Elusive Recession
Elusive
Recession
Better than expected economic data in the US, has meant that the much expected recession has proved elusive.
The lack of recession is a surprise given that interest rates have gone up by more than expected. Rightly so, economists are wondering why the interest rate hikes haven’t had an effect, yet.
The type of borrowing in the US means that for both households and companies, interest rate pain is delayed. In the case of households, who typically have very long term mortgages (of 15 to 30 years), interest rate pain is delayed for a long time, as they would have ‘locked-in’ borrowing at the low interest rates of 2020-21. New borrowers are facing a challenge of affordability, which is a headwind, but the overall impact of higher interest rates has been less significant in the near term than expected.
Companies are facing a shorter-term problem. Typically, companies borrow on shorter time frames (2-5 years) so companies are facing the prospect of renewing their loans at much higher rates than the pre-existing debt.
How US companies refinance their debt burden may be a key determinant of the economic outlook for 2024.
The signs are mixed but are appearing to nudge towards a poor growth outcome rather than continued recovery. With rising unemployment and increased loan delinquencies, we remain tilted towards higher quality assets in equities and having longer duration fixed income exposure, which should perform well if economic growth stalls and inflation pressure dissipates.
Elusive recession
One of the most heavily debated topics is that of the ‘elusive recession’. Over 70% of economists surveyed by Bloomberg in late 2022 expected a US economic recession in 2023, but it has yet to arrive. Only 50% now believe that a recession will happen in 2024.
Indeed, the macroeconomic backdrop is proving more resilient than many had expected, particularly in the US, despite interest rates rising to levels not seen since 2007.
2023 economic growth forecasts: growth estimates have risen through 2023 , as the economy has been stronger in the US than economists had expected, despite interest rates rising.
Source: Bloomberg, Artorius
There is a valid explanation. The higher interest rates have not affected many consumers and corporates yet (please note the yet).
Is it pain avoided or merely delayed? In the US, many households are paying fixed long-term mortgage rates (unlike many UK households) and companies with longer refinancing schedules have yet to pay higher rates on their debt.
While the average 30 year fixed mortgage rate on new purchases has surged to 8%, the household mortgage debt service ratio remains historically low, at just 4% of disposable personal income. This is well below the above 7% mortgage debt service ratio seen before the subprime crisis in late 2007.
There are two main reasons for this. First, the dominant mortgage product in the US is the 30 year fixed-rate mortgage, with some 15 year fixed-rate mortgages and just a small percentage that are adjustable-rate mortgages. This means that changes in new mortgage rates do not immediately affect payments on most outstanding mortgages, but rather only when people purchase new homes (first-time buyers or movers as mortgages tend not to be portable), or when those mortgages are refinanced.
Interest rate pain delayed for now
However, fewer existing homes for sale has also meant that home prices have barely fallen, limiting the negative effects from the collateral channel (borrowing against housing wealth) and the wealth effect (of falling house prices on consumer confidence). Therefore, the low pass through of higher rates via the mortgage channel, and lack of house price falls, have probably contributed to the resilience of personal consumption (along with the fast rundown of excess savings).
One of the many curiosities of this economic cycle (post 2009) has been the relatively low rate of new houses that have been built in the US. As a consequence of the lack of new homes, despite the rampant house price inflation, the US economy (a bit like the UK economy) is unlikely to see severe house prices falls as demand for new housing has outstripped supply. This in turn probably reduces the depth and duration of any recession that does materialise.
US mortgage rates for new borrowers and effective rate for existing borrowers: consumers seeking new mortgages face much higher interest rates than households with existing mortgages (whose mortgage interest rates were set in the past)
Source: Bloomberg, Artorius
US companies face higher levels of debt of refinancing in coming years.
Data as of Jan 1 2023.
Includes bonds, loans and revolving credit facilities that are rated by S&P Global Ratings. Excludes debt instruments that do not have a global scale rating.
Source: S&P Global Ratings Credit Research & Insights
Likewise for companies, despite official interest rates rising, companies haven’t yet had to face the effect of higher rates on their existing borrowing.
But unlike households with very long mortgage borrowing, most companies are due to refinance their borrowing over the next few years.
Many issuers will start refinancing their fixed-maturity debt in 2024 and 2025, and they will have to absorb higher interest rates. Some $106.7 billion of speculative-grade non-financial debt matures in 2023, according to S&P Global Ratings. That more than doubles to $247.7 billion in 2024 and rises further to $389.3 billion in 2025. When debt matures, it will need to be refinanced, and with interest rates significantly higher than they were at the time of the original loan, company finances may feel the strain of higher interest rates.
Good news and bad news in the eye of beholder
Bad news when it comes to economic data is mostly in the eye of the beholder these days. Even within the US October jobs report, there were plenty of details to be both optimistic and pessimistic about. For those in the latter camp, one could point to the unemployment rate's 0.5-percentage-point increase over the past six months. Other than in the early 1950s, we've never seen that large an increase without the US economy already being in a recession.
US unemployment rate has climbed by 0.5 percentage points (from 3.4% to 3.9%) which has only coincided with recessions in the past.
Source: Bloomberg, Artorius
*Any feedback provided can be anonymous
Elusive Recession
Better than expected economic growth in 2023 has coincided with higher-than-expected interest rates. Has monetary policy stopped working or is the economic pain ‘just delayed’?
The type of borrowing in the US means that for both households and companies, interest rate pain is delayed. In the case of households, who typically have very long term mortgages (of 15 to 30 years), the interest rate pain is delayed for a long time, as they would have ‘locked-in’ borrowing at the low interest rates of 2020-21. New borrowers have to bite the higher interest rate bullet, but the vast majority of US consumers will be ok… for now.
Companies are facing a shorter-term problem. Typically, companies borrow on shorter time frames (2-5 years), so companies are facing the prosect of renewing their loans at much higher rates than the pre-existing debt. How US companies refinance their debt burden may be a key determinant of the economic outlook for 2024.
The signs are mixed but are appearing to nudge towards a poor growth outcome rather than continued recovery. With rising unemployment and increased loan delinquencies, we remain tilted towards higher quality assets in equities and having longer duration fixed income exposure, which should perform well if economic growth stalls and inflation pressure dissipates.
Important Information
Artorius provides this document in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 17th November 2023 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested. Past performance is not a reliable indicator of future results.
Nothing in this document is intended to be, or should be construed as, regulated advice. Reliance should not be placed on the information contained within this document when taking individual investment or strategic decisions.
Any advisory services we provide will be subject to a formal Engagement Letter signed by both parties. Any Investment Management services we provide will be subject to a formal Investment Management Agreement, which will include an agreed mandate.
Artorius Wealth Management Limited is authorised and regulated by the Financial Conduct Authority. Artorius is a trading name of Artorius Wealth Management Limited.
FP20231117001