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Issue 46: US Consumer Health Report

August 21, 2023

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This Week’s Highlights

  • How are American consumers holding up?
    Last week’s retail sales showed a better-than-expected jump in July spending, underscoring strength in the US consumer sector that could lead its economy to a soft landing. On the other hand, signs that Americans are increasingly borrowing to keep up their spending points to greater risk the longer the Fed stays restrictive.
  • Yields climbed in the face of sticky inflation
    UK wage growth and a surprising jump in Canada’s CPI led traders on both sides of the Atlantic to boost their bets on more hikes out of the Banks of England and Canada in September. Meanwhile, Fed meeting minutes showed a US central bank ready to hold rates higher for longer, sending Treasury yields to a 15-year high.
  • Breaking down Country Garden
    News that Country Garden, once China’s largest property developer, would miss payments on some mainland bonds sparked concern of a more acute crisis in the nation’s real estate sector. While we don’t see this as a systemic risk, we do like the odds sinking sentiment over the debacle finally spurs Beijing to action.

US Consumer Health Report

July retail sales handily beat forecasts
Last Tuesday, the US Commerce Department gave us an update on the health of American consumers, and the data show they’re as vibrant as ever. From June to July, retail sales jumped by 0.7%, significantly higher than the 0.4% economists had expected. June data were also adjusted a tick higher to 0.3%, underscoring momentum in consumer spending over recent months. Dropping autos and gas from the calculation, the month-over-month increase was even higher, at 1%. Where were Americans spending? Definitely online and dining out, it seems, with internet sales jumping by 1.9% and restaurant spending rising by 1.4%. Sporting goods and hobby stores saw a 1.5% rise in receipts, while sales of clothing and accessories put in a 1% gain. Categories getting less love from consumers? Anything sensitive to interest rates. Sales at furniture stores, electronics retailers, and car dealers were all down month-over-month.


‘Buy now, pay later’ also surging
Given historically tight labor market conditions, it’s easy to see why Americans are spending so freely, especially on those smaller-ticker purchases that drove July’s strong retail sales. On the other hand, looking at US households’ balance sheets, even if Americans aren’t taking out loans to buy cars and houses, they’re still finding ways to spend beyond their means on a smaller scale. Amazon’s ‘Prime Day’ in mid-July was evidence of that, as internet shoppers borrowed nearly $1 billion to spend more during the two-day sale: a 20% year-over-year increase in uptake of the site’s “buy now, pay later” option, which perhaps alarmingly bypasses credit bureau scrutiny and tends to be used by more financially distressed consumers.


Credit card debt breaches $1 trillion
Amazon data match trends we’re seeing in the broader economy, as the Fed recently disclosed a record-breaking tally of US households’ credit card balances, climbing $45 billion in the second quarter to top $1 trillion for the first time ever. After a decline in consumer debt as Americans took advantage of pandemic relief programs to reduce credit card balances, the recent surge puts US consumers back on their pre-COVID path (see chart below), another indication we’re probably nearing the end of an artificial boost in Americans’ ability to spend.

Figure 1 US Credit Card Balances Exceed $1 Trillion for First Time in History

Even more troublesome, banks tracking customers’ activity observed a markedly higher incidence in recent months of ‘hardship withdrawals’ from 401(k) plans—a last-ditch provision for drawing down on retirement savings in times of financial stress—with Bank of America reporting a 36% year-over-year increase in such emergency disbursements. Stats like these point to robust consumption—arguably the biggest contributor to hopes the US might achieve a soft landing—being more vulnerable than many imagine. The longer rates remain high, the tougher consumers’ decision to keep spending on credit, and the greater the chance of a downturn in spending on services and the lower-price goods keeping the US economy going.

Update on Inflation and Yields

FOMC minutes cast doubt on cuts in 2023
Last Wednesday, the US Federal Reserve released minutes from the end-of-July FOMC meeting, and the consensus conclusion apparently matches our house view. Indeed, the meeting summary reads as though it could have been an entry from Perspectives over the last couple months, citing “inflation still well above the Committee’s longer-run goal and the labor market remaining tight” as putting a majority of members on edge over “significant upside risks to inflation, which could require further tightening of monetary policy.” Investors will look for more color from Fed chair Jay Powell’s speech on Friday at this week’s Jackson Hole conference. Futures currently put the odds of another rate hike or two by year end at 40%, with only a 15% chance that the Fed cuts by the end of 2023.


Stickier inflation seen in the UK, Canada
Fed officials are undoubtedly watching with interest as other Western central banks play out what investors hope will be the endgame in their own fights against inflation (see chart below), with a special focus on those “upside risks” to CPI. In the UK, while July brought a significant drop in headline inflation, the nation’s core CPI remains stuck at 6.9%—the highest among leading industrialized countries. Concerning the Bank of England, despite unemployment ticking up in the UK, recent wage stats showed record growth in pay at 7.8% year-over-year for the second quarter, exceeding previous figures and economists’ consensus forecast. As a result, even with softening in the job market, wage inflation seems likely to prompt another 25 bps hike at the Bank of England’s September meeting. Canada actually saw its CPI jump by 0.6% month-over-month in July, double what economists expected, prompting traders to price the chance of a September hike by the Bank of Canada at 30%.

