All Things in Moderation

Vital Statistics:

Stocks are lower this morning as energy prices continue to rise. The bond market is closed for the Columbus Day holiday.

The upcoming week is relatively data-light, which is typical for the week after the jobs report. We will get inflation data as well as retail sales. The minutes from the September FOMC meeting will be released on Wednesday.

Goldman Sachs cut its US growth forecasts as consumer spending slips. They took down 2021 estimates rom 5.7% to 5.6% and 2022 estimates from 4.4% to 4%. “After updating our estimates of the key growth impulses that drive our consumption forecast—reopening, fiscal stimulus, pent-up savings, and wealth effects—and incorporating a longer-lasting virus drag on virus-sensitive consumer services spending, we now expect a more delayed recovery in consumer spending,” the economists said.  

Semiconductor shortages are forecasted to last until the second half of next year. Ultimately they believe that slowing of fiscal support will be a drag. Again, the Federal Government has spent an extraordinary amount of money over the past year and a half, and even if it falls government spending is still highly stimulative. Again I think we are at the “pushing on a string” point of fiscal stimulus.

The wheels are coming off the Chinese real estate bubble. Evergrande is the face of the bust, but we are seeing additional companies miss debt payments. The canary in the coal mine – the corporate bond market – however is flashing warning signs. The ICE / Bank of America index of Chinese developer corporate bonds shows 24 of 59 companies trading with yields over 20%, which are distressed levels. If 40% of the industry is trading at distressed levels then it looks like the bust is here and it will be almost impossible to reverse.

Japanese bank Nomura estimates that there is $5 trillion in debt that has been raised by developers over the past 5 years. To put that number in perspective, it is about the size of Japan’s GDP, the third largest economy in the world. China has a tight grip on the financial system and it will be a fascinating to watch how they manage it. As I said before I expect them to follow the Japanese model and to prevent any major defaults. The weaker companies will be bought by the stronger companies, and the economy will enter a long recession as the bad debt accumulated during the bubble years gets worked off.

The bust will send another global deflationary wave which will pull interest rates lower and commodity prices lower. The US will probably be able to get away with profligate spending and super-low interest rates for a while longer. The problem is what happens during the next recession. Interest rates are already at the floor, and fiscal stimulus has reached the point of diminishing returns. So during the next recession, the 10 year yield probably hits zero.

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