Emerging Debt Deal Would Raise Limit, Cap Spending for Two Years

Republican and White House negotiators are moving closer to an agreement to raise the debt limit and cap federal spending for two years, according to people familiar with the matter, as time grows short to avert a catastrophic US default.

The two sides have narrowed differences in talks over recent days, according to the people, though the details agreed to are tentative and a final accord is still not in hand. The two sides have yet to agree on the amount of the cap.

Under the terms of the emerging agreement, defense spending would be permitted to rise 3% next year in line with President Joe Biden’s budget request. (…)

May Vehicle Sales Forecast: 15.3 million SAAR, Up Sharply YoY

The Wards forecast of 15.3 million SAAR, would be down 3.9% from last month, and up 21.6% from a year ago.

Chicago Fed: Pickup in Economic Growth in April

The CFNAI rose to +0.07 in April from -0.37 in March. All four broad categories of indicators used to construct the index increased from March, but two of the four categories made negative contributions in April.

Pending Home Sales Unchanged in April

Recession?

The Fed tightening has had its normal impact on interest sensitive sectors but the highly unusual circumstances of

• 10 years of QE;
• a worldwide pandemic;
• government money showering and a very accommodative Fed;
• the war in Ukraine;
• a very mild winter;
• the return of protectionism;

have together created an economic and financial environment that has made previous playbooks ineffective.

The auto and housing cycles are now showing signs of bottoming without having had their usual effects on employment and wages. Services are gradually but surely recovering, helped in part by rising interest rates that are boosting savers’ incomes, particularly baby boomers’ who are increasingly dining out and travelling.

@Mike_Zaccardi

Apartment Landlords Bleeding Cash Imperil $47 Billion of Loans The US multifamily buying boom threatens to go bust for owners getting squeezed by higher interest rates and other surging costs.

Higher interest rates and surging expenses are erasing their profits, even as rents are still climbing in many places. Debt payments already exceed income from multifamily buildings financed with more than $47 billion of securitized loans, according to data from Trepp.

Making matters worse, property taxes are escalating swiftly and the destructive path of climate change is sending insurance costs skyward. And building values are falling, complicating owners’ efforts to sell or refinance their way out of trouble.

“The problem is, nobody expected expenses to rise as much as they did,” said Jay Parsons, chief economist for RealPage, a rental-data tracker. “In particular, investors with floating-rate loans resetting at significantly higher rates could be challenged to cover debt payments.”

For now, the fallout has been limited. That’s because investors often purchase rate caps that protect them from the worst effects of soaring interest costs. But those policies are likely to begin burning off at a rapid rate later this year, leaving a growing number of owners vulnerable. (…)

Prices have fallen by an estimated 15% to 20% since the Fed began raising interest rates last March, said Aaron Jodka, research director for US capital markets at Colliers. (…)

America’s Travel Resurgence Is Finally Here Would-be tourists have the money and the desire to hit the road this summer. Their increased spending could even help fend off a recession.

(…) In a Gallup poll last May, 40% of respondents said they had been avoiding travel by airplane, bus, subway or train. By this February—the most recent survey—that figure had fallen to 18%. With the U.S. this month ending the national emergency and public-health emergency declaration put in place when the pandemic hit, people are probably even less worried now. (…)

Traditional hotel chains have been more upbeat, with many, including Marriott International and Hilton Worldwide Holdings, upping sales forecasts for this year when they reported first-quarter results. The unlocking of overseas demand, particularly in countries such as China and Japan that had strict Covid mitigation measures in place last summer, is helping boost global demand for hotel rooms.

That reflects increased comfort with international travel and is having a spillover effect for the U.S. as a destination: Over the three months starting last June, international arrivals to the U.S. were 33% lower than in the comparable three months of 2019, according to the National Travel and Tourism Office. The most recent available data shows that in the first two months of this year that gap had narrowed to 18%. (…)

Ships have gone from not having enough passengers a year ago to packing them to the gunwales, and in some cases cruise lines are canceling people’s trip after overselling. (…)

• Hotels: Occupancy Rate Down 2.0% Year-over-year

Through May 13 per STR (via CalculatedRisk): Occupancy: 65.1% (-2.0%)

• On roads (Advisor Perspectives)

“Travel on all roads and streets changed by +1.9% (+4.5 billion vehicle miles) for February 2023 as compared with February 2022. Travel for the month is estimated to be 233.7 billion vehicle miles.” The 12-month moving average was up month-over-month (MoM) by 0.14% and was up 0.5% year-over-year (YoY). If we factor in population growth, the 12-month MA of the civilian population-adjusted data (age 16-and-over) was up 0.1% MoM and down 0.6% YoY.

