student loan repayments

A bright spot

Resilient US Economy and the Path to Looser Fed Policy

Resilient US Economy and the Path to Looser Fed Policy

ING Economics ING Economics 06.07.2023 13:22
The US economy has proven to be more resilient than we expected, but the threat of recession lingers on due to lagged effects of rate hikes and tighter lending conditions while the restart of student loan repayments could come as a financial shock for millions of Americans. Inflation is subsiding and this will open the door to looser Fed policy next year.   Upward revisions to near-term growth and Fed view We have made major changes to our US forecasts this month, which see us revising up the near-term growth profile while also inserting a July Federal Reserve rate hike. Inflation is still set to slow sharply, but interest rate cuts, which we have long been expecting, are unlikely to happen before the end of this year. We expected the economy to have been more impacted by the cumulative 500 basis points of interest rate hikes and a reduction in credit availability than it has been. Certainly, the banking stresses seen in March/April appear to have stabilised thanks to massive support for small and regional banks from the Federal Reserve. Employment creation has been robust, while residential construction has been stronger than expected despite the surge in mortgage rates. The lack of existing homes for sale is keeping prices elevated and is generating demand for new homes. Inflation is slowing, but not quickly enough for the Federal Reserve and with the jobs market remaining firm officials are taking no chances. The Fed signalled that June’s decision to leave interest rates on hold should be seen merely as a slowing in the pace of rate hikes rather than an actual “pause”. Consequently, a 25bp July rate looks likely, but we doubt the Fed will carry through with the additional 25bp hike outlined in its latest forecasts.   Bank nervousness points to a contraction in lending        
Mixed US Activity Picture: July Rate Hike Likely, Followed by a Pause

Mixed US Activity Picture: July Rate Hike Likely, Followed by a Pause

ING Economics ING Economics 19.07.2023 09:43
Mixed US activity picture supports July hike then another pause Retail sales grew in June but these are dollar values and in volume terms, spending appears lacklustre. Meanwhile, with the manufacturing sector languishing and inflation showing encouraging signs of slowing, the widely-anticipated July Federal Reserve interest rate hike may be the last.   Retail sales indicate a mixed spending picture US June retail sales are a little bit softer than expected at the headline level, rising 0.2% month-on-month versus the 0.5% consensus expectation, but May's figure was revised up to 0.5% MoM growth from 0.3%. Meanwhile, the "control group" which strips out the volatile auto, building materials, gasoline and food service components was better-than-hoped, rising 0.6% MoM versus 0.3% consensus. There was also a 0.1pp upward revision to May for this series. This is important as this stripped-down version of retail sales tends to have a better correlation with broader consumer spending trends over time. The details show auto sales were weaker-than-expected (+0.3% MoM), given decent unit volume figures from manufacturers, while gasoline station sales surprisingly fell despite rising prices. It was a good month for furniture (+1.4% MoM) and electronics (+1.1% MoM) and miscellaneous (+2%) and internet (+1.9%), but building materials fell 1.2%, sporting goods were down 1% and department store sales fell 2.4%, indicating a very mixed picture for spending.   Challenges mount as credit support fades and student loan repayments restart Looking at it in year-on-year percentage terms, retail sales are up 1.7% in aggregate while the "control group" is up 4.3%, but these are nominal dollar figures so accounting for inflation, sales volumes are pretty lacklustre. Moreover, weekly Johnson Redbook sales are in negative territory YoY in early July - also a dollar value figure. This tends to lead the official retail sales numbers, so doesn't bode well. Nor does the softness in restaurant dining, which according to Opentable is running at -2% YoY for July month-to-date.   Weekly Redbook sales point to decelerating retail activity (YoY%)   Also check out the softer consumer credit numbers that have been coming through, for example rising only $7.2bn in May versus the $20bn consensus and the outright consecutive declines in the stock of consumer credit provided by commercial banks in the US over the past three weeks. With student loan repayments also restarting in the next few months the challenges facing the retail sector appear to be mounting, with a further slowing in consumer activity looking like the most likely path ahead.   Softer data indicates manufacturing recession Unfortunately, US industrial production was much weaker than anticipated in June, falling 0.5% MoM versus expectations of 0% growth. Manufacturing output fell 0.3% MoM rather than coming in flat as predicted while mining fell 0.2% and utility output dropped 2.6%. We know that the ISM has been in contraction territory for the past eight months and we know that the Baker Hughes oil and gas rig count has fallen heftily over the past three months (from 748 at the beginning of March to 675 as of last week – the lowest since April 2020 when spot prices for oil were turning negative). Given this, we aren't expecting an imminent rebound in output from the manufacturing or mining sectors.   US manufacturing output versus the ISM index   July utility output will be up sharply though, with AC units in overdrive, and this is the only hope for a positive number for industrial activity. So with the activity backdrop for the US looking more mixed and the inflation story looking more favourable, the data seemingly supports the narrative of the Fed hiking rates again in July, but pausing again in September, perhaps for a number of months.
Likely the Last Hike for a While: FOMC Meeting Insights

