Month: July 2023

More Americans Are Getting Turned Down for Loans, Fed Data Shows

The rejection rate for loan applicants jumped to 21.8% in the 12 months through June, the highest level in five years, according to the latest edition of the Fed survey, which is published every four months. Overall credit applications declined to the lowest level since October 2020.

In the previous survey, published in February before the collapse of Silicon Valley Bank and other US lenders, the rejection rate was 17.3%. The increase since then has been broad-based across age groups, and highest among those with credit scores below 680.

In auto loans, for the first time since the survey began in 2013 the rejection rate — which climbed to 14.2% from 9.1% — exceeded the application rate.

What’s more, almost one-third of auto-loan applicants expected that their loan would be rejected, a record high. There were also steep increases in reported expectations that requests for new mortgages, mortgage refinancing or increases in credit-card limits would be turned down.

NY Fed report and charts here.

Total bank lending (black) has declined a net $30B in the last 6 weeks (through July 10), all from large banks (-$49.3B). The last time we saw such large consecutive declines was between November 2008 and March 2011.

Long-feared corporate debt woes start to hit home

(…) S&P Global expects default rates for U.S. and European sub-investment grade companies to rise to 4.25% and 3.6% respectively by March 2024, from 2.5% and 2.8% this March. (…)

Reuters Graphics

The current spread on the ICE BofA global high yield bond index is at 435 basis points (bps), down from 622 bps a year ago. (…)

Miller said 122 U.S. public and private companies with liabilities over $50 million have already filed for bankruptcy protection so far this year, implying a run rate that will cause bankruptcies to exceed 200 by year-end – comparable to that seen during the global financial crisis and COVID-19. (…)

ABN AMRO said the average maturity of European high yield corporate bonds reached a record low of almost four years in May, versus an average of just over six years between 2005-2007, when the European Central Bank also jacked up rates.

That means firms have less time than previously to refinance debt, so the pain of higher rates will be felt sooner. (…)

Here’s a long term chart of credit spreads:

But this is a resilient economy:

(…) our [GS] review of official and alternative data suggests that this growth rebound may have happened anyway. If so, the strong growth momentum to start the third quarter will help offset the mounting drag from reduced bank lending, which is now apparent in the H.8 data.

Official data indicate that domestic demand growth picked up sharply to +3.5% annualized in Q1—and with two months of data in hand—is tracking at +2.6% for Q2. We are also tracking GDP growth at +2.2% annualized in the first half of the year, slightly above potential.

High-frequency data from alternative sources is also upbeat. We seasonally adjust weekly credit card spending, housing demand, and industrial freight indicators through early July, finding that consumer spending continues to grow, manufacturing activity is currently bottoming or rebounding, and the large declines in housing activity appear mostly behind us.

(…) official data indicate that consumption in discretionary services categories rose at a solid pace in April and May (+0.5% and +0.4%, respectively), and the Affinity Solutions consumer panel suggests continued—and potentially larger—gains in June and early July. (…)

The 2023 income arithmetic also remains supportive: we forecast +4% year-on-year in Q4 in real terms, thanks to continued job gains, strong wage growth, and a boost from the indexation of social security checks and other transfer payments to prior-year inflation. And encouragingly, for the moment both jobless claims and WARN layoff notices are moving back down. We expect the consumer will continue to support growth in 2023—despite a 0.2-0.3pp drag from the return of student loan payments and a likely rebound in the savings rate. We forecast consumption growth of +2.1% on a Q4/Q4 basis—and +1.5% annualized in the second half of the year. (…)

Shale Industry Is Dropping Drilling Rigs, Fast Smaller fracking companies are feeling the pinch of inflation, lower oil and gas prices, and fewer prime drilling spots.

(…) The number of rigs drilling for oil and gas has dropped to about 670 from around 800 at the beginning of the year, with private drillers accounting for roughly 70% of the decrease, according to David Deckelbaum, an analyst at investment bank TD Cowen.

The slowdown augurs tepid U.S. crude-production growth for the rest of the year, analysts said. Even though larger public companies mostly aren’t shedding oil rigs, they aren’t growing rapidly either, as they adhere to investors’ desire for capital restraint. The Energy Information Administration expects domestic growth output to increase by fewer than 300,000 barrels a day in 2024 from this year.

