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The much anticipated recession never came. Now the narrative has flipped to 'no recession', or even a 'new cycle/economic expansion'...
These have all been published within the past week or so.
All of these takes are justified. There was a strong consensus at the start of the year that 2023 would see a recession. Everything seen so far sits firmly under the slowing/normalising economy umbrella.
The narrative pendulum has now swung the other way. Economic victory laps & recession cancelled are becoming the new consensus.
So.... Are we THERE yet?
You know, the end is nigh and all that?
I've been wrong enough times to not even attempt to answer. However, chatter about a new cycle or expansion is definitely a step too far for me.
Selection bias on steroids.
Take the US housing market for example. Some of the typical leading indicators like housing starts and builder sentiment look to have turned... 👇
The cost of construction measured by PPI has fallen, allowing homebuilders to continue building and maintain the incentives/buydowns that keep sales ticking over...
However, the other side of the housing market is in the doldrums... 👇
So, housing isn't quite the indicator it was. If you look at mortgages, refinancing, and general housing turnover, it's not great. But for homebuilders, it's fine...
Employment continues to surprise
Typified by today's ADP report... 👇
Private employers added 497,000 jobs in June
Job creation surged in June, led by consumer-facing services. Leisure and hospitality, trade and transportation, and education and health services showed strong gains.
Still, the market was fragmented, with manufacturing, information, and finance showing declines.
Even though the report showed nearly half a million (!) jobs added in a month, ADP's chief economist Nela Richardson added a caveat... 👇
Consumer-facing service industries had strong June, aligning to push job creation higher than expected. But wage growth continues to ebb in these same industries, and hiring likely is cresting after a late-cycle surge.
Arguably, this hiring surge is a mixture of labour normalisation in the lagging industries, and strong demand for holidays and travel this summer.
However you measure them, wage trends are tracking lower... 👇
It's still pretty healthy, but definitely normalising. The 'red hot' labour market isn't red hot anymore, but it's a long way from the deep freeze.
The Never-Starting Recession
Between the pandemic stimulus putting money directly into pockets, and spending driven by the Inflation Reduction Act (IRA), the US economy is a long way from recession..
Once again though, we're back to the question of... for how much longer?
The more hikes the market prices in, and/or the longer that rates are priced to stay at these elevated levels, the larger the eventual drag on the economy... 👇
Time for the credit cycle to take centre stage?
We've been in the middle stage for a good six months now. Leverage has been building over the past decade of exceptionally low interest rates. This leverage is the dry kindling waiting for a spark...
TheSpreadSite has just published an excellent report looking at where we are in this credit cycle... 👇
We think this (current) stage is important for three key reasons.
High and rising leverage doesn’t matter (often for years) until vulnerable companies lose access to credit. In this sense, tighter credit conditions is the catalysts for stress to spread.
The timing of acute credit events is hard to predict, but as we saw this past spring with the regional banks, when rates are high and credit is tight, the risks of those shocks goes up by an order of magnitude.
Tighter credit and higher borrowing costs drive a negative feedback loop, by impacting corporate and consumer behavior, as we discuss below.
There's a strong case to say that rates are heading into restrictive territory. Rising rates now are at odds with recent disinflationary trends, which increases the risk of 'unforeseen' credit events and/or a negative feedback doom loop.
This next stage, which we think markets are soon entering, is the negative feedback loop from credit to the economy back to credit back to the economy.
In other words, corporates and consumers cut back at the margin – in some cases because they want to (it is more expensive to finance new capex/spending) in other cases because they have to (for example, regional banks reducing lending to build capital).
The cost cutting always begins with low hanging fruit, but eventually leads to jobs if it gets bad enough, because labor is the biggest lever available for corporates to pull. This retrenchment weakens the economy and thus earnings, which pushes corporate leverage even higher (the denominator in debt/EBITDA drops).
As a result, credit quality weakens further, bank portfolios deteriorate/ non-banks suffer portfolio stress, which leads to more credit tightening and more cost cutting.
The full report is well worth a read, and could prove very timely. Economic positivity has pushed yields back towards the regional bank pain zone.
Also keep an eye on Asia. Higher US rates increase dollar funding costs... 👇
In any case, there is a risk of disruption to dollar funding markets arising from a potentially large and sudden need for China’s banks and corporates to roll over dollar-denominated debts.
Absent a means of rapidly and efficiently dealing with these large dollar funding stresses, the adverse impacts on China’s financial stability and economic growth could be substantial, and could spill over to the rest of the world.
Summing up, risks are lurking everywhere. Nobody really seems to care for now (and hasn't since the regional bank crisis) but the scales are likely to rebalance again over coming months. Maybe sooner if rates keep moving like this.
One thing we're wondering is if the UK will be the canary in the coalmine. That's going to be tomorrow's topic...