US Retail Sales Edge Higher as Key Metric Shows Resilient Demand
The value of retail purchases rose 0.2% in June after an upwardly revised 0.5% increase in May, Commerce Department data showed Tuesday. The figures aren’t adjusted for inflation.
So-called control group sales — which are used to calculate gross domestic product and exclude food services, auto dealers, building materials stores and gasoline stations — accelerated to a 0.6% advance, twice the prior month’s gain. (…)
Receipts at restaurants and bars — the only service-sector category in the report — edged up a modest 0.1% after surging 1.2% in the prior month. (…)
My estimate of retail inflation (0.33 CPI-Durables + 0.67 CPI-Nondurables) is -0.1% in June after +0.6% in April and -0.3% in May making real sales up 0.3% in June following -0.2% in April and +0.9% in May. Erratic but still growing overall.
Notice the negative trend in goods inflation since July of 2022, down 8 of the last 12 months and 3 of the last 4.
Control sales ex-restaurants and bars are up 0.55% MoM after +0.3% and +0.55% the previous 2 months. Pretty steady.
John Authers:
So, how close is the party to being over? This resilient strength may wane sooner than many think. Crucial is how much money consumers still have left over from the pandemic. So far, bears have been surprised by how long their savings have lasted. But data from Citi Research as of July 6 show that excess savings accumulated over the pandemic are nearing depletion in the US. The contrast is stark when juxtaposed with Europe, the UK, Australia and Japan. In those economies, savings haven’t been drawn down to anything like the same extent. (…)
The following graph by TD Securities underscores the same finding. The US has seen its surplus in household savings tumble by a magnitude far greater than other major economies. This is why James Rossiter, the firm’s head of global macro strategy, sees the US entering a recession early next year.
“Excess savings have absorbed much of the nominal shock from higher inflation, allowing consumers (especially in the US) to continue consuming as usual,” he wrote in a Tuesday note. “One could therefore argue that high excess savings in other major economies might buffer consumers from higher rates going forward, but once those excess savings are eroded, interest rate pass-through will accelerate.” (…)
For another sign that conditions aren’t quite so good for consumers anymore, credit scores are falling after a pandemic-era improvement, while the banks that reported results in the last few days have all been citing higher charge-offs on credit card debt, as reported by Jennifer Surane.
It’s difficult to envisage a recession starting until those extra savings have been used up. Once they have, the chances are that high interest rates will still be in force, which will drive a slowdown in economic activity. But the resilience of American spending habits has already caught out many economists. It’s no surprise that the projected start date for the next recession keeps being pushed back.
Savings are helpful but consumer expenditures are intimately linked to labor income. Aggregate weekly payrolls (employment x hours x wages) (black) were still up 6.3% YoY in June, +3.2% in real terms, right in line with total consumer expenditures as services continue to offset slowing spending on goods. Retail sales were up 1.5% YoY in June, still a respectable 1.6% gain considering that retail inflation was -0.1%.
On a MoM basis, labor income keeps rising at a 5-6% annualized rate supported by steady wage gains (black):
One of the biggest risk for consumers, the economy and equity markets is energy inflation, -16.5% in June, boosting disposable income and corporate profit margins.
Oil Rises to $80 as Russian Supply Drop Offsets Economy Risks
Brent futures added 0.6% in thin trading volumes on Wednesday. It rose the previous session as data showed that Russia’s crude shipments fell to a six-month low in the four weeks to July 16. The curbs suggest that Moscow is fulfilling a pledge with its partners in the OPEC+ coalition to rein in supplies. (…)
Russia said it aims to reduce its third-quarter crude export plans by 2.1 million tons, in line with its previously stated pledge to cut overseas shipments by 500,000 barrels a day in August. (…)
US companies cut day-to-day costs to keep expenses in check
The total operating expenses of companies rated investment grade by S&P Global Ratings fell 5.3% in the first quarter to $2.858 trillion, indicating companies reduced day-to-day running costs such as wages and business travel.