Figure 2 US and Canada See Softening Inflation Reverse Course in July

Rising yields rain on stocks’ parade
Given the aforementioned strength of the US economy and plenty of evidence that inflation might be harder to kick than the last twelve months’ softening in CPI might suggest, traders have increasingly priced a ‘higher-for-longer’ outcome. In the Treasury market, that has manifested as a marked increase in yields at the back end of the curve, with 10-year notes hitting a 15-year high last week, peaking just above 4.3%. Stocks did what they’re supposed to do when interest rates rise and sold off, sliding to a third straight week of losses. Other factors contributing to rising long-term Treasury yields are things we’ve discussed here before: quantitative tightening by the Fed and brisk issuance by the Treasury—both of which increase supply—along with concerns over the country’s deficit, which hit on the demand side. Together, these trends are bringing us very close to a point at which it makes sense to extend duration and lock in some very attractive yields. Stay tuned.

Deep Dive on Country Garden

Developer Country Garden faces default
In another blow to China’s sputtering economic recovery, Country Garden, once the nation’s top real estate developer, saw its shares plunge to a record low last week after it suspended trading of 10 mainland bonds, triggering concerns over a default on its onshore debt obligations and driving the rest of the sector down as traders fretted over potential contagion. The company had already defaulted recently on some international bonds, but there was hope they might avoid missing payments on their onshore debt. The company plans to convene with creditors this week to talk through a restructuring that will reportedly see payment on nearly RMB 4 billion in debt coming due spread out over three years.


This is not Evergrande redux
Of course, Country Garden is not the first large developer to go down. Many will remember China Evergrande’s default in 2021—the company incidentally filed for bankruptcy protection in New York last Thursday—and some will wonder how Country Garden compares, and what its failure means for the future of China’s property market. First, Country Garden is by all accounts in a much better place than Evergrande was financially, with much less off-balance-sheet financing, so a restructuring could be more straightforward. Second, the segment of privately owned developers is also much smaller today because of past defaults, including Evergrande’s, and the sector has already tightened up in response to those episodes, so this won’t catch too many people off guard. As such, Country Garden’s troubles, despite being terrible for the company’s creditors, likely fall short of ‘systemic risk’ status.


This is also not Lehman Brothers
Some observers have been tempted to compare the current situation to conditions experienced just before the Global Financial Crisis. We believe that analogy is off, as well. Most importantly, China’s problem is not that real estate developers have loaded up on toxic derivatives or used excessive leverage to buy worthless properties such that now, as prices slump they’ll never pay back their loans. By contrast, China’s property developers—like Evergrande before and Country Garden today—own land that is unquestionably valuable. The only uncertainty is whether they’ll have liquidity to complete construction on homes they’ve already sold and still make promised payments to their investors. This isn’t China’s ‘Lehman moment’, but rather a liquidity crisis engineered by Beijing to address long-term structural problems in the property market.


Nevertheless, this isn’t good news
That said, Country Garden will have consequences for the real economy. Perhaps the biggest is that homebuyers are going to be even more reluctant to make a purchase, further weighing on slumping sales, which is something that policymakers will have a harder time fixing in the near term. One also imagines that banks, even with authorities pushing them to provide liquidity to property developers, aren’t going to be clamoring to extend credit to the survivors of a Country Garden default, so conditions will naturally be tighter. The banking sector itself is also likely to see some rerating as investors price in higher nonperforming loans, and it’s another blow to associated industries like suppliers of building material and makers of home furnishings and appliances.


Trust company defaults also bad news
In the wake of news about Country Garden, China’s market was further shaken by reports that Zhongrong International Trust—which pools capital from wealthy individuals and companies to invest in assets like stocks, bonds, and real estate—was also unable to make payments to its investors. Trusts like Zhongrong have often been associated with ‘shadow lending’ in China, offering property developers without access to traditional banks another financing channel. Once again, while we don’t see this as a catastrophe, it will have ramifications. For one thing, shadow lenders are a significant source of liquidity for some developers, so trust failures remove further liquidity from the sector. It’s also another hit to confidence, adding to homebuyers’ anxiety. Finally, in this case there’s also a direct wealth effect, since those invested in trust products are seeing their savings evaporate, making it impossible to put down on a property, even if they were bold enough to buy at this moment.


By now, bad news is likely good news
It’s somewhat ironic that China’s most acute property market headaches at the moment are mostly a result of policymakers trying to do the right thing: instigating a deleveraging of the real estate sector, encouraging capital to find better uses in the real economy and simultaneously deflating unaffordable home prices, improving people’s quality of life. At the time of China Evergrande’s downfall, authorities seemed willing to take the pain in the short-run to see this policy yield long-term benefits. But China’s economy is in a much different place now than it was then. Even if intervening now just kicks the can down the road on deeper reforms, we suspect policymakers will weigh the damage inaction is doing to a broader economic recovery—not to mention the face they would lose if 2023 growth falls short of the “around 5%” target—and decide it’s past time to show more definitive support. Announcement of concrete stimulus should be enough to unlock value in a market that, at 12x forward earnings, looks oversold.