Likely the Last Hike for a While: FOMC Meeting Insights

ING Economics ING Economics 24.07.2023 09:50
But it is likely the last hike for a while... By the time of the next FOMC meeting on 20 September, we will have had two further job and inflation reports, a detailed update on the state of bank lending plus more time for the lagged effects of the already enacted Fed tightening to be felt. In terms of inflation, the next couple of months have some tough comparisons with last year. Energy prices fell sharply last summer so headline year-on-year CPI could be a tenth or two of a percentage point higher than the current 3% rate at the September FOMC meeting, but core inflation looks set to slow further and could be down at around 4.2% versus the current 4.8% rate. If anything, the risks are that core inflation could be a little lower given decelerating housing rent inflation may materialise more quickly than we are currently conservatively forecasting. It is also the composition of inflation the Fed will be paying close attention to. Is the super core (non-energy services ex housing) slowing meaningfully? We think the answer will be 'yes' based on lead surveys such as the ISM prices paid, PPI trade services and the National Federation of Independent Business price intentions surveys.   Inflation pressures are fading   As for activity, industrial activity is already struggling with the ISM manufacturing index in contraction territory for the past nine months, while consumer spending growth is slowing. Over the next two months, we think the headwinds for activity will intensify with outstanding stock of commercial bank lending set to fall further thanks to the combination of higher borrowing costs and tightening of lending standards. This is a hugely important story given the insatiable appetite for credit within the US economy. We may also see the spreading awareness of the financial implications of the restart of student loan repayments starting to impact the spending behaviour of tens of millions of Americans. So, by the time of the 20 September FOMC meeting, we think the Fed will have evidence to be pretty confident that inflation is on the path to 2% and that activity is slowing to below trend rates and the jobs market is cooling. This is likely to be characterised as another pause and the Fed is likely to keep one additional rate hike in its forecast profile before year-end. However, our base case is that it will not carry through with it, and 5.25-5.5% marks the peak for US rates.   Market rates to edge towards 4% and money markets to slowly re-tighten post the FOMC The US rates curve has been re-pricing in recent weeks to reflect the relative robustness of the economy, primarily by pricing out many of the rate cuts that had been discounted. The liquid portion of the strip out to early 2025 is now not tending to dip below 3.75%. Adding a 30bp term premium to this suggests that the US 10yr yield could easily be closer to 4%. It’s far from a perfect model, but it does help to explain why the 10yr yield has not collapsed lower, and in fact, we rationalise this as a factor that can force US yields higher as a tactical view. It goes against the consensus out there that the inflation story is behind us but is rationalised by the reality of relative contemporaneous macro robustness. For this reason, we maintain a moderate bearish stance on the directional view, expecting market rates to remain under moderate rising pressure. A hawkish Fed pushes in the same direction, preventing the strip from becoming too inverted. The Fed may or may not choose to focus on liquidity circumstances at the press conference. If quizzed, it will likely note that the impact of ongoing quantitative tightening and resumed bills issuance by the US Treasury is largely showing up in reduced amounts going back to the Fed on the reverse repo facility. The Fed will generally be happy with this, as this facility is more of a balancing mechanism, one that can take in liquidity that is not flowing into bank reserves. Bank reserves themselves have not seen a material fall, which acts to keep the overall liquidity banks circumstance reasonably ample. It also coincides with money market funds balances still around record highs and bank deposits holding up very well, too. Many of these factors will, in fact, justify the Fed’s decision to maintain a tightening trajectory for policy, as at least the price of money continues to rise even if underlying liquidity volumes are slow to fall.
US Retail Sales Boost Prospects for 3% GDP Growth, but Challenges Loom Ahead

US Retail Sales Boost Prospects for 3% GDP Growth, but Challenges Loom Ahead

ING Economics ING Economics 16.08.2023 13:19
Strong consumer keeps US on track for 3% GDP growth Retail sales provided another upside data surprise and indicates a 3% annualised GDP growth rate is possible for the third quarter. However, higher consumer borrowing costs, reduced credit availability, the exhausting of pandemic-era savings and the restart of student loan repayments pose major challenges for fourth quarter activity.   Retail sales lifted by Prime Day and eating out We have another US data upside surprise from the household sector with retail sales rising 0.7% month-on-month in July versus the 0.4% consensus. June's growth was also revised up 0.1 percentage point to 0.3% MoM. Importantly, the control groups which excludes volatile autos, gasoline, food service and building materials, rose 1% MoM versus 0.5% consensus, but here there was a 0.1pp downward revision to June's growth to 0.5% MoM. This category, historically, has a better correlation with broader consumer spending. Remember retail sales is only around 45% of consumer spending in total, with consumer services taking a greater share. Amazon Prime Day appears to have been the main driver with non-store sales up 1.9% MoM, but there was also strength in restaurants and bars (+1.4%) while sporting goods rose 1.5%, clothing was up 1% and grocery up 0.8%. Electronics (-1.3% MoM) and vehicles (-0.3%) and furniture (-1.8%) were the weak spots. All in it points to the US being on track to report 3% annualised GDP growth in the third quarter, which will keep the Fed's language hawkish even if they don't carry through with further rate hikes, as we expect.   Official retail sales growth versus weekly chain store sales growth (YoY%)   The challenges for spending are mounting Interestingly, there has been a bit of a breakdown in the relationship between official retail sales growth of the control group and the weekly Redbook chain store sales numbers, as can be seen in the chart above. Maybe this is the Prime day effect playing out and we see a reconvergence again in August. The Retail sales report is a good story for now, but we are expecting weakness to materialise in the fourth quarter. Higher market interest rates will add to upward pressure on what are already record high credit card borrowing rates and rising auto, mortgage and personal loan rates. With households also continuing to run down pandemic-related excess savings, as measured by Fed numbers on cash, checking and time savings deposits, this will act as a brake on growth.   US consumer borrowing costs (%)   Higher borrowing costs and reduced credit availability will hurt However, it is important to remember that reduced access to credit is just as important as the cost of credit in taking heat out of the economy. The latest Federal Reserve Senior Loan Officer Opinion Survey (SLOOS) underscores how the tightening of lending conditions will increasingly act as a headwind for activity and contribute to inflation sustainably returning to target. Banks are increasingly unwilling to make consumer loans and as the chart below shows, this has historically pointed to an outright contraction in consumer credit outstanding.   Fed's Senior Loan Officer Opinion Survey points to negative consumer credit growth (YoY%)   Fed to keep rates on hold Add in the squeeze on household finances from the restart of student loan repayments for millions of households and it means further weakness in retail sales and broader consumer spending remains has to remain our base case. The concern is that it will also heighten the chances of recession, which we believe will discourage the Fed from any further interest rate increases. Instead, we expect interest rate cuts from March 2024 onwards as monetary policy is relaxed to a more neutral footing.  
Summer's End: An Anxious Outlook for the Global Economy

