Last week, Wall Street investors were betting on a soft-landing with an 'all or nothing' mindset, following positive CPI data and the Fed's decision to pause rate hikes. They have become more risk-taking when…
… increasing investments in small companies…
… and even betting more on junk bonds.
However, according to Viet Hustler, weak consumption data, the labor market starting to turn negative, and the ongoing credit crunch situation as it currently stands are warning of the brink of recession that the Fed may have to face in 2024.
Viet Hustler's weekend macroeconomics article will review the current data on consumption, labor, and corporate capital markets.
In which, Viet Hustler wants to emphasize the importance of changes in consumer spending - the biggest determinant of the current recession risk.
Additionally, Viet Hustler will also evaluate the actions that the Fed and the US government may take once a real recession hits the US economy.
1 - Consumer spending: the most important factor determining recession risk
US consumer sentiment throughout the inflation period
The chart below clearly explains the contrasting consumer demand situation in the US and China post-Covid:
In the US, consumption exploded post-Covid and remained higher than pre-Covid levels until this year, which explains why US GDP is still growing despite Fed rate hikes.
However, US consumption is showing signs of decline recently.
This is completely different from consumption in China (only increased when the two economies reopened, and plummeted severely after the 2022 real estate crisis).
In fact, consumer spending has shouldered nearly 70% of US economic growth in previous quarters,
… as households used their Covid-era savings to fund the surge in spending.
FYI: During the student debt forbearance period, up to 74% of debtors paid nothing.
This is one of the reasons for the surge in the savings rate during that period (as in the chart above), but also raises questions about whether US consumers' spending power remains when they have to resume student debt payments.
Another factor is that over the past year, consumer inflation psychology has led people to accept high prices and continue spending without hesitation:
To date, American sentiment remains mixed:
expectations that prices will continue to rise higher (left chart), while still having a pessimistic view of the economic outlook at the bottom (right chart).
(according to UMich consumer sentiment survey)
The burden of inflation and high interest rates has begun to affect consumer spending after the cash buffer is nearly depleted
Aggregate inflation has cooled (only at +3.2% y/y) but inflation remains too high in some basic items such as:
Car insurance costs: +19.2% y/y
Car repair costs: +9.6% y/y
Dining out costs: +5.4% y/y ….
Therefore, at some point, people will exhaust their Covid-era cash buffer. To maintain consumption amid inflation pressure, Americans choose to borrow:
Interest payments on US personal debt have now reached USD 500 billion - an unprecedented figure in history.
The rate of increase in borrowing costs for consumers has only surged during the Fed's more than one year of rate hikes…
Total consumer debt outstanding of Americans at commercial banks has also increased rapidly during this period.
Particularly, the credit card delinquency rate at small banks (group of banks with concentration risk on consumer credit debt) is at 7.51% - the highest level ever.
This is the premise for consumer demand starting to weaken… (when they can no longer borrow to fund consumption).
Americans have started cutting back on spending
Recent consumer data has shown a deteriorating trend:
According to Bank of America internal statistics:
Credit card spending by Americans through this bank has dropped sharply, especially in the retail consumption segment (including restaurant services).
Among them, the low-income group (< $50,000/year) has witnessed the deepest stagnation in consumption growth compared to the previous period.
=> This may signal an upcoming slowdown in overall US economic growth, which primarily relies on consumer spending.
Walmart supermarket chain also has a cautious view on Americans' consumption capacity
Declining consumer demand is directly reflected in retail sales:
US real retail sales (inflation-adjusted) fell -1.6% y/y, the 12-month y/y decline, also the longest decline streak since the 2008-09 season.
Nominal retail sales still rose +1.6% y/y but much lower than the historical average +4.7% y/y.
2- Labor market: direct warning of recession risk
If previously the Fed was still confident in a strong labor market, recent labor data and indicators may truly make the Fed cautious.
Sahm Rule (Sahm Rule) and Sahm Recession Indicator (Sahm Recession Indicator)
Content of the Sahm Rule:
Sreal recession begins when the national U3 unemployment rate (per BLS statistics) 3-month MA rises above +0.50% compared to the low in the previous 12 months.
