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Good morning. After we said the whole thing is dumb, a few readers still wanted to know what we think about Elon Musk and Twitter, which reportedly might soon receive a competing bid from Apollo Global Management.
OK, here’s our take: go read Due Diligence. Unless and until Musk makes a buyout offer for Unhedged, we will continue to cover our ears and hum when he talks. Instead, a few thoughts on economic expectations, and consumer credit, which sure is growing fast.
Here are consensus medium-term expectations about the US economy, taken from Bloomberg’s aggregate of economic forecasts:
Real growth will remain above 2 per cent
Core inflation will continue to slow
Unemployment will stay near 3.5 per cent
Housing demand will tick down a little
S&P 500 earnings per share will grow modestly
Interest rates will rise about 200 basis points in the next year
There’s a one-in-four chance of a recession
None of these, in isolation, sounds particularly nutty. Taken together, though, forecasters expect one of the softest landings ever — what JPMorgan’s chief economist has called “immaculate disinflation”. Other than maybe housing, this consensus doesn’t leave much to worry about.
This is a very odd fit with the sour mood of market participants. Especially since the Federal Reserve shares this rosy outlook, we’ve been wondering — how plausible is it? Possible cracks in consensus include:
The housing and corporate credit markets are used to low interest rates. As rates rise, one or both of these markets will stumble, forcing the Fed to choose between fighting inflation and maintaining growth.
Unemployment is ridiculously low — even lower if you look at other labour market indicators — and it will have to go up if inflation is to fall.
While aggregate earnings have been rising, that growth is becoming more top-heavy and probably more fragile. This chart from FactSet shows that more companies in the S&P 500 are seeing earnings estimates cut by analysts, and fewer are seeing them rise, over recent months:
The Covid recession was short, thanks to vaccines and fiscal stimulus, so we should expect the post-Covid recovery to end rapidly, too. George Goncalves, US macro strategy head at MUFG, thinks the optimistic forecasts reflect a belief that we are early in the cycle — but in fact we’re not.
These are not decisive arguments against a soft landing, but they do make us wonder if complacency has set in.
Here is a case for optimism. Ian Shepherdson of Pantheon Macroeconomics has been one of the most forceful bulls on the US economy, arguing that healthy household and corporate balance sheets can keep growth firm while inflation moderates. Here’s Shepherdson in a note last month:
In short, then, it’s very hard to see why the private sector would feel compelled by a fed funds rate of 2 per cent or so by the end of this year to cut back spending to the point where the economy might tip into recession. That’s not to say the whole economy will roar ahead; we expect a steep drop in housing market activity over the next few months . . . [but] housing aside, we see few reasons to expect private sector spending to weaken, and plenty of reasons to expect solid growth, notably the potential for catch-up spending on services as Covid fear recedes . . .
We just don’t buy the idea that the Fed faces a binary choice between letting inflation rip or triggering a recession. Markets love black-and-white stories, but this time we think it will be more useful to think in shades of grey.
That last point seems right — the Fed’s trade-off is probably less sharp than many think. The crucial point about a soft landing is that the path is narrow, not that it is unwalkable. Perhaps the consensus suffers from a bit of optimism bias: a perfectly plausible base case with an unsettlingly wide scope to be wrong.
Consumer credit, and especially card debt, is rising really fast. In February, total consumer non-mortgage debt rose at an annualised rate of 8.4 per cent (that includes cards, cars, education, unsecured loans, and so on). Within that, credit card loans rose by 21 per cent. Both of these are right up at the fastest rates of the past decade. Here are cards:
There are two ways to look at this. One: the American consumer is back on the crack, and we are headed for a debt crisis. Two: the US economy is going to do well, and that’s nice. Unhedged, despite its basically twisted, pessimistic soul, leans toward the latter, happier read.
Look at total outstanding revolving debt in the US:
Yes, debt is growing at a historic pace, but we are still below pre-crisis debt levels, even though the economy is significantly bigger.
Next, look at what three of the biggest credit-card issuing banks in the US told us about credit card use (and misuse) in their Q1 results last week:
Yes, credit card spending is surging, but for now delinquency and charge-off (bad debt) rates are very low and falling. Americans are not, so far, pushing their credit limits. Data from the Fed’s distributional financial accounts show that the bottom 50 per cent of US wealth distribution saw their net worth double between the first quarter of 2020 and the fourth quarter of 2021. That cohort’s wealth now sits at $3.7tn (the top 1 per cent’s wealth, depressingly, sits at $46tn). Consumer debt/total assets for the bottom half of the distribution, at 27 per cent, is the lowest since 2010. Consumer balance sheets, even excluding the rich, look good.
So far this picture all fits together. What doesn’t fit with surging credit use, however, is the absolutely abysmal level of consumer sentiment, which is at decade lows. If consumers think the economy stinks — and they do — why are they racking up debt purchases? And how long can this credit boomlet last?
