Do you have floating rate loans on your assets? Do you also own rate caps? Now’s the time to know where your strike prices are, and for two reasons: 1) If there is any chance that you’ll refinance the floating rate loan soon and then have an “orphaned” rate cap, that rate cap may be worth alot more than you paid for it, and you may want to consider selling it. 2) If your floating rate loan is Agency (Freddie Mac), and you closed the loan two or three years ago, your replacement cap escrow has likely gone through the roof or will very soon. Contact us for a blueprint on what to do next.

Inflation set a new peak – will it get worse before it gets better? The Consumer Price Index (CPI), one of the Fed’s favorite gauges of inflation, rose 8.6% year over year in May, a new four-decade high, while core prices, which exclude food and energy, more indicative of the underlying inflation trend, rose 6%. Month over month, a more realistic inflation measure, climbed 1% from April, 0.6% after stripping out food and energy. Inflationary pressures are broadening. Energy prices rose nearly 4% month over month while airfares vaulted a whopping 12.6%. Housing costs, which make up more than 40% of CPI, rose 0.8% from the month before.

Investors, who expected CPI to signal that inflation had peaked, were surprised by the jump, prompting traders to price in 0.50% rate hikes at the Fed’s June, July, and September meetings. The moves imply that the federal funds rate – the rate the Fed moves around when it hikes or cuts – will peak at 3.5%, a new high. Short-term bonds, which are more susceptible to Fed rate hikes, led the Treasury selloff, with the 5-year yield jumping 19 basis points to 3.25%, following the 2-year higher. Thirty-year yields are now at 3.19 percent, up 3 basis points.

Our take: The likelihood of a worsening inflation picture is high. We suspect that the next set of CPI data for June, released in early July, will show a 1% monthly gain, on the back of the national average gasoline price approaching $5 per gallon in the early weeks of June, combined with renewed inflation pressures emanating from China’s reopening from COVID lockdowns and Europe’s looming embargo of Russian energy. Even though America’s economy is already slowing, the dynamic will keep the Fed firmly on the path of 0.50% rate hikes at its June and July meetings, with a 0.50% hike in September looking more and more likely.

Looking further out, even if energy prices stabilize and then begin to decline before the end of the year, as oil-futures curves predict, headline CPI will average more than 7% in Q4. That will keep pressure on the Fed through the end of the year, owing to inflation’s stubbornly slow decline. But does it mean we’ll see 0.50% rate hikes at every Fed meeting through the end of the year as some project? We don’t think so. 0.50% rate hikes this week, in July and in September will emanate through markets and the economy, slowing things down enough to give the Fed room to then pause and contemplate its next moves.

In the meantime, a stealth driver of inflation to keep an eye on is rents, which comprise 30% of the CPI. Changes in rents impact CPI with a lag, which implies that rising housing-cost measures may delay a peak in CPI until early 2023 or even later. The monthly change in rents of primary residence (RPR) and the owners ‘equivalent rent component are pointing to higher run rates than during the mid-2000s housing boom. These will keep inflation higher for longer, adding roughly 2 percentage points to CPI well into 2023.

Consumer sentiment dove to a fresh low – are well all doomed? The preliminary reading of the University of Michigan’s consumer sentiment index for June declined to 50.2, a historic low, from 58.4 in May. The mood of US consumers, who drive roughly 70% of all economic activity, is now at an all-time low, diving past levels hit during the Global Financial Crisis of 2008 and the Paul Volcker– inspired inflation shock of the 1980’s. The data added to the doom and gloom mood shown by other gauges – including the New York Fed’s gauge of inflation expectations – that have risen significantly. The fact that consumers see conditions as so poor partly reflects the view that worsening sentiment could soon translate to significantly weaker spending – a key ingredient to maintaining any positive US economic momentum.

Our take: Even though pent-up demand and healthy household balance sheets will keep us all spending in months ahead, the plunge in consumer sentiment shows risks of a significant slowdown are intensifying, implying that recession lies in wait in mid-2023. The double-whammy of high and rising inflation and tanking consumer sentiment will embolden the Fed to keep on trucking toward 0.50% rate hikes through July.

Upturn in jobless claims flashes another warning sign. Weekly initial jobless claims have been trending higher since bottoming out at 166,000 in mid-March, with the most recent print coming in at 229,000, well above the pre-pandemic 2019 average of 218,000. Economists look at the jobless claims data as an early warning sign of a recession since, historically, if the number of claims reaches a low point then rises, recessions usually follow within nine to 18 months. Something to keep an eye on.

The ECB left the door open to a half-point rate hike in September – should you care? Yes you should, as any inclination on the part of the ECB to hike only adds momentum to hikes by our beloved Fed. While the European Central Bank (ECB) didn’t hike rates at its meeting on last Thursday, it announced that it plans to raise rates by 0.25% in July, with the possibility of a 0.50% hike in September if inflation “persists or worsens”. The ECB added that moderate but persistent hikes will be reasonable after September. Inflation in Europe is expected to average 6.8% in 2022, while core inflation is expected to average 3.3%.  Adding to the momentum, a number of other central banks hiked rates last week amid surging global inflation, including the Reserve Bank of India, which raised rates 0.50% to 4.9%; the Reserve Bank of Australia, which raised them by 0.50% to 0.85%; and the Central Bank of Chile, which hiked by 1.5% to 5.5%.