Companies with weaker balance sheets also trimmed costs. Total operating expenses of non-investment-grade companies fell 3.8% from the fourth quarter of 2022 to $628.71 billion, according to the latest data from S&P Global Market Intelligence.
The energy and consumer discretionary sectors were particularly active in cutting costs with declines of over 13% and 10%, respectively, among the investment-grade tranches. Non-investment-grade companies in both sectors made similar cuts, at 13.4% and 8.6% reductions in operating costs from the previous quarter, respectively.
The decline in expenses lowered the median ratio of operating expenses to total revenue for investment-grade-rated companies to 83.8% from 85.0% at the end of 2022.
By contrast, the cuts by lower-rated companies were not enough to lower the median ratio, which rose to 91.4% from 90.6% as revenues were hit harder. The most notable rises in the ratio were in real estate, communication services and information technology. (…)
The S&P Global post also shows some ratios by sector.
Canadian Inflation Slows to 2.8%, Though Core Remains Sticky
The consumer price index rose 2.8% in June from a year ago, Statistics Canada reported Tuesday in Ottawa. That’s slower than the median estimate of 3% in a Bloomberg survey of economists. On a monthly basis, the index rose 0.1%, also weaker than expectations of 0.3%.
Two key yearly inflation measures tracked closely by the Bank of Canada — the so-called trim and median core rates — also dropped, averaging 3.8%. That’s down from an upwardly revised 3.9% a month earlier but faster than 3.65% expected by economists.
While those figures showed deceleration, a three-month moving average of the core measures — which Governor Tiff Macklem has flagged as key to his team’s thinking — rose to an annualized pace of 3.81%, from 3.71% previously, according to Bloomberg calculations. (…)
A $500 Billion Corporate-Debt Storm Builds Over Global Economy
(…) “It’s like an elastic band,” says Carla Matthews, who heads contentious insolvency and asset recovery at consulting firm PwC in the UK. “You can get away with a certain amount of tension. But there will be a point where it snaps.”
That’s starting to happen already, with more than 120 big bankruptcies in the US alone already this year. Even so, less than 15% of the nearly $600 billion of debt trading at distressed levels globally have actually defaulted, the data show. That means companies that owe more than half-a-trillion dollars may be unable to repay it — or at least struggle to do so.
This week, Moody’s Investors Service said the default rate for speculative-grade companies worldwide is expected to hit 5.1% next year, up from 3.8% in the 12 months ended in June. Under the most pessimistic scenario, it could jump as high as 13.7% — exceeding the level reached during the 2008-2009 credit crash.
Of course, much remains uncertain. The US economy, for one, has remained surprisingly resilient in the face of higher borrowing costs, and the steady slowdown in inflation is raising speculation the Fed may be steering the economy to a soft landing. Yield spreads in the US junk-bond market — a key measure of the perceived risk — have also narrowed since March, when the collapse of Silicon Valley Bank briefly sowed fears of a credit crisis that never materialized. (…)
The more defaults rise, the more investors and banks may pull back on lending, in turn pushing more companies into distress as financing options disappear. The resulting bankruptcies would also pressure the labor market as employees are let go, with a corresponding drag on consumer spending. (…)
More than a quarter of the distressed debt worldwide — or about $168 billion — are tied to the real estate sector, more than any other single group, the data show.
There seems to be little relief on the horizon. A survey by property broker Knight Frank found that half of the international firms it surveyed are planning to cut down on office space. Coaxing tenants back can be expensive, particularly as businesses look for more environmentally friendly workspaces. (…)
More than $70 billion of debt from private equity owned companies is trading at distressed levels. (…)
- The $785 Billion Junk-Bond Maturity Wall Has Never Been So Close World’s riskiest borrowers in a race against time to refinance
(…) On average, these companies now have 4.7 years to put fresh financing in place, the least amount of time ever, according to a Bloomberg global index. (…)
More than 40% of the maturity wall, or debt that needs to be refinanced between 2024 and 2026, was taken out then [the pandemic]. (…)
Refinancing costs, the extra interest companies have to pay when replacing debt, stand at about 3%, more than five times the average since 2018. (…)
KKR, a savvy lender, is more nuanced on the credit cycle:
(…) this is still not the time to simply buy the market when it comes to riskier loans, and there is the possibility of a ‘double whammy’ from higher defaults and lower reference rates if the U.S. encounters a more severe downturn this cycle.
