Why a Soft Landing Could Prove Elusive Odds of the Fed reducing inflation without a recession have improved, but hazards loom

On the eve of recessions in 1990, 2001 and 2007, many Wall Street economists proclaimed the U.S. was on the cusp of achieving a soft landing, in which interest-rate increases corralled inflation without causing a recession.

Similarly, this summer’s combination of easing inflation and a cooling labor market has fueled optimism among economists and Federal Reserve officials that this elusive goal might be in reach.

But soft landings are rare for a reason: They are tricky to pull off. “You need a lot of luck,” said Antúlio Bomfim, a former adviser to Fed Chair Jerome Powell who is now at Northern Trust Asset Management. (…)

The goal faces four threats: the Fed holds rates too high for too long, economic growth accelerates, energy prices rise or a financial crisis erupts.

“The Fed could temporarily achieve a soft landing, but I’m skeptical that it could stick the landing for very long,” said Peter Berezin, chief global strategist at BCA Research in Montreal.

Once the economy is operating with little or no slack, anything that boosts demand could stoke inflation. Meanwhile, anything that lowers demand could send the unemployment rate rising, a process that is hard to stop once it starts, said Berezin. He expects a recession in the second half of next year. (…)

Since World War II, economists say, the U.S. has achieved only one durable soft landing, in 1995. “We steered the economy very expertly, but in addition, we were lucky. Nothing bad happened,” said Alan Blinder, an economist who was Fed vice chair from 1994-96. (…)

Nick Timiraos lists the 4 scenarios, to which I add my two-cents:

• The Fed stays too tight: “Officials have indicated they will hold rates at high levels for longer than they might have before the recent inflation spell to ensure price pressures don’t resurge.” The “high for longer” scenario, highly data and judgement dependent. Like a high wire act with limited visibility.
• The economy stays too hot. “Second, consumer spending and business activity are showing signs of accelerating again after slowing last year. If that continues, Fed officials could conclude that inflation’s decline risks stalling out unless they raise rates higher, increasing the chances of a recession.” The “higher for longer” scenario. I also call it “growthflation” thanks to a wealthy and employed consumer demanding that growing companies boost their wages to offset inflation.
• Energy prices take off. “Third, rising oil prices threaten to drive inflation higher while reducing growth by slowing discretionary spending.” The “stagflation” scenario which also comes with stubbornly rising wages. The worst, since the Fed has little control on the initial cause: reduced supply. Sole solution: kill demand.
• A financial-market mishap. “Fourth, the economy could be hit by some market crackup or geopolitical crisis. Many analysts see the rapid adjustment in global borrowing costs and the lagging effects of past increases as a source of instability.” A grey or black swan scenario cause by continued financial strains or any of the above scenarios.

Against these all-bad scenarios, the “Goldilocks” world looks very appealing, even if it rarely happens…Can it really occur with central bankers trying to navigate the unknown territory they created post GFC, a war in Ukraine and other geopolitical issues, China’s challenges and a hawkish OPEC+?

North America is a comparatively serene “island”, benefitting from some of the world’s problems. It has strong currencies, wealthy consumers and a powerful central bank. It is also energy independent and technologically strong with high productivity potential.

But, companies in the S&P 500 index, which captures about 82% of the total U.S. equity market value, derive a lot of their revenues from foreign markets. Actually, a 2022 research by Global X concluded that “Roughly 40% of S&P 500 revenues are generated outside of the U.S., and about 58% of Information Technology company sales were sourced from abroad.”

S&P Global has a “S&P 500 U.S. Revenue Exposure Index” (SPXREUP) designed to measure the performance of companies in the S&P 500 with higher than average revenue exposure to the U.S.. Its 252 constituents account for 38% of the total S&P 500 market cap as of August 2023.

That index has substantially underperformed the S&P 500 Index over any period in the past 10 years. Year-to-date (to August 31), its total return is only 1.7% against +18.7% for the S&P 500.

Just so you know about this “island of tranquility”.

UAW Strike Ripples Across Industry as Automakers Plan Temporary Layoffs General Motors said it would soon idle a plant in Kansas because of a resulting parts shortage, while Ford plans to temporarily lay off about 600 workers.

• Canada Autoworkers’ Strike Deadline Looms

(…) In Canada, rather than negotiating with all three major automakers at once, Unifor selected Ford as the “target” company for bargaining. A collective agreement with Ford, once ratified, will set the pattern for contracts with GM and Stellantis.

