Main Street Macro: What’s Debt Got To Do With It?

Economic

Summary:

The Federal Reserve’s move to cut its benchmark interest rate by half a percentage point won’t likely be felt immediately by its primary targets, employers, and households.

Yes, the Fed has a mandate to promote full employment and price stability, but in practice it takes a long time for rate cuts to translate into more hiring and spending on Main Street.

Instead, the first people to feel the benefits of lower rates will be borrowers. Households and businesses will find it cheaper to fund purchases and investments, which eventually will lead to more hiring.

That’s the theory, anyway. To evaluate the potential impact of Fed rate cuts, we need to look at the current state of debt relative to income in key segments of the economy.

Consumer debt

Consumers drive the lion’s share of economic growth. As such, they’re the most important target of the Fed’s monetary strategy.

Central bank policymakers began raising the benchmark rate, which influences the cost of mortgages, credit cards and car loans, in March 2022. By September 2023, the federal funds rate had risen from 0.08 percent to 5.33 percent.

Still, consumers continued to borrow even at higher rates, and household debt rose 7 percent between the second quarter of 2022 and the second quarter of 2024. But household wealth, which measures the value of financial assets and home equity, grew even faster, rising 11 percent over the same period.

Not only has household net worth increased, real disposable income, which is after-tax income adjusted for inflation, is up 6 percent from two years ago, according to data from the Bureau of Economic Analysis.

This means that consumers are positioned to better bear the cost of higher interest rates.

In fact, household debt payments, when measured as a share of disposable income, are back to their pre-pandemic average of less than10 percent. After sinking to a historic low during the pandemic when consumer spending dried up, payments have stabilized at a full percentage point below their historical norm of 11 percent.

This also means that the last two years of higher interest rates have failed to put a dent in consumer spending. Retail sales were strong in August, showing consumers holding up well in the face of higher prices and borrowing costs.

So, will lower rates encourage more debt and spending? Certainly. But will the impact on consumers be as great as it was when the Fed cut rates in 2008, when the ratio of debt payments to disposable income was at a 13.2 percent high? Probably not.

Corporate debt

Another big target for rate cuts are large employers, who are key players in the Fed’s full-employment mandate.

Rather than taking loans from banks, large employers borrow in the capital markets. One way to assess the health of this sector is to look at the ratio of corporate debt to corporate valuations, or market capitalization.

This ratio reached record lows this year largely because of strong market capitalization growth. One measure of the value of big companies, the S&P 500 index, was up a robust 17 percent in the last two years even in the face of higher-than-normal interest rates.

With large employers more capitalized than ever, will rate cuts jump-start corporate hiring? Maybe.

The labor market is in solid shape. Layoffs are near historic lows and the unemployment rate is below its historical average. That means the Fed rate cut probably won’t trigger a big hiring boom. But it could benefit smaller employers that depend on bank loans to finance growth and increase staffing.

Government debt

No review of debt would be complete without a look at the biggest borrower in the economy, the U.S. government.

The ratio of U.S. debt to U.S. income, or GDP, has fallen since the throes of the pandemic, when the government unleased much-needed emergency funding to struggling businesses and households. The national debt is now 122 percent of GDP, much higher than historic or pre-pandemic averages.

And it’s expected to climb even higher, according to the Congressional Budget Office, primarily due to non-discretionary spending on Medicaid and Social Security.

As of August, 17 percent of all federal spending went toward interest rate payments, according to the Treasury Department. A Fed rate cut will lower borrowing costs, but it won’t solve the U.S. debt problem.

My take

Again, the theory works like this: The Fed cuts rates, lowering borrowing costs for employers and consumers, and stimulating a struggling economy. Consumers get room to spend more, and companies have incentive to hire.

But what if the economy isn’t struggling? What if consumers already are spending, and household debt compared to income is relatively low? What if big employers are operating in a balanced labor market and have record low debt relative to market values?

Lower borrowing costs will help Main Street spend more, but they won’t juice the economy as much as previous rate-cutting cycles.