Taylor Sell, chief executive of Element Petroleum, said the company’s break-even—or the price needed to fund drilling without a loss—had increased by between $5 and $10 to reach between $55 and $60 a barrel, in part because the cost of materials such as steel pipes remains high, at roughly 40% more than 18 months ago, he said. (…)

Russia’s invasion of Ukraine, which pushed the U.S. benchmark past the $120 mark, saw private operators in the Permian Basin of New Mexico and West Texas commandeer about half of the rigs in that region, fueling a quick rebound in U.S. oil production. (…)

Small frackers have largely exhausted their best wells, The Wall Street Journal reported last year. Most smaller producers in the Permian Basin of West Texas and New Mexico on average have around six years of drilling locations that could generate returns at low prices, according to data provided to the Journal by energy-analytics firm Enverus.

The result has been a private-company pullback in shale regions across the country. In the Permian, private drillers’ share of rigs has shrunk to 42%, according to Enverus—a level not seen since May 2021.

Inflation and less-productive wells have increased the average break-even for companies in the Delaware portion of the Permian more than 34% since 2021 to $43 a barrel, according to Enverus. In the Permian’s Midland region, the average break-even increased more than 39% over that same period, to $47 a barrel.

While U.S. oil prices have averaged about $75 a barrel since the beginning of the year—a level that generally allows profitable operations for smaller drillers—weak natural-gas prices have eaten away at their cash flows, executives said.

Companies are also dealing with limited pipeline capacity, leaving some no choice but to flare a large chunk of gas production that they can’t bring to market, they said.

“$70-$80 [oil] is fine—if we can just get paid for our natural gas,” Pruett said.

Bigger companies have also become more efficient, allowing them to remain profitable even when oil prices slip. Pioneer Natural Resources and Devon Energy all have said their break-evens fall under $50 a barrel. (…)

BofA Survey Shows Rising Soft Landing Bets, Rush to Big Tech

(…) The firm found that 68% of surveyed fund managers expect an economic slowdown without a recession, while corporate profit expectations are now the least pessimistic since February 2022. In another sign of improving risk sentiment, investors are underweight global stocks by the smallest amount so far this year, according to BofA.

Being long big tech stocks topped the list of most crowded trades, while 42% of polled fund managers say AI will increase profits over the next two years. Investors now see the Federal Reserve reducing interest rates in the second quarter of 2024, according to BofA; in last month’s survey they predicted a cut in the first quarter.

While some Bank of America poll indicators pointed to increasing optimism, the bank’s broad measure of fund manager sentiment, based on cash positions, equity allocation and economic growth expectations, remains “stubbornly low,” strategists led by Michael Hartnett wrote. (…)

• Investors exited commodities, biggest underweight since May 2020
• Among surveyed investors, 48% predict start of global recession by the end of the first quarter of 2024, while 19% say no recession in next 18 months
• Biggest tail risk is high inflation keeping central banks hawkish, following by a bank credit crunch and global recession, worsening geopolitics and AI/tech bubble, with systemic credit event coming in last (…)

Goldman Sachs cuts probability of US recession in next 12 months

Goldman Sachs’ Chief Economist Jan Hatzius said on Monday the bank was cutting its probability that a U.S recession will start in the next 12 months to 20% from an earlier 25% forecast.

“The main reason for our cut is that the recent data have reinforced our confidence that bringing inflation down to an acceptable level will not require a recession,” he said in a research note. (…)

“We do expect some deceleration in the next couple of quarters, mostly because of sequentially slower real disposable personal income growth … and a drag from reduced bank lending,” Hatzius said. However, he expected the economy to continue to grow, although at below-trend pace. (…)

China Evergrande’s overdue results show steep losses, liabilities

China Evergrande Group, the world’s most indebted property developer, posted a steep net loss of $14.8-billion in 2022 and a rise in total liabilities in its long overdue results on Monday. (…)

Evergrande reported a net loss of 476 billion yuan ($66.36-billion) and 105.9 billion yuan ($14.76-billion) for 2021 and 2022, respectively, versus a net profit of 8.1 billion yuan in 2020 when its operation was normal.

The huge losses were caused by return of lands, writedown of properties, losses on financial assets and finance costs, it said.

Its total liabilities amounted to 2.4 trillion yuan last year, an increase of 23 per cent from 2020, while total assets were worth 1.8 trillion yuan, down 20 per cent.

Revenue dropped 55 per cent to 230.1 billion yuan in 2022 from 2020.

Its auditor, Prism Hong Kong and Shanghai Limited, however said in the report it does not express an opinion on Evergrande’s financial statements, because it has not been able to obtain sufficient appropriate audit evidence to provide a basis. (…)

Bloomberg adds that Evergrande’s biggest liabilities are from trade and other payables, which stood at around 1 trillion yuan as of December, underscoring how the whole real estate ecosystem is impacted.

Mounting lawsuits and pressure to deliver projects are also weighing on the developer. Evergrande faced 1,601 lawsuits involving 383 billion yuan related to its mainland property unit as of May, it said in an earlier filing.