=> This % increase figure is called Sahm recession indicator — an “empirical” measure proposed by Claudia Sahm, a Fed economist and member of the US Council of Economic Advisers.
The Sahm recession indicator surged from +0.2% (September) to +0.33% in October 2023.
The Sahm rule has been criticized for relying solely on a single timeseries data point, the U3 unemployment rate, and a fixed threshold (+0.5%), ignoring constantly changing factors like demographics, technological development, or labor market structure.
Nevertheless, the main significance of the Sahm rule is not in the numbers. It simply reflects that: even if the unemployment rate appears low, if there is upward momentum (3 months MA), it will quickly turn into a significant increase (as in the chart above).
The reason is that recessions have the potential to “self-escalate,” where rising unemployment is the most important criterion because it leads to sudden spending cut decisions by consumers.
Official statistics on unemployment and employment
Last week, continuing jobless claims rose to the highest level since 2021.
Currently, there are up to 1.865 million people still receiving unemployment benefits.
It must be emphasized that the unemployment benefits figure is a leading indicator of the unemployment rate (chart below).
Therefore, in the next 3-4 months, the unemployment rate may soon rise rapidly.
In addition, both composite employment indices: leading indicator (leading indicator) and coincident indicator for labor (coincident indicator) are following exactly the average trajectory during previous recessions (2008, 2001, 1990, 1980, 1970),
(measured by the number of months since the 10Y3M yield curve inverted)
Although past data does not fully reflect the future, this unexpected overlap also signals the risk of high unemployment pushing the economy into recession.
3 - Credit crunch in the financial market
Credit crunch is still present in the financial market even though most businesses have not yet felt it (due to no need for refinancing).
Lending activity at US banks is declining compared to last year:
Year-over-year (y/y) growth in total loan value has turned negative
The only time this figure fell below the 0% threshold was after the 2008-2009 Global Financial Crisis.
Additionally, delinquency on commercial real estate loans has reached a 10-year high at US banks.
FYI: Viet Hustle has previously warned that the commercial real estate market could trigger a systemic crisis for small banks (regional banks) since more than ⅔ of commercial real estate debt is held by this group of banks.
What can the Fed do in this situation?
The answer is too simple: cut interest rates… but the difficult question is: should the Fed cut rates quickly or slowly to
avoid undermining the previous rate-hiking cycle, (i.e., if the Fed cuts rates too abruptly, inflation could rise again….)
While still being timely enough to prevent the impact of declining consumer demand and credit crunch in the capital markets (FYI: credit crunch in the capital markets is the precursor for businesses to lay off employees, leading to rising unemployment)...
The market is quite excited anticipating that the Fed will cut rates by -1% in 2024 for this reason.
However, after inflation subsides, to address the decline in consumer demand, the Fed cannot act unilaterally.
Fiscal policy from the US government to stimulate consumption and reduce cost/savings pressure is also very important:
…. for example, student debt forgiveness or combating overcharges on medical costs for citizens (as in the initial action by the US Consumer Protection Bureau recently).
CONCLUSION
Consumer spending accounts for 70% of US economic growth; however, recent weakening consumer data has confirmed that this narrative is no longer realistic. Americans' sentiment may initially remain optimistic as they continue borrowing to spend. But borrowing will soon end when they realize that their debt servicing costs and total debt balances have risen too high. Currently, people are gradually cutting spending, as evidenced by inflation-adjusted retail sales growth and bank card spending figures.
Additionally, the labor market has shown initial signs of cracking as initial jobless claims have surged — this is a leading indicator that the unemployment rate will soon rise accordingly. The Fed's Sahm recession indicator also points out that once unemployment ticks up slightly, it is an early sign of unemployment exploding at the end of each recession cycle. Finally, the credit crunch in the financial market will soon impact businesses. If businesses start laying off employees due to cost and funding difficulties, the unemployment rate will truly explode in 2024.
What is particularly noteworthy, which perhaps few people are paying attention to, is the risk of a financial crisis for small banks, as these banks face concentration risk in consumer debt loans and commercial real estate debt. Perhaps, the Fed will have to consider this as well!
Comments (0)
No comments yet
Be the first to comment
Login to comment