- Europe’s PMI show a divergence between Germany and France
- China’s manufacturing sector is still contracting
- The US student debt problem is growing
First, let me do a bit of an update on economic data.
In Europe, the latest Flash composite PMIs for May were released today for the Eurozone. The overall number came in bang on expectations at 53.9. Underneath, we see the continuing divergence between France and Germany which has me putting France into an augmented periphery. This number was actually slightly lower than April’s 54.0 number.
The main highlights from the numbers are the following:
- The Flash Eurozone Services PMI Index was 53.5 versus 53.1 in April, a 35-month high
- The Flash Eurozone Manufacturing PMI Index was 52.5 versus 53.4 in April, a 6-month low
- France’s Manufacturing PMI dropped below 50 to 49.3 from 51.2 in April
- Germany’s Manufacturing PMI also fell to 52.9 from 54.1 but the services PMI was at a 35-month high of 56.4 versus 54.7 in April
Overall, I would call the data mixed, with the highlight being the dichotomy between Germany and France.
HSBC’s China flash manufacturing PMI for May was also released. And while the data was above expectations at 49.7, a 5-month high, the number is still below 50 and is consistent with the still slowing growth rate in China. The prior reading was 48.1 for April and new orders and exports rebounded from that report. So markets rallied on the back of this news.
In the US, we got jobless claims again today. And while they rose, they have been holding at really low numbers, which is good. The average is just over 322,000 on a seasonally-adjusted basis. It says that my fear of negative year-over-year comparisons may not be felt until later this year. And that is a positive sign for income growth and retail sales. As for GDP, Merrill had a note out two weeks ago saying that Q1 GDP would get revised down from 0.1% to a negative -0.4% reading. Now, let’s remember that the average forecast in December for Q1 was 2.5%. And I don’t believe the miss was entirely weather-related. It says that expectations are well ahead of actual baseline growth numbers in the US. And this is due, in my view, to still weak wage growth. Merrill still sees Q2 GDP bouncing back to above 3% though. Let’s see.
The latest data on manufacturing I have seen are weak. Last week we saw that US industrial output fell 0.6%, the fastest rate of decline in nearly two years in April. The Wall Street Journal said “weather-related distortions likely muddied the reading” though. I am sceptical. How long can we blame weather for lower readings? I don’t see the 3% number that Merrill was talking about happening for Q2. I believe the baseline for the US is 2% and the add or subtract for that is noise around that base – credit accelerator, inventories, capital spending. Also, in terms of capex, note that April capacity utilization fell 0.7% to a 78.6% rate. That doesn’t speak to a wall of business spending coming online.
The big untold story in the US is student loans. The narrative here is that, given the poor economy and the increasing cost of higher education, today’s graduates are starting out their working life more indebted and with fewer earnings prospects. That has a big negative impact, not just on economic growth but on household formation and on housing. I recommend reading House of Debt’s Student Debt and a Broken Financial System for the figures for recent graduates in terms of jobs and unemployment. The debt issue here causes household formation to slow, artificially boosting household income figures but also lowering housing starts and houing transactions as fewer people can afford starter homes. Much of the increase in house prices is a basing effect driven by both a reduction in foreclosures and by buy-to-let cash buyers from financial institutions rather than by real owner-occupied demand.
If you look at consumer credit, what you see is a picture dominated by student debt and auto loans. Revolving credit for credit cards is actually going down. And separately, mortgage debt is not a driving factor in this cycle. On May 7th, the Fed released figures. And in March, US consumer credit had its largest increase since February 2013. But the figures were boosted by growing demand for student loans and household borrowing to buy cars. Revolving credit rebounded by $1.13 billion after falling $2.73 billion in February and the month before.
I have seen a number of stories on the student loan issue that I think are relevant. First on the housing story, the BBC ran a story in April titled “$1tn student debt crisis crushes home-buying dream”. And the story has some anecdotal examples of a potential first-time home buyer saying, “we were told immediately that no mortgage company would touch me with the amount of student loan debt that I have.” In this one example student loans account for 45% of take-home pay. First time buyers are now down to 28% of buyers, with cash buyers who are buying to let taking over that segment of the market. The BBC article also notes that student loans rose from $253 billion outstanding at the end of 2003 to $1.08 trillion at the end of 2013. That’s an increase of fourfold in a decade. Larry Summers and Joe Stiglitz are onto this and were quoted making comments about the housing- student debt connection in a Wall Street Journal article published yesterday.
Most forms of student debt can now no longer be expunged in bankruptcy. Federal plans for debt forgiveness have skyrocketed as a result of the situation. According to the US Department of Education enrolment in these plans has increased by 40% in the last six months alone, with 1.3 million debtors with $72 billion in loans looking for relief. The fastest-growing plan requires borrowers to pay 10% of discretionary income per year if it is 150% of the poverty level until the debt is worked off. If someone works in the public sector or for nonprofits, then the unpaid balance is forgiven after 10 years. Expect plans like this to gain in popularity because of the big student debt issue.
Elizabeth Warren is trying to get a bill through Congress that could impact 37% of student loans securitized into asset-backed security trusts according to Barclays. The bill, called the “Bank on Students Emergency Refinancing Act” wants to lower interest rates on these loans to 3.86%, but would require specific thresholds on metrics like debt-to-income for borrowers to qualify. Hedgies like “Big Short” investor Greg Lippmann are getting into student loan ABS for just this reason. I would say this is negative for the ABS and the next recession will also be severely negative for student loan ABS because of the debt stress we are likely to see in this cohort of graduates.
Note that the Class of 2014 will be the most indebted in history.
The average Class of 2014 graduate with student-loan debt has to pay back some $33,000, according to an analysis of government data by Mark Kantrowitz, publisher at Edvisors, a group of web sites about planning and paying for college. Even after adjusting for inflation that’s nearly double the amount borrowers had to pay back 20 years ago.
Meanwhile, a greater share of students is taking on debt to finance higher education. A little over 70% of this year’s bachelor’s degree recipients are leaving school with student loans, up from less than half of graduates in the Class of 1994.
The good news for the Class of 2014 is that they likely won’t hold the title of “Most Indebted Ever” very long. Just as they took it over from the Class of 2013, the Class of 2015 will probably take it from them.
This trend is clearly unsustainable and will have very severe negative consequences in the next downturn for consumption, housing and overall GDP.
Those that went to the best schools are best positioned to repay the debt according to a study from the National Bureau of Economic Research.
Graduates from four-year colleges tend to repay more of their debts (see the point above about making more money). Two-year colleges and for-profit colleges turn out the most defaulters (and more drop-outs), even though their debts are lower. (Critics of for-profit schools blame the schools for this; the schools themselves say they are simply serving a more financially precarious population, in essence shifting the blame to their students.)
The student loan problem and the auto loan bubble are the two biggest credit stories to watch because of the negative impact they will have on consumption and on financial markets when this cycle turns down.