🎙️ Inflation's Too High

“(Inflation) remains too high.”

💭 That’s not us saying that; those words are from Fed Chairman Jerome Powell, who sits at the center of America’s monetary policy and battle with rising prices.

The reality is that although higher interest rates continue to slow the rate of price increases, they won’t bring prices back down.

The promise of cooling inflation doesn’t mean a return to pre-pandemic prices, speaking as someone who paid $16.50 for a sandwich, fries, and a shake at Chick-fil-A yesterday 😅

— Shawn

Here’s the rundown:

Today, we'll discuss the three biggest stories in markets:

• Powell says the inflation struggle isn’t over

• What the exploding U.S. budget deficit means

• The bankruptcy plan for WeWork

All this, and more, in just 5 minutes to read.

CHART OF THE DAY

IN THE NEWS

 💬 Powell Warns of More Rate Hikes to Fight Inflation (Axios)

The other day, we joked that the 2023 bull market could continue for another few months after Nvidia's slam-dunk earnings report. Federal Reserve Chairman Powell has other plans.

What’s happening: On Friday, Powell took the podium to make his annual speech in Jackson Hole, Wyoming, and he made one thing clear — inflation isn’t yet under control. That means rates aren’t going down anytime soon.

• Last year’s speech was famously brief and hammered the Fed’s seriousness about fighting inflation into markets. This year’s speech had a similar but less sternly delivered message.

Why the less stern tone? Inflation, as measured by the Consumer Price Index (CPI), has come down from over 9.1% on a year-over-year basis in 2022 to just 3.2% last month.

• Powell expressed surprise that while higher interest rates have brought down inflation, the economy hasn’t fallen into recession with a spike in job layoffs — a historical anomaly.
  

• Yet, it’s too early to celebrate. From Powell: "We’re prepared to raise rates further, if appropriate, and intend to hold policy at a restrictive level until we’re confident that inflation is moving sustainably down toward our objective."

Translation: Price increases in most things, from used cars to new homes, groceries, and healthcare, have slowed greatly in the last year, but that doesn’t mean the battle has been won. The Fed wants near-certainty that inflation won’t rear its ugly head again before considering easing interest rates.

• However, elevated and rising interest rates are a major headwind for stocks. Why buy stocks when you earn 4 or 5% in high-yield savings accounts and low-risk government bonds?

Why it matters:

‘Til data do us part: The Fed is in a wait-and-see mode, hoping more data reports in the coming months will confirm the slowdown in inflation.

• In Powell’s words, "We’ll proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data…As is often the case, we’re navigating by the stars under cloudy skies.”
  

• As one macroeconomic analyst put it, "This is straight down the middle…The Fed is encouraged by progress but a long way from calling victory."

Side effects: In a paper presented at Jackson Hole, economists Yueran Ma and Kaspar Zimmermann warned that higher interest rates previously "have had noticeable effects on innovation funding such as [venture capital] investment."

• For years, when interest rates were extremely low, there was a flood of venture capital funding supporting startups.
  

• The opposite has been the case since interest rates started to rise rapidly in 2022, prompting concerns that the Fed’s inflation-fighting efforts could stifle innovation.

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💰 U.S. Budget Deficits Are Exploding (Bloomberg)

Death, taxes, inflation. Another certainty: U.S. government spending that could keep interest rates and price changes elevated for years to come.

U.S. politicians are spending loads of cash to charge the economy. In turn, borrowing costs might stay high even after the inflation fight ends.

• Though the economy appears in good shape, the federal budget deficit has soared. It’s made investors apprehensive, worrying a sustained budget deficit could push rates higher, further driving the deficit by adding to the government’s interest bills.

Look, headlines have said U.S. government spending is out of control for years, yet the economy chugged along throughout the 2010s. The stock market soared. But this year’s surge in the budget deficit, which doubled to $1.6 trillion in the 10 months through July, reminds investors of what happens when the government “goes into recession-fighting mode.” Yet, there’s no recession.

YOLO: Other governments are borrowing and spending like there’s no tomorrow, too, perhaps stealing out of Generation Z’s post-pandemic YOLO mindset (you only live once).

