US bank-held consumer credit on the rise

Bank-held consumer credit in the US continues to rise. It's impossible to tell from this weekly data what portion is credit cards debt vs. auto and other. This of course does not include any new student loans, which are all held by the federal government. With wage growth remaining tepid, the consumer is starting to put on some leverage.

________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

Still extrapolating the bubble

Economists and pundits continue to draw a line through the US GDP chart to show how the current economic growth is so far below trend (blue line below). Look, we are operating so much below capacity because of ... whatever it is that they want to complain about.

Nonsense. The real trend is the red line. Extrapolating the “bubble era” trend is suggesting that the credit/housing bubble was the norm.

Source:  @mattyglesias

________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

US energy markets are not insulated from the unrest in Iraq

The situation in Iraq continues to unravel. The nation's government and some in the media are calling this a "terrorist insurgency". In reality what we have is a large armed Sunni group, supported by militant factions from Syria, quickly gaining ground against the Shia-controlled government forces. It's a civil war. Many Shia families are leaving Baghdad as the Sunni militants advance. And now Iran is getting militarily involved in an attempt to defend Shiite interests in Iraq.

The risk of further escalation is threatening to cut Iraq's oil output and even destabilize the region.

NY Times: - traders are worried that the action could spread, threatening supplies. Iraq is the second largest oil producer in OPEC, representing the largest source of growth among the 12 member countries.

Of perhaps greater concern is that the growing instability in Iraq and the unrest in other big petroleum-producing countries could alter the geopolitical dynamics that have kept oil prices remarkably stable although relatively high for the last three years. The Russian annexation in Crimea and the chaos in Libya “point to a systemic and seismic shift geopolitically,” Edward L. Morse, head of commodities research at Citigroup, wrote in a note to clients on Friday.

Oil prices have been on the rise as a result, with US crude prices following Brent higher.

WTI (US) crude oil (source: barchart)

US crude inventory however is still near the top of its five-year range and there is no immediate risk of any crude shortages in the US. Yet prices are rising. Energy "independence" does not mean price independence.

Source: EIA

US politicians and to some extent the public continue to believe that higher domestic production will somehow shield Americans from this type of Middle-East-driven price volatility. While increased energy production is helping reduce the trade deficit, unrest elsewhere in the world can still become a problem at the pump in the US. And as the situation in Iraq destabilizes further, the impact on the US consumer will intensify. Iraq is "closer to home" than many would like to believe and the equity markets are beginning to reflect it.

Source: Ycharts

________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

TLTRO impact questioned as the carry trade provides easy money

The Eurozone banks' longer-term borrowings from the central banking system continue to decline, a trend that many economists view as a form of  "passive" tightening in the area's monetary conditions.

LTRO balance outstanding (source: ECB)

As discussed earlier (see post), the ECB will attempt to replace some €400bn of the lost balances with a new program dubbed TLTRO ("targeted" LTRO). Here is the official description:

The ECB: - Counterparties will be entitled to an initial TLTRO borrowing allowance (initial allowance) equal to 7% of the total amount of their loans to the euro area non-financial private sector, excluding loans to households for house purchase, outstanding on 30 April 2014. In two successive TLTROs to be conducted in September and December 2014, counterparties will be able to borrow an amount that cumulatively does not exceed this initial allowance.

During the period from March 2015 to June 2016, all counterparties will be able to borrow additional amounts in a series of TLTROs conducted quarterly. These additional amounts can cumulatively reach up to three times each counterparty’s net lending to the euro area non-financial private sector, excluding loans to households for house purchase, provided between 30 April 2014 and the respective allotment reference date in excess of a specified benchmark. The benchmark will be determined by taking into account each counterparty’s net lending to the euro area non-financial private sector, excluding loans to households for house purchase, recorded in the 12-month period up to 30 April 2014. All TLTROs will mature in September 2018.

The interest rate on the TLTROs will be fixed over the life of each operation at the rate on the Eurosystem’s main refinancing operations (MROs) prevailing at the time of take-up, plus a fixed spread of 10 basis points. Interest will be paid in arrears when the borrowing is repaid.

Starting 24 months after each TLTRO, counterparties will have the option to repay any part of the amounts they were allotted in that TLTRO at a six-monthly frequency.

