February 9, 2024

“It’s obvious that there’s going to be stress and losses”

The above is from Janet Yellen’s comments this week and comes from the discussion of the ongoing CRE dumpster fire. Stress and losses aside, the Treasury Secretary was unruffled, following up with the comment, “I hope and believe that this will not end up being a systemic risk to the banking system.” Yellen did admit that size matters. While “The exposure of the largest banks is quite low,… there may be smaller banks that are stressed by these developments”. As a first estimate of exactly how much pain and how many banks could catch a cold, this NBER paper notes of its findings in the abstract that “CRE distress can induce anywhere from dozens to over 300 mainly smaller regional banks joining the ranks of banks at risk of solvency runs”, with the caveat that the analysis reflects “market conditions up to 2023:Q3”.

“Changing the picture on inflation”

However, the dumpster fire aside, much of Wall Street is waiting on the CPI revisions due this Friday before making any new big bets. While normally the playground of the pocket-protected and bookish, the revisions have taken on new importance for those who, once bitten, now may be twice shy. As this article from Bloomberg notes, while the seasonal adjustment factors are “likely to make eyes glaze over, even among hardcore economic nerds. Not this year” after last year’s revisions “were large enough to cast doubt on overall inflation progress”. Such doubt is particularly unwelcome this year as bond markets and commentators are both taking a “when, not if” look at rate cuts, as exemplified by Governor Waller, who noted in the speech we highlighted a few weeks ago that “One piece of data I will be watching closely is the scheduled revisions to CPI inflation”, “potentially changing the picture on inflation” and while his “hope is that the revisions confirm the progress we have seen,… good policy is based on data and not hope”. This seems to come at a particularly sensitive time for those looking for inflation to continue cooling, with the latest ISM numbers coming in remarkably robust, with both Manufacturing and Services seeing New Orders and Prices Paid leap northward.

We’ll leave the “he loves me, he loves me not” analysis of whether the revisions will be a big deal to others (see this note from ING if you’d like a bit more of a trip into the weeds). But we would note the asymmetry. Having already hinted, winked and nudged that cuts are inbound and there’s nothing to fear from the inflation bogeyman, Powell and company have left themselves room to disappoint. Markets have priced in the cuts already, packed their bags, and even looked at the Disneyland map to see the fastest way to get from Space Mountain to Pirates of the Caribbean. It would be a shame if the trip were cancelled, and we strongly suspect that the Fed has no intention of disappointing markets this year. At the very least, we think they will offer markets an ice cream cone.

At the moment, the markets seem to be, with apologies to Bon Jovi, Livin’ On A Prayer: “We’ve got to hold on to the cuts we’ve got; it doesn’t make a difference if we make it or not, we’ve got the deficit, and that’s a lot for love… We’ll give it a shot!”

PS. As it happened, the CPI revisions were just as boring as usual (apologies to those who love seasonal adjustment).