio management fees, for example, follow stock market prices with a lag, and the broader S&P 500 has retreated somewhat from the frenzied high of June 2. Similarly, with oil prices retreating from their peak, airfare costs ought to come down.
Still, inflation expectations remain high: Consumers expect prices to rise 4.6% over the next year, and at an annual rate of 3.3% over the next five to 10 years, according to the same University of Michigan survey. Joanne Hsu, the survey’s director, noted that “the cost of living remains at the forefront of consumers’ minds. Over half of consumers spontaneously mentioned that high prices are weighing down their personal finances.”
Higher-than-usual tax refunds have helped bolster consumers in recent months, while a reaccelerating labor market and rising stock prices are also supporting spending. Even so, workers across sectors have seen pay gains fail to keep up with inflation. Employee compensation, for example, rose 0.4% in May, matching estimates, but also matching the monthly advance in the PCE, leaving consumers no better off. Indeed, these figures are unlikely to ease central bankers’ concerns about inflation—certainly, their concerns about wage growth once adjusted for inflation.
The fact that wages are high, but not higher than globally rising prices for goods and services, has many people either saving less or turning to credit cards to maintain consumption habits; the savings rate dropped to 3% on an annual basis, down from the 3.6% average of the last five months. Furthermore, data compiled by the Fed shows that the outstanding amount of revolving credit is returning to all-time highs (Figure 2).
Here, too, the Seesaw motif continues: While rolling balances are at all-time highs, the pace of annual usage is slower than in recent history (Figure 3). In fact, last year marked a period of decline, indicating more paydowns, or payment-in-full customers.
Last Monday also saw the passing of Alan Greenspan, who had joined the centenarian club several months earlier. During his successful tenure as Fed Chair from 1987 to 2006, Greenspan didn’t give press conferences or offer dot plots, and he deliberately spoke in a complex way that committed him to nothing. (Kevin Warsh may end up returning the Fed to a similar communication style.) As Figure 4 shows, Greenspan presided over a period of low inflation, low unemployment, and low long-term interest rates.
Recently, Treasury Secretary Scott Bessent has pointed to Greenspan’s decision to keep rates low as the bull market boomed in the late 1990s, as a way of justifying rate cuts now; Greenspan resisted rate hikes during the technology boom of the 1990s—and history proved him right.
Warsh may look to borrow Greenspan’s communication tactics, but time will tell if he can adopt Greenspan’s open mind. The same openness will help to determine if Warsh can lead the Fed as successfully as Greenspan did. For now, economic data continues its seesaw pattern.
FROM THE DESK
Agency CMBS — The Treasury rally brought on more supply from the Ginnie Mae originators. We’re hearing of continued weakness in the REMIC market—so when coupled with heavier supply, spreads widened out, nearly deleting the benefit from the drop in the 10-year Treasury. DUS spreads were mostly steadfast, maybe slightly weaker, week over week.
Municipals — AAA tax-exempt yields were mixed, week over week, with some pressure on the front end and a firmer tone on the long end, resulting in a slightly flatter curve. The market absorbed a heavy new issue calendar, supported by strong reinvestment demand and elevated cash balances, allowing deals to clear effectively. While overall execution remained constructive, investor selectivity became more apparent, particularly on tighter structures and lower concessions, though secondary trading remained balanced with limited signs of broader weakness. Looking ahead, issuance is expected to decline significantly in the upcoming holiday-shortened week. Fund flows also continued to provide key forward indications, with $633 million of inflows, including limited demand for high yield, which accounted for roughly 10% of total inflows ($66 million).
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