But from Donald Trump’s tax costs to President Joe Biden’s subsidies, plus the multi-trillion-dollar pandemic response (queue the money printer), Congress is increasingly eager to spend.

• In a strong economy with low unemployment, politicians “really have no impetus to think they need to change anything,” says one JPMorgan director.

“You have a tremendous amount of fiscal spending—an unprecedented amount in non-war times. There are a lot of factors coming together to push long-end rates higher.”

Why it matters:

The consequences are substantial. Housing hasn’t been this unaffordable since the mid-1980s, and it will stay that way if Powell keeps his word about further rate hikes. Stocks might also suffer as higher borrowing costs for businesses cut into profits, especially as companies roll over cheap debt taken out during the low-rate pandemic era.

• Economists have warned that the Biden administration’s spending, including hundreds of billions into EV manufacturing and semiconductors, could rekindle inflation and make the Fed’s job even harder.

Addicted to debt: The dynamic is playing out globally. Advanced economies likely will have more debt in the next few years.

• Wrote one economist: “If deficits remain permanently larger, then long-term interest rates may need to remain higher as well.”

• But politicians are under pressure to spend as America’s population ages, driving higher health care and social services costs. Governments also want to spend money to fight climate change, among other initiatives in semiconductors and artificial intelligence.

And money well spent in those areas could be positive, boosting productivity, education, and scientific research, reducing the debt burden.

MORE HEADLINES

📈 Affirm shares rocket 26% after better-than-expected earnings

⚡ Maui government sues Hawaiian Electric for causing catastrophic fires

🏠 Home affordability falls to the worst level since 1984

👨‍⚖️ Court sides with Wall Street on landmark lending case

👗 Shein and Forever 21 agree on fast-fashion partnership

🏢 Wall Street Funds Brace for Potential WeWork Bankruptcy Plan (WSJ)

Remember when WeWork was briefly the world's most valuable startup, valued at $47 billion? Not much remains of the company's rise to fame in 2019, as it now grapples with a potential bankruptcy.

The company had a simple mission (in theory): Bring affordable co-working spaces to all. That is, provide freelancers, remote workers, and small businesses the opportunity to flexibly rent out shared office space, with no shortage of small luxuries.

• WeWork offices have included everything from wellness rooms, kombucha kegs, and coffee bars to even karaoke.
  

• The company’s vision became almost laughably grandiose in hindsight, hoping to do more than just “ build…beautiful, shared office spaces” and, instead, “elevate the world's consciousness.”

Filing Chapter 11: After previously extending hundreds of millions in loans to WeWork, several Wall Street firms, namely BlackRock, King Street, and Brigade Capital, are now encouraging WeWork to file for bankruptcy.

• These investment firms have a lot of sway after extending some $1.2 billion in loans to WeWork in March (constituting about half of the company's total long-term debt.)

Would bankruptcy help? Bankruptcy could allow WeWork to shed a portion of its expensive commercial real-estate leases and also hand over control of the company to creditors (in this case, the Wall Street titans mentioned above.)

• Still, the hope is to renegotiate as many of its high-cost office leases with landlords and bring down its cost of rent, allowing WeWork to bypass bankruptcy.

Why it matters:

Since late 2019, WeWork has modified or terminated numerous leases, reducing its fixed lease payments by an estimated $12.7 billion.

Costly co-working: Despite this, the new CEO, David Tolley, maintains that high rental costs and low occupancy remain the company's primary challenges.

• “By finally addressing our cost of rent in a meaningful way, we’ll be able to continue to invest in our member experience and new products and services,” said Tolley, confirming the company aims to avoid Chapter 11 bankruptcy.

Escaping debts: As mentioned, bankruptcy could let WeWork offload some of its costly property leases, including its hefty $10 billion worth of lease obligations due through 2027, plus another $15 billion through 2028.

• But its public stock would likely become worthless. In fact, it already almost is — its stock price has been in free fall over the past few years.
  

• Typically, firms undergoing bankruptcy nullify existing shares and transfer control to creditors or third-party investors through new stock issuance, inflicting significant losses on existing major shareholders like SoftBank.

See you next time!

That's it for today on We Study Markets!

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