NikkeiAsia reports that a seller recently had to cut her price 10.4% before a potential buyer showed up:

(…) The number of properties on the existing-home market jumped 25% between the start of the year and early June, according to the E-House China R&D Institute, a real estate think tank. The sharpest jump, at 82%, was seen in Shanghai, China’s biggest local economy. (…)

“We managed to close one sale in April, but haven’t had a single one since May,” Wang said. The agent feels that more prospective buyers are opting to wait until the market bottoms out.

In last quarter’s urban depositors survey by the People’s Bank of China, 16.5% of respondents expected housing prices to fall over the next three months, marginally more than the 15.9% who saw an increase.

The numbers suggest that people are worried about a vicious cycle fueled by low transaction volumes and potential buyers spooked by sliding housing values. According to Wang, people who held multiple homes for investment purposes suddenly decided to offload those properties at a loss.

“They couldn’t foresee any profit off sales,” said Wang. “The hope that the housing market will rise again wanes the further we go up the socioeconomic ladder,” Wang added. (…)

The myth of the never-ending housing boom in China is steadily crumbling in higher-tier cities as well. There are concerns that the real estate market will suffer a prolonged, structural correction if the appetite for purchasing homes weakens visibly.

A known unknown morphing into a known known, perhaps even a huge black swan in slow, but accelerating, motion.

U.S. Companies Score Partial Reprieve From Global Minimum Tax Deal New agreement will delay until 2026 some potential tax increases under the deal

Under the updated agreement negotiated by the Treasury Department, companies will have an extra year—until 2026—before foreign countries can start imposing new taxes on any U.S. companies deemed to pay too little tax in the U.S. And the clean-energy tax credits at the core of last year’s Inflation Reduction Act will be counted in a more favorable way than some companies had feared, offering certainty as a tax-credit trading market gets under way.

The Organization for Economic Cooperation and Development, which is leading the talks, detailed the changes Monday in technical guidance after negotiations among countries.

The U.S. and about 140 other jurisdictions agreed in late 2021 to impose a 15% minimum tax on large companies in each country where they operate. Negotiators, including Treasury Secretary Janet Yellen, hailed the deal as a landmark achievement in international cooperation and a bulwark against corporate tax dodging. (…)

The 15% minimum tax must be calculated consistently across countries and companies, requiring clear definitions of income and taxes. That has led to a series of technical rules, including Monday’s 91-page update.

Some countries—Japan, South Korea and members of the European Union—are forging ahead with minimum taxes under the deal, but the U.S. isn’t. After negotiating the deal, the Biden administration couldn’t push the changes through the Democratic-controlled Congress last year. Republicans, who now lead the House, oppose the deal, calling it a global tax surrender.

The U.S. has a 10.5% minimum tax on U.S. companies’ foreign income that was created in 2017 and a 15% minimum tax on large companies’ global profits that was enacted last year. Neither conforms to the global deal, however. So as the OECD hammers out the rules, the U.S. has looked for ways to make the country’s system fit the international framework. (…)

If other countries move ahead and the U.S. doesn’t, the U.S. could lose $122 billion in revenue over a decade compared with less widespread implementation, according to the nonpartisan Joint Committee on Taxation.

Part of Monday’s guidance addresses a provision scheduled for 2025 called the Undertaxed Profits Rule, or UTPR. The UTPR is a way to make sure companies based in countries outside the deal still have to pay 15%.

Under the UTPR, a foreign country can look at a company’s tax rate in every country and, if that isn’t 15%, charge more in taxes. For example, France could see that a U.S. tech company is paying a 10% rate to the U.S. and require it to pay more to France. Monday’s guidance delays that rule until 2026 in countries where the tax rate is at least 20%. The U.S. corporate tax rate is 21%; the delay gives Congress time to address this with other expiring tax provisions in 2025. (…)

U.S. lawmakers have objected, arguing that the deal undermines Congress’ ability to offer tax incentives. Monday’s guidance doesn’t change what happens to research credits. But it acknowledges a need to respond to the size and scale of the IRA tax credits, which are worth hundreds of billions of dollars and can be sold from renewable-energy developers without tax liability to companies looking for tax breaks.

That market—where large companies will likely buy tax credits for 90 to 95 cents on the dollar—is just getting started. The update to the deal set out rules for all tradable tax credits, including IRA credits. For those buyers, the U.S. credits likely will be treated so that only the net benefit—the gap between the tax credit and the purchase price—is considered a tax cut.

That will give more confidence to companies considering purchasing the credits, ensuring that they can use them without pushing their tax rates too low and triggering foreign taxes.