Summer's End: An Anxious Outlook for the Global Economy

ING Economics ING Economics 01.09.2023 08:48
Remember that 'back to school' feeling at the end of summer? A tedious car journey home after holiday fun, knowing you'll be picking up where you left off? I'm afraid we've got a very similar feeling about the global economy right now. 'Are we nearly there yet?'. No.  Very few reasons to be cheerful Lana del Rey's Summertime Sadness classic comes to mind as we gear up for autumn. And I'm not just talking about chaotic weather or even, in my case, disappointing macro data. Most of us have had the chance to recharge and rethink over the past couple of months. and I'm afraid all that R&R has done little to brighten our mood as to where the world's economy is right now. Sure, the US economy has been holding up better than we thought. And yes, the eurozone economy grew again in the second quarter. Gradually retreating headline inflation should at least lower the burden on disposable incomes. And let's be thankful for the build-up of national gas reserves in Europe, which should allow us to avoid an energy supply crisis this winter unless things turn truly arctic. But that's about as upbeat as I can get. We still predict very subdued growth to recessions in many economies for the second half of the year and the start of 2024. The stuttering of the Chinese economy seems to be more than only a temporary blip; it seems to be transitioning towards a weaker growth path as the real estate sector, high debt and the ‘de-risking’ strategy of the EU and the US all continue to weigh on the country's growth outlook. In the US, the big question is whether the economy is resilient enough to absorb yet another potential risk factor. After spring's banking turmoil, the debt ceiling excitement, and more generally, the impact of higher Fed rates, the next big thing is the resumption of student loan repayments, starting in September. Together with the delayed impact of all the other drag factors, these repayments should finally push the US economy into recession at the start of next year. And then there's Europe. Despite the weather turmoil, the summer holiday season seems to have been the last hurrah for services and domestic demand in the eurozone. Judging from the latest disappointing confidence indicators, the bloc's economy looks set to fall back into anaemic growth once again.   Little late summer warmth This downbeat growth story does have an upbeat consequence; inflationary pressure should ease further. It's probably not going to be enough to bring inflation rates back to central banks’ targets, but they should be low enough to see the peak in policy rate hikes. Central bankers would be crazy to call an end to those hikes officially; they don't want to add to speculation about when the first cuts might come, thereby pushing the yield further into inversion. And there's also the credibility issue - you never know, prices might start to accelerate again. So, expect major central bankers to remain hawkish at least until the end of the year. In our base case, we have no further rate hikes from the US Federal Reserve and one final rate rise by the European Central Bank. However, in both cases, these are very close calls, and the next central bank meetings are truly data-dependent. Sometimes, a Golden Fall or Indian Summer can make up for any summertime sadness. But it doesn’t look as if the global economy will be basking in any sort of warmth in the coming weeks. The bells are indeed ringing loud and clear. Vacation's over; school is here. And while I'm certainly too old for such lessons, I'm taken back to that gloomy, somewhat anxious feeling I had as a kid as summer wanes and the hard work must begin once again.      
US Inflation Report Sets the Tone for Upcoming FOMC Meeting

Fiscal Support and Worker Power: Shaping the Economic Landscape

ING Economics ING Economics 01.09.2023 08:55
Fiscal support Huge government deficits in the 1970s may not have caused the initial inflation spike, but they undoubtedly amplified it. So, too, did the massive interventions at the start of the Covid pandemic and the “excess savings” pile they helped create. That story is now clearly changing. The US fiscal position is tightening and in the short term, a resumption of student loan repayments is symptomatic of Congress’ reluctance to allow further big spending packages. In the EU, the Stability and Growth Pact – the rules that mandate fiscal responsibility by European governments – is coming back to the fore. As we wrote a few months back, there’s a growing recognition that the rules need to be more flexible, especially when it comes to public investment. However, political uncertainty in the Netherlands and Spain could undermine an agreement on the new rules. In this scenario, and in the absence of yet another activation of the escape clause, eurozone fiscal policies would become more restrictive. That said, after a decade of austerity and ultra-low interest rates, particularly in Europe, the lesson from both the pandemic and the Ukraine War is that fiscal policy can be a powerful lever. Met with a fresh, unexpected shock, we suspect the bar to another large fiscal intervention is lower than it might have been in the 2010s.   Worker power and unionisation Trade unions were a powerful force in the 1970s, a sharp contrast to what we see today. The share of employees who are members of trade unions has decreased markedly, a trend that’s gone hand-in-hand with the decline of manufacturing across the West.       But we need to make a distinction between trade union membership (which is generally low in Europe, at least according to official data) and collective bargaining coverage. The latter is the proportion of employees whose wages are centrally negotiated, and in Europe, that’s often in excess of 90% and has typically changed much less since the 1980s. Negotiated wage growth is the highest in 30 years, albeit it has tracked well below headline inflation, and this looks more like a "catch-up" than any kind of wage-price spiral. Even in countries where collective bargaining is unusual (the US and UK), there are hints that worker power is growing. On a one-year rolling basis, the number of strike days is at its highest level since at least the early 2000s in the UK and US. That doesn’t mean union membership is increasing per se, not least because the power of trade unions under law in the likes of the US and UK has reduced over time. But it does suggest workers feel they can push for inflation-busting pay rises.       In short, regardless of whether unionisation increases over the coming years, the pandemic has shown that wage growth can still rise quickly if there are widespread worker shortages. This is changing, and most countries have seen participation rates return to pre-Covid levels. And even where they haven’t (as in the UK), there are signs that worker supply is improving. We think economic slack will increase as rate hikes increasingly begin to bite. Still, the pandemic also gave us a flavour of how the ageing populations we see in many developed economies could actually be inflationary in the medium term. In the US in particular, we saw millions of people retire in a very short amount of time. And that undoubtedly contributed to worker shortages which fed through to higher wage growth. Many economies were already starting to see this in certain industries (e.g. long-distance lorry driving) before Covid-19, and worker shortages are likely to become a persistent issue over the coming years. The ability of workers to protect real wages in future inflation shocks may well increase. That said, it’s possible that some of the labour scarcity associated with ageing will be countered by technological advances, not least Artificial Intelligence.  
Assessing the Resilience of the US Economy Amidst Rising Challenges and Recession Expectations