The catch is government debt, which is the only economic ratio that hasn’t returned to a pre-pandemic normal. U.S. debt continues to soar, and Federal Reserve rate cuts can do only so much to help.

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Warren Takunda

Economic

Australia's central bank on Tuesday held interest rates steady as expected and reiterated that policy needed to stay tight to bring inflation to heel, sticking to its guns a week after the Federal Reserve started its easing campaign with a bang.

The hawkish stance sent the Australian dollar 0.4% higher to $0.6864, the highest this year, and markets pared the chance of a December rate cut to 59% from 64% before the decision.

Wrapping up its September policy meeting, the Reserve Bank of Australia (RBA) kept rates at a 12-year high of 4.35% and said policy would have to be sufficiently restrictive to ensure inflation returned to target.

"While headline inflation will decline for a time, underlying inflation is more indicative of inflation momentum, and it remains too high," the board said in a statement largely similar to the one in August.

"Data since then have reinforced the need to remain vigilant to upside risks to inflation and the Board is not ruling anything in or out."

Markets had wagered heavily on a steady outcome given underlying inflation remained sticky and the labour market held up surprisingly well.

"Underlying inflation is still too high for the RBA’s liking, and progress back to the target range is frustratingly slow," said Sean Langcake, head of macroeconomic forecasting for Oxford Economics Australia.

The RBA has kept rates steady since November, judging that the cash rate of 4.35% - up from a record-low 0.1% during the pandemic - is restrictive enough to bring inflation to its target band of 2-3% while preserving employment gains.

With underlying inflation stubborn at 3.9% last quarter and the labour market churning out lots of new jobs, there appears to be no urgency to ease policy like what the Federal Reserve did last week, cutting by 50 basis points to preempt sharp job losses.

Governor Michele Bullock has used every opportunity recently to stress that the central bank does not expect a near-term rate cut. That has prompted the markets to gradually price out the chance of a rate cut this year, with the first easing in December priced just at 64%.

"We retain the view that rates will be on hold until Q2 2025," Langcake said. "The path of core inflation back to the target range has stalled somewhat, and it is hard to see a major improvement in the near term."

Market sentiment in Australia on Tuesday was aided by more stimulus from China's central bank, which announced cuts to reserve requirements and lending rates, including for existing home loans.

Investors are now waiting for the monthly inflation data for August on Wednesday. Headline inflation is likely to have slowed to an annual rate of 2.7% thanks to the government's electricity rebates, but the core gauge could once again highlight sticky prices.

The RBA already trails other central bank in cutting rates, and the political pressure is ramping up for an easing. The left-wing Greens on Monday demanded the government to engineer a cut in interest rates in exchange for their support in parliament to pass the long-delayed reforms to the RBA.

Source: Reuters

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Warren Takunda

Stocks

London stocks rose in early trade on Tuesday, with sentiment boosted after China unveiled new stimulus measures.

At 0825 BST, the FTSE 100 was up 0.5% at 8,299.23.

Matt Britzman, senior equity analyst at Hargreaves Lansdown, said easing monetary policy continues to dominate the global narrative.

"Asian markets ripped as China announced a series of easing measures designed to stimulate the world’s second-largest economy," he said.

"The People’s Bank of China has delved into its bag of tricks to try to get growth back to the 5% target, including cuts to interest rates, mortgage rates, and down-payments for house buyers. This isn’t the central bank going all-in on stimulus, there’s plenty more left in the tank, but It’s a clear sign that it’s not going to sit back and watch growth disappoint.

"Brent oil futures are trading around $74.6 per barrel this morning, recouping losses from previous sessions as traders give supply concerns a slight edge over demand weakness. On the demand side, stimulus from China’s central bank should also act as a small tailwind given the region’s status as the world’s top oil consumer."

In equity markets, Prudential, Standard Chartered and Burberry - all of which are exposed to China - rallied.

Heavily-weighted miners also gained, with Antofagasta, Rio Tinto and Glencore among the top performers on the FTSE 100 as copper prices advanced.