The Treasury Department said that it welcomed the guidance and that the IRA’s transferable credits would be treated like refundable credits, which companies can convert into cash. (…)

China’s Economy Barely Grows as Recovery Fades The sluggish growth coupled with a record high in youth unemployment in June is evidence of a fading recovery that risks leaving the global economy underpowered.

(…) China’s economy grew just 0.8% in the second quarter compared with the first three months of the year, China’s National Bureau of Statistics said Monday, less than half the 2.2% quarterly pace recorded in the January-to-March period. The result reflected weak retail sales, subdued private-sector investment and a reversal in exports—which propelled growth throughout the pandemic—but they are suffering now as major central banks ratchet up interest rates.

Compared with the same quarter the previous year, growth in the second quarter accelerated to 6.3% from a 4.5% annual pace in the first quarter, a worse performance than the 6.9% pace expected by economists polled by The Wall Street Journal. The pickup in the annual rate was flattered by a deep slump in the second quarter of last year, when businesses in Shanghai were closed to contain a citywide outbreak of Covid-19. (…)

Retail sales in June rose just 0.2% compared with May, a sign that households are wary of spending. (…)

China’s headline measure of joblessness, the surveyed urban unemployment rate, held steady at 5.2% in June. But youth unemployment rose yet again, with joblessness among those aged 16 to 24 rising to 21.3% in June from 20.8% in May.

Investment in buildings, machinery and other fixed assets rose just 0.4% in June compared with May, hurt by weakness in real estate. Industrial production expanded 0.7% over the same period. (…)

(Zerohedge)

• China Warns Youth Unemployment to Worsen After Hitting Record The government has said it expects a record of nearly 12 million students to graduate from colleges and universities this year.

• China June property sales fall at fastest clip this year

Property sales by floor area declined 28.1% year-on-year, extending a 19.7% fall in May, according to Reuters calculations based on data from the National Bureau of Statistics (NBS).

For June, property investment totaled to 1.2849 trillion yuan, falling 20.6% from a year earlier after a 21.5% drop in May, according to Reuters calculations.

For January-June, property sales by floor area were down 5.3% year-on-year compared with a 0.9% fall in the first five months.

Property investment fell 7.9% in the first six months, after slumping 7.2% in January-May from the same period a year earlier.

New construction starts measured by floor area fell 24.3% year-on-year, after a 22.6% drop in the first five months.

Funds raised by China’s property developers were down 9.8% on year after a 6.6% slide in January-May.

• Second-hand residential property prices in China’s Tier One cities fell 0.7% in June on a month-over-month basis, the largest decrease since Sep. 2014. If there is one thing that could really open the Pandora’s box in China, it’s falling property prices. Period. (@ShanghaiMacro)

  

• Chinese Oil Demand Doesn’t Make Sense Global crude need and prices could soon take a hit

  China’s economy is having a rough summer, but the country is still churning out record amounts of diesel and importing vast amounts of crude oil. That imbalance is unlikely to persist forever.

  Either China’s economy will accelerate rapidly in the second half—a prospect that currently looks unlikely—or oil demand will revert to more regular patterns, dragging global consumption and, potentially, prices down with it. (…)

  China’s apparent petroleum demand—refinery runs plus net oil product imports—was up 25% and 17% year over year in April and May respectively, according to figures from data provider CEIC. Diesel production in May was 26% higher than a year earlier, and a full 40% higher than in May 2019 before the pandemic hit. (…)

  Chinese refiners and regulators—like much of the world—misjudged both the strength of China’s recovery and the global energy market.

  Chinese refiners need government permission to export fuels such as diesel—part of China’s residual price controls. According to Reuters, the first round of quotas for 2023 was nearly 50% higher than a year earlier—presumably to help refiners take advantage of attractive global prices while Chinese demand was still in the doldrums. Net petroleum product exports in early 2023 were indeed very strong. But in the second quarter, they cratered. Diesel production kept roaring along, however, even with lower global prices and a smaller export quota from Beijing this spring. (…)

  Chinese refiners—who had already cranked up diesel output in late 2022 for export—might have decided to keep production high in hopes of a property-driven and infrastructure-driven demand boom at home in early 2023. With still-high state-set fuel prices at home and falling crude prices globally, refiners would also have been in a position to reap some juicy margins. Unfortunately, the hoped-for demand surge now looks questionable.

  China doesn’t regularly publish petroleum inventory data as the U.S. does, so it is difficult to say for sure how much diesel might be sitting in storage somewhere. At some point, though, refiners might need to capitulate to reality and dial down output, unless the government’s strategic reserve decides to step in.

  When and if that happens, Chinese apparent oil demand could well take a hit, weighing further on global oil prices in late 2023.

