The end of ‘easy money’ (in terms of monetary policy) leads to the end of easy money (in terms of financial service sector profitability).
The economy of Janet & Brad
As I’ve droned on about, the realm of macroeconomics is slow, and that glacial pace has something to do with why virtually all institutions get it so wrong. I mean, who can sit there looking at nothing much happening for such a long time, especially when you’re being paid to manage whatever is impacted by macroeconomic factors? And so we get noise generation, i.e. make-work … people engaging in activity to create the illusion of being busy. This behavior has been going on for so long that most people now believe their make-work roles are, in fact, real work.
Here’s a little proof that aligns with my current watch on employment markets. I saw the following article in the Financial Times a couple of days ago:
A $1bn budget for lay-offs! Assuming the same average severance cost per employee as the $186m for the 7,000 staff already ‘let go’ in the last quarter (3-month period ending Sep-23), $1bn implies some 37,600 additional people will be out of work in the near future. And you can be sure that it’s not just Wells Fargo who will be doing this.
I’ve been saying for some time that the sequence of events is:
central bank rate hikes (& inflation) squeeze household budgets
households reduce their consumer spending, which hits corporate profits
corporates look to reduce costs (staff) to maintain their profitability
recession
But there are lags in this process (usually, it’s approximately 2-years from the beginning of the Fed’s hiking until the full blown recession):
central banks raise interest rates [the Fed started in March 2022 in the current cycle]
most households have fixed costs (i.e. mortgage rates), so it is only marginal activity that is exposed to higher interest rates in the central bank tightening cycle, which takes time to feed through to have a noticeable impact on corporate profits, but household credit card interest rates are hit immediately with interest rate hikes and many people in the U.S. live on credit (i.e. paying the minimum and not the full balance each month).
corporates think that they may be able to ‘ride out’ this trickle of reduced consumer spending, but they also trim a few staff here & there (including not replacing staff who leave, i.e. natural attrition); engage in accounting tricks; and the management of expectations (i.e. talking down earnings numbers so that announced results beat expectations and their share price continues to rise). [The tech sector laid off hundreds of thousands in 2022, but that was due to huge falls in their stock prices, whereas most other businesses began trimming some staff this year, in 2023]
as more households are impacted by the tightening cycle (e.g. more people have to do things that expose them to higher interest rates, like moving home etc.) the impact on corporate earnings grows, so corporates make more significant plans. These plans, as the above FT article shows, are made many months in advance of execution. Corporates have decide where they can trim the fat, so that involves committee work, which is always slow, as everyone involved has to find time in their diaries. [As Wells Fargo demonstrate, most of these lay-offs are due to occur before the end of December 2023, but some of them will now occur in 2024]
“Soft-landing”, my ass! Yet, ‘soft landing’ is the prevailing narrative and what the markets are pricing in. In actual fact, everything I’ve been posting here for the last 2.5 years is right on schedule. And this one is a biggie. Certainly, bigger than anyone around today has experienced, especially in terms of the impact it will have on markets. It’s not hard to imagine how or why: not only have we had the fastest & largest jump in interest rates in many decades impacting an economy driven by leveraged asset price gains, but we also have a major population bubble in retirement who will be extremely sensitive to their net worth diminishing in their post-earning years.