On the downside, engineering solutions business Smiths Group was under the cosh as its full-year adjusted pre-tax profit missed estimates. The company also announced the acquisitions of two North American companies to bolt on to its HVAC and Flex-Tek businesses for a combined £110m.

Dunelm tumbled after its biggest shareholder, Will Adderley, and his private investment firm WA Capital, sold a 4.9% stake in the homeware retailer in a placing to institutional investors.

Barclays, which acted as sole global co-ordinator, said that WA Capital - which is controlled by Adderley and his wife - sold 10m shares at 1,140p each.

Recruiter SThree also fell as it reported an 8% drop in third-quarter net fees amid continued challenging market conditions.

Source: Sharecast

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S&P Global Inc.

Economic

The September PMI data bring encouraging news, with solid economic growth being accompanied by a cooling of selling price inflation. The data therefore hint at a 'soft landing' for the UK economy, whereby the fight against inflation is showing increasing signs of being won without higher interest rates having caused a downturn.

A slight cooling of output growth across manufacturing and services in September should not be seen as too concerning, as the survey data are still consistent with the economy growing at a rate approaching 0.3% in the third quarter, which is in line with Bank of England's forecast.

Business optimism has also risen, albeit with concerns about the impact of the Autumn Statement jangling nerves somewhat, notably in the manufacturing sector. Investment plans in particular are reported to have been put on ice pending clarity on the new government's policies, especially towards taxation. Hiring likewise has been stifled by business uncertainty about the near-term economic outlook ahead of the Budget.

In the meantime, stubbornly elevated services charge inflation, which has been the bugbear of the Bank of England, cooled in September to the lowest since February 2021 to help bring the Bank of England's 2% inflation target closer into view. The survey data therefore support the view that interest rates could fall further in the closing months of 2024.

Output growth moderates but remains solid

Business activity rose for an eleventh straight month in September, according to early PMI survey data. The rate of growth lost some momentum but closed off the third quarter which has seen the PMI run slightly above the average seen in the second quarter. The headline economic growth indicator from the flash PMI surveys, the seasonally adjusted S&P Global UK PMI Composite Output Index, fell from 53.8 in August to 52.9 in September but remained well above the 50.0 no change level.

The latest PMI reading is broadly indicative of the UK economy growing at a quarterly rate of 0.25% in September and a near 0.3% rise in the third quarter as a whole, based on the historical relationship of the PMI with GDP. This is broadly in line with Bank of England expectations and adds to signs that the economy has sustained a robust underlying pace of expansion after a solid first half to the year.

Official GDP data have come in stronger than the PMI so far this year, signaling a 0.7% expansion in the first quarter and a 0.6% rise in the second quarter, but monthly real GDP data for June and July have shown no growth. This points to a cooling of the economic growth rate signalled by the ONS data as we head into the second half of the year, but the PMI data suggest that the underlying expansion remains relatively healthy and less volatile than indicated by the ONS GDP data.

Manufacturing and services expand but goods sector suffers further export fall

At the broad sector level, the expansion in September was driven by rising output across both manufacturing and services, albeit with both sectors losing some growth momentum.

However, service sector growth reflected rising IT and financial services activity, with consumer-facing services, transportation and business services all reporting lower output to reveal very divergent trends within the services economy.

In manufacturing, a key divergence persisted in terms of the expansion being driven by domestic demand, as export orders continued to fall, having now deteriorated in 36 of the past 37 months. Exporters blamed slower global demand growth, barriers to easy exporting and the recent strength of sterling.

Service sector inflation at 43-month low brings BoE target closer into view

While growth remained resilient, price pressures moderated further to hint further at the economy experiencing a 'soft landing', whereby the fight against high inflation has been won without the economy sliding into recession. Most importantly from a policymaking perspective, the PMI survey data point to a moderation of service sector inflation, which has been the main area of concern to the Bank of England. Services inflation ticked higher to 5.6% in August, according to official data, but the PMI's gauge of average prices charged for services fell further in September to its lowest since February 2021. Particularly weaker price trends were indicated for business services and hotels & restaurants.