• Wanda Warns of $200 Million Shortfall on Bond, Surprising Market

(…) A key unit of Dalian Wanda Group Co. — among the few Chinese real estate conglomerates to stay afloat even as peers succumbed to an industrywide debt crisis in recent years — told some creditors Monday it’s still raising funds for a $400 million note that matures July 23, according to people involved in the private conversations who asked not to be identified.

The unit, Dalian Wanda Commercial Management Group Co., said it faces a funding gap of at least $200 million for repayment of the bond, the people said, adding the firm is weighing an alternative plan that it didn’t provide details of. There’s no grace period to pay the principal, according to bond documents. (…)

One of the few survivors in China’s offshore high-yield market, Wanda has so far avoided defaulting on public dollar debt. But there’s been a surge in delinquencies by Chinese issuers since the start of 2022, especially among property firms in the wake of that sector’s liquidity crunch.

Worries about Wanda’s debt have circled the firm for months amid the delayed listing of a mall unit in Hong Kong. If that firm doesn’t go public this year, the conglomerate may have to repay that unit’s other investors about 30 billion yuan ($4.2 billion). (…)

• Buoyant Global Economy Is Starting to Sag The World Bank expects the global economy to expand 2.1% this year, down from 3.1% in 2022

• German economy may disappoint as sentiment worsens – Bundesbank

• German House Prices Fell By Double Digits Amid Higher Mortgage Rates

(…) According to the Federal Statistical Office (Destatis), Germany is expected to experience a worsening housing shortage as the number of new building permits has dropped by 31.9 percent compared to the previous year. In April, only 21,200 new homes were given approval for construction in the largest economy of Europe, marking the most significant decline since March 2007 after nearly a year of continuous decrease. (…)

• The green transition takes hold of Germany’s property market More than 60% of the current German housing stock will need to be renovated over the next ten years to meet climate targets set by the European Commission. The transition will come with soaring costs and increasing house price divergence, with energy efficiency expected to rise rapidly to the top of the list of priorities for buyers

Economists Are Cutting Back Their Recession Expectations Forecasters still expect GDP to eventually contract, but later, and by less, than previously.

Easing inflation, a still-strong labor market and economic resilience led business and academic economists polled by The Wall Street Journal to lower the probability of a recession in the next 12 months to 54% from 61% in the prior two surveys. (…)

In the latest WSJ survey, economists expected gross domestic product to have grown at a 1.5% annual rate in the second quarter, a sharp uptick from 0.2% in the previous survey. They still expect GDP to eventually contract, but later, and by less, than previously. They expect the economy to grow 0.6% in the third quarter, in contrast to the 0.3% contraction expected in the prior survey, followed by a 0.1% contraction in the fourth. Forecasters said GDP would increase 1% in 2023, measured from the fourth quarter of a year earlier, double the previous forecast of 0.5%.

Nearly 60% of economists said their main reason for optimism about the economic outlook is their expectation that inflation will continue to slow. (…) Economists expect it to reach 3.7% by the fourth quarter of this year, though that is still well above the Fed’s 2% target. (…)

On average, economists still expect the labor market will lose 10,551 jobs a month in the first quarter of 2024, broadly unchanged from their previous forecast. But unlike in the April survey, economists no longer expect job cuts in the third and fourth quarter of this year. They expect employers will add jobs in the second and third quarters of next year, suggesting any downturn will be mild. (…)

Economists expected the midpoint of the range for the federal-funds rate will peak at 5.4% in December, up sharply from a 5% forecast in the last survey. The latest prediction implies at least one more 25-basis-point increase by the Fed. (…)

Economists are also pushing back their estimates for when the Fed will eventually start cutting rates. In the latest survey, only 10.6% of economists expected a rate cut in the second half of this year, down from 36.8% in the last survey. The majority of economists, nearly 79%, expected the Fed will cut rates in the first half of 2024 as the unemployment rate rises. Some 42.4% expected that first cut will come in the second quarter. (…)

The resumption of student-loan payments is expected to have a relatively minor impact this fall, shaving 0.2 percentage points, annualized, from consumer spending growth, measured from the third quarter to the fourth quarter of this year. (…)

• Letting go of recession fears (Fortune)

In our latest poll of 143 CEOs conducted in collaboration with Deloitte, only 38% said they had a “pessimistic” or “very pessimistic” outlook for the global economy for the next 12 months, down substantially from the 76% answering the same question last October.

But inflation fears remain strong. Indeed, 57% of the CEOs said they expect inflation to disrupt their business over the next 12 months. A similar percentage said they expected geopolitical developments to disrupt their business over the next year.

