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The Fed will be in Jackson Hole next week, where Chairman Jay Powell is expected to speak following the inflation read last week: CPI registered 3.2% through July, and was up a modest .2% from last month, though core inflation is still elevated in the high 4s. Many believe the moderation has validated the Fed’s posture. Continued U.S. economic strength extending into Q3, however, adds further uncertainty to their future course. While the surprising resilience of the U.S. economy, with low unemployment and consumer confidence holding up, has many believing there is room for a soft landing, it has also complicated the Fed’s job. The Fed has made it clear they need to see wage and price pressures subsiding, which could translate into keeping rates higher for longer. Nevertheless, there are cracks in the consumer story beginning to materialize, as we’ve discussed here.
Deutsche Bank’s Chief US Economist, Matthew Luzzetti, says he still expects a mild recession, despite a Q3 re-acceleration, which he says could be above 3% despite tighter bank lending standards. Luzzetti believes the Fed lag, credit tightening, and rising delinquency rates will take its toll, and expects a hawkish message out of Jackson Hole. Rising credit card balances, rising delinquencies, and slowing student loan repayments — down $7 billion — are also on his radar. As excess savings is being drawn down by consumers, there are also signs they are making trade-offs (services v. durable goods currently). So far, however, the U.S. consumer is hanging there.
We thought we’d mention two ratings downgrades that occurred recently. The first was by Fitch, which moved US Treasury debt lower by one level earlier this month. Fitch downgraded US sovereign rating from the top-ranked AAA to AA+ as a result of the government’s fiscal deterioration, following up one day later with a downgrade to the credit ratings of Fannie Mae and Freddie Mac.
Fitch cited as an example a “marked increase in general government debt …due to a failure to address medium-term public spending and revenue challenges” “Over the next decade,” the Fitch report said, “higher interest rates and the rising debt stock will increase the interest service burden, while an aging population and rising healthcare costs will raise spending on the elderly absent fiscal policy reforms.”
This is only the second time U.S. debt has been downgraded, the first occurring in 2011 by Standard and Poor’s also after a debt ceiling negotiation. Republican Budget Committee members have been highly critical of Democrats on this score — saying they have only occurred under Presidents Obama and Biden — and arguing that this is a wake up call to address fiscal issues that have been glossed over in the debt-ceiling debates. In a statement, the Majority said if not addressed, the downgrades will affect the U.S.’s ability to “absorb a major financial shock in the future; and if we don’t change course, the U.S. will not only incur another credit downgrade, we will undermine the dollar as the global reserve currency.”
Alexandra Wilson-Elizondo of Goldman Sachs said this week she did not believe, at this point, the Fitch downgrades would have long term effects but in the nearer term it could cause an elevated debt burden to crowd out private investment and that’s that’s not good for long-term productivity of the economy.
In a move that brings regional banks and CRE back into focus, Moody’s cut the credit ratings of several small to mid-sized U.S. banks Monday and said it may downgrade some of the nation’s biggest lenders. They downgraded 10 banks by one level and placed six large banks, including Bank of New York Mellon, US Bancorp, State Street, and Truist Financial on review for potential downgrades. Moody’s said the sector’s credit strength is likely be tested by funding risks and weaker profitability.
Goldman Sach’s Ashish Shah said the Moody’s downgrade is “reflective of the information we learned in March… the challenges to regional banks business model” and the fact that the commercial real estate (CRE) stress is at a real issue. CRE “continues to be a real thing that is playing out,” Shah agued. Shah added, however, that he does not believe the issue of asset valuation in CRE necessarily bleeds into the real economy, though it creates risk.
Eyes will be on inflation data coming out this week. The news on that front has been trending positive and suggests the Fed is nearing the end of the rate hiking cycle.
As we’ve been discussing here, the second quarter was strong and the third quarter appears to be holding up on the consumer front as well, as the jobs market softens slightly and corporate earnings weaken (as firms lose pricing power with supply chains are repaired). Unemployment remains at 3.5%, good for consumers but possibly also a source of wage pressure that keeps the Fed inclined to hold rates higher for longer. Though commodity declines in recent months have also been a boon, a recent pop in oil prices complicates the picture.
Joel Kahn of the Mortgage Bankers Association (MBA) summarizes it well: “The incoming economic data continue to convey conflicting signals about the strength of the economy. Indicators of manufacturing and service sector health remain lackluster, measures of inflation have moved lower, while GDP growth in the second quarter was stronger than expected and consumer spending remains resilient.”
Meanwhile, Morgan Stanley’s Michelle Weaver says no less than 1% of mortgages are in the money for refinance after millions jumped on the opportunity of low rates during the pandemic. The effect [of homeowners remaining in homes with lower rates and reducing existing supply] has made it tough for first time homebuyers who have had to remain renters, and has put upward pressure on rents, Waiver said on the Morgan Stanley podcast “Thoughts on the Market.” Her colleague Jim Egan noted that existing single family housing inventories are at 40 years lows and “We say ’40 year lows’ because that’s just as far back as the data goes, this is the lowest we’ve seen that,” Egan said.
Egan also argued that “while affordability is bad, it’s not getting worse” and is likely to improve, and “while supply is tight, it’s not getting tighter”—he believes we are stuck in a range for a while. Egan said while the Case-Shiller index turned negative this year for the first time since 2012, Morgan Stanley forecasts prices will be unchanged over the coming year. And as JPMorgan’s Michael Cembalest pointed out in his recent “Eye on the Market” podcast, the tight supply of existing homes has made the market more resilient to to rising rates. Consumers, however, are continuing to burn off savings, which might run out in 2024, Cembalest said. JPMorgan sees weakness possible for Q4/Q1, with economic growth down to 1%.
On that consumer front, credit card balances continue to climb, the Fed reported, with total indebtedness rising $45 billion in the April-through-June period, an increase of more than 4% — and taking the total amount owed to over $1 trillion, the highest gross value in Fed data going back to 2003. Total household debt rose $16 billion to $17.06 trillion, also a record. Fed researchers said the rise in balances reflects both inflationary pressures as well as higher levels of consumption. The Fed said its measure of credit card debt 30 or more days late rose to 7.2% in the second quarter, up from 6.5% in Q1, which is the highest rate since the first quarter of 2012 (though close to the long-run average). Total debt delinquency rose slightly 3.18% from 3%.
We’ve talked about commercial office challenges facing the market in the many months ahead. A report in the Wall Street Journal is also sounding an alarm on multifamily apartment owners. While vacancy rates are low and rents are high, some owners saddled themselves with too much debt as rents rose, often borrowing more than 80% of the building value from bond markets, the Journal reported. Though most apartment loans are fixed-rate, long-term mortgages, more investors took shorter-term, floating-rate loans during the pandemic. The surge in debt costs last year “threatens multifamily owners across the country,” the Journal said.
CoStar said apartment-building values fell 14% for the year ended in June after rising 25% the previous year, roughly the same as the fall in office values. And although mortgage delinquencies in the multifamily category are low, they are increasing, the Journal reports: “Borrowing costs have doubled, rent growth is slowing and building expenses are rising…Outstanding multifamily mortgages more than doubled over the past decade to about $2 trillion, according to the Mortgage Bankers Association. That is nearly twice the amount of office debt, according to Trepp. The data provider adds that $980.7 billion in multifamily debt is set to come due between 2023 and 2027.”