Chart of the Week
October 16, 2020
Commercial Credit | Banks tighten, Market loosens
Adding to the growing list of things zigging this days as opposed to how they have historically zagged is commercial credit. As has historically been the case in a recession, banks have tightened up their standards for lending to businesses. This tightening of lending standards has historically corresponded with higher credit spreads in the publicly traded corporate debt markets - i.e., an increase in the yield on corporate debt relative to risk-free government debt - as investors require more compensation for the increased risk of default. Not this time, however. As the graph below shows, banks are continuing to tighten credit (the blue line) as one would expect, but corporate credit spreads (the red line), after initially spiking higher in March, have normalized back to less stressed levels thanks to the actions taken by the Federal Reserve to buy corporate bonds for the first time to calm the markets. This has led to record corporate debt issuance in recent months as large corporations with access to the public debt markets have taken advantage of the accommodating market environment and low interest rates. Smaller businesses that rely on banks for loans have not been as fortunate. The growth in total corporate debt usually slows or turns negative following a recession, leading to a decline in corporate debt as a percentage of GDP (see the second chart). The growth of commercial loans from banks looks likely to follow that historical pattern, but the issuance of new publicly traded corporate debt may lead total corporate debt to buck that trend. Much like with the burgeoning federal government debt, it remains to be seen if and when ever higher levels of corporate debt will cause problems.
October 9, 2020
Consumer Credit | Paying off those credit cards
As the powers-that-be in Washington continue to debate additional fiscal stimulus, it is clear that one of the things individuals have done with the first round of Covid-relief checks and extra unemployment insurance is to pay off some of their outstanding credit card balances. As shown in the blue line in the chart below, revolving consumer credit is down over 9% since last year - a much quicker drop than previous recessions. Auto loans and other non-revolving consumer credit (the red line) has continued to grow but is also starting to show signs of slowing down. The second chart shows the monthly flows in revolving and non-revolving credit. The fact that individuals are putting their fiscal houses in order should help set a firmer foundation for the future economic expansion, but to the extent it is indicative of wary consumers and lenders, it may be another sign of a pending slow economic recovery.
Consumption and Savings | An unusual recession
October 2, 2020
The government's unprecedented fiscal stimulus has thus far in aggregate more than offset the decline in wages and income as seen in the first chart below. The government has done a good job in mitigating declines in income during past recessions. This time around, however, the government has more than compensated, leading to a record jump in disposable income in April, and even through August, disposable personal income in aggregate was still nearly 4% higher than it was last year at this time while income and wages were down by more than 2%. That plus the odd conditions accompanying a pandemic have led to some unusual spending and savings numbers over the past six months. In particular, the consumption of goods (the blue line in second graph) has spiked higher while the consumption of services (the green line) has lagged. Typically the reverse is true, but a pandemic makes getting out difficult and buying stuff online more attractive. At the same time, given the uncertainty of the moment and the amount of cash the government has pushed out the door, folks are also saving much more than usual. The personal savings rate spiked to over 30% in April when the government dumped money into bank accounts, but you couldn’t leave your house to spend it. Five months later, the savings rate was still higher than at about any point in the past sixty years. This should provide some cushion for individuals if more government stimulus is not passed, but if savings remains high that clearly will slow consumption and the economic recovery.
September 25, 2020
Federal Debt | Does it matter? We shall see.