(…) although we remain cautious about the outlook for margins, HY credit fundamentals are much better than they have been in past cycles. Just consider that the average issuer now has a rating of BB or higher, versus B or lower in 2006-2007, and that about a quarter of the BB market is now senior secured, up from zero percent pre-GFC.
(…) we continue to think that RE lending overall will hold up much better than it did in the GFC thanks to lower LTVs, less pro-forma underwriting, and the fact that asset values have already reset in many sectors, providing more of an equity ‘cushion’ before bondholders take losses. As such, we think that CRE lending may be one of the most compelling ways to add Real Estate exposure in scale at this point in the cycle.
(…) our analysis actually suggests that CRE defaults will not be as negative this cycle as they were during the GFC. For instance, our base case shows aggregate CRE bank loan losses this cycle at 3.4%, versus 5.7% in our bear case and fully 10.5% during the GFC. On the CMBS side, our base and bear cases for cumulative losses are slightly higher at 4.8% and 7.5%, respectively, though still well below the 10.1% recorded after 2008.
Why do we expect a more benign CRE credit cycle this time around? For one thing, we are of the view that a lot of the pain for investors this cycle will be heavily concentrated in Office debt, which is actually only about 30% of the total CRE debt market. In fact, for most sectors and most vintages in the remaining 70% of CRE loans, asset values are not significantly lower than they were at underwrite (though loans underwritten during the go-go years of 2021-2022 may run into some trouble).
By contrast, Office values actually peaked back in 2019, which means more outstanding loans will have trouble refinancing. Overall, the potential for losses to be concentrated in a single sector would be a lot easier for markets to navigate versus the GFC when CRE asset values declined sharply across almost all sectors.
Second, underwriting standards for CRE debt have become much more rigorous since the financial crisis, with a lot less pro-forma underwriting and an average underwrite LTV of around 55-60%, versus 65-70% in the pre-GFC years. As such, there is a lot more protection for lenders baked into CRE capital structures. Risk-retention requirements and better credit enhancement have helped mitigate risk for high-grade CMBS, too. So, our bottom line is that we do not think that the risks for holders of CRE debt overall will be as severe as they were during the last major default cycle.
However, we are not sounding the all-clear, and we do think there are several different factors that could make CRE defaults a challenging issue for smaller banks this cycle. First, large banks have generally stepped back from CRE lending since the GFC, while smaller banks (i.e., those with $100 billion or less in assets) have taken market share. In fact, CRE loans now account for roughly 30% of all assets at smaller banks, versus just seven percent at large banks.
Second, a lot more of smaller banks’ CRE exposure this cycle is to Office debt, which actually makes a big difference if we are right that CRE losses will be heavily concentrated in this asset class.
Finally, our research shows that there is a lot more floating-rate CRE debt outstanding versus the GFC. If the Fed really does hold short rates higher for longer this cycle, as our base case suggests, then lower debt-service coverage ratios (and more expensive cap renewals) could compress the timeline for CRE defaults, leaving smaller banks with less time to provision for losses and a potentially bigger ‘hole’ in their capital structure.
(…) As such, we think the current regional banking crisis could continue for some time, including the potential for more bank blow-ups and less bank lending to small businesses.
The good news, however, is that we do not think CRE defaults have the potential to cause significant stresses in the broader financial system this cycle, as the largest banks have less risky CRE debt on their balance sheets and remain well-capitalized, while life insurers have remained disciplined in how they construct their CRE portfolios.
- Apollo’s Chief Economist Says a ‘Default Cycle’ Has Begun Due to Fed Hikes Slok eyes rising delinquency rates on credit cards, auto loans