Counterparties that have borrowed under the TLTROs and whose net lending to the euro area non-financial private sector, excluding loans to households for house purchase, in the period from 1 May 2014 to 30 April 2016 is below the benchmark will be required to pay back borrowings in September 2016.

The goal here is not just to pump up the Eurosystem's balance sheet, but, more importantly, to stem the relentless declines in corporate and household credit growth. The rationale for excluding mortgages apparently stems from fears of igniting another property bubble.

The portion in blue is particularly important. The ECB is "waiving a carrot" in front of the banking system: "do more lending over the next year and we will reward you with cheap funding."

Some argue that the TLTRO offering is useless because there is no demand for credit in the euro area. That's simply not true. The private sector credit supply/demand imbalance has widened significantly over the past year. Given the tepid growth in the Eurozone, the availability of credit is vital to maintaining the recovery. The ECB has finally given up on the notion of "creditless expansion" (see post).

Source: Credit Suisse

The biggest hurtle for the TLTRO program is the banks' unwillingness to grow private credit. The area's banks' ability to borrow based on their "loans to the euro area non-financial private sector" does not mean that they plow the new funds into the private sector. In fact analysts expect banks to borrow at 0.25% fixed for 4 years from the central bank and use a good portion of the proceeds to buy government paper that yields significantly more. Even at 0.37%, Spanish 1-year notes would be profitable for banks as a "carry trade".

Spanish 1-y government bond yield (source: Investing.com)

Part of the reason for this concern is the constant pressure to deleverage and tougher capital requirements under the new Basel rules. Short-term sovereign paper meets both, the minimal additional capital requirements as well as the liquidity criteria that banks are looking for. Why bother with personnel-heavy loan underwriting, high capital charges and illiquidity when there is easy money to be made. Government paper is in effect crowding out private credit.

Reuters: - Many analysts believe that, while bonds yields have narrowed substantially since the last LTRO, there is still an appealing carry compared with the 0.25% the ECB is charging for the funds. Sovereign debt carry trades will be doubly appealing because banks do not have to hold additional capital against such positions - but do against corporate bonds, loans to businesses and other assets.

"Carry trade yields have come down, but there is still money to be made," said Jon Peace, a bank analyst at Nomura. "With the zero risk-weighting on sovereign bonds, the carry trade will continue to appeal."

The carry trade will make the banking system the largest beneficiary of this program - as was the case in the previous 3-year LTRO offering. European bank shares are up some 60% over the past couple of years. Yet over the same period, private sector loans outstanding have been steadily declining. Some point to this program as being another example of central banks helping bank shareholders and irresponsible governments without significant benefits to the overall economy.

The argument from the ECB would be that only banks with large loan portfolios will be "rewarded" with this cheap financing, providing some level of incentives (particularly compared to the previous LTRO program). Furthermore, the improved bank profitability resulting from TLTRO is expected to help with the deleveraging process, which should result in a stronger banking system.

However, with all the easy money to be made in government bonds, the impact of the program on private sector credit expansion remains unknown.
________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

Will China avoid a severe housing market correction?

Staying with the topic of residential property markets, let us now take a look at China. Investors continue to be concerned about the nation's builders who have been under pressure lately. As housing price appreciation slows, some media outlets are calling the situation an outright "panic" (see video). Others are pointing to tight credit conditions hitting property developers:

Want China Times: - There is ample liquidity in the inter-banking market since overnight rates and seven-day repurchase agreement rates are both at low points, but borrowing rates continue to climb, signaling higher costs for businesses, the newspaper stated.
...
The banks' more cautious attitude has resulted in liquidity not being channeled into the real economy, the newspaper said.
...
The property sector is expected to bear the brunt under the government's financial reform plans, according to UBS chief China economist Wang Tao, since the current market downturn, unlike those in the past, is caused by oversupply, the government's anti-corruption campaign, and the growing number of investment options.

Some are also concerns about the "wall" of maturing debt in China's property sector.

Bloomberg: - The amount of dollar-denominated bonds that must be repaid in 2015 will jump to $2.83 billion, the most in data compiled by Bloomberg going back to 1993. Most Chinese builders listed on the mainland or in Hong Kong are behind fiscal-year sales targets and achieved less than 33 percent of their target in the first four months, analysis based on Bloomberg data show.

