Week in Review: Some good news on inflation
Last week contained some good news regarding inflation, with the consumer price index and the producer price index both coming in below expectations. The Consumer Price Index rose only 0.1% month-over-month after spiking in January and February. The Producer Price Index declined by 0.5%. Both reports should give the Fed an excuse to pause the rate hiking cycle.
The year-over-year numbers were high for the CPI, however much is due to real estate. The real estate component of CPI will end by this summer as it looks like real estate peaked in late Spring / early Summer of 2022. The last piece is wages, and it looks like we are beginning to see some indications of weaker labor demand.
The FOMC minutes were released on Wednesday afternoon, and the big revelation was that the staff sees a recession this year. The voters on the Fed did mention the banking crisis and the risk that it might tighten credit further.
Participants agreed that the U.S. banking system remained sound and resilient. They commented that recent developments in the banking sector were likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. Participants agreed that the extent of these effects was uncertain. Against this Federal Open Market Committee background, participants continued to be highly attentive to inflation risks…
Many participants remarked that the incoming data before the onset of the banking sector stresses had led them to see the appropriate path for the federal funds rate as somewhat higher than their assessment at the time of the December meeting. After incorporating the banking-sector developments, participants indicated that their policy rate projections were now about unchanged from December…
With inflation still well above the Committee’s longer run goal of 2 percent, participants agreed that inflation was unacceptably high. Participants commented that recent inflation data indicated slower-than-expected progress on disinflation. In particular, they noted that revisions to the price data had indicated less disinflation at the end of last year than had been previously reported and that inflation was still quite elevated.
The Silicon Valley Bank situation was still pretty new so there was quite a bit of uncertainty regarding the effects. They FOMC was leaning towards being more aggressive given the inflation prints in January and February. The FOMC might have been thinking 50 basis points in March, but the Silicon Valley Bank situation pulled them back towards 25 basis points.
Earnings season kicked off on Friday with some of the big banks reporting. JP Morgan reported a 56% increase in earnings per share. This was driven primarily by an increase in net interest income, and a slower increase in expenses. JP Morgan did see an inflow of deposits due to the Silicon Valley Bank situation. Average deposits were down during the quarter, but end-of-period deposits were up. The company’s guidance does contemplate further declines in the deposit base.
On the earnings conference call, JP Morgan CEO Jamie Dimon was asked if the Silicon Valley Bank collapse will cause a credit crunch. He replied: “I wouldn’t use the word credit crunch, if I were you. Obviously, there’s going to be a little bit of tightening. And most of that will be around certain real estate things. You’ve heard it from real estate investors already. So I just look at that as a kind of a thumb on the scale. It just makes the finance conditions will be a little bit tighter, increases the odds of a recession. That’s what that is. It’s not like a credit crunch.”
JP Morgan did build reserves, and there have been concerns about problems in the commercial real estate market. Most of the pain is in the office area, and JP Morgan apparently doesn’t have a tremendous amount of exposure here. Their commercial real estate exposure is largely multi-family lending and there is a shortage of residential real estate in the US right now.
Jamie Dimon was asked about using shareholder funds to prop up banks that got their asset and liability management wrong, referring to the First Republic Bank situation where a consortium of banks agreed to deposit $30 billion at First Republic. “And we’re not -- look, we’d like to help the system when it needs to help if we can reasonably. And we’re not the only ones. You saw a lot of banks do that. And I was proud of them. I was proud of them. I think all of us did the right thing, whether ultimately, it works out or not, you could second guess that when it happens. But the fact is I think people want to help the system. And this whole banking theme is bad for banks. And I knew that the second I saw the headline. And you have Credit Suisse. We want healthy community banks.”
He also thinks that the numbers out of the regional banks will be good next week. This will be the big focus of earnings. The analyst community will be asking a lot of questions about deposit inflows and outflows as well as the state of commercial real estate. Office real estate in particular is struggling. The poster child for struggling office real estate is S.L. Green, Manhattan’s Landlord.
SL Green was ground zero for the work-from-home phenomenon. The company’s focus is mainly Manhattan office buildings. S.L. Green has heavy exposure to industries that are well-suited for work-from-home - tenants are mainly finance, law and media. Occupancy has not recovered to pre-pandemic levels; in fact it continues to fall. At the end of 2022, occupancy had fallen to 90.3%. The company cut its dividend last year and it currently yields 14.2%, which means another cut is probably in the cards.
SL Green concentrates on Class A buildings, which are the newest and highest quality. In a recession, the top quality buildings generally are least impacted as people will sometimes take advantage of the weakness to trade up from Class C or Class B properties. Office real estate will continue to be a problem for bank balance sheets. That said, so far any sort of banking crisis appears to be reasonably well-contained.