European energy prices are coming down from recent peaks. Our weekly energy PDF is available here.
European Energy Price Monitor
Rising Risks of a Recession in Europe in 2023
The consensus is close to forecasting a recession in Europe in 2023, see chart below.
Slowing Growth in Europe
Last week, the European Central Bank (ECB) raised interest rates by a significant 75 basis points, which takes European short-term interest rates out of negative territory for the first time in years. This comes against a backdrop of elevated inflation and slowing growth in the region. In fact, the consensus has dramatically downgraded their 2023 forecasts for Europe to the point where they are close to expecting a recession. Because of impacts from the situation in Ukraine, growth is slowing much faster in Europe than in the US. This could result in fewer rate hikes from the ECB when compared to US Federal Reserve. Looking ahead to this week, on Tuesday we will get August CPI inflation data. In July, inflation came in at 8.5% and the consensus is expecting the August numbers to slightly tick down to 8.1%. Although inflation is trending in the right direction, it still remains dramatically higher than the Fed’s 2% target.
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Interest Rates on Checking Accounts Have Not Increased
The Fed has been increasing the Fed funds rate, but banks have not increased interest rates on checking accounts and savings accounts, see chart below.
Households that want to benefit from rising short rates need to actively take money out of their bank accounts and into CDs, money market funds, or floating rate credit funds.
The implication for markets is that the transmission mechanism for monetary policy is weaker because the idea with a higher Fed funds rate is to attract money into savings and away from consumer spending.
With very high household savings and very high levels of deposits in banks, this lack of an increase in interest rates on checking accounts and savings accounts is likely a contributing reason why consumer spending is still so strong.
Our weekly Slowdown Watch PDF is linked here.
HY Spreads and the Fed
The Fed asks banks about credit conditions for firms and consumers, and the latest Senior Loan Officer Survey shows that banks are starting to tighten lending standards on commercial and industrial loans.
This is what the Fed wants to see because the goal for the FOMC is to slow down hiring and capex spending and, ultimately, inflation.
The challenge for the Fed is that the ongoing tightening in lending standards has not yet resulted in a corresponding widening in high yield spreads, see chart below.
The Fed’s goal is to tighten financial conditions and credit conditions, and if credit spreads don’t widen out further, then the Fed will have to do more with rates. Financial conditions are not tightening as much as the Fed would like to see, and as a result, the Fed will have to do more of the work by raising short-term interest rates further. Because the Fed is fully committed to getting inflation down from the current level at 8.5% to the Fed’s 2% inflation target.
For markets the conclusion is straightforward: The Fed wants to tighten financial conditions and investors should be positioned accordingly.
The Rise of the Zombies
There are about 4500 publicly listed companies in the US, and about 16% are zombies, see chart below. A zombie company is a firm that has existed for ten years and had an interest coverage ratio of less than one for more than five consecutive years. After the financial crisis in 2008, interest rates were kept at zero for a decade, and low borrowing costs made it possible for many firms to continue to operate. With high inflation and rising interest rates, the number of zombie firms is likely to come down as the costs of capital continue to rise. For more discussion see this Fed publication and this BIS publication.
Outlook for Credit Markets
The 2022 sell-off in credit has been highly synchronized across credit ratings compared to the sell-offs in 2008 and 2020, see the first chart below. In other words, markets are currently not pricing in a recession with significant differentiation across credits. Our latest credit market outlook presentation is linked here.
Downside Risks to Earnings
CEO confidence is a leading indicator of corporate profits, and the chart below suggests that markets should be more worried about the outlook for earnings.
Slowdown Watch
Weekly hotel indicators, including occupancy rates, are softening for seasonal reasons, but the Average daily rate and RevPar are still well above pre-pandemic levels, see charts below. Our weekly Slowdown Watch presentation is linked here.