Total miles traveled, however, is one of those metrics that should be adjusted for population growth to provide the most meaningful analysis, especially if we want to understand the historical context. (…)

In fact, there’s a good case for using the Census Bureau’s mid-month estimates of total population (POPTHM) rather than civilians age 16 and over for the population adjustment. The reason is that a portion of total miles traveled is specifically to support children’s needs (daycare, schools, children’s activities, etc.) and the needs of elders who might have licenses but no longer drive. Ultimately the division of miles traveled by either population group (CNP16OV or POPTHM), while not a perfect match with drivers, is a consistent and relevant metric for evaluating economic growth.

(…) In the total population-adjusted version, the latest data point is 5.65% off-peak. This population-adjusted version puts us at a level we first achieved in 1999.

• By air: TSA checkpoint travel numbers show passenger volumes up 12.2% YoY in May (through May 24) and +7.1% from the same period in 2019.

• A Barbecue Craze in China Shows Why Its Economy Is Undercooked The journey of Zibo from industrial backwater to meat-grilling vacation hot spot reflects the bitter reality of China’s postpandemic recovery

Thousands of tourists sip cheap lager in plastic cups and grill mutton skewers in the open air every night in this hardscrabble Chinese city. The revelers snap selfies with friends, many on their first vacations since China lifted Covid-19 restrictions.

Until recently, few Chinese could place Zibo on a map. Now it is one of the country’s top vacation hot spots. Its skyrocketing popularity captures a national mood that increasingly places fun and thriftiness over lavish spending—with consequences for China’s postpandemic recovery. (…)

Even as they indulge in parties with friends, many Chinese people are scrimping on bigger-ticket items such as furniture and appliances. The dim job prospects are also leading many young people to put off getting married and having children, which in turn will likely worsen China’s falling population in the years to come.

“Young people think differently now,” said 23-year-old Shao Xiaoru, who was visiting Zibo earlier this month. “They all want to go out and have fun instead of staying at home.”

Shao perused a popular bookstore in Zibo that is shaped like a giant pagoda. Few were buying books though and only three of its nine floors were operating. The throngs of tourists instead indulged in another pastime that doesn’t cost anything—taking selfies to put on social media.

Zibo’s emergence as a selfie-worthy destination reflects the pent-up demand for fun that Chinese leaders hope can revive the world’s second-largest economy. But turning that exuberance into sustainable economic growth is more complicated. (…)

While the number of domestic trips nationwide jumped 19% versus the last prepandemic year of 2019, total tourist spending only rose 0.7%, according to the Ministry of Culture and Tourism. (…)

Europe’s Economic Engine Is Breaking Down Germany is at risk of a long, slow decline — with consequences for the whole of the EU

Decades of flawed energy policy, the demise of combustion-engine cars and a sluggish transition to new technologies are converging to pose the most fundamental threat to the nation’s prosperity since reunification. But unlike in 1990, the political class lacks the leadership to tackle structural issues gnawing at the heart of the country’s competitiveness. (…)

While Berlin has shown a knack for overcoming crises in the past, the question now is whether it can pursue a sustained strategy. The prospect looks remote. Chancellor Olaf Scholz’s make-shift coalition has reverted to petty infighting over everything from debt and spending to heat pumps and speed limits as soon as the risks of energy shortfalls eased. (…)

Economists see German growth lagging behind the rest of the region for years to come, and the International Monetary Fund estimates Germany will be the worst-performing G-7 economy this year. (…)

Germany finds itself ill-suited to sustainably serve the energy needs of its industrial base; overly dependent on old-school engineering; and lacking the political and commercial agility to pivot to faster-growing sectors. The array of structural challenges points to a cold awakening for the center of European power, which has become accustomed to uninterrupted affluence.

