The US economy is arrogantly strong. Services have been picking up the slack for contracting manufacturing. Job market is resilient. Even home sales decreased less in Jul23. And thus, in spite the sharpest rise in interest rates over 2 decades.
Are we going too far? No matter how much the oracles of Jackson Hole would obsess about the R*, which measures the theoretical level at which rates neither stimulate nor restrict an economy, the data they feed into the equation is changing fast.
There remains that US yields are much higher than anywhere else in the developed world, with the notable exception of the UK that struggles with brexiting issues of its own. This shows in the supreme strength of the USD that is notching new 2023 highs.
Is that a problem? For starter, it is forcing the hand of global central banks to follow suit in the rate-hiking spree. Hiking rates support their currency, but in doing so they burn some reserves, notably US treasuries. China’s and Japan’s holding of US bond declined by a combined $200bn between Jun22 and Jun23. So far, other countries have been picking up the slack, as a 5%-ish USD return remained too compelling.
For the US, deleveraging has barely started. Households are said to be exhausting their remaining savings only in late 2023, corporate debt wall only comes meaningfully in 2025, and effective rate on US mortgages is only at 3.6%.
The net result is that higher interest rates have not sunk in, and the effect remains to be seen across high yield credit. The pressure is still very much on for real estate, consumer credit and therefore banks. Banks are provisioned and ready, albeit smaller ones are still in the woods, scrambling for liquidity branches to cling to.
Deleveraging comes with collateral damage. In China, the brutal stop in real estate lending has caused major lenders, such as Evergrande and Country Garden, as well as shadow banks to go belly up. In the US, delinquency rates started to pick up on credit cards and auto loans, although the overall delinquency rate remains rock bottom at 1.72% in 2Q23.
In all likelihood, cheap liquidity will buffer any major shock well into 2024. At the same time, high interests rates on national debt will get harder to carry. The wild card is surely on inflation trajectory. More fundamentally, political determination to drain the excess liquidity fully will certainly be challenged in an election year. If the debt ceiling episode is any hint, I’d say that the debt-binging saga will go on.
We are surely treading on a thin line. Bear in mind that US rates are as high as they were in Jun2007…on the eve of the GFC. The wind always blows the same way: banks are likely to cause the next upheaval. As such, we’ll be monitoring any acceleration in credit deterioration from the bottom up, but from China to the US the move has surely started.
Well, on this note, stay safe out there !
360 Advisory LLC is a Boston-based RIA managing investments