There is little doubt that we are going to see some failures among developers. The question is what will this do to the housing market in China. Is a severe correction on the horizon? According to Deutsche Bank, this is simply a part of another housing cycle - a third one in 6 years.

Source: Deutsche Bank

DB feels that buyers are simply waiting for discounts and will begin to move back into the market once prices are cut.  DB's economists make the following points:

1. Chinese property buyers/investors have seen this downturn a couple of times before in the last few years. This is not a panic. In the past, discounts of 20% on new properties brought buyers back and cleared excess inventory in a few months. We could definitely see a correction as we did in the past two cycles, but nothing too severe.

2. Current inventory levels and price increases are fairly close to their historical averages.

3. Some correction will likely occur in the "tier 2" cities, where inventory levels are elevated. That's also where we may see some developers fail. Unsold inventory in Beijing, Shenzhen, Guangzhou, and Shanghai on the other hand is at moderate levels.

4. Wages in China have been growing faster than housing prices, making properties more "affordable" (though a great deal of the new housing is not accessible for the bulk of urban residents).

5. Nearly half of China's urban population lives in "pre-housing-reform" dwellings. Given the horrible quality/conditions of many of these structures, they will need to be replaced soon. Such buildings get demolished, taking housing stock out of the market.

6. There are estimates that some 150 million more people will be migrating into the cities in years to come, increasing the demand.

As China's population ages, construction is expected to slow in the long run. But for now DB does not see anything other than a cyclical adjustment.

DB: - We think this replacement or upgrading demand coupled with the migration of at least another 150mn people to the cities could support urban residential construction at about last year’s level for many more years.

... our perspective on the property market sees the current difficulties as primarily cyclical – tightening credit, slowing growth and over-exuberance on the part of some developers – rather than structural. 

... In the near term, the cyclical downturn that began late last year is likely to continue at least a few more months. But we are confident that once developers start cutting prices meaningfully – 20% seems a reasonable guess – demand will revive.

Consolidation among property developers is inevitable. A severe housing correction however seems unlikely.
________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

The UK housing sector: fighting the last war

The media and the blogosphere continues to buzz about the risks building in the UK residential housing sector. Just look at this housing price index - we are way above the pre-recession peak. Compare it to home prices in Spain to see this massive divergence (see chart). It's a bubble and it's about to burst...

UK housing price index (source: Office for National Statistics)

Hogwash. As discussed before (see post), the UK is struggling with a housing shortage. Unlike the US and Spain who overbuilt prior to the financial crisis, the UK started the recession with an insufficient housing inventory. And the new supply of homes entering the market remains inadequate. Here is a chart of UK housing starts...

Source: Department for Communities and Local Government

... and here is the UK population over the same period.

Furthermore, there is little evidence of any material speculative investing activity in resi property markets that we saw in the US prior to the crisis. And most importantly there is no evidence of aggressive mortgage lending. In fact the amount of new mortgages approved in the UK is declining this year after last year's increase.

Source: Investing.com

So for all of your folks who are looking for financial bubbles across the globe, this is not one of them. And yes, you hear regulators, IMF officials, and politicians talk about this as being the next scary problem for the UK. In reality however these people are just "fighting the last war".


________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

Labor force participation and the skills gap in America

Debate among economists around the drivers of declining labor force participation in the US has intensified. How much of the decline since the Great Recession is from the demographic effects of aging population and how much is due to disillusioned workers giving up on job searches and "dropping out" of the workforce? The answer is not obvious, since the participation rate has peaked around the year 2000 and had started declining years before the Great Recession.

First, a bit of background. The reason for the rise in labor force participation between the early 60's and the end of the 20th century is mostly due women entering the workforce as well as Americans starting to work longer before retiring. This brought a larger portion of the population into the workforce, increasing the participation rate. But as the baby-boomers began to retire, the participation rate started to decline.

The answer to this question has significant implications for the Fed's monetary policy trajectory because it is a major determinant of the amount of slack in US labor markets. Decisions on the timing of rate hikes will depend to a great extent on whether the labor market has become sufficiently tight to generate wage pressures. And if companies can draw on a large pool of workers who had left the labor force, it will be a while before wage growth begins to accelerate.

