Just a tick early as mid-year officially won’t occur until this Saturday with the second quarter officially ending, Friday. This said, not much is likely to change the current status between now and Friday or for that matter, any time soon.
The first half of 2023 can be summed up through a look at two issues: inflation and interest rate policy via the Federal Reserve. Both have had profound impacts on the healthcare sector as each has created principally the current economic state the U.S. is in.
At his Congressional testimony this past week, Fed Chair J. Powell indicated that the current pause in rate hikes (the Fed Funds rate) should not be construed as a change in overall direction. He testified that he was reasonably certain additional rate hikes would be required to push inflation down to the Fed target of 2%. The pause is to get a clearer view of where the economic dynamics are and to see how the recent history of rate hikes, fold into the economy. Interest rate increases have a lagging effect on economic growth and thus, inflation.
The May Consumer Price Index rose .1% compared to April and was 4% higher across the recent twelve months (year over year). Some key data points to note are below. The full release is available here: https://www.bls.gov/news.release/cpi.nr0.htm
- Falling energy masks the overall level of inflation still embedded within various categories. Services for example, minus food and energy, were up 6.6%.
- Food was up 6.7%
- Energy was down (-11.7%) led by fuel oil (-37%) and gasoline (-19.7%). Electricity was up 5.9%
- New vehicles were up 4.7% while used cars and trucks were down (-4.2%)
- Shelter (housing) was up 8% and transportation services, up 10.2%
- Core inflation, all goods and services less food an energy, was up .4% for the month and 5.3% for the recent 12 months (year over year). This illustrates the impact falling energy prices, principally gasoline and fuel oil, have on overall inflation as measured by the CPI. Core inflation is the number the Fed claims to base most of its rate policy on.
Rising interest rates have adversely impacted the capital markets in a number of ways. Aside from increasing the cost of borrowed capital, variable rate debt instruments, separate from any synthetic rate fixing instruments, have risen precipitously. Bank failures have further caused debt access limitations by virtue of a reduction in overall lending outlets as well as a renewed stringency on lending facilities. Credit has tightened.
- While the cost of capital has risen, margins have not across the same period. Rates realized via reimbursement have also not kept pace with inflation, internal costs of capital, etc. This fundamentally translates to new risks.
- Default risk on current variable rate debt increases and has, rapidly as rates have risen rapidly.
- Capital improvement projects necessary for maintenance or new construction, remodeling have slowed or evaporated as borrowing costs have reduced the feasibility financially. For projects that don’t equate to new revenue but are merely, improvements needed to remain competitive, this pushes deferred maintenance further out and harms enterprise value.
- Rising capital costs also translate to rising product costs, worldwide. Existing product shortages are further adversely impacted by higher capital costs as a myriad of products and services, are created and maintained via credit facilities. Think agricultural products for example. Everything from grains to beef, pork and poultry are raised and ultimately sold via credit facilities (crop and herd loans).
- Interest rate uncertainty caused by vague Federal Reserve guidance hinders the ability of a business to plan and strategize. As of today, the Fed continues to signal a higher probability of continued increases vs. rate reductions.
The outlook is for continued uncertainty. The Fed’s pause is really more about trying to gauge rate increase impacts on inflation than a directional shift. The primary “stick” to inflation today is government spending and excess liquidity in the economy caused principally by trillions of COVID related programmatic and policy infusions of cash. Sans the dollars going to any productive output or corollary to any increase in productivity and growth in the economy, inflation occurs. This is the result simply stated, of a negative return on investment expressed as inflation. The Fed’s fix or attempted fixes have only so much impact and react often, as a blunt instrument. The damage from the blunt instrument may be recession or as we are seeing in senior living and health cae, increasing defaults.
There are a number of watch areas to look at going forward, for a directional bias on rates but also on the economy and capital markets. This list is in no particular order.
- The labor markets/job reports: While the reports on the surface look good in terms of jobs created, there are key data points that bear watching as more relevant to where the labor market is.
- Labor participation rates are soft and below historical norms. This means a great deal of people are still not working.
- Productivity has not returned to pre-pandemic levels. This (is) anathema to growth and rising GDP which, helps to ease inflation.
- Wage increases have not kept up with inflation. While wages are up, their trend remains below CPI and core inflation. This trend bodes negatively for a variety of industries such as residential real estate. Prices are steady to up for existing homes however, sales are almost nil given higher rates and lower overall economic ability to purchase. As new inventory (new builds/starts) require capital, development has slowed substantially and U.S. housing access and inventory, is problematic for many.
- Energy has been the big assist in lowering CPI but as we view with core inflation, where energy is stripped, inflation remains “hot”. Energy in terms of fuel oil and gasoline are the laggard but again, heavily influenced by govt. policy as of late. The Biden Administration has used the Strategic Petroleum Reserve to bolster market supply, keeping energy costs somewhat suppressed as has worldwide demand (soft). OPEC however, has hinted a output reductions to bolster petroleum costs and as of now, prices at the pump are creeping higher. The outlook is for higher gasoline and fuel oil prices in the near term. A hurricane season heading our way with possible refinery impacts (storm related shut-downs) could shock gasoline prices by late summer early winter.
- The probability of a recession remains high as Fed policy effectively exists to do only one thing, slow economic activity. Signs exist (increasing layoffs, new jobless claims, etc.) that the economy is slowing. The concern is how much is it slowing and given the lag effect of rate hikes, time will tell. GDP growth has been fairly anemic which, suggests slowing is occurring. First quarter 2023 GDP was 1.3% compared to 2.6% for the 4th quarter of 2022.