The UBS strategy team, led by Matthew Mish, makes a good point about this, using results from its quarterly consumer finance survey. Americans’ confidence that they are going to keep their jobs is rising, among both the more- and less-educated:
Inflation makes everyone thing that the economy is bad, for excellent reasons. But if Americans don’t think they are going to get fired, they will spend.
There are two stings in the tail here. One is that it might be better, all things considered, if Americans would cool it a bit with the spending, so inflation would cool off, too. Strong balance sheets and propensity to borrow are not unalloyed good news in this environment.
The other is that the improvement in the balance sheets of the bottom 50 per cent of Americans was driven primarily by rising real estate values. Property accounts for well over half the increase in their assets since the pandemic began. Rising US consumer spending and consumer credit are underwritten by house prices, for better or worse.
People finance pets, and other people threaten to repossess them.
Air travel chaos and cost of living worries have spurred a surge in bookings by Britons for domestic summer holidays, offering hope to a sector struggling with financial pressures and a worsening economic outlook.
UK domestic holiday businesses had feared 2022 would spell an end to the summer staycation boom of the pandemic’s first two years, when onerous travel restrictions and fears of catching Covid-19 deterred holidaymakers from international travel.
But inquiries and late bookings for domestic summer holidays have jumped since early June, after flight cancellations caused major travel disruption during the school half-term holiday and balmy weather swept across the country.
Last-minute bookings for summer holiday accommodation from Sykes Holiday Cottages, one of the UK’s leading holiday rental agencies, were up 22 per cent at the start of June, compared with the same period last year.
Just under 40 per cent of Britons said they were more likely to choose a domestic holiday instead of an overseas break than before the pandemic, according to polling conducted in mid-June and published on Friday by VisitBritain, the UK’s tourist board.
Of those choosing a staycation, 65 per cent told VisitBritain it was because UK breaks were easier to plan, 54 per cent said they wanted to avoid long queues at airports and the risk of cancelled flights, and 47 per cent said it was because UK holidays were more affordable.
“Whether families think they can’t afford a summer getaway abroad, or they’ve had their flights cancelled, or the potential of sitting with four kids for 12 hours in the airport has just scared them off, many are opting to stay at home,” said Sir David Michels, president of the Tourism Alliance, a lobby group. “That’s a net-positive for the UK tourism industry.”
Michels said he did not expect demand for domestic holidays this summer to surpass the heights of summer 2021, but it was possible levels of demand could mirror last year.
He added that sterling’s depreciation this year “certainly wouldn’t hurt” the domestic market as it would “put some people off” travelling overseas. The currency is down 9.3 per cent against the dollar and 2.2 per cent against the euro since the start of 2022.
Cottage bookings on Awaze, a vacation rental company, for June were flat compared with 2021 and up 21 per cent on 2019, while bookings for August this year were 6 per cent higher than the same month last year and 46 per cent up on 2019. July was slightly down on 2021 levels.
Graham Donoghue, chief executive of Sykes Holiday Cottages, said the UK was “continuing to ride the staycation wave despite the return of foreign travel”.
“Uncertainty around Covid restrictions has seemingly been replaced with another worry — overseas travel disruption — while an increased pressure on household budgets is leading to many turning to staycations as the better value option,” explained Donoghue.
On Thursday, British Airways check-in staff voted to strike later in the summer over pay, setting the stage for yet more air travel disruption.
Henrik Kjellberg, Awaze chief executive, said the travel chaos had “benefited” the domestic tourism market as holidaymakers looked to “avoid the stress and hassle” of overcrowded airports.
He said people had been “introduced to the charms of staycations” during the pandemic and they were “here to stay”, adding that pandemic travel restrictions had combined with a “gradual trend of people thinking more and more about their CO₂ footprint” to encourage more families to consider holidaying locally.
Meanwhile, members of the trade body UKHospitality reported a 20-30 per cent uplift in inquiries over the platinum jubilee weekend in early June from customers searching for holidays in late summer or over the school half-term holiday in October, according to Kate Nicholls, chief executive.
Nicholls said the extension of the staycation boom would provide a lifeline for independent businesses, which have been hit hardest by cost pressures resulting from supply chain issues and the war in Ukraine.
“British holidaymakers will tend to go for the less obvious options,” said Nicholls. “There’s a proportion of customers who will always go branded, but there is also a proportion of domestic visitors who are much more confident about going off the beaten track and looking for independents, looking for boutique options.”
The success of domestic tourism has become more significant because inbound tourism is not expected to rebound to pre-pandemic levels until 2025.
