A lot of the recent incoming data has been soft. And while this may just be a blip, the breadth of weak numbers seems to be increasing. We could be in the midst of a global growth slowdown just as G-10 monetary policy has turned more hawkish. Some brief comments below
Deeply negative European data suprise numbers are mean reverting
Now last week, I mentioned the possibility of an enduring slowdown with specific reference to Europe.
the Citi Economic Surprise Index (CESI) for the Eurozone, fell to -79.2 at the end of last week. That’s abysmal. It’s the lowest reading since at least April 2013.
The caveat was that such deeply negative figures are mean-reverting. And from a market perspective, the CESI below -70 meant positive equity returns in 14 of 15 occasions over the past decade and a half.
So I think policymakers in Europe are looking through these data. The ECB would, therefore, be poised to end quantitative easing later this year. And rate hikes would then be on the table for 2019. The inflation data don’t support it at a rise of 1.3%. But, like the Fed, I sense the ECB is keen to normalize policy with its largest member state, Germany, growing at 2.5%.
Emerging markets are weakening too
Europe’s not the only place where the data have been soft. Last month, research from Capital Economics showed emerging market growth slipping to as low as 4%. The peak seems to have been at the end of the third qurter of 2017, they say. And their proprietary nowcast data show a broad-based slowdown across the emerging market universe.
UBS is seeing the same thing now. Their data show annualized quarterly data up only 3.3% sequentially in Q4 last year. And that’s down from 4.1% in Q3, the peak growth quarter Capital Economics saw. UBS say the sequential declines are masked by positive year-on-year numbers. But once the Q1 and Q2 2017 numbers get stripped out even those numbers will show a decline.
Still, the IMF sees rosy things ahead. As the IMF holds its annual meeting, it is stcking by its growth estimates for 4.9% for EM in 2018. That’s up from 4.8% in 2017 — so the opposite of what Capital Economics’ nowcasts are saying. The IMF is also predicting 5.1% growth for 2019 for EM.
Given what UBS and Capital Economics are saying, we should be cautious about the IMF figures. PMI data show a broad slowing in emerging markets from Turkey, the Czech Republic, and Poland to Russia and India where the numbers are barely above 50. And then in South Korea, the PMIs are below 50, meaning the manufacturing sector is contracting.
And these numbers are in concert with many weak Eurozone PMIs in March. Auto sales in Europe came in at their weakest in five years this morning. That’s inline with the weakening PMIs. And it suggests slowing consumer demand growth.
Credit sector softness in the US
Meanwhile, in the US, Q1 growth is also going to come in weak when figures are released later this month. But, for me, its the subprime auto sector we should care about. Back in November, non-bank lender loans were going sour at financial crisis delinquency levels.
Almost 9.7 percent of subprime car loans made by non-bank lenders — including private-equity-backed firms catering to car dealers — became 90 or more days past due in the third quarter, the highest annualized rate in more than seven years, according to the New York Fed’s quarterly report on household debt and credit. That’s more than double the 4.4 percent rate for subprime loans made by traditional banks, a number that’s been falling pretty steadily since the end of the financial crisis.
Those numbers keep rising.
“60+ day delinquency rate of subprime auto loans has now risen to 5.8%, up from 5.2% a year ago, and up from 3.8% in February 2014. It’s the highest rate since October 1996, higher even than during the Financial Crisis” https://t.co/8Pvk995FLEpic.twitter.com/sdLCt2OQQn
— Trevor Noren (@trevornoren) April 16, 2018
Now, a lot of this is likely specific to non-bank lenders. Moreover, there were only $25 billion of asset-backed securities pooling subprime auto loans in 2017. Compared to the $1.2 trillion of asset-backed securities backed by home loans in 2005 and 2006, this is chicken feed. It’s simply not a systemic issue.
Is subprime auto a canary in the coalmine?
Nevertheless, the cracking of the subprime auto space is significant as a credit event. It could be a canary in the coalmine that suggests there is more to come. This is especially true in an environment where spreads are very low and rates are rising. Add to this mix a potential slowing in growth and you have negative end of cycle dynamics.
However, San Francisco Fed President John Williams reinforced the message I was trying to make in yesterday’s post. I said that curve flattening isn’t inversion. And the 90s bull market saw a curve just as flat as the one today for the entire period. It’s inversion we should care about.
And Williams said exactly the same thing in comments in Madrid.
The flattening of the yield curve that we’ve seen is so far a normal part of the process, as the Fed is raising interest rates, long rates have gone up somewhat – but it’s totally normal that the yield curve gets flatter.
A truly inverted yield curve “is a powerful signal of recessions,” he added.
My takeaway, then, is that the Fed recognizes the risk of a yield curve inverting. That doesn’t mean they see it as a definitive market signal. It also doesn’t mean that they won’t continue raising rates right up until the curve inverts.
So we should expect the Fed’s tightening to continue. And if growth continues to be weak globally, the curve will flatten even more from here. As I have said, my bogey is 25 basis points by mid-year between the 2 and the 10-year Treasury. And then we’ll just have to wait and see.