As this survey gauge tends to lead the official data by many months, the PMI's price gauge points to services inflation cooling in the months ahead, albeit remaining somewhat elevated. The services price gauge has now fallen to 54.2 from 55.0 in August, which compares with a pre-pandemic ten-year average of 51.7 but represents a further marked slowing in the rate of inflation compared to the highs seen in the pandemic.

Although goods price inflation picked up to a 16-month high in the September flash PMI survey, when combined with the weaker PMI selling price data from services, the overall signal from the PMI for goods and price inflation is one of prices rising at the slowest rate since February 2021, bringing the Bank of England's 2% inflation target closer into view.

Jobs growth slows

The lower price pressures in services in part reflected lower input cost growth, which increased in September at one of the slowest rates seen over the past three and a half years. The relatively subdued cost growth in turn reflected reduced wage pressures as hiring slowed in the service sector as well as in manufacturing, the latter in fact reported a drop in employment for the first time in three months. Overall, employment rose in September at the slowest rate since June.

These reduced hiring trends can be linked to backlogs of uncompleted work falling in both manufacturing and services in September, which typically points to the existence of surplus operating capacity relative to demand, but also in part reflected some uncertainty about the economic outlook, notably in terms of government policies ahead of the Autumn Statement.

Outlook marred by uncertainty

More positively, future output expectations ticked higher in September to remain well above the survey's long-run average. However, there were mixed signals by sector. While service sector optimism recovered to the third-highest seen over the past 31 months, manufacturing optimism slumped to the second-lowest in 21 months to indicate a potential divergence in the growth paths of the two sectors in the near-term.

Improved sentiment was centered on expansion plans amid a supportive economic environment as the cost of living impact continues to wane and demand remains resilient.

However, political uncertainty and the new policies of the fresh government in the UK, as well as concerns over the broader global geopolitical environment and growth worries in major trading partners, notably Europe, injects some uncertainty - especially at manufacturers. Investment plans in particular were often reported to have been put on ice pending clarity on the new government's policies, especially towards taxation.

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S&P Global Inc.

Economic

The PMI survey data for September showed average prices charged for goods and services rising at the slowest rate since February 2021. The survey PMI's selling price index has in fact now fallen to a level below that consistent with the ECB's 2% target. Importantly, services inflation has cooled further, down to its lowest since March 2021. Goods prices are falling.

However, any success in driving down inflation appears to be coming at an increased cost in terms of economic growth. Output across manufacturing and services fell in September as a deepening manufacturing downturn was accompanied by a near-stalling of output in the services economy. Both sectors are reporting weakening demand conditions and sentiment about business prospects has further soured.

The flash PMI data therefore suggest that the risks of the eurozone economy facing a 'hard landing', whereby higher interest rates have only beaten inflation by causing an economic downturn, have risen.

Here are our top five takeaways from the September flash PMI data:

1. Output falls in September

Last month we warned that an improvement in the eurozone PMI looked temporary, in part reflecting a boost to business activity in France surrounding the Paris Olympics. As expected, this impact has waned in September, contributing to a fall in business activity across the region which reflects a broad-based economic weakening.

The seasonally adjusted HCOB Flash Eurozone Composite PMI Output Index, based on approximately 85% of usual survey responses and compiled by S&P Global, fell from 51.0 in August to 48.9 in September. The latest reading signals the first monthly drop in output since February.

The decline in the PMI means the September survey data are consistent with GDP falling at a 0.1% quarterly rate, dragging the average reading for the third quarter as a whole to a level signalling near-stagnation.

The PMI data therefore point to the eurozone economy losing momentum in the third quarter from the 0.3% increase registered by official data for the second quarter, with our PMI-based model indicating 0.0% GDP growth.

2. Broad-based malaise

Having surged to a 27-month high of 53.1 in August on the back of a jump in service sector activity, coinciding with the Paris Olympics, the composite PMI for France slumped back to 47.4 to indicate the steepest monthly fall in output since January. However, it was not just France's service sector that deteriorated, as the country's factory output fell at the sharpest rate since January.