To its credit, industrial behemoths like Volkswagen AG, Siemens AG and Bayer AG are flanked by thousands of smaller Mittelstand companies, and the country’s conservative spending habits put it on a stronger fiscal footing than its peers to support the transformation ahead. But it has little time to waste. (…)

Affordable power is a key precondition for industrial competitiveness, and even before the end of Russian gas supplies, Germany had some of the highest electricity costs in Europe. Failure to stabilize the situation could transform a trickle of manufacturers heading elsewhere into a stampede.

Berlin is responding to concerns by seeking a cap on power prices for some energy-intensive industries like chemicals through 2030 — a plan that could cost taxpayers as much as €30 billion ($32 billion). But that would be a temporary patch, and shows Germany’s desperate situation in terms of supply. (…)

The bitter reality is that resources for generating that much clean power are limited in Germany by its relatively small coastline and lack of sun. In response, the country is looking to build a vast infrastructure to import hydrogen from the likes of Australia, Canada and Saudi Arabia — banking on technology that hasn’t been tested at this scale.

At the same time, Germany will need to speed the construction of high-voltage grids linking wind farms off the coasts in the north to power-hungry factories and cities further south. And there’s little in the way of storage to ensure the country can withstand disruptions. (…)

While small manufacturers still thrive, the number of new startups is declining in Germany — in contrast to growth seen in other developed economies, according to the OECD.

The reasons include excess bureaucracy — company registrations often taking place in paper form — and a cultural aversion to risk. Financing is also an issue. Venture-capital investment in Germany totaled $11.7 billion in 2022 compared with $234.5 billion in the US, according to DealRoom. Germany also labors under a ponderous academic system and doesn’t have a single university in the top 25 of the latest Times Higher Education ranking.

Patent data shows that Germany’s ability to stay at the forefront is fading. In 2000, the country was among the top three for world-class patents in 43 of 58 key technology categories, but in 2019, it achieved that rank in fewer than half the number of areas, according to a recent study by the Bertelsmann Stiftung.

(…) Germany’s electric cars have struggled. BYD Co. overtook VW to become the best-selling car brand in China last quarter. Key to its push was an electric model that costs around a third of VW’s ID3, but offers greater range and connectivity with third-party applications. (…)

Germany’s lack of investment is particularly acute in digital technology. Despite infrastructure that had it ranked 51st in the world for fixed-line Internet speeds, it had the fourth-lowest spending among OECD countries relative to the economy’s size. (…)

With Scholz’s messy three-way coalition racked with bickering, Germany is poised for instability, and the far-right Alternative for Germany has seized on the political vacuum, vying for second in some polls. (…)

This year, more than 1 million Germans will reach retirement age — about 320,000 more than those becoming adults. By the end of the decade, the German employment agency says the shortfall will rise to as much as 500,000 — roughly equivalent to the city of Nuremberg, adding to the strains on the economy.

In a recent report, the OECD put the scale of the challenges in stark terms: “No major industrialized economy has ever had the very basis of its competitiveness and resilience so systematically challenged by changing social, environmental and regulatory pressures.”

That in turn will ripple across the entire continent, according to Dana Allin, a professor at SAIS Europe. “The health of the German economy is crucial for the broader European economy, and the bloc’s harmony and solidarity,” he said.

• BYD Seagull EV Priced From $11,400, Gets 10,000 Orders On First Day Battery packs range from 190 miles (305 kilometers) and 251 miles (405 km),charging up to 80% in 30 minutes.

• TSMC in Talks for Up to Half German Plant’s Cost in Subsidies

Taiwan Semiconductor Manufacturing Co., the world’s biggest contract chipmaker, is in talks to receive German government subsidies for as much as 50% of the costs to build its new semiconductor plant in the country, people familiar with the matter said. (…)

The deliberations over the Dresden plant, which could cost as much as €10 billion ($10.7 billion) to build, show how competition for semiconductor manufacturing capacity has intensified. The top end of the subsidies being discussed would put German government support for the fab on par with what Japan’s offering TSMC to build a factory there. It would also outpace the 40% maximum that most other chipmakers are getting for their plants in Europe. (…)

Less than half of the oil and gas industry’s unprecedented cash flow from the energy crisis is going back into traditional supply and only a small fraction to clean technologies

Data: International Energy Agency; Chart: Alice Feng/Axios

Full International Energy Agency’s analysis.