Assessing the Resilience of the US Economy Amidst Rising Challenges and Recession Expectations

ING Economics ING Economics 01.09.2023 09:34
The US confounded 2023 expectations that it would fall into recession as households used pandemic-era savings and their credit cards to maintain lifestyles amidst a cost-of-living crisis. But with loan delinquencies on the rise, savings being exhausted, credit access curtailed and student loan repayments restarting, financial stress will increas.   Robust resilience in the face of rate hikes At the beginning of the year, economists broadly thought the US economy would likely experience a recession as the fastest and most aggressive increase in interest rates inevitably took its toll on activity. Instead, the US has confounded expectations and is on course to see GDP growth of 3%+ in the current quarter with full-year growth likely to come in somewhere between 2% and 2.5%. What makes this even more surprising is that this has been achieved in the face of banks significantly tightening lending conditions while other major economies, such as China, are stuttering and even entering recessions, such as in the eurozone.   Consumers still happy to spend with the jobs market looking so strong So why is the US continuing to perform so strongly? Well, the robust jobs market certainly provides a strong base, even if wage growth has been tracking below the rate of inflation. Maybe that confidence in job security has encouraged households to seek to maintain their lifestyles amidst a cost-of-living crisis by running down savings accrued during the pandemic and supplementing this with credit card borrowing. The housing market was another source of concern at the start of the year, but even with mortgage rates at 20-year highs and mortgage applications having halved, prices have stabilised and are now rising again nationally. Home supply has fallen just as sharply, with those homeowners locked in at 2.5-3.5% mortgage rates reluctant to sell and give up that cheap financing when moving to a different home and renting remains so expensive. This has helped lift new home construction at a time when infrastructure projects under the umbrella of the Inflation Reduction Act are supporting non-residential construction activity.   But lending is stalling and savings have been run down The Federal Reserve admits monetary policy is now restrictive, and while it could raise interest rates further, there is no immediate pressure to do so. With inflation showing encouraging signs of slowing nicely, this is fueling talk of a soft landing for the economy. With less chance of an imminent recession, financial markets have scaled back the pricing of potential interest rate cuts in 2024, with the resiliency of the US economy prompting a growing belief that the equilibrium level of interest rates has shifted structurally higher. This resulted in longer-dated Treasury yields hitting 15-year highs earlier this month.   Outstanding commercial bank lending ($bn)   Nonetheless, the threat of a downturn has not disappeared. We estimate that around $1.3tn of the $2.2tn of pandemic-era accumulated savings has been exhausted and at the current run rate all will be gone before the end of the second quarter of 2024. At the same time, banks are increasingly reluctant to lend to the consumer with the stock of outstanding bank lending flat lining since the banking stresses in March, having increased nearly $1.5tn from late 2021. We suspect that financial stresses have seen middle and lower income households accumulate the bulk of the additional consumer debt and have run down a greater proportion of their savings vis-à-vis higher income households so a financial squeeze for the majority is likely to materialise well before the second quarter of 2024.   Rising delinquencies will accelerate as student loan repayments resume Indeed, consumer loan delinquencies are on the rise, particularly for credit card and vehicle loans with the chart below showing data up until the second quarter of this year. Since then the situation has deteriorated further based on anecdotal evidence with Macy’s CFO expressing surprise at the speed and scale of the rise in delinquencies experienced through June and July on their own branded credit card (Citibank partnered). With credit card interest rates at their highest level since 1972 and with household finances set to become more stressed with the imminent restart of student loan repayments, something is likely to give. We see the risk of a further increase in delinquencies, which will hurt banks and lead to even further retrenchment on lending, together with slower consumer spending growth and potentially even a contraction.   Percent of loans 30+ days delinquent   Downturn delayed, not averted The manufacturing sector is already struggling and we see the potential for consumer services to come under increasing pressure too. On top of this there are the lingering worries about the demand for office space and the impact this will have on commercial real estate prices in an environment where there is around $1.5tn of loans needing to be refinanced within the next 18 months. With small banks the largest holder of these loans, we fear we could see a return to banking concerns over the next 12 months. Consequently, we are in the camp believing that it's more likely that the downturn has been delayed rather than averted. Fortunately, we think inflation will continue to slow rapidly given the housing rent dynamics, falling used car prices and softening corporate pricing power and this will give the Federal Reserve the flexibility to respond swiftly to this challenging environment. We continue to forecast the Federal Reserve will not carry through with the final threatened interest rate rise and instead will switch to policy loosening from late first quarter 2024 onwards.  
Summer's End: Gloomy Outlook for Global Economy

