THE DAILY EDGE: 3 APRIL 2023

Consumer Spending Growth Slowed in February Consumer spending increased a seasonally adjusted 0.2% in February, compared with January’s revised 2% increase, which was the largest one-month gain in nearly two years.

I generally post excerpts of the WSJ articles because it is the most read financial media and I think important to convey the mainstream narrative. I am skipping it today because this particular piece on consumer spending does not differentiate between nominal and inflation-adjusted data and can be misleading.

My own narrative:

• Real expenditures declined 0.1% MoM in February, following a 1.5% jump in January, itself following very weak Q4’22 data, particularly during the important months of November and December.
• The large January jumps in disposable income and expenditures hide what could be seen as slowing trends since last summer.
• January’s disposable income benefitted from annual wages and salaries adjustments, a weather-related jump in hours worked, an 8.7% inflation boost to social security payments and sharply lower income taxes.
• Americans chose to quickly spend the bounty after skimping on Christmas. Nominal spending on goods jumped 3.6% MoM in January with durables up 7.0%.
• The glass-half-full reading combines January and February to conclude that the consumer is flush, happy and spending merrily.
• The glass-half-empty reading says that January was an aberration and that February data confirms the slowing trends observed at the end of 2022.

The debate will persist through spring data. It is fair to say, however, that the positive spending numbers early in 2023 helped merchants reduce their bloated inventories. This may explain the rise in goods prices in January and February (+3.2% a.r.) when most economists, including the Fed’s, were expecting continued goods deflation for a while.

Core PCE inflation is not slowing much. In fact, since October 2022, any combination of 2 or 3-month data shows core inflation accelerating. The red line below is where monthly inflation needs to be for the Fed to reach its 2% target.

Growth in Compensation is also slowing, even more so if we normalize January. Note also the 5 consecutive monthly declines in current taxes, boosting disposable income growth well above personal income. Since October, personal income rose 6.0% annualized but disposable income 11.1% a.r..

Meanwhile, the savings rate keeps rising, 4.9% in February, from 2.7% in June 2022 while consumer credit growth slowed to +3.2% annualized in December-January, down from +8.1% a.r. in the 6 months prior.

My conclusions:

• Overall, consumers remain reasonably solid financially but basic inner trends are worrisome.
• There is no immaculate disinflation just yet.
• The Fed’s focus on inflation, at some point, will impact employment and wages. If inflation does not react rapidly, the income squeeze will intensify.
• Rising interest rates encourage savings and discourage borrowing.
• Post covid-helicopter money, consumer spending is now more dependent on its basic fundamentals: labor income (employment, hours, wages).
• February data was back on trend: slowing employment growth, slowing wages and declining hours. Even with the strong January, labor income growth has slowed to the 6% annualized range on 3 and 6-month periods, only about 1% above inflation. But the downward trend in labor income is clear, and faster than the downward trend in inflation (see the inflation chart above). With a hawkish Fed still on board.

I bet that most people would be surprised to learn that, on an annual basis, personal disposable income actually declined 0.1% in 2022, in nominal dollars. How then could consumer expenditures jump 9.1%?

The bars below represent annual $ changes in the contributors to personal expenditures. It illustrates the wild swings in savings during the pandemic and the disappearance of disposable income contribution in 2022 supplemented by an abnormally large increase in credit. All in nominal dollars.

As seen above, labor income growth is slowing and threatens to fall below inflation. And Americans have increased their savings rate since last September.

Moody’s last week warned us of developing adverse trends in consumer credit:

Loans originated in 2022 have gotten off to a rough start, though this trend varies by product. The performance for recently originated first mortgage and
home equity accounts is comparable to vintages that originated prior to the pandemic, though their performance is worse than that of loans written in 2021 and 2022. (…

The situation is more concerning for nonresidential loans, particularly consumer spending-related credit products. Credit card and consumer finance lenders aggressively expanded lending in late 2021 and early 2022, looking to make up for falling demand during the height of the pandemic. At the same time, a combination of excess savings on the part of households and borrower support programs on the part of creditors pushed down delinquency and default rates, which, by proxy, lifted credit scores. As a result, the risk profiles for borrowers, visible to lenders and underwriters, improved, even if the underlying creditworthiness of the borrower pool was unchanged.