Fed Officials Were Divided Over a June Rate Pause After the most recent rate increase, several policy makers thought further hikes “may not be necessary,” according to the minutes of their May meeting.

“Several participants noted that if the economy evolved along the lines of their current outlooks, then further policy firming after this meeting may not be necessary,” said the minutes of their May 2-3 meeting released Wednesday.

Others believed they would need to lift rates in the months ahead because they expected “progress returning inflation to 2% could continue to be unacceptably slow,” the minutes said. (…)

Some Fed officials have expressed anxiety that the economy and inflation haven’t shown more visible signs of slowing. But they have also become uncertain about whether to keep lifting rates because of the potential fallout from three bank failures since March, including a credit crunch as banks face higher funding costs.

Fed Chair Jerome Powell has largely kept the rate-setting committee united since inflation surged two years ago, with only one dissent since the central bank began unwinding its pandemic-era stimulus policies at the end of 2021. The minutes illustrated how it could grow more difficult, however, to maintain a strong consensus in the coming months. (…)

Fed officials revised their postmeeting statement this month to suggest much less conviction about the need for further rate increases. Some of them said they didn’t want market participants to interpret those changes as signaling that the Fed was considering rate cuts or that further increases had been ruled out, according to the minutes. (…)

The minutes showed the Fed’s staff continued to expect a recession would begin around the fourth quarter of this year as the lagged effects of rate increases and banking strains slowed economic activity. (…)

The May flash PMIs signalled continued economic momentum as a strong and strengthening service sector more than offsets weak demand for goods.

At 55.1, the S&P Global Flash US Services Business Activity Index signalled a strong expansion in service sector output midway through the second quarter. The rate of growth in activity was the fastest for just over a year, with firms linking the upturn to greater demand from new and existing clients. (…)

New orders rose at the fastest rate since April 2022, with the pace of expansion also exceeding the series average. Contributing to the sharper increase in total new orders was a renewed rise in new business from abroad. New export orders grew for the first time in a year, and at a solid rate.

Overall consumer demand should remain solid given the healthy labor market:

Service providers noted an increased ability to bring in new staff during May, as employment rose at a quicker pace. The rate of job creation was the fastest for ten months, with firms recording broadly unchanged levels of unfinished business as a result of greater capacity improvements. This followed back-to-back expansions in backlogs of work in March and April.

[Manufacturing] firms continued to hire new workers as the availability of candidates improved. Employment growth was solid overall and the quickest since last September.

But sustained demand comes with stubborn inflation, particularly on services:

Inflationary pressures remained historically elevated across the service sector in May. Although easing, rates of increase in input prices and output charges were faster than their respective series averages. Companies often stated that greater wage bills drove inflation, as firms sought to pass-through higher cost burdens to clients.

This surely helps a lot:

Nationally, the average price per gallon of regular gasoline has been $3.53 throughout May 2023, compared to $4.60 a year ago. (Axios)

Data: Energy Information Administration, GasBuddy. Chart: Kavya Beheraj/Axios

As to the potential impact of the “banking crisis”:

Banking Crisis Is Over, Top Executives Say Threats to the global banking system have ebbed, but the industry might be forced to curtail lending and revamp business models in an era of higher interest rates.

(…) “What’s not been solved yet is what is the funding model that will work going forward.”

Barclays Chief Executive Officer C.S. Venkatakrishnan added that the acute crisis has passed but that many banks will be forced to change their business models—including possibly by curtailing lending. “I think the phase of initial discovery is over and I think there’s going to be a little bit of a longer-term discovery and adjustment,” he said. (…)

Doubts about the health of banks are leading some households and businesses to turn to lenders and investors outside of traditional banks that aren’t covered by banking regulations. Money-market funds, for instance, have drawn big inflows at the expense of bank deposits.

“I do think there’s a very big question here that needs to be solved and it should be solved because…you don’t want more of this business going into the shadow-banking sector,” [UBS] Kelleher said.