Summer's End: Gloomy Outlook for Global Economy

ING Economics ING Economics 01.09.2023 10:08
Remember that 'back to school' feeling at the end of summer? A tedious car journey home after holiday fun, knowing you'll be picking up where you left off? I'm afraid we've got a very similar feeling about the global economy right now. 'Are we nearly there yet?'. No. Very few reasons to be cheerful Lana del Rey's Summertime Sadness classic comes to mind as we gear up for autumn. And I'm not just talking about chaotic weather or even, in my case, disappointing macro data. Most of us have had the chance to recharge and rethink over the past couple of months. and I'm afraid all that R&R has done little to brighten our mood as to where the world's economy is right now. Sure, the US economy has been holding up better than we thought. And yes, the eurozone economy grew again in the second quarter. Gradually retreating headline inflation should at least lower the burden on disposable incomes. And let's be thankful for the build-up of national gas reserves in Europe, which should allow us to avoid an energy supply crisis this winter unless things turn truly arctic. But that's about as upbeat as I can get. We still predict very subdued growth to recessions in many economies for the second half of the year and the start of 2024. The stuttering of the Chinese economy seems to be more than only a temporary blip; it seems to be transitioning towards a weaker growth path as the real estate sector, high debt and the ‘de-risking’ strategy of the EU and the US all continue to weigh on the country's growth outlook. In the US, the big question is whether the economy is resilient enough to absorb yet another potential risk factor. After spring's banking turmoil, the debt ceiling excitement, and more generally, the impact of higher Fed rates, the next big thing is the resumption of student loan repayments, starting in September. Together with the delayed impact of all the other drag factors, these repayments should finally push the US economy into recession at the start of next year. And then there's Europe. Despite the weather turmoil, the summer holiday season seems to have been the last hurrah for services and domestic demand in the eurozone. Judging from the latest disappointing confidence indicators, the bloc's economy looks set to fall back into anaemic growth once again   Little late summer warmth This downbeat growth story does have an upbeat consequence; inflationary pressure should ease further. It's probably not going to be enough to bring inflation rates back to central banks’ targets, but they should be low enough to see the peak in policy rate hikes. Central bankers would be crazy to call an end to those hikes officially; they don't want to add to speculation about when the first cuts might come, thereby pushing the yield further into inversion. And there's also the credibility issue - you never know, prices might start to accelerate again. So, expect major central bankers to remain hawkish at least until the end of the year. In our base case, we have no further rate hikes from the US Federal Reserve and one final rate rise by the European Central Bank.   However, in both cases, these are very close calls, and the next central bank meetings are truly data-dependent. Sometimes, a Golden Fall or Indian Summer can make up for any summertime sadness. But it doesn’t look as if the global economy will be basking in any sort of warmth in the coming weeks. The bells are indeed ringing loud and clear. Vacation's over; school is here. And while I'm certainly too old for such lessons, I'm taken back to that gloomy, somewhat anxious feeling I had as a kid as summer wanes and the hard work must begin once again.   Our key calls this month: • United States: The US confounded 2023 recession expectations, but with loan delinquencies on the rise, savings being exhausted, credit access curtailed and student loan repayments restarting, financial stress will increase. We continue to forecast the Federal Reserve will not carry through with the final threatened interest rate rise. • Eurozone: The third quarter may still be saved by tourism in the eurozone, but the latest data points to a more pronounced slowdown in the coming months. Inflation is falling, but a last interest rate hike in September is not yet off the table. The European Central Bank will be hesitant to loosen significantly in 2024. • China: The latest activity data has worsened across nearly every component. Markets have given up looking for fiscal stimulus, and have started making comparisons with 1990s Japan. We don’t agree with the Japanification hypothesis, but clearly a substantial adjustment is underway, and we have trimmed our growth forecasts accordingly. • United Kingdom: Uncomfortably high inflation and wage growth should seal the deal on a September rate hike from the Bank of England. But emerging economic weakness suggests the top of the tightening cycle is near, and our base case is a pause in November. • Central and Eastern Europe (CEE): Economic activity in the first half of the year has been disappointing, leading us to expect a gloomier full-year outlook. Despite this, we see a divergence in economic policy responses, driven by countryspecific challenges. • Commodities: Oil prices have strengthened over the summer as fundamentals tighten, whilst natural gas prices have been volatile, with potential strike action in Australia leading to LNG supply uncertainty. Chinese concerns are weighing on metals, but grain markets appear more relaxed despite the collapse of the Black Sea deal. • Market rates: The path of least resistance is for longer tenor rates to remain under upward pressure in the US and the eurozone and for curves to remain under disinversion (steepening) pressure. We remain bearish on bonds and anticipate further upward pressure on market rates from a tactical view. • FX: Stubborn resilience in US activity data and risk-off waves from China have translated into a strengthening of the dollar over the summer. We still think this won’t last much longer and see Fed cuts from early 2024 paving the way for EUR:USD real rate convergence. Admittedly, downside risks to our EUR/USD bullish view have grown.     Inflation has only been falling for a matter of months across major economies, but the debate surrounding a possible “second wave” is well underway. Social media is littered with charts like the ones below, overlaying the recent inflation wave against the experience of the 1970s. These charts are largely nonsense; the past is not a perfect gauge for the future, especially given the second 1970s wave can be traced back to another huge oil crisis. But central bankers have made no secret that nightmares of that period are shaping today's policy decisions. Policymakers are telling us they plan to keep rates at these elevated levels for quite some time.
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Turbulent Times Ahead: US Spending Surge and Inflation Trends

