The improved resilience of the US economy enabled the consensus to change in favor of a soft landing.
Recession forecasts have dropped considerably since the beginning of the year. After 30% rise in the S&P 500 in almost 10 months, the prospects of a hard landing for the American economy (hard-landing) have become a minority according to the latest Bank of America survey conducted among managers. The latter now anticipate a soft landing.
This change in opinion and this major rebound in the markets can be explained by the greater than expected resilience of the US job market. Indeed, despite high inflation and the rise in interest rates, the unemployment rate remains close to its lowest levels, below 4%.
However, the job market is not immune to the economic slowdown. There are growing signs of deterioration as evidenced by the sharp decline in temporary jobs and the drop in resignations since the summer of last year and the upward trend in weekly jobless claims since the start of the year.
Furthermore, headwinds remain plentiful and are expected to strengthen over the coming months, increasing the chances of a recession just as the consensus has changed. The end of the year is therefore likely to be much more volatile than what we have experienced since January.
The pressure on the American consumer will intensify
Pressure on U.S. consumption will build as 1) excess savings accumulated at the start of the pandemic have run out according to the San Francisco Fed, 2) credit conditions for credit cards have tightened. tightened with rates reaching record highs of 20%, and 3) federal student loan repayments will resume in October after three years.
About 26.8 million Americans are expected to face payment resumption, with almost half of them facing monthly payments over $200, and almost one in five over $500. More than half (56%) say they will be forced to choose between paying off their loan and living out basic necessities like rent and groceries, according to a new survey from Credit Karma.
The pressure on the real estate sector should also increase. Construction in progress is at record levels (~1.7M on an annualized basis) at the very moment when demand is falling given the surge in rates. The resilience of property prices thanks to the housing shortage had allowed the market to hold up relatively well since the beginning of the year, but the recent surge in mortgage rates (20-year high of the 30-year rate) could put an end to this resilience, according to the NAHB indicator, which fell again in August.
Credit conditions continue to tighten
Another headwind to the US economy is the continued tightening of credit conditions for business and industrial loans. A majority of institutions have tightened their credit conditions for five consecutive quarters, which has never been observed outside of a recession.
This trend is unlikely to reverse as the pressure on banks continues to be significant due to the violent rise in rates which not only reduces the present value of their assets, but also pushes depositaries towards alternative more profitable such as money market funds (MMF). Additionally, the US credit card delinquency rate hit a record high of 7.2% at smaller banks during the first quarter, which should further limit their appetite for risk.
The reduction in the public deficit will weaken the economy
Finally, the likelihood of a fiscal boost decreases. On June 3, President Biden signed into law the Fiscal Responsibility Act of 2023. Key provisions of this law, among other things, suspend the debt ceiling until 2024 and establish statutory limits for discretionary spending for fiscal years 2024. and 2025. S&P Global Market Intelligence estimates that if the spending caps are enforced, limiting spending growth would reduce GDP growth by about a quarter of a percentage point in 2024, and smaller and decreasing amounts thereafter.
Adding to all these headwinds in the US economy, the Fed’s monetary policy is unlikely to change anytime soon due to the persistence of inflation, which is expected to stay above 3% through to less the end of the year.
In the rest of the world, the outlook is also clouding due to 1) restrictive monetary policies in most economies due to excessively high inflation and 2) the disappointing recovery of the Chinese economy (which should continue to disappoint in lack of support measures for Chinese consumers).
All of these elements suggest that the global economy should continue to slow in the coming quarters and could disappoint. However, the markets do not seem very worried given the very low implied volatility of the American market (VIX), less than 20% since April…
The risk/reward ratio therefore currently seems asymmetrical on the markets, with risks underestimated by operators (probably thanks to the enthusiasm around AI and a soft-landing, etc.).
2023-08-24 05:00:00
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