In its latest long-term forecast for the federal budget released this week, the Congressional Budget Office (CBO) projected that the federal debt held by the public would increase steadily towards nearly 200% of GDP by 2050, nearly double the previous peak reached during World War II. (See the first graph below.) The CBO’s bi-annual projections have painted an increasingly dire fiscal picture for the federal government with the latest deterioration being driven by the pandemic-induced recession and the massive fiscal spending that has accompanied it. The sizable long-term budget deficits forecasted by the CBO are in large part based on the expectation for rising interest expense as both the amount of debt and the cost of financing it are projected to increase over time. (See second chart below.) The CBO projects that the net interest expense as a percent of GDP will rise from 1.6% today to 6.5% in 2050. For some perspective, the net interest expense on the federal debt was just 3.2% in 1991 when concern about the federal deficit was at its zenith. Lawmakers have been able to ignore the expanding federal debt over the past two decades as declining interest rates have kept down the cost of financing large annual deficits. Even if interest rates never go up again, the CBO projections indicate that the federal debt will continue to grow faster than the economy. But the powers-that-be will likely continue to ignore it, for better or worse, until the cost of paying for the snowballing debt gets high enough to once again grab their attention.
Source: Congressional Budget Office,
Low Rates | Gonna need a bigger piggy bank
September 18, 2020
The Federal Reserve indicated this week that it plans to keep interest rates at their historically very low level until at least 2024. The suppression of risk-free interest rates (and now even risky interest rates with the Fed's recent actions in the corporate bond market) has undoubtedly played a role in pushing asset prices higher in recent months. What the other positive or negative ramifications of the Fed's policies will be remains to be seen. One potential unintended consequence could be increased savings (and in turn lower consumer spending) as the amount of savings necessary to generate income has skyrocketed (see the chart below). The alternative is for investors to move further and further out the risk curve in search of income (and in turn push risky asset prices higher and higher, fostering potential financial instability). Policymakers are in the unenviable position of having to try to untie the Gordian knot of how best to support the economy in the short and long run. The Fed's swift and unprecedent response to the pandemic have helped to prop up the economy and the market over the past six months, but it's possible policymakers are offering up too much of a good thing for the long-run health of the country.
Source: fred.stlouisfed.org, AOWM calculations -- $50k / 10-yr yield
Inflation | Speeding along thanks to used cars
September 11, 2020
How inflation behaves in the coming months and years will play a big role in determining how effective the unprecedented fiscal and monetary stimulus that has been unleashed will ultimately prove to have been for supporting the economy and the market. If high, volatile inflation has been unleashed, economic growth and stock valuations will suffer in the long run. Recent months have seen a jump in inflation, but so far it may just be a reasonable rebound from the unusual decline in prices experienced back in the spring during the lockdowns. August inflation numbers released on Friday saw another healthy month-over-month increase in consumer prices. Monthly inflation was down from July, but core monthly inflation excluding food and energy (the blue line in the first graph below) continues to run hotter than it has since the early 1990s. The high monthly inflation in August was in part due to the biggest monthly jump in used car prices since 1969 when overall annual inflation was running at more than 5% (see second chart below).
Historic Market Rally | Main Street Still Hurting
September 4, 2020
At the close of the market on Wednesday, the S&P 500 Index hit another record high capping a 60% rally off its March 23 low – a five-month rally unlike anything seen since the early 1930s. (See the first chart below.) And those market rallies in the 1930s came only after investors had endured almost three years of falling prices that drove the market down by more than 85%. We just had to endure a 34% month-long market decline, before stocks took off fueled by unprecedented fiscal and monetary stimulus that drove the valuation of the S&P 500 relative to forward estimated GAAP earnings above levels seen during the tech stock boom in the 1990s. But as the last two days of the week suggest, the market may have gotten more than a little ahead of itself. Indeed the latest jobs report for August released Friday, while showing an encouraging drop in unemployment to 8.4% and further declines in temporary layoffs, also reported a new increase in the number of permanent job losses – which is a better indicator for the underlying health of the job market. As the second chart below of the year-over-year change in the S&P 500 and the year-over-year change in permanent unemployment (inverted) indicates, the market does indeed bottom and start to show life before the economy, but the gap between Wall Street’s forward optimism and Main Street’s current pain is larger than normal. Even after the sell-off at the end of the week, the S&P 500 is still up more than 15% over the past year while permanent job losses are up 2.1 million and trending higher.
