Fed Rate Hikes Threaten Pension Funds; U.S. Economy Avoids a Recession

By the Curmudgeon with Victor Sperandeo

Economic News Last Week:

As widely expected, the Fed and the ECB each raised rates last week by 25 bps to reach 22-year highs.

l  The Fed Funds rate now is between 5.25% and 5.5%.  The effective rate on July 28th was 5.33%.

l  The ECB  interest rates on the main refinancing operations and on the marginal lending facility and the deposit facility will be 4.25%, 4.50% and 3.75% respectively, effective on August 2, 2023.

U.S. GDP came in much stronger than expected at 2.4% (annualized) for the second quarter of 2023.  That was well above the consensus forecast of 1.8% and the Conference Board's forecast.

The Personal Consumption Expenditures Price Index (PCE) - the Fed’s favorite inflation gauge- was reported lower than forecast on Friday.  It was up only 3.0% in June from the previous month in 2022.  Quite an improvement from the 4.3% increase in April!

PCE Change from Month One Year Ago:

l  June 2023       3.0 %

l  May 2023       3.8 %

l  April 2023      4.3 %

l  March 2023       4.2 %

The PCE price index, released each month in the BEA’s Personal Income and Outlays report, reflects changes in the prices of goods and services purchased by consumers in the United States. Quarterly and annual data are included in the GDP release.


U.S. Equity Market Review:

Stocks moved slightly higher Monday, July 31st which capped a strong month for all the major indexes. The S&P 500 and Nasdaq had their fifth straight month of gains. Year-to-date, the Nasdaq is up more than 37%, while the S&P 500 is up 19.5%, and the Dow is higher by 7.3%.

All three major U.S. indexes ended last Friday with gains: For the week, the Nasdaq climbed 2.02%, while the S&P rose 1.01%, and the Dow (DJI) gained 0.66%. The gains gave the S&P 500 its highest close since April 4, 2022, which was slightly higher on Monday.

The DJI rallied for 13 consecutive days through Wednesday and then again on Friday and Monday July 31st.  The 13 straight DJI advances was the longest such streak since 1987.  BofA technical strategist Steve Suttmeier noted that the July 2023 streak triggered an upside breakout for the DJI and a bullish confirmation signal for Dow Theory. These and other technical signals suggest a rally into year-end and 2024.

Most of the 11 major S&P 500 sectors posted gains, led by communications services, which gained 2.3% as big tech companies kept an upward trend after announcing earnings earlier this week.

Contrary to the Curmudgeon’s earlier opinion, it seems a lot more than a bear market counter-trend bounce!

With inflation showing signs of cooling, the CME Fed Watch Tool indicates only a 27% probability that the Fed will raise rates again this year.  There's also a 9.1% chance the Fed will cut rates by 25 bps at the end of the Dec 2023 FOMC meeting.

More than half of the firms listed on the S&P 500 have reported second quarter earnings as of Friday, out of which 78.7% have surpassed analyst expectations, according to Refinitiv data. 

Fidelity’s Jurrien Timmer said on Twitter, “Half of the S&P 500 index has reported and 81% of companies have beaten estimates by an average of 566 bps. The 81% is typical but the 566 is outsized.”

While the narrow breadth narrative in the market continues to garner attention, plenty of indicators have confirmed that market breadth is expanding.

"People are more sanguine about the possibility of inflation being under control and the economy avoiding a recession," said Win Murray, director of research at asset manager Diamond Hill.


Future Fed Rate Hikes a Threat to Pension Funds:

Looking at Ibbotson data from 1926, the U.S. Intermediate Treasury Notes never had two back-to-back down years...until 2021-2022. The iShares 7-10 Year Treasury Bond ETF (IEF) has a 3 year total return of -6.54%, which includes its +1.54% YTD return in 2023.

If further Fed rate hikes are coming, Pension Funds (which we don’t hear much about) will be in a world of hurt. That could potentially cause alarm bells to go off, just before the November 2024 elections.

Pension Funds are long a great deal of U.S. Treasury debt and that’s significantly increased in the last 12 years (see chart below).  That asset class has to bear the brunt of future Fed rate increases.

A graph with a line going up

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Source:  St. Louis Fed

The Fed saved the regional banks with the Bank Term Funding Program (BTFP) which made additional funding available to eligible depository institutions. The assets banks pledged as collateral for the loans were valued at par, even though they are now -15 to -25% below that level. The BTFP facility helped the banks and allowed the Fed to keep raising rates.

Will the Fed or U.S. Treasury Department save the Pension Funds if they can’t meet their commitments due to losses on their bond positions?   Will an equivalent BTFP be created?

Recession in 2023?                                

The universal consensus call for a recession this year (including Victor, the Curmudgeon, AND the Fed) seems to be wrong. That’s despite 11 Fed rate hikes since 2022, 15 consecutive monthly declines in the Leading Economic Indicators (LEI) and the most inverted yield curve in decades!

-->Has the business cycle been repealed?

We changed our view on recession in 2023 one month ago based on new understanding that U.S. Fiscal Policy threw a curve ball, which spaced out government spending over several years to keep the economy humming into the 2024 election.

BofA’s chief strategist Michael Hartnett noted, “it’s tough to get a U.S. recession when unemployment is 3% and the budget deficit is 9% of GDP."

Fidelity’s Timmer cites another reason for the resilient U.S. economy, “One reason: A large swath of the economy has locked in low rates for longer. The Bloomberg MBS index still has an average coupon of under 3%. Family mortgages totaling $13.5 trillion are mostly immune to the Fed’s rate increases.”

Victor posits that there’s another reason which has not been understood by economists.  It’s that retired baby boomers (those born between 1946 and 1964) are spending lots of money on travel, restaurants, fine wine, playing golf, and other leisure pursuits.

According to the debt clock and including retirees before 2011 (the Curmudgeon retired in 2005 at age 57), there are a total of 57,445,470 retired people who enjoy spending their hard-earned money. What’s a good retirement age? This cartoon provides an answer:

Cartoon of a person and person sitting at a desk with a computer

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The increase in consumer spending (which accounts for 70% of GDP) from retirees is yet another reason why there is no recession yet. Fed rate increases will not stop retirement spending.  But they will negatively impact small businesses, start-ups, and future growth of the U.S. economy.

BlackRock’s Larry Fink:  Fed Rate Hikes to Continue

Despite most market participants believing the Fed is done raising rates, Blackrock [1.] CEO Larry Fink said on Wednesday, “The Fed is not finished. Inflation is still too strong, too sticky.”

Note 1. Blackrock is the largest U.S. investment firm with $9.09 trillion under management at the end of the 1st quarter of 2023.  Fink controls trillions of dollars in investment money and sits on all the key globalists boards.  He has been a big advocate for reducing carbon emissions to reach a “net zero” world.

Fink added that there’s no guarantee that the U.S. economy will tip into a recession and that it would be modest “if we even have one.”

More about Fink’s agenda in an article titled, “Larry Fink says corporations must work harder to ‘force’ people to change behaviors.”

Victor’s Conclusions:

The game has changed, and the economy is now more complex than ever with many unknown influences.

The Fed has a Keynes based education and mindset. Therefore, the people on the FOMC have been educated to only Keynesian economics.  What this means to me is the Fed will always be wrong!



Be well, success, good luck and till next time (?)………………

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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