Talks with Ford began in August and the union has rejected two offers from the automaker. The contract expires at 11:59 p.m. on Monday and Unifor members voted almost unanimously in support of a strike if an agreement isn’t reached. (…)

US Homebuyers Cancel Purchases at Highest Rate in 10 Months About 16% of contracts were scrapped in August, Redfin reports

Nearly 60,000 deals to purchase homes fell through in August, according to a report released Friday by Redfin Corp. That’s equal to roughly 16% of homes that went under contract last month, the biggest share of cancellations since October. (…)

“I’ve seen more homebuyers cancel deals in the last six months than I’ve seen at any point during my 24 years of working in real estate,” Jaime Moore, a Redfin agent, said in the report. “They’re getting cold feet.” (…)

US retailer holiday hiring to drop to levels last seen in 2008

U.S. retailers will hire the lowest number of seasonal workers for this holiday season since 2008, due to increased labor costs and shaky consumer confidence, according to a report by Challenger, Gray & Christmas provided exclusively to Reuters.

Retailers are expected to add just 410,000 seasonal jobs this season, according to an analysis of nonseasonally adjusted data from the Bureau of Labor Statistics (BLS) by the global outplacement and executive coaching firm. That is just slightly above the 324,900 workers they added during the last quarter of the financial recession of 2008.

U.S. retailers added 519,400 jobs in the last quarter of 2022, a 26% decline from the same period in 2021. (…)

U.S.-based companies have so far announced just 8,000 planned hires for the holiday season, compared with the 258,201 planned hires announced by employers by this point in 2022, according to Challenger, Gray & Christmas’ tracking.

“We have never gone this far into September and not had big hiring predictions from retailers,” said Andrew Challenger, senior vice president at Challenger, Gray & Christmas. “It’s really surprising”, he said adding that it signals uncertainty and lower seasonal hiring trends this year. (…)

• US holiday sales set for slowest year since 2018 as consumers turn frugal, report says

Holiday sales in the United States are estimated to grow at their slowest pace in five years, according to a report released on Wednesday, as dwindling household savings and worries over the economy prompt consumers to spend judiciously.

Sales across physical stores and online channels are expected to rise by 3.5% to 4.6% between November and January, for a total of $1.54 trillion to $1.56 trillion, according to Deloitte.

That compares to a 7.6% increase in 2022, Deloitte said, when high inflation drove up prices for everything from Christmas cardigans and toys to home appliances. (…)

Actually, there is no slowdown in real terms, quite the opposite: my “retail inflation” index (35% CPI-Durables + 65% CPI-Nondurables) was up 11.0% in 2022 when total retail sales rose 9.7% (per PCE data, real expenditures on goods declined 0.5% in 2022).

In the first 6 months of 2023, “retail inflation” was 1.8% vs total sales up 3.2% (real expenditures on goods rose 1.1%). Averaging July and August: “retail inflation” was +0.1% vs retail sales +2.6%.

From The Transcript:

• “In the US, things are better than I would have expected them to be when we started the year. I was concerned about the amount of inflation in categories like dry grocery and consumables, and how that would impact discretionary purchases. Had an eye on the consumer balance sheet, all those things that we were all thinking about at the beginning of the year. But things have held up better than I would have guessed.” – Walmart (WMT ) CEO Douglas McMillon
• “From a macro standpoint, I think what we’re seeing is consistent with what you’re hearing from other banks, which is the consumer remains strong” – US Bancorp (USB ) CEO Andrew Cecere
• “I mean, what we see from a consumer standpoint is that the consumer continues to be resilient. They continue to be spending on travel, they continue to be spending on experiences even as we look at the data through the end of August. .” – Mastercard (MA ) CFO Sachin Mehra
• “They have more money than they’ve had. Home price has gone up for the last 15 years. Asset prices have gone up. Their balance sheet is in great shape. Their incomes have gone up. They’ve got more cash in their checking accounts than pre-COVID. It was a lot more, and it’s been coming down so that excess — we call it excess savings seems to be normalizing. Wages are going up, particularly at the low end. It’s pretty good, which is why you have a pretty good economy.” – JPMorgan Chase (JPM ) CEO Jamie Dimon
• “But putting all of that together, I think the consumer is really solid position. It’s been strong. We see credit normalizing as we would expect. But overall, again, the consumer is looking pretty good.” – Capital One Financial (COF ) CEO Andrew Young
• “…they are in good shape and they’re angling down. They’re spending a little bit of it, but they still have on the lower-end probably two to three times more cash than they had pre-COVID.” – Bank of America (BAC ) Regional President Dean Athanasia
• “So broadly, the consumer is still pretty strong. They carried over some savings from COVID that are still on their balance sheets, and their credit scores are still above 2019, which is a good sign. So when we look forward, that’s a real positive.” – Equifax (EFX ) CEO Mark Begor

Did you miss The Wealth Defect?