These two factors likely led to riskier consumer loans being underwritten, the toll of which is now beginning to materialize. (…)

Consumers are stretching to deal with higher prices but thus far have been able to lean on excess savings and credit to cover the shortfall between income and expenditures. The unemployment rate will rise from 3.6% to approximately 4% by the end of 2024, while monthly job gains slow from their current pace of 250,000 per month to less than 100,000.

At the same time, excess savings will be exhausted, particularly for lower-income households. Credit stress will intensify, particularly for lower-credit-score borrowers in the consumer finance and credit card segments. Fortunately, these markets are small enough that the shock will not change the outlook of no
recession under the baseline forecast, but creditors with significant exposure to these products should be watched. (…)

Recession risks are elevated. The Federal Reserve remains aggressive; the baseline forecast assumes the central bank will continue to raise rates during the first half of the year. The concern is that the Federal Open Market Committee could overshoot its target, tightening in the face of slower job growth and difficult financial conditions, tipping the U.S. into recession. Credit markets would contract under this scenario, while performance, which has deteriorated in recent months, would worsen further.

• Citi card spending: “March to date is down 8.9% and is on pace to be the weakest month since April 2022. Ex-Food spending decreased 13.7% vs -13.0% in March” (ZeroHedge)
• Even High-End Travelers Are Reining In Their Spending So much for a golden age of revenge travel. Tighter budgets, busy airports and soaring prices are seeing a more frugal tourist return

OPEC+ Makes Shock Million-Barrel Cut in New Inflation Risk Oil Surges 8% After OPEC+ Blindsides Market With Production Cut

Via Bloomberg:

• The announced cuts from OPEC+ will amount to “about 1.1% of global supply in the next two months and about 1.6% of global supply in the back half of this year,” said Vivek Dhar, Commonwealth Bank of Australia’s director of mining and energy commodities research. The eight countries planning to shave production do have the capacity to do so, he added. “So we are talking north of one million barrels a day that can be an actual reality,” Dhar said. “People should be paying attention to these cuts because they can actually be realized.” (Commonwealth Bank of Australia Ltd.)
• “Any unexpected 1 million barrel per day change in supply or demand conditions over the course of a year can impact prices between $20 and $25 per barrel,” said Francisco Blanch, head of commodity and derivatives research at Bank of America. “OPEC is no longer afraid of a major US shale oil supply response if Brent crude oil prices trade above $80 per barrel, so cutting volumes to push oil prices higher does not carry the same risks it did five years ago,” he said.
• “Given extremely low managed money positioning, low open interest and high volatility, the markets can expect a price overshoot just as Fed tightening and banking turmoil led prices to fall two weeks ago far more than balances warranted.” (Citigroup)

OPEC’s Shock Cut Is a Capitulation to Oil’s Decline

(…) The question, then, is why those countries want more oil cash, and what they plan to do with it.

In Saudi Arabia, the biggest player, the money very clearly isn’t mainly going into building additional production capacity. During annual results last month, Saudi Arabian Oil Co. Chief Executive Officer Amin Nasser was unyielding in rebutting analysts’ suggestions that the company should be using its $159 billion in net income to upgrade its spending plans. Capital expenditure will instead level off around the middle of this decade, with only half of the total dedicated to boosting output and no plans to build capacity beyond 13 million barrels a day. That represents a modest increase from current levels, especially when inflation is taken into account.