The poll also shows CEOs are very bullish about new developments in A.I., with 79% saying A.I. is likely to significantly enhance business efficiencies in their organization. You can read more from the new poll here.
A separate poll from JPMorgan also out this morning shows only 45% of midsize business leaders expect a recession before year-end, down from 65% six months ago.

In monetary policy, it’s all about the lags

In Central Banking 101, there is frequent talk of “long and variable lags” — the idea that after making an interest rate move, there is a delay of uncertain length before it really affects the economy. A central question facing the Fed as it meets two weeks from now and in the months ahead is: Just how long, and how variable?

If the interest rate increases enacted in 2022 and early 2023 are still rippling through the economy, the Fed may be about done with rate increases. But if their impact was front-loaded and has now mostly already been felt, there could be significantly more rate-hiking pain on the way, given high inflation. (…)

At the Fed’s June 13-14 policy meeting, “several” members of the rate-setting committee raised the possibility that the effects of previous hikes may have already been realized, according to minutes from the gathering.

Dallas Fed president Lorie Logan said last week she was “skeptical about the potential for large additional effects” from the Fed’s previous moves.

• Logan said the effects started to take hold in one key channel in early 2022 as the Fed readied to raise rates: Financial conditions began to tighten — bond yields up, stock prices sagging, etc. The last burst of tighter conditions occurred last fall.
• “[W]e have already had a fair amount of time to see the overall effects of monetary tightening,” Logan said — one reason it would have been “entirely appropriate” for a rate hike in June, she added.

Yes, but: “Markets can go up right away, but contracts reprice much more slowly,” San Francisco Fed president Mary Daly tells Axios.

• Daly said big economic events impacted by the Fed’s tighter policy — lease renewals, salary negotiations and repricing on inventory-forward contracts — play out on lengthier timetables.
• “When you make sharp pivots with a policy rate, it takes time for this to be digested.”
• If the troubles at regional banks earlier this year cause a broad credit tightening, that would typically take many months to play out.

“We know monetary policy has lags. How long they are and when they are completed, we just don’t know,” Daly said.

• “I think it’s probably overstated to say the lags are over. I think it’s overstated to say they haven’t started yet. I think somewhere in the middle is where we need to be,” Daly said.
• Daly added that a “proxy” measure for the Federal funds rate developed by the San Francisco Fed shows that policy started to restrict the economy a year ago: “I think this fall is really when we start to see [the lags take effect] — and we’re already starting to see it.”

• ‘It’s not working as quickly or as powerfully as we thought’: Tiff Macklem explains why BoC restarted rate hikes

(…) Monetary policy is working. Inflation has come down a lot. It was 8.1 per cent last summer, it’s 3.4 per cent now, and we think it’s going to be around 3 per cent going forward. So it’s working. But we have been surprised by the ongoing strength in demand in the economy and persistence of underlying inflationary pressures.

Labour markets have eased a bit but remain very tight. And households have accumulated what we sometimes call extra savings. I’m sure households don’t see it that way, but they accumulated more savings during the pandemic, and that may be supporting more consumption going forward. So those are elements that are common across a lot of countries.

In Canada, we also have the added dimension that we have strong levels of immigration. … That’s actually helping to ease some of the pressures in the labour market, but it is at the same time adding demand to the economy, because those new entrants into Canada, they’re new consumers, they rent apartments, they buy houses, they go shopping like the rest of us.

(…) from our perspective, those households that are financially stressed, that are having real trouble making their payments, they’re not the ones that are going shopping. They’re not the ones that are adding to demand.

At a high level, things are playing out more or less as we expected. We’ve raised rates a lot, the demand for interest-sensitive items slowed, inflationary pressures are receding.

And the fact that central banks did this around the world is helpful, because by all raising interest rates on a roughly similar schedule, collectively we’ve kept inflation expectations well anchored, we’ve moderated the demand for globally traded goods. That’s helping all of us. Services in our economies are more affected by domestic demand, and that’s where the interest-rate increases in Canada are moderating.

So it’s working. But it’s not working as quickly or as powerfully as we thought it would. There, I think, there’s some question. It’s been a long time since we raised interest rates this much. So has something changed in the monetary policy transmission mechanism? Maybe. I think the more likely explanation is the forces that we’re working against are stronger. … Households have more accumulated savings. The tightness of labour markets. The growth in the population. Those things are all adding to demand. So there’s more work to be done. (…)

When you start to see demand is stronger, consumer spending is stronger, housing is coming back, the labour market is still tight, underlying inflationary pressures are stronger than expected, the downward momentum in inflation is easing. When those things are all pointing in the same direction, you need to do some more. (…)

But as I underlined, there are a number of things that have to happen for that easing in inflation to happen. … Excess demand in the economy needs to diminish, the economy needs to come into better balance, and in our forecast we have the economy moving into modest excess supply next year. … We need to see a better balance in the labour market and we need to see wage growth moderate.

