Why the Latest Economic Report is a Rorschach Test

0:28The Federal Reserve left interest rates unchanged. resource that you need to manage. And that opens up two questions. What do you care about most? And what sacrifices are you going to make in order to prove that? I'm your host, Paula Pant. Once a month, we do a monthly economic update episode. And so welcome to the June 2024 monthly economic update episode. To my longtime listeners, thank you for your patience. We typically do these episodes on the first Friday of the month, but last week I was in Boise, Idaho. Beautiful city, maybe one of the cleanest places in America I have ever seen. A lot of remote workers are moving there.

1:05That was a trend that actually started about a decade prior to the pandemic. I remember looking at rental properties there back in 2014, 2015. And even back then I thought, man, too late. And of course, that was mistake thinking because, wow, what a run up it's had. So let that be a lesson. I make these mistakes too. Anytime that you are comparing numbers to recent prior numbers and thinking, oh, look at the run-up that it's had. Does that mean I've missed the run-up? Does that mean it's too late? No, it might mean that there's hockey stick growth going on and you're somewhere in the middle of that stick.

1:37So when I was looking at the numbers from a distance back in 2014, 2015 and thinking, man, this place has already had its run-up, I was committing the cognitive error known as price anchoring, where my impression of what the prices quote unquote should be were so anchored to what they had recently been that what I missed were fundamentals that showed that this is a town poised for growth. Even back in 2014, 2015, pre-pandemic, a lot of knowledge workers who were fleeing the high cost of living in California were moving into places like Boise and Bozeman. And that is a trend that has, of course, only accelerated since 2020, quite rapidly so.

2:19Northwest Arkansas, by the way, that's another area I'm keeping my eye on. It's an incredible quality of life play for remote workers. Low cost of living, absolutely gorgeous setting. It's an area that's seen quite a lot of growth, and I'm bullish that it will continue to do so. At any rate, let's get to today's docket, starting with the Federal Reserve. They meet eight times a year, on average, once every six and a half weeks. As everybody expected, They held interest rates steady. The markets are now pricing in a 71 % probability that they will make their first rate cut by the September meeting.

2:57So they're meeting again on September 18th. And the markets, based on what we know right now, based on current inflation data, the markets are widely expecting that the first rate cut may happen at that September 18th meeting. However, remember that to get to where we currently are right now, the benchmark overnight interest rate is between 5.25 % to 5.5%. In order to get there, the Fed raised rates 11 times. So while it will be directionally great news for borrowers, great news for anybody who wants a mortgage, it'll be directionally great to see rates start to fall. The first cut, which will likely be a quarter point, is not going to make a significant difference.

3:41However, if that cut is then followed by 10 more consecutive cuts, all right, now we're talking turkey. By the way, if you want to mark your calendars, the Fed is meeting four more times this year. So end of July, July 30, 31st is their next meeting. Nobody expects them to lower rates at that meeting. After that, they meet in September, they meet in November, and they meet in December. So July, September, November, December are the four remaining meetings this year. Investors and analysts right now are predicting two rate cuts over the span of those next four meetings, not in July, but two rate cuts across the September, November, December meetings.

4:17The consensus seems to be that we're going to end the year with benchmark interest rates that are likely 50 basis points, maybe 75 basis points lower than where they are right now. What that means, by the way, when I say basis point, that's just a nerdy way of saying percentage points. So in other words, right now the benchmark interest rate is between 5.25 % to 5.5%. Let's take the top end of that range, which is 5.5%. A decrease of 50 basis points would be 5 % rather than 5.5. A decrease of 75 basis points would be 4.75%. The reason that people use the word basis points or percentage points is because technically you can't say that it would drop by half of a percent.

5:06It isn't being reduced by a percentage of the number 5.5. It's being reduced by a particular increment. And so in order to keep those increments consistent, we use the phrase basis point or percentage point. Even though that sounds jargony, it's a way of, believe it or not, it's a way of reducing confusion. Even though typically jargon oftentimes only adds to confusion or only creates a little bit of a wall between people who think about this stuff every day and people who don't. The reason that that jargon is there is an attempt to make it clear that when we talk about an interest rate cut or an interest rate hike, we are not talking about a cut or hike that is calculated as a percentage of the current number.

