Thread by @RickRieder

To elaborate on my interview last week on @BloombergTV, as well as my response to @elonmusk, a thread.

Restrictive policy rates have succeeded in slowing the rate-sensitive segments of the U.S. economy (including goods inflation), but a >5% Fed Funds rate is not doing much to slow the insensitive, services-oriented segments. In fact, given the unique historical context, we believe >5% cash rates are doing unnecessary damage to certain cohorts today and may even be supporting services inflation.

1/13

The @sffed visualized this very well in a recent analysis… the components of inflation that are “most responsive” to rates have completely normalized! It is the “least responsive” components that are responsible for the sticky inflation we are experiencing today... there is not much Fed policy rates can do about that.

2/13

It’s important to note that most of the “least responsive” components are in the services sector, which is a much larger share of the economy today than it has been historically.

It used to be that slowing the rate-sensitive, goods-oriented, sectors was sufficient to slow the entire economy; in today’s services economy that is not the case.

3/13

To understand what is driving services inflation, let’s take a closer look at the U.S. consumer…

Catalyzed by one of the largest public-to-private transfers in history, the ratio of U.S. Wealth/Disposable Income has surged to new all-time highs.

4/13

For 30 years, the U.S. consumer was a net debtor, but the incredible infusion of capital from the public sector has now resulted in the U.S. Household having no net debt in aggregate!

This means that, in aggregate, U.S. Households are not deterred by higher rates!

5/13

Though, looking under the hood, we see the bottom 50% of the wealth distribution does take on some stress.

This cohort has less than $1 trillion of cash but holds $3 trillion of credit card & other non-mortgage debt.

This is especially relevant as these forms of debt, which are either floating rate, or shorter maturity, are creating the most stress today as rates are becoming more punitive (as compared to mortgage debt where the average rate outstanding is still <4% and 30-year maturities are the norm).

6/13

We can see below how pernicious the interest payments on these forms of debt have become as they have surged to eclipse mortgage payments for the first time on record…

7/13

The stress of these payments on lower income cohorts is evident in 1) increasing delinquencies on credit card and auto debt, which is most pronounced in the low-income cohorts, 2) large reductions from the low-income cohorts in the spending data, and 3) pervasive references of weakening low-income demand in Q1 earnings reports.

8/13

We can see a similar bifurcation in the underlying economic reality occurring from a different angle as well: that of age cohorts.

The 55+ cohort holds very little debt relative to net worth. It is the younger cohorts that are more indebted.

9/13

… and, as illustrated by the @WSJ, Baby Boomers control more wealth today than ever before, which they can now invest at the highest real rates in >20 years!

10/13

These older cohorts account for more spending than any other age group (a dramatic ascent from just 20 years ago when they accounted for the least spending of any cohort).

It’s easy to see why high real rates benefit this group as they head into retirement.

11/13

Importantly, it is the beneficiaries of high rates that make up the majority of consumption and ultimately drive the aggregate economy (especially in services).

Hence, as these cohorts benefit from higher rates they are continuing to spend comfortably, which keeps pressure on services prices.

12/13

So, some cohorts are net creditors that are benefitting from higher rates and keeping services consumption robust, while others are net debtors that are struggling under the pressure of higher rates.

In aggregate, though, rates are not slowing the consumer! If anything, we believe services consumption is being supported by high rates.

Hence, we believe that a healthy moderation of the Fed Funds rate into the 4% to 5% range may help services inflation moderate from here. Yet, we think the Fed will probably stay where they are for at least a couple of months.

13/13