What we’ve seen instead is a flurry of investments in everything except new crude output — $7 billion for a refinery in China announced last week; $8.5 billion in contracts signed in February to build a green hydrogen plant near the Neom planned city close to the Jordanian border; 33 billion riyals ($8.8 billion) for new tourist facilities on the Red Sea and another $50 billion for another development on the outskirts of the capital Riyadh. In total, the government expects some $1.3 trillion to be invested by 2030 with the goal of diversifying the economy away from oil production. (…)

While the numbers of operating oil rigs in the US have more or less returned to pre-pandemic levels, in the Middle East, they’re struggling to break above three-quarters of previous numbers. (…)

• At the Eurozone level, online sales signal weakness ahead for total retail sales.

Source: Pantheon Macroeconomics via the Daily Shot

Flight to Money Funds Is Adding to the Strains on Small Banks Silicon Valley Bank’s collapse has caused savers to seek out alternatives, but the shift poses risks to the financial system and the wider economy

(…) And smaller banks are feeling the pain much more acutely than their giant peers. Deposits at such lenders slumped $120 billion in the week ended March 15 while those for the 25 largest firms rose almost $67 billion, Federal Reserve data showed. Outflows at US lenders more broadly continued the following week, with $125.7 billion withdrawn, though smaller banks posted a slight increase. (…)

Actually, the jump in large bank deposits during the week ended March 15 was almost totally withdrawn the following week, likely moved to other instruments such as mutual funds. In total, deposits at all banks declined $362B (2.1%) in three weeks. American banks stopped bleeding the week ended March 22, but foreign banks saw further deposit losses which explains that total deposits kept dropping.

Is that all, -2.1%?

John Authers:

(…) For a notion of how serious the US crisis is, it’s worth looking at this great piece of data visualization from Bloomberg Opinion’s Paul Davies and Elaine He. The banks that ran into trouble were outliers that had made themselves hugely exposed to rising interest rates. This is one of several charts in their piece that makes clear that disaster for these banks does not necessarily imply disaster for the entire financial system:

Long-term and Short-term Bonds

SVB and Silvergate were outliers in the types of assets they held as a % of their total assets

(…) it’s important to look at how serious an effect the banks will have on the economy. Obviously, this would change if one of the biggest systemically important institutions ran into problems, but reasonable estimates at present suggest that the damage should not be that great — and also that Europe might suffer a more negative impact than the US. After a stress test that involved adding the tightening of lending conditions to the raising of policy rates that has already happened, Silvia Ardagna of Barclays said the effect would be noticeable, but not overwhelming. Tighter lending standards as a result of the banks’ problems would reduce GDP growth by about 0.25 percentage points. (…)

China Home Sales Continue to Rise in Latest Sign of Recovery New home sales by the 100 biggest real estate developers climbed 29.2% YoY after a 15% rise in February, when the market posted its first increase in 20 months.

EARNINGS WATCH

The Q1’23 earnings season is only 2 weeks away.

Compared with Q4’23, we have 10% more pre-announcements and 40% more negative ones.

S&P 500 earnings are now seen down 5.0% in Q1 (+1.4% on January 1), slipping another 3.9% in Q2 (-0.3%) before hopefully turning 2.8% positive in Q3 (+5.5%), reaching +10.5% in Q4 (10.6%!). Why is Q4 hanging in?

From 9 negative sectors in Q4’22, 7 are expected negative in Q1’23, 5 in Q2, 4 in Q3 and only 1 in Q4. Note how Consumer Discretionary companies are forecast to lead the way. This while the FOMC is fighting demand.

These numbers look increasingly fragile as analysts rethink their assumptions. Forecasts for the current fiscal year are increasingly negative:

  

(Factset)

Yet, forward estimates at $220.59 are only 0.5% below trailing EPS ($221.49) and have only declined 0.8% since their November 2022 peak. That seems like a real tail risk to me, only apparent in large caps since forward estimates for S&P 400 and S&P 600 companies are 8.1% and 4.2% below trailing EPS respectively.

(Factset)

Social Security Reserves Projected to Run Out Earlier Than Expected The program won’t have enough money to pay all beneficiaries the amount they are entitled to starting in 2034, a report said.