Changes in biweekly Loans and Leases are now relatively stable, even at smaller banks:

Deposits are not falling faster than before SVB:

Deposits are gradually returning to trends as excess savings are being used or redeployed:

Not to say that all is great in the credit market following a 500bps jump in interest rates. Richard Bernstein Advisors (RBA) warn:

• Defaults accelerating: Beware the coming credit crunch

(…) Charts 1 and 2 highlight how the weakest companies are feeling the heat of tighter lending standards and higher interest rates. The first chart clearly shows that repeat bankruptcies – those companies that have defaulted before and have now defaulted a second time – are nearly at all-time highs. An underlying poor business takes precedent over restructuring debt and wiping out equity holders.

The second chart should concern private credit managers. Note that small private companies (the types of companies found in private credit portfolios) are defaulting at an alarming rate compared to larger public companies. Small companies are typically the canaries in the credit mine.

Right on cue, earlier this month (May 13/14) 7 large companies defaulted. And if RBA’s proprietary default model is any guide, bankruptcy filings should get worse.

One looming concern overhanging the corporate bond market is the structure of the Collateralized Loan Obligation (CLO) market. CLOs have historically been the biggest buyer of leveraged loans, owning upwards of 2/3 of the entire loan market. As reinvestment periods end and CLO new issuance falls, the CLO’s demand for bank debt is scaling back. The combination of decreasing demand and higher rates on floating rate debt and a profit recession imply conditions couldn’t be worse for the lowest-rated corporate debt.

Yellen Says U.S. ‘Almost Certain’ to Miss Early June Payments Unless Debt Limit Is Raised The Biden administration isn’t working with investors on how to respond to a potential default on the U.S. debt, Treasury Secretary Janet Yellen said, adding the focus remains on raising the debt ceiling.

• Fitch Considers U.S. Rating Downgrade Ratings firm said failure to raise the debt limit would erode U.S. creditworthiness

Fitch said Wednesday evening it had placed the U.S. triple-A credit rating on “rating watch negative.” While the ratings firm said it still expects Democrats and Republicans to reach an agreement on raising the debt limit, it said there was a greater risk it could fail to do so in time. Treasury Secretary Janet Yellen has said the U.S. could begin missing payments as soon as June 1.

“​​The brinkmanship over the debt ceiling, failure of the U.S. authorities to meaningfully tackle medium-term fiscal challenges that will lead to rising budget deficits and a growing debt burden signal downside risks to U.S. creditworthiness,” Fitch said.

Fitch said that a missed payment after June 1 would likely be inconsistent with a triple-A rating. The ratings firm also said that potential workarounds—such as invoking the 14th amendment to ignore the debt limit—would undermine U.S. creditworthiness. (…)

• Is the safe haven still safe?

Last March, RBA published an interesting analysis:

Treasury bonds have long been considered the financial markets’ “safe haven” asset. That remains generally true, but investors should appreciate the risk of default is causing the financial markets to re-assess Treasuries’ superiority as a safe haven relative to other assets. (…)

The markets re-priced Treasuries to account for the downgrade of US debt by Standard & Poors in 2011. The cost to the US government has more consistently been between 100-200 bps higher yield relative to German Bunds than it was prior to the downgrade (see Chart 1).

In other words, the 10-year T-note yield has carried a consistent risk premium to German Bunds since the downgrade of US government debt in 2011. Because all US debt prices off US Treasuries’ yields, the downgrade and subsequent increased risk premium means US corporate, municipal, and mortgage debt has also had an imbedded risk premium and higher associated interest costs.

One should not downplay the potential damage of a growing risk premium despite generally lower absolute interest rates. US rates actually fell in absolute terms after the US downgrade because the economy weakened. The chart points out, however, that the US nonetheless experienced relatively higher rates which ultimately detracted from US competitiveness. (…)

Investors seem shocked by the recent bank failures, but there could be a significantly more meaningful financial event looming.

The notion that 2011’s near-default was a non-event has proven totally false. Of course, financing costs would have been much higher if there actually had been an extended government default, but the US economy has nonetheless paid higher interest costs and experienced slower growth because of 2011’s fiasco.

Investors should appreciate another near-default or actual default could similarly result in a meaningful secular relative increase in US relative interest costs and slower US relative economic competitiveness and growth. (…)

Germany Enters Recession in Blow to Europe’s Economy Second straight quarter of contraction in eurozone’s largest economy might prompt greater caution by central bankers

(…) Germany’s statistics agency said Thursday that gross domestic product—a broad measure of the goods and services produced by an economy—was 0.3% lower in the three months through March than in the final quarter of last year. It had previously estimated that the economy flatlined in the first quarter, having contracted by 0.5% in the final quarter of last year.

