The Fed Needs to Acknowledge Slowing Economy
As any market veteran can tell you, those on the sell-side are the second-to-last to concede to a slowdown in economic activity. It’s unseemly to make negative calls when a firm’s main objective is keeping its clients fully invested in risky assets; the two aims naturally conflict.
Hence the surprise when Bank of America Merrill Lynch said autos are headed for a “decisive downturn” that will trough in 2021 at around a 13-million-unit annualized rate, down from last year’s blistering record 17.6 million. A week earlier, Morgan Stanley, whose numbers are not quite as grim, also reduced its sales forecast, recognizing that the best days of the cycle have come and gone.
The U.S. economy is consumption-centric. Growth in the current recovery has centered on three industries that have fed through to consumption in its various forms -- autos, energy and financial services. There’s something almost poetic in finance’s re-emergence, especially for those on Wall Street who’ve profited smartly from unprecedented levels of deal flow.
Have a debt problem? Solve it with more debt. And why not? This system has worked for generations; insatiable demand for debt is why interest rates have staged their historic decline.
Debt lit the fire that ignited the shale revolution. Debt put a floor under and then helped commercial real estate reach for the skies. Debt kept dying retailers alive. And debt made easier back-to-back years of record car sales.
The question so many bullish economists must answer is what debt can do for the economy in the future.
Much to the Saudis’ dismay, the energy industry is as lean and mean as it’s ever been; operating efficiency gains have been magnificent in a do-or-die environment. Energy is growth neutral going forward.
Retailers are now choking on their debt as profit margins implode. Since February, retail payrolls have contracted by 81,000. There are 4.5 million salespersons and 868,000 grocery store cashiers. Draw all the positive conclusions for lower grocery tabs you like as a result of the expedited consolidation catalyzed by the marriage of Amazon and Whole Foods. There’s no reason to think retail will cease to be a drag on growth going forward.
Restaurants now employ 10.6 million people. As furious as the retail righting has been, comeuppance could be even swifter for big-footprint restaurant chains. Nature dictates that many eateries will suffer as malls die. But more importantly, executives are being jolted by the reality that they had better follow their brick-and-mortar colleagues down the path of preemptive paring of locations that will soon be cash-flow negative and/or losing money. As far as this mega-sector pertains to future economic growth, it’s safe to say clouds are forming.
As for autos, the bad news was baked in long ago as record lease sales laid the groundwork, according to Bank of America Merrill Lynch.
Pressures on used car prices is manifesting in slumping new car sales, which have fallen for five straight months. Against this backdrop, record incentives are losing their ability to incentivize.
Adding to the angst, losses on securities backed by auto loans are piling up; all signs point to the 2015 vintage of subprime-auto ABS being a record year for bloodletting. Delinquencies for even prestigious prime-borrower-backed auto ABS are amassing at a rate that has surprised industry followers. Rumblings about fraud at fast-money car lenders have also begun to percolate. So lending standards are tightening after years of laxity.
Layoff announcements have followed. It started with the major car manufacturers announcing temporary dismissals at year-end. But the bad news has since solidified into permanent layoffs. Absent a meaningful rebound in sales, supplier manufacturing and auto dealership pink slips will follow.
Thus there is pressure building under the unemployment rate, even as it recently hit this cycle’s nadir of 4.3 percent, the lowest since 2001. Further evidence is becoming increasingly clear in credit card delinquencies; Experian reported the national bank card default rate rose to 3.53 percent in May, a four-year high. There are even nascent signs that households have begun to struggle to make their mortgage payments.
Peek under the hood of the University of Michigan Consumer Sentiment survey and you will see growing anxiety as the number of people who say they expect higher unemployment has bottomed and begun to tick up. Workers in vulnerable industries have started to sense the flip side of the very same good news being celebrated by investors.
Finally, those whose fortunes are tied to commercial real estate have started whispering among themselves. Cycles never end the same way, but old hands can attest to the sheer amount of supply building in the pipeline and its implications. It’s all good and well that strained industries want to extract what value remains from their CRE exposure as part of their exit strategies. But this only works in isolation. If motivated sellers move in tandem, you can bet teetering CRE valuations will be among the casualties, taking many over-exposed mid-size and small banks down with them.
Call it a confluence of factors that bodes ill for the economic recovery, even as optimists hope the growth streak can stretch into a 10th year. By the way, leading the optimists’ charge is the Federal Reserve itself.
Central bank policy makers’ expectations for future growth indicate the current economic recovery will unseat the record holder, the expansion that finally flamed out in 2001 after enjoying a life of exactly 10 years. But then it is the Fed that’s the very last to capitulate, to say nothing of forecast, a slowdown in economic activity.
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Danielle DiMartino Booth at Danielle@dimartinobooth.com
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