El-Erian Warns of ‘Massive’ Corporate Refinancing Next Year

“If you look at high yield, if you look at commercial real estate, there’s massive refinancing needs next year. Massive,” he said on Bloomberg Television Friday. “So that’s the point of pain which starts to happen.”

“There are things that have to be refinanced in this economy that cannot be refinanced in an orderly fashion at these rates,” according to the chief economic adviser at Allianz SE and Bloomberg Opinion columnist. (…)

The US junk bond market faces a looming wall of debt coming due over the next few years with $41 billion maturing in 2024 and another $113 billion the following year, Bloomberg compiled data show. (…)

“Now, some people will tell you there’s lots of distressed credit funds with lots of money waiting to come in,” El-Erian said. “We’re going to see a game of chicken between the two.”

• Corporate Borrowers Are Giving In to High Rates, Wells Fargo Says

Corporate borrowers are coming to terms with the likelihood that Federal Reserve officials will keep interest rates in the US elevated for a protracted period of time, according to Wells Fargo & Co.

Companies are finding ample appetite for new bond sales across both investment-grade and high-yield debt markets — and many executives are taking advantage of that to tap US debt markets, said Maureen O’Connor, global head of high-grade debt syndicate at the bank. That’s as some finance chiefs see signs that elevated borrowing costs are set to linger. (…)

Issuance has been robust this month across both high-grade and junk debt markets, with more than $110 billion of bonds sold globally last week. That’s the busiest start to any September on record, according to data compiled by Bloomberg. (…)

Reuters: “Refinancing is also coming at a higher cost. Junk bond issuers are now paying roughly 100 to 300 basis points more in coupons on new refinanced debt relative to in-place coupons, according to the report. Leveraged loan issuers are paying 60 to 250 basis points more when they refinance their loans.”

EARNINGS WATCH

Higher Gasoline Prices Boost Retail Sales

Higher pump prices helped drive a 0.6% increase in total U.S. retail sales in August from the prior month, while consumers modestly boosted their spending on other goods, the Commerce Department said Thursday. Excluding gasoline, other sales at stores, online and at restaurants rose 0.2%. (…)

“The jump in energy prices is the new influence on inflation,” said Peter Boockvar, chief investment officer at Bleakley Financial Group. “Fuel filters into just about everything.” (…)

Shoppers also spent more last month at electronics and appliance stores and for clothes as students headed back to school. They boosted sales at car dealerships despite higher interest rates and prices. (…)

The producer-price index, which captures what companies charge businesses and other customers, rose 0.7% in August from the prior month, the Labor Department said.

Excluding energy, though, the PPI increased just 0.1% in August. A less volatile so-called core measure—which excludes food, energy and supplier margins—climbed 0.3% last month, the same as July’s revised reading. (…)

Based on this week’s inflation reports, the core PCE price index rose just 0.1% in August from the prior month, according to forecasts by economists at JPMorgan Chase, Goldman Sachs and Citigroup. That would mark the smallest monthly increase in over a year and would lower the 12-month core PCE inflation rate to 3.8% in August from 4.2% in July. (…)

So many ways to skin the retail sales cat as Wells Fargo shows.

Since April:

• total sales: +5.8% annualized, last 3 months: +5.2% a.r.. Last 2 months: +6.7% a.r..
• control sales: +5.6% annualized, last 3 months: +4.9% a.r.. Last 2 months: +5.5% a.r..

Americans are still buying a lot of goods.

Strong sales at apparel and general merchandise stores in July and August suggest a good back-to-school season which bodes well for holiday sales in the important 4th quarter.

A narrow measure of spending on services, sales at restaurant and bars rose 0.3% MoM in August after +0.8% in July. Since April: +9.2% annualized. Last 3 months: +7.0% a.r.. Last 2 months: +6.6% a.r..

This highly discretionary spending category is not showing any alarming sign, is it?

UAW Strikes at GM, Ford and Stellantis Plants The walkouts are the first to hit all three automakers at the same time and affect factories in Missouri, Ohio and Michigan.

China’s Economy Shows Fresh Signs of Fragile Recovery Spending in stores and factory production rose in August, and unemployment fell, but the property sector continued to threaten growth.

(…) Retail sales rose 4.6% last month from a year earlier, compared with a 2.5% annual gain in July. Industrial production expanded 4.5% year over year, after a 3.7% increase in the prior month.