6:00We're talking about a cut or a hike that is levied as a consistent increment. With all of that being said, as of what we know today, a lot of analysts are expecting that in September, November, December, we will see in total across those months an interest rate decline that is somewhere between half of a percentage point to three quarters of a percentage point relative to where we are today. But again, that all could change based on inflation data, which leads to the next topic, the CPI report. So the May CPI report is out. That's the Consumer Price Index. It is unchanged. So May's inflation rate is absolutely the same, seasonally adjusted.

6:53And inflation overall over the last 12 months has risen by 3.3%. Now, that is above the Fed's target of 2%, but it's far more in line with historic norms. On Wednesday, which was the same day that the inflation data became public, the Fed put out a statement. They put out a press release stating, quote, inflation has eased over the past year but remains elevated, which is essentially stating the obvious. In their press release, they also noted that unemployment has remained low, job gains have remained strong, and they repeated their commitment to their 2 % inflation objective. They said it four times in one page, which I'm going to interpret as the Fed's way of signaling, hey, we know that 3.3 % is historically normal, but we're not going to rest on our laurels.

7:49We're not going to call it done. we're still going to push for 2%. Given that, and of course, we're going to have to see how the inflation data plays out over the next couple of months. But given that, there's a case to be made that the Fed might only reduce rates once this year. This is the pessimistic case. They might only reduce rates once this year, and it might be a meager 25 basis points. So I'd say the probabilistic range of the type of rate cuts that we can expect to see by the end of the year is somewhere between 25 to 75 percentage points, which means somewhere between one quarter to three quarters of a percent.

8:25And of course, the reason that I'm spending so much time on this is mortgages. So many of you want to know if you're an existing homeowner, at what point do those golden handcuffs start to loosen? And if you're not yet a homeowner, but you want to be, well, there's a balance because as interest rates decline, there's a likelihood that buyer activity is going to rise, which means more competition. So the smart thing would be to buy now while there are fewer competitors, because if you're waiting for interest rates to drop, so is everybody else, which means that if you enter the market after interest rates drop, so did everybody else.

9:04So what I would say is if you're a renter and you want to buy, I would do so immediately while competition is low. If you're an existing homeowner and you want to sell, Well, you're going to be in a golden handcuff situation for a long time. So if at all possible, this is going to vary for people depending on your own individual budget. But if possible, if you can hold on to that low interest rate mortgage that you have, turn your existing property into a rental property and just hold it for a few more years. There is a pretty strong case to be made that most homes across most parts of the country are going to continue rising in value.

9:44The longer that you can continue to make those equity gains, keep that low interest rate mortgage, enjoy the equity gains and grow wealth between your low rate mortgage and the growth of your property values. I would do that for as long as possible. I don't see any, unless there's some need within your budget, like if you're really strapped for cash. But if you have the flexibility to do so, there's a strong case for holding. So that's the reason, by the way, I spend so much time watching what the Fed is doing and looking at inflation rates and looking at interest rates. It's my way of assessing the housing market.

10:22But of course, this goes beyond just housing. It also goes to car loans. It goes to student loans, which we're going to talk about later in this episode. It goes to all kinds of borrowing. One area where the latest Fed news doesn't seem to have any effect at all is stock market performance. The S &P 500 has hit new highs. The last six months, the S &P 500 has risen by nearly 14%. Now that is massively driven by NVIDIA and a handful, a very, very small cohort of other large cap tech companies that are poised to accelerate through AI. In fact, the S &P 500 is what's called cap weighted, which means that the biggest companies are massively overrepresented in the composition of the S &P 500.

11:17Like the big companies are allowed to dominate the returns. There's a different version of an S &P 500 index. It's called an equal-weighted version. The idea behind an equal-weighted S &P 500 index is that it's an iteration of that index fund that tries not to have overexposure to the biggest companies. Now, the equal-weighted S &P 500 has grown only 4 % this year. So 14 % for cap-weighted versus 4 % for equal-weighted. What that tells us is just how much of the growth of the S &P 500 has been driven by a small handful of superstars. NVIDIA in particular is up more than 200 % over the past year.

12:09It's now one of only three companies that are valued at over$3 trillion, the other two being Microsoft and Apple. So if you're wondering, why is the S &P 500 going gangbusters even in a period of high interest rates? Why didn't the markets react to the fact that the Fed held rates steady? Why isn't the market reacting to the fact that people widely expect that the Fed will also hold rates steady in their July meeting? High interest rates are supposed to slow down the economy. The whole point is to cool off the economy. But the promise of AI is stronger than the friction caused by the high cost of capital or the high cost of borrowing.