The task for the industry now is to convince British holidaymakers to keep returning in future summers. “If the sun keeps shining, I think it’s going to be a much fuller UK with UK residents than summers before the pandemic,” said Michels. “We’ve now had three years of lots of people holidaying at home. I don’t think this is going away.”
“The longer this trend lasts, the stickier those habits become and the more beneficial it will be for communities across the country,” said Nicholls.
Brenda McKinley has been selling homes in Ontario for more than two decades and even for a veteran, the past couple of years have been shocking.
Prices in her patch south of Toronto rose as much as 50 per cent during the pandemic. “Houses were selling almost before we could get the sign on the lawn,” she said. “It was not unusual to have 15 to 30 offers . . . there was a feeding frenzy.”
But in the past six weeks the market has flipped. McKinley estimates homes have shed 10 per cent of their value in the time it might take some buyers to complete their purchase.
The phenomenon is not unique to Ontario nor the residential market. As central banks jack up interest rates to rein in runaway inflation, property investors, homeowners and commercial landlords around the world are all asking the same question: could a crash be coming?
“There is a marked slowdown everywhere,” said Chris Brett, head of capital markets for Europe, the Middle East and Africa at property agency CBRE. “The change in cost of debt is having a big impact on all markets, across everything. I don’t think anything is immune . . . the speed has taken us all by surprise.”
Listed property stocks, closely monitored by investors looking for clues about what might eventually happen to less liquid real assets, have tanked this year. The Dow Jones US Real Estate Index is down almost 25 per cent in the year to date. UK property stocks are down about 20 per cent over the same period, falling further and faster than their benchmark index.
The number of commercial buyers actively hunting for assets across the US, Asia and Europe has fallen sharply from a pandemic peak of 3,395 in the fourth quarter of last year to just 1,602 in the second quarter of 2022, according to MSCI data.
Pending deals in Europe have also dwindled, with €12bn in contract at the end of March against €17bn a year earlier, according to MSCI.
Deals already in train are being renegotiated. “Everyone selling everything is being [price] chipped by prospective buyers, or else [buyers] are walking away,” said Ronald Dickerman, president of Madison International Realty, a private equity firm investing in property. “Anyone underwriting [a building] is having to reappraise . . . I cannot over-emphasise the amount of repricing going on in real estate at the moment.”
The reason is simple. An investor willing to pay $100mn for a block of apartments two or three months ago could have taken a $60mn mortgage with borrowing costs of about 3 per cent. Today they might have to pay more than 5 per cent, wiping out any upside.
The move up in rates means investors must either accept lower overall returns or push the seller to lower the price.
“It’s not yet coming through in the agent data but there is a correction coming through, anecdotally,” said Justin Curlow, global head of research and strategy at Axa IM, one of the world’s largest asset managers.
The question for property investors and owners is how widespread and deep any correction might be.
During the pandemic, institutional investors played defence, betting on sectors supported by stable, long-term demand. The price of warehouses, blocks of rental apartments and offices equipped for life sciences businesses duly soared amid fierce competition.
“All the big investors are singing from the same hymn sheet: they all want residential, urban logistics and high-quality offices; defensive assets,” said Tom Leahy, MSCI’s head of real assets research in Europe, the Middle East and Asia. “That’s the problem with real estate, you get a herd mentality.”
With cash sloshing into tight corners of the property market, there is a danger that assets were mispriced, leaving little margin to erode as rates rise.
For owners of “defensive” properties bought at the top of the market who now need to refinance, rate rises create the prospect of owners “paying more on the loan than they expect to earn on the property”, said Lea Overby, head of commercial mortgage-backed securities research at Barclays.
Before the Federal Reserve started raising rates this year, Overby estimated, “Zero per cent of the market” was affected by so-called negative leverage. “We don’t know how much it is now, but anecdotally its fairly widespread.”
Manus Clancy, a senior managing director at New York-based CMBS data provider Trepp, said that while values were unlikely to crater in the more defensive sectors, “there will be plenty of guys who say ‘wow we overpaid for this’.”
“They thought they could increase rents 10 per cent a year for 10 years and expenses would be flat but the consumer is being whacked with inflation and they can’t pass on costs,” he added.
If investments regarded as sure-fire just a few months ago look precarious; riskier bets now look toxic.
A rise in ecommerce and the shift to hybrid work during the pandemic left owners of offices and shops exposed. Rising rates now threaten to topple them.
A paper published this month, “Work from home and the office real estate apocalypse”, argued that the total value of New York’s offices would ultimately fall by almost a third — a cataclysm for owners including pension funds and the government bodies reliant on their tax revenues.
“Our view is that the entire office stock is worth 30 per cent less than it was in 2019. That’s a $500bn hit,” said Stijn Van Nieuwerburgh, a professor or real estate and finance at Columbia University and one of the report’s authors.