Source: Yahoo Finance, fred.stlouisfed.org, AOWM calculations
Monetary Policy | Shooting for more inflation
August 28, 2020
This week the Federal Reserve announced a significant update to its stated longer-run goals and monetary policy strategy. The Fed has moved from having a specific inflation target of 2%, above which monetary policy would likely be tightened, to a flexible average inflation target that would allow monetary policy to remain more accommodating during a recovery. Specifically, the revised strategy statement indicates that "following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time." Long-term Treasury yields ticked up slightly on the news and the expectation for potentially higher inflation. Long-run market inflation expectations as measured by the spread between the nominal 10-year Treasury yield and the 10-year Treasury Inflation-Protected Securities (TIPS) yield has been grinding higher since the market bottom at the end of March and continued to do so after yesterday’s announcement. The graph below shows the nominal 10-year Treasury yield (the blue line), the real 10-year TIPS yield (the red line), and the expected break-even inflation rate (the orange line) from which we take note of two things: 1) 10-year inflation expectations remain well below the Fed’s 2% target suggesting that investors don’t yet believe the Fed will be able to generate its target average inflation, though their belief that higher inflation is on the horizon grows with each passing day; and 2) while market inflation expectations have been moving higher, nominal rates have remained largely unchanged as real yields decline, all suggesting the bond market has been increasingly pricing in expectations for a period of stagflation (i.e., rising inflation but weak economic growth). How much the Fed’s growing balance sheet is distorting the signals provided by the bond market is an open question as is how increasing efforts to emphasize an extremely loose monetary policy for as far as the eye can see might be inflating asset prices to a dangerous degree.
Stocks | What Bear Market?
August 21, 2020
The S&P 500 Index set a new all-time high this past week, eclipsing its pre-Covid lock-down high on February 19 and officially making the 34% decline in the market that bottomed on March 23 the shortest bear market in history at just 32 calendar days and 23 trading days. The typical bear market over the past 75 years has lasted for over a year with the previous shortest bear market during that period being the market blip in 1987 that lasted 100 calendar days and 71 trading days. The rebound has been equally unprecedented, with the overall market reclaiming all of its lost ground in less than four months when it typically takes years. Again the previous quickest recovery was after the 1987 market decline and that took nearly two years. The trillions of dollars in fiscal and monetary stimulus that have been pumped into economy have helped the market quickly rebound while also potentially pushing some stocks to overly optimistic valuations. The rising market tide has not lifted all boats equally, however, as 64% of the stocks in the S&P 500 are still below their price on February 19 with 47% down more than 10% and 33% down more than 20%. Whether the winners of the past few months will falter to join the laggards or the economy will rebound sufficiently for the laggards to catch up is the big question. Trading technicals and investor sentiment suggest that the general stock market is due for at least a mild correction or pullback, but Mr. Market has proven to be inclined to defy expectations these days.
Source: YCharts, Yahoo Finance, AOWM calculations
Financing the Federal Deficit | No TIPS Please
August 14, 2020
Thus far the US Treasury has largely funded the federal government's record budget deficit this year by issuing record amounts of short-term Treasury bills that mature in one year or less. This has pushed the T-bills’ share of the Treasury’s marketable debt to over 25%. In recent weeks, the Treasury has started to shift its financing out the yield curve by increasing the auction sizes for its long-term Treasury notes and bonds. However, the Treasury is not increasing its issuance of inflation-protected securities (TIPS) despite its massive financing needs and the strong demand for TIPS at the moment. TIPS are harder for the government to payback as their redemption value grows with inflation which forecloses a popular method for paying off the public debt by inflating the value of the currency. TIPS have fallen to less than 8% of the Treasury’s outstanding marketable debt. The charts below show the record net issuance over the last two fiscal quarters of 2020 (the federal government’s fiscal year ends on September 30) and the percentage of outstanding Treasury debt in T-bills, TIPS and floating rate notes.