12:51And that's why we're seeing the market hit new highs, even with persistently high rates. So what's going to happen, you know, if there are rate cuts in September, it's possible that some of the mid-size or smaller companies that are represented in the stock market, the ones that have not performed quite as strongly as the top 10 large cap tech companies have, it's possible that those companies, the mid-cap and small cap companies, would be the beneficiaries of a lower interest rate environment. Historically, over the long term, small cap stocks tend to outperform large cap stocks, and that is not what's been happening.

13:31So it may be that small cap funds right now are value plays. And again, this is not investment advice, but it may be that small cap funds are poised to benefit from the cost of borrowing becoming cheaper. The large cap companies have not worried about that. They have a lot of cash on their books. And in addition to that, there's so much promise with AI that they view that spending to be worth it. But the smaller companies, which have not done as well, these may be the companies that stand to benefit the most as rates decline. Shifting to employment, the Bureau of Labor Statistics published the May Employment Report earlier this week.

14:20It's a little bit of a mixed bag. So the good news is employment is way higher than we expected it to be. Economists were forecasting that we would add 180 ,000 new jobs in May. We actually added 272 ,000 new jobs. Now that's non-farm payrolls added in May. That's nearly 100 ,000 more jobs than what economists had forecast. So hiring surged way beyond expectations. Now, I say that this is a mixed bag because the unemployment rate also rose just a little bit. The unemployment rate in April was 3.9%. In May, it ticked up to 4%. So both the unemployment rate and the number of new jobs added, particularly relative to expectations, are high.

15:15Oh, and actually, there's a third thing that's higher than expected. average hourly earnings. Wages rose by 0.4 % month over month. That's up from 0.3%, which is what had been forecast. Bill Adams, the chief economist for Comerica Bank, who I think had the best commentary on it, where he said the May jobs report is a Rorschach blot. The Rorschach test is that famous psychological test where you see an ink blot, and whatever you interpret that inkblot to be really says more about you. It's just an inkblot. So your interpretation of it just reflects what's going on in your mind. That's the May jobs report.

15:56If you are bullish, if you are optimistic, what you see is higher wages and an explosion of new jobs, 272 ,000, way, way higher than what anyone had predicted it would be. That's what you're going to see if you're an optimist. If you're a pessimist, you're going to see that unemployment also ticked up. Unemployment is now at its highest point since the early part of 2022. So it's at its highest in over two years. So jobs have grown, wages have grown, and unemployment has grown. And after that jobs report came out, bond yields jumped. And yields, of course, have an inverse correlation to prices.

16:34So bond prices fell. What a crazy mom. May's jobs report was bananas. And And whether you're an optimist or a pessimist, you're going to find support for that in the May jobs report. It was truly the Rorschach test of jobs reports. Speaking of interpretations of economic data, one of the things that I've talked about on many of these monthly economic reports is the disconnect between public sentiment and economic data. So you have on one hand high employment, low unemployment, a stock market that's hitting all-time highs, a housing market that's creating massive equity growth for anyone who is an existing homeowner.

17:14You have on one hand all of this positive economic data. On the other hand, you have people who are totally bummed about the economy and they feel like everything sucks. And I think what that highlights is how K-shaped this experience is. It's one thing to talk about the data. It's another thing to talk about lived experience. Remember how I said earlier that the cap-weighted S &P 500, which highlights the growth of NVIDIA, Alphabet, Apple, Meta, all these tech giants. Yeah, that's up 14 % just this year alone. That's hitting massive highs. But the equal weighted index is up only 4 % and is like not doing that well.

18:02Think of that as a microcosm for society. You have, in this K-shaped recovery, certain geographic areas, certain sectors, certain industries, certain occupations, where you're really seeing a lot of this growth. And you're seeing new millionaires get minted. Last year, in 2023, 500 ,000 people became millionaires for the first time in the U.S. So the population of Americans who are millionaires grew by 7.3%. That's according to a report from Capgemini. So you have that on one side of that K-shaped distribution. And then on the other side, there are industries, there are geographic regions, there are occupations that feel stuck.

18:55To paraphrase the economist Peter Atwater, they're not looking at the annual rate of inflation, they're looking at the cumulative weight of inflation, not the annual rate. And the cumulative weight, weighing them down, are all the price hikes that have happened in 2020 and in 2021 and in 2022 and in 2023 and then again this year. And now they can't even walk into a McDonald's without their jaw hitting the floor when they see the price of a Big Mac. And sure, there are some poindexters sitting in their air-conditioned offices in fancy chairs saying, hey, in aggregate, wage growth has actually outpaced inflation.

