You wouldn’t know it by the headlines. But the US economy is breaking in plain sight. Only the savings cushion of the richest 20% are keeping it afloat. And if interest rates keep rising nearly every day, even that won’t be enough.
The beginning of the quarter has gotten off to a torrid start with long-term Treasury yields rising above 4.75% in the first day and a half of trading through Tuesday morning. It’s a continuation of the end-of-quarter trend, when almost every day we hit new multi-year highs across the longer maturity end of the Treasury curve.
Sure, yields can go higher without a recession, as last week’s column attested. After all, job openings remain plentiful judging by Tuesday morning’s data. But the pace of the recent yield rise is so unrelenting that eventually something will break — either the march higher in yields or the US economy.
The tone has changed, too. Last quarter, the drive higher in real and nominal yields seemed driven by soft-landing bets. Now the dynamic seems less based on such an optimistic outcome, with former bond bulls switching sides and chasing yields higher amid a glut of Treasury supply. That’s having broad implications by pulling up the US dollar and elevating rates across the world financial system, from mortgages to high-yield bonds and beyond.
The combination of higher yields, a higher US dollar and higher oil prices is a toxic brew for corporate earnings. This should be apparent in the forward-looking statements in earnings calls later this month. The result will likely be that the earnings recession continues into this quarter, bringing equities down with bonds. The US real economy may not be far behind.
Last week, I spoke of how the view that the economy could prosper even in the face of an historic rise in short-term interest rates was itself causing longer-term rates to rise, dooming those very predictions. That was a view focused narrowly on this business cycle and on market-driven outcomes.
This week, my colleagues economists Tom Orlik and Anna Wong have weighed in with a more expansive view across cycles. And their conclusion is similar:
With alarming regularity, soft landing calls peak before hard landings hit.
Why do economists find it so difficult to anticipate recessions? One reason is simply the way forecasting works. It typically assumes that what happens next in the economy will be some kind of extension of what’s already happened — a linear process, in the jargon. But recessions are non-linear events. The human mind isn’t good at thinking about them.
Linear thinking means extrapolating the existing situation forward without incorporating the lagged impact of rate hikes on household and corporate borrowing. We saw in March, for example, how that thinking was flawed when Silicon Valley Bank and a couple other regional banks failed. Behind the scenes late in 2022 and early in 2023, the stresses in the banking system from deeply diminished asset prices were taking their toll. Then it seemed like almost without warning, we were in a mini banking crisis. That’s the kind of non-linearity Orlik and Wong are talking about.
But let’s think about this in real day-to-day terms. Through the pandemic and into this year, the shot in the arm from government transfers has been a huge cushion for the private sector. But the San Francisco Fed has recently calculated that excess savings from the pandemic will be all gone by September.
And in fact, Bloomberg Economics calculates that the least wealthy 80% of workers now collectively have less cash on hand than they did when the pandemic started.
As inflation, rising rent costs and higher interest rates hit early in 2022, the money had already run out for the bottom 40% of households. But this year the same has happened for the middle 40%, with extra pandemic savings for the top 20% on a downward trajectory close behind. Since the higher-income households tend to save more anyway, it seems like the support for consumer spending has already more or less disappeared.
– The personal savings rate for US households in August 2023
Figuring out how this business cycle progresses depends on what happens next with the personal savings rate. In August, US households got down to 3.9% of disposable income being saved. To put that in context, take a look at the historical comparisons in the chart below.
As with many things, the real outlier in the chart is the pandemic, since the savings rate topped out at a massive 32% when the US was in a country-wide lockdown. But you can see that we are near the low end of the range already. Taking a simple average of each month from 1959 to today shows US households saving about 8.5% of disposable income every month for the last six decades. That figure is 9.4% if you count all monthly data from 1991 forward.
We should consider 3.9% savings a low figure, then. We get figures that low usually during bubbles like the period after 2004 as the housing bubble formed or under recessionary stress as in 2008. The late 1990s was another example, when a low savings rate, driven by stock market wealth effects, lasted through the bubble and into 2001, the beginning of the bust.
If personal savings rates increase enough as the top 20% of households deplete their pandemic savings, that will drive the US economy into a recession.
The economy is not only about the spending habits of households but the investment decisions of businesses and the availability of credit. The SVB collapse was a blow on that front but not a fatal one, as credit only mildly tightened.
Nevertheless the paper losses by regional banks due to interest rates increasing will restrict credit further. A slide from a recent presentation by Apollo Global’s Chief Economist Torsten Slok shows you that after a couple of quarters of those losses diminishing, they are now increasing again. And they will increase even more as long-term interest rates rise.
I expect two countervailing outcomes as long as yields remain high, keeping balance sheets under stress. First, because the Bank Term Funding Program started in March allows Treasuries to be loaned to the Fed at par, institutions won’t be forced into a fire-sale as interest rates rise. That means marking assets to market on sale is not a lethal threat for most financial institutions. However, since they still face funding pressure due to low deposit rates, their incentive to reach for yield by taking on risky bets increases. Just as in the 1980s, the last time we had this problem with rising rates, high-yield bond issuers could actually benefit.
The desire to reach for yield by banks can help the economy through tougher times as we hit maturity walls for low-grade corporate borrowers then. Of course, in the 1980s, regulatory forbearance for insolvent Savings & Loans eventually led to a wide-scale problem. So such an outcome cannot be discounted this time.
The other reaction to the losses — and the more prudent one — is to rein in credit availability, helping to transmit the Fed’s tightening to the economy through the credit channel. This is what the Fed has wanted to see happen and expects to happen with a lag. But the 1980s S&L crisis experience tells you that even after a recession, lingering balance sheet issues can lead to perverse outcomes due to misaligned incentives.