Source: U.S. Treasury, https://home.treasury.gov/system/files/221/TreasuryPresentationToTBACQ32020.pdf
Labor Market | Encouraging Signs
August 7, 2020
Some encouraging news for the labor market this week. Initial jobless claims, though still over a million, fell to the lowest level since the surge in claims began in mid-March, and the jobs report for July released Friday morning showed the economy added 1.8 million jobs last month as the unemployment rate fell to 10.2% from 11.1% in June and a peak of 14.7% in April. Employees continue to be called back from temporary layoffs (the red line in the chart below), and even more encouragingly the number of permanent job losses (the blue line in the chart) stabilized in July after increasing rapidly over the preceding four months. Whether the increase in permanent job losses has peaked or merely paused is the big question.
Source: U.S. Bureau of Labor Statistics, Unemployment Level - Permanent Job Losers [LNS13026638], retrieved from FRED, Federal Reserve Bank of St. Louis; Unemployment Level - Job Losers on Layoff [LNS13023653], retrieved from FRED, Federal Reserve Bank of St. Louis; August 7, 2020.
Economic Growth | Historic Decline
July 31, 2020
The initial estimate of real GDP growth in the second quarter is that the economy shrank at an annualized rate of 32.9% and was 9.5% smaller than it was a year ago. While the recovery appears to have slowed over the past month, the annualized growth this quarter is still likely to be impressively strong. The New York Fed recently developed a Weekly Economic Index to attempt to track the growth of the economy in real time. That index currently estimates that the economy is still about 6.6% smaller than it was a year ago. (For some perspective, at the nadir of the last "great" recession, the economy was down 3.9% on a year-over-year basis.) However, even if the economic recovery completely stalls at this depressed level, annualized real GDP growth in the third quarter will still be over 16% based on the current Weekly Economic Index estimate – historic economic growth that may feel like anything but that with unemployment above 10% and weekly initial jobless claims consistently well over one million. The first chart below shows the year-over-year change in real GDP in red since 1948 and the Weekly Economic Index in blue since 2008. The bottom chart shows the Weekly Economic Index over the past year.
Source: Lewis, Daniel J., Mertens, Karel and Stock, James H., Weekly Economic Index (Lewis-Mertens-Stock) [WEI], retrieved from FRED, Federal Reserve Bank of St. Louis; ; U.S. Bureau of Economic Analysis, Real Gross Domestic Product [GDPC1], retrieved from FRED, Federal Reserve Bank of St. Louis;
Notable Trends | Tracking Covid-19's Impact
July 24, 2020
Starting the last week in April, the U.S. Census Bureau began a new weekly survey to measure the impact of the Covid-19 pandemic. Below are the changing responses over the past eleven weeks. The survey indicates that half of the households in the US have now experienced some loss of income since the middle of March, and over a third expect to experience a loss of employment income over the next four weeks – a number that has ticked higher in recent weeks as Covid-19 cases have spiked and the economic recovery has at best slowed. Unprecedent relief payments from the federal government have largely offset those losses in wages to date; however, even with the passage of another government stimulus package on the horizon, the negative economic impact of the pandemic is likely to increase in the coming months for millions of Americans.
Source: US Census Bureau, https://www.census.gov/programs-surveys/household-pulse-survey.html
July 17, 2020
Banks | Deposits up, Loans down
This past week, the biggest banks reported second quarter earnings, which were generally better than lowered expectations thanks to trading profits offsetting increasing provisions for credit losses as the outlook for the economy turned gloomier over the past quarter. On the plus side, bank deposits have increased significantly in recent months because of the significant government stimulus which has left bank accounts flush with cash. The effect of that stimulus has thus far been somewhat muted by the fact that banks have not multiplied that freshly printed cash through the financial system via new loans, excluding loans made as part of the Paycheck Protection Program. Indeed bank loans as a percentage of bank deposits have fallen to their lowest level since the mid 1970s (the blue line in chart below), accompanying a general decrease in the velocity of money – i.e., how many times a dollar circulates through the economy (the red line in the chart below). A decline in the demand and supply of bank credit as borrowers look to pay down debt and banks tighten lending standards in the current uncertain environment would be a headwind to a brisk recovery. However, at the same time, the decline in the velocity of money should also mitigate concerns about inflation, at least in the short term.