ING Economics ING Economics 01.09.2023 10:11
US spending surges, but it’s not sustainable US consumer spending is on track to drive third quarter GDP growth of perhaps 3-3.5%. However, this is not sustainable. American consumers are running down savings and using their credit cards to finance a large proportion of this. With financial stresses becoming more apparent and student loan repayments restarting, a correction is coming.   Inflation pressures are moderating Today’s main data release is the July personal income and spending report and it contains plenty of interesting and highly useful information. Firstly, it includes the Federal Reserve’s favoured measure of inflation, the core Personal  Consumer Expenditure deflator, which is a broader measure of  prices than the CPI measure that is more widely known. It rose 0.2% month-on-month for the second consecutive month, which is what we want to see as, over time, that sort of figure will get annual inflation trending down to 2% quite happily.   Services PCE deflator (YoY%)   The slight negative is the core services ex housing, which the Fed is watching carefully due to if being more influenced by labour input costs. It posted a 0.46% MoM increase after a 0.3% gain in June so we are not seeing much of a slowdown in the year-on-year rate yet as the chart above shows. With unemployment at just 3.5% a tight jobs market could keep wage pressures elevated and mean inflation stays higher for longer so we could hear some hawkishness from some Fed officials on the back of this. Nonetheless, the market is seemingly shrugging this off right now given signs of slackening in the labour market from the latest job openings data and the Challenger job lay-off series.
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Consumer Spending Strength, Sustainability Concerns, and Excess Savings

ING Economics ING Economics 01.09.2023 10:13
Consumer spending is strong, but is unlikely to be sustainable We then turn to personal spending, which was strong, rising 0.8% MoM nominally and 0.6% MoM in real terms. This gives a really strong platform for third quarter GDP growth, which we are currently estimating to come in at an annualised rate of somewhere between 3% and 3.5%. However, the key question is how sustainable this is – we don't think it is. The robust jobs market certainly provides a strong base, but wage growth has been tracking below the rate of inflation. Note incomes rose just 0.2% MoM in July. Maybe it is that confidence of job security that is encouraging households to seek to maintain their lifestyles amidst a cost-of-living crisis, via running down savings accrued during the pandemic and supplementing this with credit card borrowing. The problem is savings are finite and the banks are tightening lending standards significantly. Credit card borrowing costs are the highest since records began in 1972 so there is going to be a lot of pain out there. The chart below shows the monthly flows of excess savings since the start of the pandemic. Fiscal support (stimulus checks and expanded unemployment benefits) more than offset falling income resulting from job losses in 2020. Meanwhile, less spending versus the baseline due to Covid constraints further boosted the accumulation of savings.   Contributions of monthly changes in income and spending to the flow of savings ($bn)     Then through 2021 spending picked up, but then through 2022-2023 the nominal pick-up in incomes has been less than the increase in spending. Consequently we have seen savings flows reverse and now we are running them down each and every month, which is not sustainable over the long term.    Stock of excess savings peaked at $2.2tn, but we have been aggressively running this down ($tn)   Excess savings will soon be exhausted and financial pressures will intensify Based on this data, the $2.2tn of excess savings accumulated during the pandemic, $1.3tn has already been spent. At the current run-rate it will all be gone by the end of the second quarter of 2024 and for low and middle incomes that point will come far sooner. With banks far more reluctant to provide unsecured consumer credit, based on the Federal Reserve’s Senior Loan Officer Opinion survey, the clear threat is that many struggling households may soon find their credit cards are being maxed out and they can’t obtain more credit. With student loan repayments restarting, we expect consumer spending to slow meaningfully from late fourth quarter onwards and turn negative in early 2024.
Europe's Economic Concerns Weigh as Higher Rates Keep US Markets Cautious

Softening US Jobs Market Signals the Fed's Mission is Complete

ING Economics ING Economics 04.09.2023 10:30
Softening US jobs market suggests the Fed’s work is done The US August jobs report shows modest jobs growth, benign wage pressures and a large jump in the unemployment rate as the labour market slackens. With inflation set to continue slowing, the Fed is surely not hiking interest rates in September and is unlikely to do so in November either.   Employment growth is softening US non-farm payrolls increased 187k in August versus the 170k consensus, but there are a net 110k of downward revisions to the past couple of months, indicating that the slowing trend in employment growth remains in place. The private sector created 179k of those jobs, led yet again by private education and health with 102k jobs. Leisure and hospitality also remains a healthy provider of employment with a 40k increase. Information (-15k), trade and transport (-20k – presumably Yellow bankruptcy related) and temporary help (-19k) were the key areas of weakness.     Those numbers are all from the establishment survey of employers. The household survey, which is used to calculate the unemployment rate, reported a slightly stronger jobs gain of 222k, but the number of people classifying themselves as unemployed rose 514k with it seeming that more and more people are returning to the labour market. This increase in the participation rate is what the Fed wants to see and at 62.8%, it has risen nicely since a year ago when it stood at 62.1% and should help to keep wage pressures in check.   Wages cooling and unemployment is rising In that regard, wage growth (average hourly earnings) is soft at 0.2% MoM, the smallest increase since February 2022, while the unemployment rate jumps to 3.8% from 3.5% (consensus 3.5%). It’s pretty safe to say the Fed isn't hiking in September with this backdrop, and we don't think they will in November either, with core CPI set to slow pretty rapidly in the next couple of months.   Tightening lending conditions point to a higher unemployment rate   The Fed's work is done The chart above shows the relationship between bank lending conditions and the unemployment rate. With higher borrowing costs, less credit availability and student loan repayments all set to increasingly weigh on economic activity we fear that the unemployment rate will climb further. Unfortunately, it is unlikely to be just through rising participation rates but will likely involve some job losses too. As such, we continue to believe that US interest rates have peaked and the next move will be a cut. We are currently forecasting that to happen in March 2024.
Fed's Final Hike Unlikely as Economic Challenges Loom

