The Summer of Discontent
Frustrations are mounting with the U.S. economy and as we hit the hot summer months the American consumer is increasingly grumpy. And why shouldn’t they be. According to AAA as well as pretty much anyone with wheels and a wallet, the average price of a gallon of regular is $5.00 and in many places it’s even higher. A dour inflation report on Friday showed prices up 8.6% on an annualized basis, which was worse than the 8.2% economists had predicted. Food inflation was up 10.1% in May, the twelfth consecutive month of increases in that category. The Dow dropped 880 points on Friday alone with the tech-heavy NASDAQ down 3.52%. For the year most major stock market indices are down 15-20% with the NASDAQ down 27%.
Meanwhile, the cost of housing whether it is to buy, build, or rent continues to increase too. According to the National Association of Realtors, in April the median home price nationwide was $391,200, up 14.8% over the past 12 months (after a big jump up in the 12 months prior to that, as well). According to the researchers at Rent.com, one-bedroom and two-bedroom rents are both up just over 25% in the past year. Rents in places like Nashville, Long Beach, Austin, Oklahoma City and dozens of other American cities are up by nearly 50% or more. Reporter Clio Chang wrote in response to the median rent hitting $4,000 in New York City:
The report also found that Brooklyn rents have jumped nearly 7 percent since last month, to reach a median of $3,250. Also the invasive spotted lanternfly is back and rats are out of control. See you at the beach (where there are no lifeguards). Happy summer!
All of this comes amid what feels like a steady barrage of tragic, sad, and anger-inducing events from the school shooting in Uvalde, Texas to the January 6th Committee Hearings to the ongoing war in Ukraine with its various atrocities and related humanitarian crisis. Supply chain issues persist, the labor crunch has not subsided, and browntail moths abound (here in Maine, at least). A report out on Friday said that Americans are $22 billion behind in utility payments as energy prices have surged.
On Friday, the University of Michigan, which has been tracking consumer sentiment since the mid 1970’s, reported its lowest reading ever, noting:
Consumer sentiment declined by 14% from May, continuing a downward trend over the last year and reaching its lowest recorded value, comparable to the trough reached in the middle of the 1980 recession. All components of the sentiment index fell this month, with the steepest decline in the year-ahead outlook in business conditions, down 24% from May. Consumers' assessments of their personal financial situation worsened about 20%. Forty-six percent of consumers attributed their negative views to inflation, up from 38% in May; this share has only been exceeded once since 1981, during the Great Recession. Overall, gas prices weighed heavily on consumers, which was no surprise given the 65 cent increase in national gas prices from last month (AAA).
What to Make of it All
There are actually several things going notably right in the current economy. The unemployment rate is 3.6%, which was about what it was just prior to COVID-19. Prior to that you’d have to go back to 1969 to see a rate that low. Americans also have more savings and higher credit scores than usual and homebuyers have more equity in their homes than ever before.
If you could go back to the spring of 2020 and tell policymakers that in the spring of 2022 there would still be over 100,000 new COVID cases every single day but the unemployment rate would be 3.6% with one tradeoff being that inflation would be running particularly hot, that is probably a deal those 2020 policymakers would have taken. The longer inflation persists, however, the more that trade-off will start to feel out of balance.
For better or worse, we are a consumer-driven economy. And if consumers are feeling pessimistic, they are going to pull back from spending. Plus mathematically speaking if people are spending an extra couple hundred bucks on food and gas every month not to mention their rent and mortgage payments are going up, they’re just not going to have as much to spend on eating out, travel, entertainment, or other discretionary spending.
There is a school of thought right now that we are talking ourselves into a recession. In other words, the steady stream of negative headlines are themselves a key cause of economic worry, like talking yourself into a headache. I remember the same attitude from certain CNBC personalities in the summer of 2007, an attitude that completely ignores the real frustrations Americans are feeling and the holes that are being blown in many household budgets due to high prices.
What these comments get at, however, is that once a cycle like this begins, it is hard to bottle it back up as economic momentum has a way of perpetuating itself. At the current moment, the root causes of economic uncertainty are very real: staggeringly high inflation figures, rapidly rising interest rates, and a housing crunch for both buyers and renters for virtually all market price points especially low and middle income earners. Not to mention the fact that as much as we might try to ignore it, COVID persists.
On April 3rd I wrote that I think a recession is coming. My thinking has only hardened since then. The negative impacts of a recession would be worrisome to say the least, especially on low and moderate income Americans who are the most directly impacted by rising food, energy, and housing prices. It is hard to draw firm conclusions over just a few weeks of data, but the fact that inflation is still running as hot as it is and things like food and gas prices have not leveled off is more than a bit concerning.
I do expect interest rates to continue to surge. Prime Rate right now is 4.00% after being 3.25% for most of the last two years. I expect it will be 5.00% by the end of the summer and 5.50-6.00% by the end of the year. What that means on commercial debt, which is what I focus on in my bank work, is that rates on commercial loans are likely to be 6.00-7.00% this fall and into the winter, which is certainly going to ease back the throttle on the robust commercial banking activity we have seen over the past several years. As the cost of borrowing goes up, borrowing activity will go down.
There used to be a saying in the investment world, “Sell in May and go away,” which references the perceived seasonality of the stock market in that stocks tended to do better from November to May than they did from May to October. It also harkened back to Wall Street bankers taking the summer off and going to The Hamptons or Martha’s Vineyard for the summer. From where we stand today, a lot of the loss in the stock market is already baked in. While the market could always drop another 15-20%, the fact that it is already down so much for the year suggests this is not actually a good time to sell. And while checking out of the financial world for a few months and spending time at the beach may be possible for a select few, most people will have to trudge on. The summer ahead is likely to be full of financial pitfalls and frustrations.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram. Opinions and analysis do not represent First National Bank.