Source: Board of Governors of the Federal Reserve System (US), Loans and Leases in Bank Credit, All Commercial Banks [TOTLL], Deposits, All Commercial Banks [DPSACBW027SBOG], Velocity of M2 Money Stock [M2V], retrieved from FRED, Federal Reserve Bank of St. Louis;
Labor Market | Hard to Comprehend
July 10, 2020
The jobs report for June offered hopeful signs of a recovering labor market as unemployment fell to 11.1% and labor force participation moved higher. However, behind the encouraging headlines was the disconcerting rapid increase in permanent job losses which are increasing much more quickly than in the past two recessions. Also hard to square with the falling official unemployment rate is the continuing high number of individuals claiming unemployment benefits each week. Initial weekly claims for unemployment insurance remain above 1.3 million, and nearly 33 million individuals were receiving unemployment benefits as of the middle of June. These numbers may have only worsened in the past few weeks as some states have paused or rolled back reopening in the face of rising Covid-19 cases. How 33 million individuals can be receiving unemployment benefits while official unemployment has declined to less than 18 million is one of the many headscratchers of the current moment.
Source: U.S. Bureau of Labor Statistics, Unemployment Level - Permanent Job Losers [LNS13026638], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/LNS13026638, July 9, 2020.
Treasury Cash Balance | Uncle Sam Seeks Liquidity
July 2, 2020
During the second quarter, the federal government raised an unprecedented $2.8 trillion in cash via new net debt issuances, and the US Treasury cash balance has reached historically high levels over $1.6 trillion. The Treasury has stated that its “cash balance will likely remain elevated as Treasury seeks to maintain prudent liquidity in light of the size and relative uncertainty of COVID-19-related outflows.”
Source: Board of Governors of the Federal Reserve System (US), Liabilities and Capital: Liabilities: Deposits with F.R. Banks, Other Than Reserve Balances: U.S. Treasury, General Account: Week Average [WTREGEN], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/WTREGEN, July 2, 2020.
Corporate Debt | Escalation
June 28, 2020
In the first quarter of 2020, non-financial corporate debt grew at a rate of 24%, exceeding its post-WWII growth rate record of 22% set in the first quarter of 1970. In conjunction with its rapid growth, as the chart below illustrates, nonfinancial corporate debt has also now reached all time highs as a percent of U.S. GDP, approaching nearly 50%. Corporate debt was at a high level before the pandemic and has only climbed higher as companies have raised cash to maintain liquidity. The high level of debt could further exacerbate the weak economy if defaults escalate and companies seek to de-lever.
Board of Governors of the Federal Reserve System (US), Nonfinancial Corporate Business; Debt Securities and Loans; Liability,Level [BCNSDODNS], retrieved from FRED, Federal Reserve Bank of St. Louis; June 26, 2020.
Percent Change | Consumer Spending
June 19, 2020
Opportunity Insights, a research and policy institute based at Harvard University, has developed a real-time tracker of economic activity using anonymized data from several private companies, such as credit card processors and payroll firms. The “Economic Tracker” provides statistics on the economy’s week-to-week recovery from the Covid-19 shutdowns. Among other things, the tracker shows that consumer spending is still down 11.3% from its level in January. Spending had a strong initial bounce from the 33% decline reached in early April, but the pace of the recovery has slowed in recent weeks. The data also indicate that spending in high income zip codes remains more depressed still down 16.8% versus middle income (down 9.9%) and low income (down just 4%). You can find more information at tracktherecovery.org.
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