Fed's Final Hike Unlikely as Economic Challenges Loom

ING Economics ING Economics 18.09.2023 09:10
We don't think the Fed will carry through with that final forecast hike. The combination of higher borrowing costs and less credit availability plus pandemic-era savings being exhausted and student loan repayments restarting should mean that households feel more of a financial squeeze in the fourth quarter and beyond. Rising credit card and auto loan delinquencies also hint at more pain with the Federal Reserve’s Beige Book warning that we may be in "the last stage of pent-up demand for leisure travel from the pandemic era". The concern is that economic softness could go too far (as highlighted by some officials in the July FOMC minutes) and heighten the chances of recession. Given this risk and the positive developments on inflation and labour costs, we think the Fed will be on hold for a number of months with the data flow gradually weakening the case for a November or December rate hike – which the market itself only gives around a 50:50 chance. Our base case continues to be more aggressive interest rate cuts through 2024 than suggested by the Fed and priced by financial markets.   A word on r* There has been some chatter about the Fed adjusting its expectation for the long run forecast for what the Fed funds target rate should be, which would be a big story given the anchor this provides for longer dated Treasury yields. This has been put at 2.5% for quite some time, but as the graphic below shows we have started to see individuals nudge their own assessments higher. The momentum suggests it is only a matter of time before it does indeed change.   FOMC individual member expectations for longer run Fed funds rate   Our own assessment is that it is likely to be closer to 3%. Fiscal policy has been loosened significantly under the Trump and Biden administrations and we don’t see that changing anytime soon – the Bloomberg consensus is for the US to run a fiscal deficit of 6% out to 2025. This will mean that monetary policy will need to be more restrictive in order to keep inflation under control. On top of this we have the so called “Triple D” of demographics, decarbonisation and deglobalisation, which will all keep upward pressure on inflation and interest rates. Regarding demographics, Baby boomers have been saving for retirement which has contributed to a glut of savings, driving down real interest rates. This process is ending as they liquidate the accumulated savings while shrinking birth rates means more competition for workers that could put upward pressure on wages. As for decarbonisation, switching from cheap and abundant fossil fuels to renewables is expensive and then there is the issue of storage and expanding the electrical grid. Energy bills are likely to be higher, which will increase costs throughout the economy. Then on deglobalisation – Covid, Russia-Ukraine, China-Taiwan have highlighted concerns about stability of global supply chains. Re-shoring and “friend-shoring” is now in vogue, but this will be disruptive and expensive, putting up costs. As such, we believe it is only a matter of time before the Fed formally declares that interest rates, over the longer term, will need to be higher than we experienced over the past 20 years.   Market rates more focused on where the Fed funds rate is in 2025. And liquidity excesses to tighten more in 2024 The journey for market rates in recent weeks has been impacted by the reduction in the size of the rate cut discount as priced by the markets out to 2025. In that sense there has been some separation between delivery of Fed policy up front and direction for market rates, with market rates rising while the immediate Fed policy rate call has been broadly non-committal (the market discount). That said, the probability for a future rate hike has been on the rise of late, relative to a clearer discount for no change only a couple of week ago. Still, the bigger impact for longer tenor rates is dominated by how low the funds rate can get to when the Fed turns to cutting. Currently that is not much below 4%. We think that will be forced lower as the economy weakens. But it is where it is for now, and that’s helping to keep the 10yr Treasury yield well above 4%, with a tendency to test towards 4.5% (Fed funds low plus a 30-50bp term premium). In terms of liquidity circumstances, the Fed will acknowledge that the volume of cash going back to the Fed on the reverse repo facility has fallen to US$1.5tr; that’s down some US$1tr from its peak. It’s an important milestone, one that is an echo of the ongoing balance sheet roll-off of Treasuries and MBS from the Fed’s balance sheet (US$95bn per month). Interestingly bank (excess) reserves have not fallen, and in fact if anything they have risen some, now in the US$3.3tr area. This is comfortable, and indicative of ongoing ample liquidity conditions despite the ongoing (soft) quantitative tightening. The Fed might like to comment on this too, largely asserting that this is a good thing, where the falls in balances going into the Fed’s reverse repo facility is the more natural means to excesses exiting the system. The reverse facility has been doing its job, and as balances ease it implies less need for a job to be done. It will feel tighter when bank reserves fall, likely through 2024 and into 2025.   Few reasons for dollar to hand back gains, yet The dollar is going into the September Fed meeting at the strongest levels since March. The concept of US ‘exceptionalism’ (both in growth and interest rates) looms large over the market and as yet there have been few reasons to bet against the dollar. The event risk of the September FOMC meeting does not seem a particularly bearish one for the dollar. As above, we are not expecting the Fed to call time on its tightening cycle. And by leaving one more hike in the dot plot, the Fed can avoid yields at the long end of the bond market slipping too far and providing premature stimulus. Indeed, the greater risk might be the Fed scaling down its dot plot median forecast of a 100bp easing cycle in 2024. A hawkish September FOMC does not mean the dollar has to rally a lot. But assuming there are no surprises, it probably means ideas of a prolonged pause in the policy cycle will see interest rate volatility fall even further and demand for the carry trade stay strong. In practice, this could see USD/JPY work its way much closer to 150 and provoke Japanese authorities into intervention – as they did this time last year. Expect EUR/USD to trade on the soft side now that the ECB has told us that rates have peaked. However, we suspect good demand will emerge near the 1.05 level. Our house call is that US ‘exceptionalism’ does not last and that US growth converges on the weak eurozone story into 2024. Typically, November and December are seasonally weak months for the dollar. Our call is that weaker US activity data will become evident over time and that the current period will come to be viewed as ‘as good as it gets’ both for US growth and the dollar. We are sticking with our call that EUR/USD will be trading above 1.10 by year-end. 
US Housing Market Faces Challenges Due to Soaring Mortgage Rates