The agency said a 1.2% fall in household consumption was the main reason for the contraction, as households saw their spending power eroded by a surge in food prices. In March, German households were paying 21.2% more for their food purchases than a year earlier. (…)

Business surveys have pointed to a return to growth in Germany during the second quarter. But the impact of higher borrowing costs and a weak expansion in many of its main export markets point to the possibility of a renewed contraction in the three months through September. (…)

Should the estimates for growth in other eurozone members be unchanged, the new measure of GDP for Germany suggests the currency area’s economy as a whole contracted slightly in the first quarter. The European Union’s statistics agency currently estimates it grew at an annualized rate of 0.3%, after shrinking by 0.2% in the final quarter of last year. 

From May’s Eurozone flash PMI:

Eurozone business output grew for a fifth straight month in May, according to the latest HCOB flash PMI survey data produced by S&P Global, pointing to robust economic growth so far in the second quarter. The rate of expansion moderated in response to a near-stalling of new business inflows, however, and the upturn grew increasingly uneven.

Strong service sector growth contrasted with a steepening loss of factory output, linked in turn to a widening divergence in demand growth for goods and services.

Relative to other Eurozone economies, Germany is more goods and more China sensitive.

• It Just Had an Energy Crisis, Now Europe Faces a Food Shock Inflation as a whole is falling, but food prices are rocketing, forcing consumers to tighten their belts and presenting a new policy challenge for governments still reeling from a spending spree to support households through the pandemic and an energy crisis.

China Warnings Flash Across Global Markets China’s muted economic rebound are reverberating around the globe.

(…) Recent data suggest gross domestic product growth this year will be closer to the government’s target of about 5%, contrary to expectations of a large overshoot formed earlier in the year. The figures also show a lopsided rebound that’s being led by consumer services, while industrial activity lags far behind. (…)

In the crisis-ridden property market, sales are slowing after an initial rebound. Combined with the persistent financial troubles of real estate developers, that’s hampering new projects in a sector which accounts for about 20% of China’s GDP after including related sectors. Infrastructure spending is being constrained by the hefty debt loads of local governments, symbolized this week by an 11th hour bond repayment by a state-owned firm.

Disappointing construction activity is weighing heavily on many commodities markets. Copper — long considered a barometer of an economy’s health because of its wide range of uses — has dived below $8,000 a ton while iron ore has breached $100, unwinding all of the gains made after Beijing called time on its Covid Zero policies late last year.

China is the world’s biggest buyer of items like crude oil and copper, and its vast steel industry accounts for well over half of global iron ore demand. (…)

• China’s New Covid Wave Set to See 65 Million Cases a Week

China is likely to see its Covid-19 wave peaking at about 65 million infections a week toward the end of June, according to a senior health adviser, while authorities rush to bolster their vaccine arsenal to target the latest omicron variants.

XBB has been fueling a resurgence in cases across China since late April and is expected to result in 40 million infections a week by the end of May, before peaking at 65 million a month later, local media outlet the Paper reported Monday, citing a presentation by respiratory disease specialist Zhong Nanshan at a biotech conference in the southern city of Guangzhou.

His estimate provides rare insight into how the much anticipated second wave may play out, with immunity among the country’s 1.4 billion residents waning nearly six months after Beijing’s sudden dismantling of Covid Zero curbs saw coronavirus run rampant. In the wake of the pivot to living with the virus, the Chinese Center for Disease Control and Prevention stopped updating its weekly statistics earlier this month, leaving a question mark over Covid’s impact.

The 65-million-case estimate from disease modeling indicates the resurgence is likely to be more muted compared with the previous wave unleashed late last year and into January. Back then, a different omicron sublineage probably infected 37 million people every day, sending residents scrambling for limited supplies of fever medicine, overwhelming hospitals and crematoriums.

China is also preparing to roll out new vaccines that will target XBB. The country’s drug regulator has already given preliminary approval to two and another three or four “will be cleared soon”, Zhong said. “We can lead the pack internationally in developing more effective vaccines.” (…)

Swedish Housing Starts Slump 55% in Latest Sign of Crisis