Looking at the long cycle, the interest rate level in 2008-2019 is actually abnormal. Investors need to be prepared for the long term of high interest rates, there will be occasional easing in the future, but not the start of continuous interest rate cuts, the classic "money-credit-growth-inflation" cycle is returning, the "low inflation-low interest rate" state in the post-financial crisis era is over, and the monetary liquidity factor in the valuation-driven logic of U.S. stocks is also over.
Text: Tianfeng Macro Song Xuetao / Contact Xiang Jingshu
Since the US banking crisis in March, the debate on whether the US economy is a "recession" or a "soft landing" has intensified. From the perspective of market performance, commodities and long-end US bonds showed recession expectations, while US stocks remained very tenacious. Since the beginning of this year, we have insisted that the US economy may not "not recession" (see "The US economy may not decline"), even if there is a regional banking crisis and commercial real estate turmoil during this period, judging from the recent performance of US economic data, we still adhere to our previous judgment. As of the first quarter of this year, US GDP, excluding fluctuations in inventory investment, has rebounded significantly in most sub-items. Among them, commodity consumption rebounded sharply from 0% to 1.5%, service consumption grew steadily to 0.6%, residential fixed asset investment fell significantly to -1.4%, net exports turned a profit, government expenditure accelerated slightly to 1.3%, and only the growth rate of non-residential fixed asset investment fell to 0.3%. The Markit composite PMI has rebounded strongly since December, rebounding to 53.4 in April, with the relatively weak ISM manufacturing PMI rebounding slightly to 47.1 in April.
Why has the US economy remained resilient despite high interest rates and high inflation? Judging from the performance of various economic agents, high inflation and high interest rates have not crushed the US economy.
The first is that the banking sector, considered "on the verge of bankruptcy", actually benefits from high interest rate spreads. The essence of the profit model of commercial banks is to borrow short-term loans for a long time, absorb low-interest short-term deposits, and lend long-term high-interest loans to earn interest rate spreads. Although the Fed has raised the federal base rate over the past year or so, Bank of America has not raised the deposit rate by the same amount. According to FDIC data, as of April 17 this year, the average deposit rate of US banks and savings institutions was only 0.39%, compared to 4.83% for US Treasuries of the same maturity. At the same time, the loan interest rate of the bank is not based on the yield of 10-year Treasury bonds, the benchmark of corporate loan interest rates is Prime Rate, and the benchmark of residential mortgage interest rates is 30-year Mortgage Prime Rate, and the spread between the two and 10-year US Treasury bonds has widened by 90~100Bps compared with before the epidemic. These have allowed the US banking sector to record interest margin income. As of Q4 2022, the interest margin income of the US banking industry was nearly $180 billion, with a year-on-year growth rate of 31% in 22Q4, of which small banks (less than $50 billion in assets) had the largest net interest margin, more than 4%, and large banks (greater than $750 billion in assets) had the lowest net interest margin, only slightly more than 2%.
Secondly, the corporate sector, which was "targeted" by the risk of interest rate hikes, was not crushed by high interest rates, and the increase in junk bond defaults and the wave of zombie company failures, which were common in previous interest rate hike cycles, did not appear this time. Although the Fed raised interest rates at the fastest pace in history, as of Q4 2022, the year-on-year growth rate of corporate profits has not turned negative, with the energy sector contributing the most. The rapid rate hike has not caused crude oil prices to plummet as quickly as they have done over the past decade, with energy profits in the S&P 500 hitting a record high of $186.2 billion in 2022, a full $114 billion higher than in 2021. Even after price adjustments, energy and utilities profits hit record highs in Q1 2023, while software services profits were second only to 2021. On the other hand, corporate balance sheets have also been repaired during the pandemic. In 2020 and 2021, US corporate bond issuance and IPOs hit record highs, and enterprises have abundant cash flow on hand; After corporate debt replacement, the peak of maturity has shifted backwards, and only about 10% of the trillion-dollar leveraged financing debt (high-yield bonds and leveraged loans combined) will be due in 2022-24, and there is little pressure to repay the debt. As a result, a serious recession in the corporate sector is unlikely to occur in the short term. In this round of the fastest interest rate hike cycle in history, the wave of junk bond defaults did not appear. Judging from the recovery of credit spreads and leveraged loan spreads of CCC and below-rated enterprises, the recovery is not as large as the small cycle of 2016, which did not have a recession, and is far from the level of 2008. The wave of corporate bankruptcy also did not appear as expected, with the number of commercial bankruptcy filings falling by 6% to 13,481 from 14,347 in 2021 and the number of non-commercial bankruptcy filings falling by 6.3% to 374,240 by the end of 2022.