US Housing Market Faces Challenges Due to Soaring Mortgage Rates

ING Economics ING Economics 25.09.2023 11:04
US housing feels the squeeze from high mortgage rates A tripling of US mortgage rates constrained both the demand and supply of housing, leaving existing home sales at post-GFC lows. Mortgage rates will rise further in the wake of the market's reaction to yesterday's Fed forecasts, further constraining activity.   Market acknowledges the risk of a final hike, but it will depend on the data The Fed's messaging of higher for longer interest rates has been taken on board by financial markets, with the dollar strengthening and the yield curve shifting higher in the wake of yesterday's decision. Nonetheless, the market remains somewhat sceptical on the prospect of the final 25bp interest rate rise that the Fed's forecasts signalled for this year, with the pricing for November's FOMC meeting only being 8bp with 13bp priced by the time of the December meeting. The jobs market remains tight, as highlighted by low jobless claims numbers today, but we continue to believe that core inflation pressures will slow meaningfully, the economic outlook will soften, and the Fed won't end up carrying through. The jobs market is always the last thing to turn lower in a downturn and there are areas of more obvious weakness.  For example, US existing home sales fell 0.7% MoM in August to a level of 4.04mn rather than rising the 0.7% MoM as the market expected. This is due not only to weakness in demand but also a complete collapse in properties available for purchase. The affordability issue is front and centre here, with prices having risen nearly 50% nationally during the pandemic, but demand has obviously been crushed by the fact that mortgage rates have tripled since the Federal Reserve started hiking interest rates. But this surge in borrowing costs is constraining the supply of homes for sale as well - people who are locked in at 2.5-3.5% mortgage rates cannot afford to give them up. They can't take the mortgage with them when they move home, so even if you downsize to a smaller, cheaper property, you are, in all likelihood, going to end up paying a higher monthly dollar mortgage payment.   We're in a crazy-sounding position Consequently, we are in a crazy-sounding position whereby the number of housing transactions is on a par with the lows seen during the global financial crisis, yet home prices are rising. This should be a boon for home builders, but note the big drop in sentiment and housing starts seen earlier in the week. The drop-off in prospective buyer traffic is making builders cautious. Mortgage rates at 7%+ will obviously do that over time, but it may be another sign of the household sector starting to pull back at the margin now that the Fed believes pandemic-era savings are close to being exhausted.   Existing homes sales transactions and home prices   Leading index still indicates recession can't be ruled out Meanwhile, the US leading economic indicator, which combines a range of other numbers, including jobless claims, orders, average work week, the yield curve and credit conditions, posted its 17th straight monthly decline. As the chart below shows, the index at these sorts of levels has been a clear recession indicator in the past, but for now, GDP growth is strong.   Leading index versus GDP (YoY%)   Our view remains that this strength in activity has been caused primarily by households running down pandemic-era accrued savings aggressively and borrowing more on credit cards. But with savings obviously being finite - note the Fed's Beige Book citing evidence of the "exhaustion" of these savings - and consumer credit harder to come by and certainly less affordable than it was, the cashflow required to finance ongoing increases in spending will have to increasingly come from rising real income growth. Rising gasoline prices will erode spending power while student loan repayments, strikes and the prospect of a government shutdown will add to the financial stresses on millions of households, so we will need to see substantial wage increases for everyone - not just auto workers - to keep this growth engine firing.  Given this situation, we not only think the Fed will leave rates at their current levels, we also see the potential for more rate cuts next year than the 50bp currently being signalled by the Federal Reserve.
A Bright Spot Amidst Economic Challenges

A Bright Spot Amidst Economic Challenges

Ipek Ozkardeskaya Ipek Ozkardeskaya 25.09.2023 11:05
A bright spot If there is one bright spot in Britain with all this, it is the FTSE100. First, the rising energy prices are good for the energy-rich FTSE100. Second, softer sterling makes these companies more affordable for international investors, who should of course think of hedging their sterling exposure, and third, more than 80% of the FTSE100 companies' revenues come from oversees, which means that when they convert their shiny dollar revenues back to a morose sterling, well, they can't really complain with a stronger dollar. Consequently, if a more dovish BoE is bad for sterling, the combination of a hawkish Fed and a dovish BoE and a pitiless OPEC is certainly good for the FTSE100. The index has been left behind the S&P500 this year, as the tech rally is what propelled the American index to the skies, but that technology wind is now turning direction. The FTSE 100 broke its February to September downtrending trend to the upside and is fundamentally and technically poised to gain further positive traction, whereas, the S&P500 is heaving a rough month, with technology stocks set for their worse performance this year, under the pressure of rising US yields, which make their valuations look even more expensive.   Interestingly, the US 2-year yield peaked at 5.20% after the Fed's hawkish pause this week and is back headed toward the 5% mark, but the gap between the US 2-year yield and the top range of the Fed funds rate is around 40bp, which is a big gap, and even if the Fed decided not to hike rates, this gap should narrow, in theory. If it does not, it means that bond traders are betting against the Fed's hawkishness and think that the melting savings, the loosening jobs market, tightening bank lending conditions and strikes, and restart of student loan repayments and a potential government shutdown could prevent that last rate hike to happen before this year ends. And indeed, activity on Fed funds futures gives more than 70% chance for a third pause at the FOMC's November meeting, and Goldman Sachs now sees the US expansion slow to 1.3% from 3.1% printed in the Q3. KPMG also warned that a prolonged auto stoppage may precipitate contraction. And if no deal is inked by noon today, the strikes will get worse.   One's bad fortune is another's good fortune  The Japanese auto exports surged big this year, they were 50% higher in yen terms. The yen is certrainly not doing well, but yes, you can't have it all. That cheap yen is one of the reasons why the Japanese export so well outside their country. And in case you missed, the BoJ did nothing today to exit their hyper-ultra-loose monetary policy. They didn't even give a hint of normalization, meaning that the yen will hardly strengthen from the actual levels. In the meantime, Toyota, Mitsubishi and Honda shares are having a stellar year, and the US strikes will only help them do better. 

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