The unemployment rate fell to 5.2% in August from 5.3% in July. China last month stopped publishing figures for youth unemployment, which had become a focus of international attention after joblessness among those ages 16 to 24 pushed past 20%. Officials said they wanted to make some methodological improvements to the data. (…)

The central bank said Friday that it cut the interest rate on 14-day loans to banks, while on Thursday it said it would lower banks’ reserve requirement ratio by 0.25 percentage point, to 7.4%, making more funds available for loans. The ratio was last cut in March. (…)

In the first eight months of 2023, outlays on buildings and other fixed assets were up 3.2% from the year-earlier period, slowing from the 3.4% pace of January-July. Investment in infrastructure and manufacturing was up, but real-estate investment was down 8.8%. Overall private investment was down 0.7%. (…)

Of the 70 cities, 52 reported a monthly decline in August, up from 40 cities in July. Average home prices in August were down 0.55% from a year earlier, compared with July’s 0.57%. (…)

(ZeroHedge)

Reuters:

New home prices fell at the fastest pace in 10 months in August, down 0.3% month-on-month after a 0.2% decline in July, according to Reuters calculations based on National Bureau of Statistics (NBS) data. Prices were down 0.1% from a year earlier, after a 0.1% decline in July.

For August, property investment fell for the 18th straight month, down 19.1% year-on-year from a 17.8% slump the previous month, separate data showed on Friday. Home sales are down for the 26th consecutive month, according to Reuters calculations based on the data. (…)

Around 30 cities eased home purchase curbs and relaxed mortgage rules for buyers in recent weeks but analysts say Beijing may have to introduce more aggressive property easing measures to deliver a real recovery.

Authorities may also need to lift almost all restrictions on home transactions, invest more in the urban renovation programme, speed up infrastructure spending and restructure local government debt, said Nomura.

Moody’s on Thursday cut China’s property sector outlook to negative from stable, citing economic growth challenges, which the rating’s agency said will dampen sales despite government support. (…)

• China’s Housing Woes Swamp Another State-Linked Developer

Sino-Ocean Group said on Friday that it has suspended payments on eight U.S. dollar bonds with a total face value of around $4 billion, and will seek to restructure its offshore debt. The developer, which is about 30% owned by state-owned insurer China Life, has hired Houlihan Lokey as its financial adviser and Sidley Austin as legal adviser.

The company said it recently experienced a rapid decline in contracted sales and has been facing mounting liquidity pressure. Sino-Ocean’s Hong Kong-listed shares dropped 9% on Friday. Prices of some of its dollar bonds had tumbled to below 10 cents on the dollar earlier this week, according to FactSet.

Some other state-linked property companies, including Central China Real Estate and Greenland Holdings, have defaulted in recent months. China’s top surviving private developer, Country Garden, narrowly averted an international debt default recently after making two overdue bond-coupon payments right before the end of a grace period.

European Central Bank Raises Key Interest Rate to Record High Central bank signals this might be enough to combat inflation, but doesn’t rule out further increases

In a split decision, ECB officials raised the bank’s deposit rate to 4%, the 10th increase in a row and a vertiginous rise from below zero last year. (…)

ECB officials judge that rates “have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution” to reducing inflation to their 2% target, Lagarde said, repeating language used in the bank’s policy statement. (…)

New economic forecasts published by the ECB Thursday suggested that eurozone growth will slow significantly more than previously expected this year and next, while inflation will remain markedly above the ECB’s target of 2% through next year. The bank raised its forecast for inflation next year from 3% to 3.2%, mainly to reflect “a higher path for energy prices.” (…)

Underlying inflation in August was 5.3% in the eurozone and 4.3% in the U.S. (…)

Canadian household debt ratio down in second quarter as disposable income grew

The agency says household credit market debt as a proportion of household disposable income, on a seasonally adjusted basis, fell to 180.5 per cent in the second quarter compared with 184.2 per cent in the first quarter of the year. (…)

Meanwhile, the household debt service ratio, measured as total obligated payments of principal and interest on credit market debt as a proportion of household disposable income, was 14.79 per cent in the most recent quarter, down from 14.90 per cent in the first quarter, when it hit its highest point since 2019.

The moves came as seasonally adjusted household credit market borrowing fell to $17.1-billion in the second quarter compared with $20.4-billion in the first quarter as demand for mortgage loans fell to their lowest point since 2005.

The seasonally adjusted total stock of household credit market debt in the second quarter was $2.86-trillion, up 0.6 per cent from the first quarter, while mortgage debt totalled $2.13-trillion.

EQUITIES

Goldman’s Peter Oppenheimer’s charts show that the S&P 500 is up 17% YtD but the median stock is up only 3%.

This chart suggests that even excluding “Big Tech”, U.S. valuations are stretched.

The decline in core inflation from 4.7% to 4.3% reduced the Rule of 20 P/E to 25.0, still expensive, even using forward PS (R20 P/E = 23.5).

Since November 2022, trailing EPS have declined 2.9% but inflation slowed from 6.6% to 4.3%, boosting the Rule of 20 Fair Value (yellow line in chart) 16% to 3400.