The best way to answer this question of demographic effects on the participation rate is to find a "control" country. It would need to be a nation that has a very similar demographic distribution to the US but had not been as severely impacted by the Great Recession. Scotiabank's Derek Holt argues that Canada is indeed such a country. Canada's so-called population pyramid is very similar to the US.

Source: Scotiabank

At the same time Canada's experience with the Great Recession was not nearly as severe. Reasons include Canada's commodity boom, far less aggressive mortgage lending, a better capitalized banking system, a milder housing boom, less fiscal tightening, etc. The labor force participation rates of the two nations have diverged dramatically after the Great Recession.

Source: Scotiabank

This shows that the decline in the US participation rate has indeed been driven more by cyclical factors rather than by the demographics. In fact the economic difficulties that Canada experienced in the 1990s created a sharp dip in participation (chart above) - which again argues for the labor force participation being a cyclical effect.

Problem solved? Not quite. It turns out that the severity of the impact on participation due to cyclical factors varies materially across the population groups. Here is an illustration. The chart below shows labor force participation for workers with a bachelor's degree or higher (that are 25 and older.) The downward trend over the past 20 years is relatively stable and exhibits only a minor impact of the Great Recession. This is mostly demographics - baby-boomers with a college degree retiring as they get older.

In contrast, let's take a look at the population group without a high school diploma. The Great Recession had a significant impact on the participation trend among these workers. This effect is clearly far more cyclical in nature.

We could think of the US labor markets as consisting of two distinct pools of workers: skilled and unskilled. And while the unskilled workers are leaving the labor force, the skilled labor market is starting to tighten. That's part of the reason for the persistent mismatch between job openings and the unemployment/marginal employment rate - the so-called Beveridge Curve. Many openings represent roles that are specialized - particularly in sectors such as healthcare - and can not be easily filled even with vast numbers of Americans in need of work.

And US firms increasingly need workers that are highly specialized - in part because "commoditized" labor skills can be obtained cheaper offshore. This means that we could have wage increases across a number of sectors, particularly in urban areas - in spite of the declining participation rate. We saw signs of that in the rising unit labor costs last quarter, which came as a surprise to some economists (see chart). The effect also showed up in the Fed's Beige Book.

WSJ: - Rising demand for skilled workers could push up salaries across more sectors of the U.S. economy, according to the Federal Reserve's latest survey of regional economic conditions. ... Companies in several regions reported difficulty filling jobs for highly skilled and upper-management positions.

Derek Holt is right. The overall decline in US labor participation rate has certainly been more heavily impacted by the economic downturn in recent years rather than the demographics. But the effect of the downturn has been highly uneven, and while the overall labor market slack is significant, it varies materially across the skills spectrum. Millions of skilled workers lost their jobs in the recession, but a much smaller percentage of them completely dropped out of the work force for economic reasons. That unfortunately was not the case with the "unskilled" population. This "skills divide" of the US labor force has widened the wage gap, leaving large groups of Americans behind. And if the skilled labor force continues to shrink due to aging, this gap will only continue to widen.
________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor:

US consumer and domestic stimulus reducing risks to China's economy

American consumers are helping to pull China out of its economic malaise. The recent credit card driven spending surge in the US (discussed earlier) sent China's trade surplus to new highs. The trade balance clocked at almost $36 billion (vs. $23 billion expected).

Risks surrounding China's credit markets, stemming from property developers and "wealth" products, will persist.  However Beijing's stimulus efforts, combined with increased US consumer spending, should keep China's economy avoid a more severe slowdown.

Scotiabank: - China’s economy is on the mend compared to concerns that spanned the winter months.
...
As the government increases spending on targets including railways and broader infrastructure and the People’s Bank of China lowers reserve ratio requirements and injects fresh liquidity into markets, the policy bias in China is to take out insurance against further downside risks in an effort to preserve its 7.5% GDP growth target. Default risks across China’s shadow banking sector remain material over 2014H2 but improved fundamentals may be a significant offset from a market standpoint.

________________________________________________________________________________

SoberLook.com

Sign up for our daily newsletter called the Daily Shot. It's a quick graphical summary of topics covered here and on Twitter (see overview). Emails are distributed via Freelists.org and are NEVER sold or otherwise shared with anyone.


From our sponsor: