Strong Consumers & Corporate Credit Beat Back Recession Expectations: In The Week Ahead
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Good afternoon everybody, and happy Monday.
The US economy has been in a state of ambivalent will-they-won't-they when it comes to the recession question. For 3 years, data has been mostly positive with bouts of uncertainty, and we find ourselves in yet another one of these mixed situations.
Consumer sentiment broke out to a 3-year high as we reported on Friday, and strong retail sales data further confirms just how resilient consumer spending is, even after the holidays. In over 9,000 US general merchandise retailers surveyed, same-store weekly sales are 5% higher than this time last year, indicating that consumers are not worse off after another year of rate hikes, but better:
This strength does have a big asterisk, with the US having a record-wide deficit as a % of GDP—meaning "rising" economic activity in the private sector is increasingly enabled by government debt issuance. Perpetual credit expansion at the government level is one of many tools used to prop up American consumption and paper over any recession that would occur without it:
It is not just the widening deficit that has enabled the US' recent bout of "growth." According to a report from Hedgeye, almost 25% of the new jobs added to the US economy in 2023 were in the government sector. For reference, a government hiring rate above 10% coincides with an impending recession, without fail. Again, the dynamic of the government pulling up the sagging pants of US economic activity is at play, even picking up slack in the labor market to ensure it.
According to data from BMO, corporate bond markets are doing extremely well, with January's IG (investment-grade) issuance already the heaviest on record and set to beat the current record-holder of $175 billion in new supply which happened in 2017. Total issuance when the month is through could beat $175 billion by as much as 30%—an absolute blowout and indicative of just how strong demand for corporate credit is.
Credit spreads have now narrowed to their post-2008 tights as strong demand continues to outstrip supply. The risk-on impulse across markets is very high:
Positive risk sentiment reflected in credit paired with the last few weeks' strong economic data has sent US Treasury yields higher and pared back the expectations for rate cuts. The 2 and 10-year yields have moved ~20 bps higher this week:
The expectation for rate cuts has been pared back slightly, from 3.5 cuts by the June 2024 FOMC meeting to just 2 now:
All things considered, financial conditions are still very loose. The onus is on the Fed to continue relative hawkishness considering the aforementioned economic strength and how risk-on markets continue to be—ready to pivot on a dime however, at the first sign of economic weakness, which may be closer than many realize.
A quadruple whammy is set to hit financial markets and the real economy in March, as interbank liquidity to write loans dries up along with consumers' stockpile of cash for spending running mostly dry
The Fed's bank term funding program is slated to expire on March 11th, at which point loans cannot be extended and start to expire. The $161.5 billion that sits in the facility will have to find a new home, and will likely see a commensurate multi-billion dollar reduction in liquidity in financial markets as banks de-risk and move into other risk-free facilities and assets, at the Fed and in US Treasuries:
According to the San Francisco Fed, only ~$290 billion in aggregate excess savings from post-COVID stimulus remain—down from $2.1 trillion at its peak. At this rate, they will be drained by March, and we'll see how resilient US consumers really are:
Emergency loans from Federal Home Loan Banks are also coming due in March, with many banks already paying down their FHLB balances in advance of this. Like BTFP's closure, this is another major de-risking impulse that will substantially tighten up loan activity from banks. In a credit-based economy, a tightening of loans means a commensurate reduction in economic activity:
The fourth factor is the Fed's reverse repo facility which is actively being drained as investors rotate into higher-yielding facilities and products, namely US Treasuries. Once it hits zero towards the end of Q1, bank reserve balances will be the main source of funds tapped for banks to buy US Treasuries, which will be yet another headwind for financial markets and apply downward pressure on interbank loan activity and loan activity into the real economy:
All eyes are on March. We will see how resilient the US labor market is when it becomes substantially more difficult for businesses to access loans at the competitive rates they have been afforded for the better part of the last 4 years. We will see how sturdy spending is when the post-COVID stimulus that allowed so many to spend above their means runs dry, and people are left to their income alone to fund themselves.
Powell may have been right to forecast rate cuts. Rate cuts always come in response to economic contraction, and we could be in for a sharp one if consumer spending takes a complete 180* heel turn and credit markets dry up forcing companies to begin layoffs, downsizing, and closure. The mixed signals from financial markets could become much, much clearer as the end of Q1 rears its head in a few short months. Time will tell.
Hope you all have an excellent Monday,
Joe Consorti
Theya is an app for simplified Bitcoin self-custody. With its 2-of-3 multisig custody solution, you can enjoy maximum security for your Bitcoin and the peace of mind that comes with it.
Download Theya on the App Store and declare your sovereignty today.