Last week was relatively quiet from a macroeconomic perspective with no updates to material change the observed economic vector. This week’s news pace picks up highlighted by 1 of 2 monthly inflation readings prior to the next FOMC meeting. Midway through the 1st quarter is a good point to more fully orient to where I think we are at.
Treasury rates have flattened in a bear steepening pattern with longer maturity yields higher between 28 to 30 basis points from the start of the year. Rates 1-year and less are only modestly changed. Overall the curve remains steeply inverted which is a noted recession signal as well as an earnings headwind to spread lenders. Forward rate expectations have lessened to -125 bps from -150 bps and become more back half loaded. Quarter point cuts are priced in May, June, September, November and December.
Expectations for the U.S. economy as expressed by the Atlanta Fed GDPNow model are for continued above trend growth. Optimistically, January PMI readings included the best Manufacturing reading since October 2022. While the year plus Manufacturing contraction is improved from the summer lows, the Services numbers show no weakening in that sectors expansion. In my opinion, economic growth is significantly due to continued fiscal stimulus. The calendar year 2023 Federal budget deficit reported by the Treasury was $1.786T with no observable slowing in the -$150B average monthly deficit.
Broad equity markets are testing new highs daily with the S&P 500 and Nasdaq Composite up year to date by 5.4% and 6.5%, respectively. Meanwhile the value oriented Russell 2000 is lower by -0.8%. Bank equities are in full correction territory following their historic increases to close 2023. The Nasdaq BANK Index is lower in 2024 by -6.7% and the KBW Regional Bank (KRE) index is down -10%.
My mid-cap bank Equity Risk Premium model begins the week at a 5.08% premium up from a recent low of 4.41%. The last twelve month average premium is 7.08%. Factors influencing changes are bank equity prices, the year to date rise in risk free rates and a lack of positive 2024 earnings revisions following the 4Q23 results announcements.
The recent news cycle on Commercial Real Estate risks seems to have quieted in the near term. Despite the large amount of high pitched commentary, the most recent available sector funding data remains stable. I am watching this dynamic closely as well as how bank equities respond with passing the year ago stress period. As the calendar moves out of the winter months, the expected 9% median EPS growth for 2025 will begin to become a factor in my risk premium model potentially allowing for equity price increases assuming constant risk free rates.
When I think about the potential for higher 2024 credit costs entering models and lowering expected net income, I have a hard time seeing this start to occur before April dependent on 1Q24 reports unless there is an acute funding event that materializes.