The decline has not yet registered “because there’s a very large segment of the office market — 80-85 per cent — which is not publicly listed, is very untransparent and where there’s been very little trade”, he added.
But when older offices change hands, as funds come to the end of their lives or owners struggle to refinance, he expects the discounts to be severe. If values drop far enough, he foresees enough mortgage defaults to pose a systemic risk.
“If your loan to value ratio is above 70 per cent and your value falls 30 per cent, your mortgage is underwater,” he said. “A lot of offices have more than 30 per cent mortgages.”
According to Curlow, as much as 15 per cent is already being knocked off the value of US offices in final bids. “In the US office market you have a higher level of vacancy,” he said, adding that America “is ground zero for rates — it all started with the Fed”.
UK office owners are also having to navigate changing working patterns and rising rates.
Landlords with modern, energy-efficient blocks have so far fared relatively well. But rents on older buildings have been hit. Property consultancy Lambert Smith Hampton suggested this week that more than 25mn sq ft of UK office space could be surplus to requirements after a survey found 72 per cent of respondents were looking to cut back on office space at the earliest opportunity.
Hopes have also been dashed that retail, the sector most out of favour with investors coming into the pandemic, might enjoy a recovery.
Big UK investors including Landsec have bet on shopping centres in the past six months, hoping to catch rebounding trade as people return to physical stores. But inflation has knocked the recovery off course.
“There was this hope that a lot of shopping centre owners had that there was a level in rents,” said Mike Prew, analyst at Jefferies. “But the rug has been pulled out from under them by the cost of living crisis.”
As rates rise from ultra-low levels, so does the risk of a reversal in residential markets where they have been rising, from Canada and the US to Germany and New Zealand. Oxford Economics now expects prices to fall next year in those markets where they rose quickest in 2021.
Numerous investors, analysts, agents and property owners told the Financial Times the risk of a downturn in property valuations had sharply increased in recent weeks.
But few expect a crash as severe as that of 2008, in part because lending practices and risk appetite have moderated since then.
“In general it feels like commercial real estate is set for a downturn. But we had some strong growth in Covid so there is some room for it to go sideways before impacting anything [in the wider economy],” said Overby. “Pre-2008, leverage was at 80 per cent and a lot of appraisals were fake. We are not there by a long shot.”
According to the head of one big real estate fund, “there’s definitely stress in smaller pockets of the market but that’s not systemic. I don’t see a lot of people saying . . . ‘I’ve committed to a €2bn-€3bn acquisition using a bridge format’, as there were in 2007.”
He added that while more than 20 companies looked precarious in the run-up to the financial crisis, this time there were perhaps now five.
Dickerman, the private equity investor, believes the economy is poised for a long period of pain reminiscent of the 1970s that will tip real estate into a secular decline. But there will still be winning and losing bets because “there has never been a time investing in real estate when asset classes are so differentiated”.
A consortium of Chinese state banks has lent $2.3bn to Pakistan to help the country stave off a foreign payments crisis, finance minister Miftah Ismail said on Friday.
Confirmation of the support from China, a close economic and military ally of Pakistan, came on the same day Islamabad announced a one-off 10 per cent ‘super tax’ on important industries that is intended to lead to a stalled $6bn IMF loan package being resumed.
“I am pleased to announce that Chinese consortium loan of Rmb15bn ($2.3bn) has been credited in to SBP [State Bank of Pakistan, Pakistan’s central bank] account today, increasing our foreign exchange reserves,” Ismail said in a tweet on Friday evening.
A senior government official said the arrival of the loan was “one of the signals that we’re about to return to the IMF programme”.
China had quietly urged Islamabad to repair ties with the IMF “as an essential step to improve Pakistan’s economic health and avoid a default”, the official said.
The Chinese loan will raise Pakistan’s liquid foreign reserves of $8.2bn to $10.5bn and could help shore up the rupee, which has slumped against western currencies.
Pakistan began to receive IMF payments in 2019 under a 39-month loan programme, but the fund has so far given only about half of the $6bn agreed.
In recent months, sliding confidence in Pakistan’s economy has prompted concerns it could follow Sri Lanka in defaulting on international debt.
Prime minister Shehbaz Sharif, who was elected by parliament in April following the ousting of rival Imran Khan, unveiled on Friday the new super tax to be levied on manufacturers of cement, beverages, steel, tobacco and chemicals.
“The government has decided to impose a 10 per cent ‘poverty alleviation tax’ on large-scale industries of the country,” Sharif tweeted.
Business leaders widely criticised the move and share prices on the Karachi Stock Exchange fell nearly 5 per cent after news of the tax emerged. Analysts said the decision would further fuel inflation, a central concern for households across Pakistan.
Zaffar Moti, a former KSE director, said: “This is a major setback for the economy. The government has decided to further tax those who are already paying their taxes.”
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