Moreover, weakness was by no means confined to France. The flash composite PMI for Germany also continued to fall, signaling a contraction of output for a third successive month. The index dropped from 48.4 in August to 47.2 to signal the steepest contraction since February. The steepest fall in manufacturing output for 12 months in Germany was accompanied by a near-stalling of service sector growth. Elsewhere, the rate of expansion across the rest of the region cooled to its weakest since January.

Across the eurozone as a whole, manufacturing output fell at the sharpest rate for nine months, declining for an eighteenth successive month. The goods-producing sector has been in decline in all bar two of the past 28 months, and an accelerated rate of loss of new orders in September points to the downturn deepening further in October.

The service sector meanwhile came close to stagnating, recording its weakest growth since February, as inflows of new business fell for the first time in seven months.

3. Confidence slides

Boding ill for the near-term outlook, future output expectations slumped to a ten-month low in September, descending further below the survey's long-run average to point to subdued business prospects by historical standards. Most pronounced was a steep deterioration in business sentiment in the manufacturing sector, down to an 11-month low, though sentiment also dipped to a nine-month low in the service sector.

The decline in confidence was, however, confined to Germany, as year-ahead sentiment picked up in France and the rest of the region as a whole.

4. Job losses accelerate

The deteriorating demand environment and gloomier outlook led to further job cuts. The flash PMI signaled a decline in employment for a second successive month, the rate of job losses remaining modest but nevertheless reached the highest since December 2020.

Services employment showed the smallest - only modest - rise for 13 months, accompanied by a further solid fall in manufacturing workforce numbers, which dropped for a sixteenth straight month. The factory payroll decline was the sharpest since the height of the pandemic in August 2020 and, prior to that, July 2012.

Germany reported a fourth successive monthly fall in employment, recording the sharpest fall since June 2020. Outside of the pandemic, German employment has not fallen at this rate since July 2009, at the height of the global financial crisis. Job numbers were largely unchanged in France but rose elsewhere on average.

5. Prices rise at increased, but still modest rate, as input cost growth moderates

The combination of weakening demand, improved supply chains - as indicated by a further marked quickening of supplier delivery times in September, and reduced hiring led to lower cost pressures. Average input prices rose in September at the slowest rate since November 2020. Significantly, cost growth is now running below the average pace seen in the decade preceding the pandemic.

Manufacturing input costs fell for the first time in four months, and service sector input cost inflation - which is being watched especially closely by the European Central Bank as this gauge is heavily influenced by wage pressures - fell to its lowest since March 2021 and is now only slightly above its pre-pandemic decade average.

Lower cost growth fed through to reduced upward pressure on selling prices. Average prices charged for goods and services across the eurozone rose only very modestly in September, rising at the slowest rate since February 2021. The decline pushes the PMI's selling price index to a level below that consistent with the ECB's 2% target, according to historical comparisons.

Manufacturing prices fell slightly in September while services charges rose at the slowest rate since April 2021. By country, charges for goods and services notably fell in France for the first time since the pandemic lockdowns of February 2021 and rose in Germany at the slowest rate since January 2021. Elsewhere across the eurozone, the rise in prices was the slowest since March 2021.

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Alex

Forex

The Pound Sterling (GBP) could edge higher but is unlikely to reach the major resistance at 1.3400. In the longer run, there has only been a slight increase in momentum, and it remains to be seen if GBP can break above 1.3400, UOB Group FX analysts Quek Ser Leang and Peter Chia note.

To remain bullish above 1.3250

24-HOUR VIEW: “Yesterday, we expected GBP to trade in a range between 1.3270 and 1.3340. We did not anticipate the ensuing volatility as GBP fell sharply, but briefly to 1.3249, snapping back up to reach a high of 1.3360. Despite the strong advance from the low, upward momentum has not increased much. Today, GBP could edge higher, but it is unlikely to reach the major resistance at 1.3400 (there is another resistance at 1.3370). Support is at 1.3325; a breach of 1.3300 would indicate that the current upward pressure has faded.”