Even the fragile financial and corporate sectors have not been problems, let alone resilient household sectors. The US labor market has maintained strong resilience in the interest rate hike cycle, and as inflation readings declined, the growth rate of real disposable income of residents turned positive again, supporting continued improvement in household consumption. Although the growth rate of real disposable income of residents in 2022 turned negative due to the impact of high oil prices, the excess savings of 2.6 trillion yuan in 2020 and 2021 smoothed the downward trend of consumption to some extent. In 2023, with the decline in inflation and the resilience of the labor market, the growth rate of real disposable income of residents has continued to turn positive and rebound, which will further support household consumption. In April, nominal wages in the United States were the highest in the past five years, with real wages in leisure and catering, trade and logistics growing by 1.9% and 1.7%, and manufacturing real wages growing by 1.7%, respectively in the 75%, 64% and 67% percentiles since 2010.
Overall, the U.S. economy is not bad, let alone the basis for debt crisis and deep recession (hard landing), the root cause of the economic slowdown is the inventory cycle, 2020-2021 excessive household consumption, real estate sales and corporate inventory investment squeezed out the subsequent consumer real estate and inventory investment, only need time to gradually digest the previous excessive consumption and inventory accumulation. There is a high probability that there will be no recession in the US economy (recession refers not to a cyclical decline in GDP growth, but a series of indicators of economic activity that have fallen significantly and are widespread and lasting several months), and the tight balance of supply and demand in the labor market will not reset, so inflation and interest rates will be difficult to return to pre-pandemic levels. The structural supply shortage in the US labor market remains much higher than in past cycles, with the ratio of job vacancies to unemployed rebounding to 1.79 in April and only 1.2 at the high of the previous economic cycle (2017-2019), meaning that even if the unemployment rate rises, wage growth has less room to decline than in previous cycles. The recent year-on-year pick-up in Atlanta's wage growth means that the super-core inflation that the Fed cares about (excluding food and energy rents) will also rebound, and it will be difficult for core inflation to return to the 2% target level in the future.
Current consumption does not depend on excess savings in the previous period, as inflation readings fall, residents' real disposable income rebounds, household consumption will recover again, inventory de-stocking promotes inflation to rise again, this is the classic inventory cycle. Since there is no recession, the Fed's monetary policy objective will be anchored to inflation without cutting interest rates.
Looking at the long cycle, the level of interest rates in 2008-2019 is actually abnormal. Investors need to prepare for high interest rates for the long term, the core inflation center will rise above 3%, the Fed will also maintain restrictive high interest rates for longer, and there will be occasional easing in the future, but not the start of consecutive rate cuts. The classic "money-credit-growth-inflation" cycle is returning, the post-financial crisis era of "low inflation-low interest rates" is over, and so is the monetary liquidity factor in the valuation-driven logic of US stocks.
Risk Warning
The global economy is in a deep recession, the Fed's monetary policy tightens more than expected, and inflation exceeds expectations
Team introduction
Song Xuetao | Principal Investigator of Macro
Training lecturer of China Securities Association, 100 people of Insurance Asset Management Association. Ph.D. in Economics, North Carolina State University, USA. He used to be a visiting researcher of the Research Bureau of the People's Bank of China, a CF40 invited researcher, and published CF40 monographs, academic papers, central bank working papers, etc. 2018, 2019 and 2020 Golden Bull Award Most Valuable Analyst in the Market (Top 15), 2021 Golden Bull Award Best Analyst (3rd), 2020 and 2021 Wind Gold Analyst (3rd), Shanghai Securities Report Best Analyst (5th), 2019, 2020, 2021 Sina Golden Kirin Analyst, 2020 21st Century Gold Analyst (5th), 2020 and 2021 Shortlisted New Fortune Best Analyst.
Xiang Jingshu | researcher
He used to work for AHL, the core quantitative hedge fund of Man Investments. Master from London Business School. He is mainly responsible for the research of the US economy, global central banks and US stocks and US debt.
Lin Yan | researcher
He used to work in the quantitative investment research department of Hongshang Asset (Sequoia Capital's securities asset management platform in China), responsible for commodity futures investment. Master of Financial Engineering from Wuhan University, mainly responsible for large-scale asset allocation and fundamental quantitative research.
Guo Weiwei | Assistant researcher with a master's degree in finance from Wuhan University, mainly responsible for ESG, industrial policy, and industry research.
Zhang Wei | Researcher with a master's degree in finance from the University of International Business and Economics, mainly responsible for economic policy and interest rate research.
Sun Yongle | Researcher, Master of Industrial Economics, Central University of Finance and Economics, mainly responsible for domestic macroeconomic and monetary liquidity research.