In our last blog we highlighted our "take on rates" where we made the case that the markets were overestimating the probability of rate hikes from the Federal Reserve. Since then, many economists have begun to lower their estimates for cuts from three to two, one, or maybe even none for the year. Higher rates, along with recent geopolitical events, have caused the stock markets to stall as investors adjust to this realization. With an economy that continues to exceed expectations, elevated rates have caused the dollar to appreciate considerably against a number of other currencies. The U.S. dollar index, which compares an aggregate of six major currencies against the dollar, currently is up 4.88% year to date. Axios reported on 4/19/24 how this increase in the dollar is impacting the monetary decision making of other central banks as they try to manage their economies. With the dollar rising, international consumers are seeing price increases not only for U.S. made products, but for the products of any country who's economy uses the dollar as the primary medium of exchange (which is a lot of places given the dollar's status as a reserve currency). In a nutshell our economy is causing other economies to delay or even rethink lowering rates to boost growth in their respective countries. These policy makers now have to combat inflation that is a result of unfavorable exchange rate dynamics. European Central Bank president Christine Lagarde recently called this phenomenon " imported inflation".
If we want any clues as to when this trend may end, take a look at the spending habits of your friends and family. Americans continue to consume goods at elevated levels, and this consumption drives approximately 68% of our economy. The U.S. personal savings rate currently is 3.6%, which is at a 10 year low, and is much lower than the pre-Covid percentage by almost 40%. Contrast this number with the savings rates of our European and Asian neighbors where personal savings averages 12% and exceeds more than 30%, and one could make the case that the American consumer has very little ammunition to withstand financial shocks that could come via higher tax rates, energy prices, or trade tariffs down the road. On 5/1/24 the Federal Reserve elected to hold rates steady and expressed a desire to reduce rates once inflation data showed signs of softening. It is our opinion that this will not happen until the savings rate and consumption habits of Americans reverts back to its historical levels. If this does not happen, the Federal Reserve may be forced to become more restrictiveto combat inflation that is being driven by a consumer that in the post pandemic era has sacrificed savings for consumption. This may force the Fed's hand and cause them to choose between their two mandates, and concentrate more on policies that focus on lowering inflation even if it may could lead to potential job losses. One way that this could be accomplished would be via rate hikes which is a possibility the markets are neither prepared for, nor considering at this point in time.