What we’ve seen through this period of high inflation is companies are increasing their prices much more frequently – and by more. We’ve started to see that normalize – the size and the frequency have both come down a bit. But we need to see that process of normalization continue.

We have different models we use to estimate the neutral rate [the central bank’s estimate of where its policy rate would settle if the bank were neither trying to stimulate nor restraining the economy]. … Those models, based on the data we have, still suggest a neutral rate in the range of 2 to 3 per cent.

When we look forward, and we look at a number of the forces, it seems more likely that the neutral rate is going to be higher than that … [rather] than lower than that. We don’t have that data yet. But there are a number of factors.

More people are retiring. The labour market looks like it could be sort of structurally tighter going forward. Globalization has at least stalled, if not reversed. That could create more cost pressures. We’re going to need a lot of new investment in cleaner technologies if we’re going to meet our emissions-reduction targets. When I say ‘we,’ it’s the world – so that’s going to affect global real interest rates.

So when you look forward, it seems more likely that the neutral rate is higher, not lower. And the message is that households, businesses, governments, the financial system, they need to be prepared for that possibility. (…)

Look, for some households, it is going to be difficult. But for many households, they will have built up more equity in their home. They probably will have gotten a raise over that period, their incomes will be higher. Our sense is that as long as the job market is healthy, people have got jobs, it will certainly squeeze people’s budgets, but most people will be able to manage that.

The risk from a Canadian perspective is if there was a global recession, if Canada goes into a recession, unemployment does go up. That will make it much more difficult when people have to reset their mortgage. And we are a more highly indebted country, and that could amplify that pain. (…)

The fundamental issue in the housing market, and this has been an issue in Canada for 10 years, at least, is structurally the demand for housing is growing faster than the supply. And so yes, interest rates go up, the housing market will slow. But it’s only going to slow so much because there is a sort of structural shortage of supply relative to demand.

I think what you’re seeing is that with supply growing less than demand, the housing market has started to tick back up, housing prices have started to tick back up. That’s something we need to take into account in monetary policy. But we’re not targeting the housing market. We have one target: CPI inflation. (…)

Earnings by Big Banks Show Signs of Soft Landing Profits from JPMorgan and Wells Fargo make it easy to forget there was a banking crisis this year.

JPMorgan Chase’s profit soared 67% in the second quarter from a year earlier and Wells Fargo’s jumped 57%, lifted by the income they earned lending out money at higher rates. Citigroup’s net interest income was a bright spot, though profit fell 36%. All three banks beat analysts’ expectations for profit and revenue.

The three banks collectively grew their loan books from a year earlier, thanks partly to an increase in credit-card balances, which padded revenues. The banks lifted their forecasts for their 2023 lending profits, proof they don’t expect to see a major shift in borrowing or deposits. (…)

[JPM’s card loans rose 16% YoY, 6% QoQ].

“I don’t know whether it’s going to be a soft landing, a mild recession or a hard recession,” JPMorgan Chief Executive Jamie Dimon told reporters.

Loan defaults increased slightly but remain historically low. The big banks set aside some money for potential future defaults, particularly in commercial real estate, but the charges weren’t as large as what they took when anticipating steep economic declines. (…)

JPMorgan, Wells Fargo and Citi together earned $49 billion in net interest income last quarter, up 31% from a year earlier, as loans increased and they charged more for them.

Customers at all three banks spent more on their credit cards, and more borrowers carried over balances each month. Loans to businesses were up at JPMorgan and Wells Fargo.

Even mortgage originations, which are heavily impacted by rates, increased from earlier in the year at Wells and JPMorgan, though they remained down sharply from a year ago.

“Overall, I’d say we are seeing a more cautious consumer, but not necessarily a recessionary one,” Citi CEO Jane Fraser said. (…)

Deposits fell 3% from a year earlier at JPMorgan and 6% at Wells Fargo. They were roughly flat at Citi. (…)

Investment banking, which includes fees from mergers and selling corporate stock and debt, fell 6% from a year earlier at JPMorgan and 24% at Citi. Trading declined 10% at JPMorgan and 13% at Citi. (…)

• JPMorgan saw a 1% increase in deposits from the previous quarter, excluding its First Republic business, and an 8% decline from last year.
• Wells Fargo deposits fell 1% from Q1 and 7% from a year ago.
• Citigroup deposits have remained roughly flat.
• Meanwhile, the average interest rates they’ve had to pay on deposits have moved up 1%–3%, from “next to nothing” a year ago, WSJ notes. (Axios)

EARNINGS WATCH

30  S&P 500 companies have reported. Beat rate: 80%. Surprise factor: +10.7%. Actual earnings growth for those 30 companies: +12.9%.