We cannot expect linear outcomes with yields, the dollar and oil prices all rising in tandem. Eventually there will be a torrent of equity selling and a much greater risk of recession as spending slows and precautionary savings grows.
But the move higher in yields has become so extended that I expect a reprieve soon, especially if the economic data start to slow. That will allow for more glide-path outcomes, including even a soft landing. My base case is still a recession, starting as soon as December. The risks outlined above tell you why.
By the way, having said all that, I’d love to get your take. This week’s MLIV Pulse survey is about the rise in yields and its impact on the stock market. Where do you expect 10-year yields to end this year? How will that impact stocks? Share your views here.
VICTORIA – British Columbia is forecasting a record budget deficit and a rising debt of almost $129 billion less than two weeks before the start of a provincial election campaign where economic stability and future progress are expected to be major issues.
Finance Minister Katrine Conroy, who has announced her retirement and will not seek re-election in the Oct. 19 vote, said Tuesday her final budget update as minister predicts a deficit of $8.9 billion, up $1.1 billion from a forecast she made earlier this year.
Conroy said she acknowledges “challenges” facing B.C., including three consecutive deficit budgets, but expected improved economic growth where the province will start to “turn a corner.”
The $8.9 billion deficit forecast for 2024-2025 is followed by annual deficit projections of $6.7 billion and $6.1 billion in 2026-2027, Conroy said at a news conference outlining the government’s first quarterly financial update.
Conroy said lower corporate income tax and natural resource revenues and the increased cost of fighting wildfires have had some of the largest impacts on the budget.
“I want to acknowledge the economic uncertainties,” she said. “While global inflation is showing signs of easing and we’ve seen cuts to the Bank of Canada interest rates, we know that the challenges are not over.”
Conroy said wildfire response costs are expected to total $886 million this year, more than $650 million higher than originally forecast.
Corporate income tax revenue is forecast to be $638 million lower as a result of federal government updates and natural resource revenues are down $299 million due to lower prices for natural gas, lumber and electricity, she said.
Debt-servicing costs are also forecast to be $344 million higher due to the larger debt balance, the current interest rate and accelerated borrowing to ensure services and capital projects are maintained through the province’s election period, said Conroy.
B.C.’s economic growth is expected to strengthen over the next three years, but the timing of a return to a balanced budget will fall to another minister, said Conroy, who was addressing what likely would be her last news conference as Minister of Finance.
The election is expected to be called on Sept. 21, with the vote set for Oct. 19.
“While we are a strong province, people are facing challenges,” she said. “We have never shied away from taking those challenges head on, because we want to keep British Columbians secure and help them build good lives now and for the long term. With the investments we’re making and the actions we’re taking to support people and build a stronger economy, we’ve started to turn a corner.”
Premier David Eby said before the fiscal forecast was released Tuesday that the New Democrat government remains committed to providing services and supports for people in British Columbia and cuts are not on his agenda.
Eby said people have been hurt by high interest costs and the province is facing budget pressures connected to low resource prices, high wildfire costs and struggling global economies.
The premier said that now is not the time to reduce supports and services for people.
Last month’s year-end report for the 2023-2024 budget saw the province post a budget deficit of $5.035 billion, down from the previous forecast of $5.9 billion.
Eby said he expects government financial priorities to become a major issue during the upcoming election, with the NDP pledging to continue to fund services and the B.C. Conservatives looking to make cuts.
This report by The Canadian Press was first published Sept. 10, 2024.
Note to readers: This is a corrected story. A previous version said the debt would be going up to more than $129 billion. In fact, it will be almost $129 billion.
The Canadian Press. All rights reserved.
NANAIMO, B.C. – Former Bank of Canada governor Mark Carney says he’ll be advising the Liberal party to flip some the challenges posed by an increasingly divided and dangerous world into an economic opportunity for Canada.
But he won’t say what his specific advice will be on economic issues that are politically divisive in Canada, like the carbon tax.
He presented his vision for the Liberals’ economic policy at the party’s caucus retreat in Nanaimo, B.C. today, after he agreed to help the party prepare for the next election as chair of a Liberal task force on economic growth.
Carney has been touted as a possible leadership contender to replace Justin Trudeau, who has said he has tried to coax Carney into politics for years.
Carney says if the prime minister asks him to do something he will do it to the best of his ability, but won’t elaborate on whether the new adviser role could lead to him adding his name to a ballot in the next election.
Finance Minister Chrystia Freeland says she has been taking advice from Carney for years, and that his new position won’t infringe on her role.
This report by The Canadian Press was first published Sept. 10, 2024.
The Canadian Press. All rights reserved.
HALIFAX – The Nova Scotia government has introduced a bill that would kick-start the province’s offshore wind industry without federal approval.
Natural Resources Minister Tory Rushton says amendments within a new omnibus bill introduced today will help ensure Nova Scotia meets its goal of launching a first call for offshore wind bids next year.
The province wants to offer project licences by 2030 to develop a total of five gigawatts of power from offshore wind.
Rushton says normally the province would wait for the federal government to adopt legislation establishing a wind industry off Canada’s East Coast, but that process has been “progressing slowly.”
Federal legislation that would enable the development of offshore wind farms in Nova Scotia and Newfoundland and Labrador has passed through the first and second reading in the Senate, and is currently under consideration in committee.
Rushton says the Nova Scotia bill mirrors the federal legislation and would prevent the province’s offshore wind industry from being held up in Ottawa.
This report by The Canadian Press was first published Sept. 10, 2024.
The Canadian Press. All rights reserved.
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