1-3 WEEKS VIEW: “We have held a positive GBP view since early last week. In our latest narrative from last Friday (20 Sep, spot at 1.3280), we highlighted that “while the price action continues to suggest GBP strength, overbought conditions could potentially limit any further advance.” We added, “the next level to watch is 1.3350.” Yesterday (23 Sep, spot at 1.3310), we indicated that “while GBP could rise above 1.3350, the potential of it reaching 1.3400 seems low for now.” GBP subsequently rose to 1.3360. There has only been a slight increase in momentum, and it remains to be seen if GBP can break above the significant resistance at 1.3400. On the downside, should GBP break below 1.3250 (‘strong support’ level previously at 1.3210), it would mean that it is not strengthening further.”

Source: FXSTREET

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Justin

Economic

Germany’s business outlook worsened again — reinforcing fears that Europe’s biggest economy is in a recession with no quick rebound imminent.

The Ifo Institute’s expectations gauge dipped to 86.3 in September from 86.8 the previous month. That’s still the lowest since February and slightly below what analysts in a Bloomberg poll had seen. A barometer of current conditions declined more strongly.

“The outlook for the coming months continues to decline,” Ifo president Clemens Fuest said Tuesday in a statement, highlighting that the index for manufacturing is at its lowest level since 2020. “The German economy is coming under ever-increasing pressure.”

Talk of Germany’s economic decline is once again growing louder after a string of bad news underscored weaknesses in its key auto sector. The underperformance is weighing on the euro area as a whole, with an early-year recovery in the 20-nation bloc fizzling out.

“The lack of orders has intensified,” Fuest said. “The core sectors of Germany industry are struggling.”

While stressing that a severe economic slump looks unlikely, the Bundesbank has warned that Germany may already be in recession, with another contraction in the third quarter possible after a 0.1% decline in the second. It’s president, Joachim Nagel, will give a speech on the economy later Tuesday.

S&P Global said Monday that its latest Purchasing Managers’ Index for Germany fell more than anticipated, to 47.2 — the lowest level in seven months and well below the 50 mark that separates growth from contraction.

The main weak spot remains manufacturing, whose gauge dropped to a one-year low. Services activity, however, also softened.

Economists have already begun lowering this year’s predictions, with some now seeing stagnation or even another slight downturn. Germany was the only Group of Seven economy to contract in 2023.

Its struggles, and the wider implications for the continent, are fuelling market bets that the European Central Bank will cut interest rates again as soon as next month, rather than waiting until December as several officials suggested of late.

“Parts of the euro-area economy are in free fall, others are simply loosing its dynamic — it’s clear that interest rates are too high for investment spending and growth to pick up,” said Karsten Junius, chief economist and head of economic and strategy research at Bank J Safra Sarasin in Zurich.

“The ECB should review the case for front-loading policy rate cuts similar to the Fed,” he said.

Source: Theedgemarkets

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Main Street Macro: What’s Debt Got To Do With It?

Australia's Central Bank Keeps Rates on Hold, Stays Hawkish

Source: Reuters

London Open: FTSE Gains on China Stimulus Measures

Source: Sharecast

Flash UK PMI Signals Solid Economic Growth and Further Downshifting of Inflation

Output growth moderates but remains solid

Manufacturing and services expand but goods sector suffers further export fall

Service sector inflation at 43-month low brings BoE target closer into view

Jobs growth slows

Outlook marred by uncertainty

Flash Eurozone PMI Top Five takeaways: Heightened Risk of Economy Facing Hard Landing

1. Output falls in September

2. Broad-based malaise

3. Confidence slides

4. Job losses accelerate

5. Prices rise at increased, but still modest rate, as input cost growth moderates

GBP/USD: Unlikely to Reach the Major Resistance at 1.3400 – UOB Group

To remain bullish above 1.3250

Source: FXSTREET

German Business Confidence Dips in Latest Recession Warning

Source: Theedgemarkets

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