Yet:

Q3 estimate now +1.0% vs +1.3% Jul 1.

Q4 estimate now +9.1% vs +9.5% Jul 1.

Trailing EPS: $213.24. 2023e: $217.28. Forward EPS: $229.97e. 2024e: $244.74.

The ‘Everything Rally’ Is Back. So Is the Casino Crowd

Boats seaworthy and otherwise are being lifted by the rising tide in stocks, itself part of a cross-asset “everything rally” that was the biggest in three years this week. Gains spread, with banks and commodity producers ascendant. And there were flimsier propositions: Meme stocks had their best week since January, while unprofitable tech firms jumped 11%. (…)

Whether the pattern is repeating, this was a week of nearly unprecedented buoyancy across asset classes. Among five major exchange-traded funds tracking stocks, Treasuries, corporate bonds and commodities, each was up more than 1.7%. In data going back almost a decade, only once was there a bigger concerted rally: March 2020.

And while that particular echo may stoke bulls, a lot has changed between now and then in terms of policy and valuation. Back when Covid-19 was raging, the Federal Reserve rushed to lower interest rates and the government doled out trillions of stimulus checks to Americans. The S&P 500 was valued at roughly 14 times earnings, while 10-year Treasury yield stood below 1%.

Now the central bank is in the midst of the most aggressive monetary tightening in decades, the 10-year rate has jumped to 3.8%, and the S&P 500’s price-earnings ratio hovers near 20. (…)

The upcoming July 24th Nasdaq-100 special rebalance (GS)

Before the open on July 24th – for just the second time in 25 years – Nasdaq will conduct a special rebalance of the Nasdaq-100 Index (NDX). On Friday, Nasdaq released details of the upcoming special rebalance that it initially announced on July 7th. The rebalance will maintain the existing index constituents but adjust their index share counts and weights in order to reduce the concentration of the NDX. (…)

According to EPFR, $261 billion in active and passive mutual fund and ETF AUM is currently benchmarked to the NDX (…).

(… ) on July 3rd the six largest issuers each had an index weight greater than 4.5% and collectively accounted for 51% of the index. (…)

When the special rebalance occurs on Monday, July 24th, the current 7 largest NDX stocks will see their collective weight reduced to 44% from 56% today. NVDA and MSFT will be the most affected stocks, with the weight of each declining by about 3 percentage points. AAPL will see its weight fall to 11.5% (from 12.1%) but it will become the largest constituent and MSFT will rank second with a 9.8% pro forma weight (from 12.8% today). (…)

The diminution of weights in the largest stocks will be offset by increased weights in smaller index constituents. AVGO will experience the largest increase in weight (from 2.4% to 3.0%).

At the sector level, Info Tech will continue to account for roughly half of the NDX. The sector’s weight will decline slightly, from 51% to 49%. (…)

At the stock level, the rebalance will cause passive investment products tied to the NDX to algorithmically adjust their portfolios. We estimate that declining weights will drive passive net selling worth more than a day’s average trading volume in GOOGL and more than one-third of a day’s volume in MSFT, AMZN, and NVDA.

Price action on Monday, July 10th, the first day following the rebalance announcement, suggested investors were pre-trading some of these changes. (…)

The sole previous special rebalance, which took place in 2011, suggests that the upcoming adjustments will have a limited impact on the affected stocks. (…)

The NDX special rebalance is unlikely to solve the challenge that elevated current market concentration poses for many benchmarked investors. According to the Investment Company Act of 1940, a “diversified” fund cannot hold more than 25% of its portfolio in positions that each account for greater than 5% of its portfolio.

The outperformance of the largest stocks and their increased weights in benchmark indices have driven persistent mutual fund underweights in those stocks, which in turn have created large headwinds to funds’ relative returns. YTD only 31% of large-cap funds are outperforming their benchmarks. However, only $10 billion of active mutual fund AUM is benchmarked to the NDX, compared with $805 billion for the Russell 1000 Growth and $2 trillion for the S&P 500.

Even after the rebalance, the NDX will remain too concentrated to be considered an actively managed “diversified” fund according to the SEC (stocks greater than 5% weight will total 32% of the index).

At the S&P 500 level:

@Mayhem4Markets

Matt Levine: Ripple Is a Security and It Isn’t Crypto tokens are securities unless you are anonymously dumping them on retail investors.