by Alex Harding, CFA
Vice President
Equity Research and Portfolio Management
On Wednesday, the last significant economic data release occurred before the Federal Open Markets Committee (FOMC) meeting next week. Overall, inflation appears to be tamed with the August Consumer Price Index (CPI) falling to a 2.5% growth rate compared to a year earlier, hitting a new three-year low. While inflation has made a notable improvement since it peaked at 9% in June of 2022, the core CPI, which excludes volatile items such as food and energy, came in higher than expected as housing cost inflation refuses to roll over. The stickiness of housing costs leaves the odds of a 0.25% vs. 0.50% interest rate cut a virtual coin flip.
Regardless of the size of the cut, it’s clear the time has come for the Fed to pivot away from their restrictive policy stance. As shown in the chart below, there is an almost 3% gap between the Fed’s target rate and the inflation rate. This gap is too wide with job growth slowing and price pressures abating. As mentioned in last week’s blog, the Fed has shifted its focus towards its mandate to promote maximum employment and does not welcome any further cooling of the labor market.
Although we don’t anticipate a recession on the horizon, cracks in consumer credit are appearing. Presenting at an industry conference this week, Ally Financial and Citigroup highlighted the impact elevated prices and slowing wage growth are having on lower-income consumers and their ability to pay monthly loan obligations. Ally Financial, an auto lender with a skew to subprime borrowers, saw its stock plummet more than 17% on Tuesday after announcing a reacceleration of retail auto loan delinquencies and expectations of higher loan charge-offs than previously forecasted. Meanwhile, Citigroup’s chief financial officer, Mark Mason, explained the ongoing bifurcation between high and low income consumers, and the impact it’s had on discretionary spending within their credit card portfolio.
“We're seeing a pickup in revolving credit with our card customers. When I look through that, payment rates are starting to come down a bit. The nature of spend is evolving. So, when I look at the type of spend that is going on, it's going from discretionary to more staple-type spend. And we're also seeing ticket sizes within discretionary come down. When I look at spend growth, all of the spend growth is skewing from our largely affluent customers and so there's a dichotomy, if you will, between the higher FICO score and the lower FICO score customers.” (Source: Transcript from Citigroup Investor Relations website)
Unsurprisingly, consumer discretionary stocks have lagged the S&P 500 this year as investors anticipated that the Fed’s restrictive policy stance would negatively impact many consumers’ ability to purchase non-essential items. Although the Fed will begin cutting rates next week, it will take more than a 0.25% – 0.50% cut to provide relief to struggling borrowers and reignite discretionary purchases. As such, we continue to tilt our portfolios towards defensive areas of the market such as consumer staples, healthcare and utilities.
Takeaways for the Week
For the first time since 2020, the Fed will cut its benchmark interest rate next week
The rate of inflation hit a new three-year low with August CPI expanding only 2.5% compared to a year ago
The stock market recovered its post-Labor Day holiday losses with the S&P 500 posting a positive return each day this week