19:42But aggregate doesn't matter to the individual who is on the bad side of that bifurcated K, right? When I say K-shaped, you think of the letter K, it forks, right? The capital letter K, it forks in two directions. And if you have a job scenario or if you're in a geographic region where you've veered into a different direction, then you are the equivalent of an investor in a publicly traded company that's not doing that well. And you're looking at, you know, yeah, NVIDIA is up 200 % in the last year. But this other smaller company that isn't in tech and doesn't benefit from AI and is being hampered by the high cost of borrowing, that company is not doing that well, right?

20:33Your situation is the equivalent of that. In the same way there's a small cohort of highly successful companies that are pulling up the entire S &P 500, there's a small cohort of geographies and industries that are doing exceptionally well. And then there are other geographies and industries that are not and that are absolutely stymied by the fact that housing costs, fuel costs, food costs are so high. And that, in addition to the lack of mobility related to housing, existing homeowners have a golden handcuff scenario, so they lack mobility. And people who are not yet homeowners are facing that trifecta of high home prices, high interest rates, low inventory.

21:19So regardless of whether you're a homeowner or a renter, everyone is feeling a lack of mobility. So that combination of K-shaped distributions plus near universal lack of mobility, in my view, accounts for a big portion of why the public feels pretty awful about the economy, despite the fact that their 401k balance is up. Stated simply, you're not looking at your 401k balance when you walk into a McDonald's and try to order a Happy Meal. When we come back, we're going to share actionable tips that might help you defer or eliminate your student loans. Then we'll talk about the GameStop guy. He is back.

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26:06Welcome back. Let's start with the actionable part. If you have student loans, there is a deadline that you need to know about. That deadline is June 30, so it's coming up in two weeks. This is the student debt relief deadline. It applies to 3.6 million borrowers who have federal direct loans. Many of those borrowers might be able to see your remaining debt wiped out completely. It's a one-time account adjustment, and it retroactively counts more periods of repayment, deferment, and forbearance, such as the ones that were granted during the pandemic. it retroactively counts that towards loan forgiveness.

26:46So if you have student loans and if you are on an income-driven repayment plan, or if you were on one in the past, or if you're in the public service loan forgiveness program, or if you have loans from the direct or federal family education loan program, you're eligible to submit an application. And essentially the way that it works is that after you make the required number of payments, your remaining loan balance gets forgiven. So for example, if you're working towards public service loan forgiveness, after you make a required number of payments, your remaining loan balance gets forgiven. and through this particular application, which the deadline is in two weeks, it's June 30, there will be months in the past that up to now haven't been counted, like those deferral months during the pandemic, that with this application, those months then will be counted.

27:43So if you think that you qualify, if you think that you have a chance, go online, go to the Department of Education's Federal Student Aid Office website and apply for this program. Now, in order to have a chance at having your loans forgiven, you'll need to apply to consolidate your loans. The consolidation is free of charge. There's no cost associated with it, and the whole application is going to take around 30 minutes. So if you even think that you qualify, go to the Department of Education's website and check it out. That said, shifting gears away from the actionable thing, which is that application, to general news about student loans, this week a lot of borrowers got notices saying that they may not have to make a student loan payment in July.

28:32So if you are enrolled in something that's called the Saving on a Valuable Education Plan, which goes by the acronym SAVE, if you're enrolled in that plan, which is a new type of income-driven repayment plan, then your payments right now are getting recalculated. And while that's happening, your payments for the month of July are paused. So basically, while they're figuring out the new formula, they've paused payments for the month of July. There are 8 million people who have enrolled in the SAVE plan. and if you are among them, check to see if you got any notices. Check your mail. Check your email.

29:14Check to see if you got a notice saying that your July payment is paused. Now, all of that said, there are a couple of legal challenges that are also playing out. There's one in Kansas and there's one in Missouri. Both of those, I won't go deep into the details, but both of those are challenges to some of the changes associated with the SAVE plan for the case that's happening in Missouri in particular. A ruling is expected any day. It's expected to happen pretty soon. So yet another reason, if you are a student loan borrower under that plan, to pay close attention to what is happening, because this is an arena where things are changing pretty rapidly.