There are a total of 45 million people with student loans, and the average monthly student loan payment is around $200. So resuming student loan payments in October will subtract roughly $9 billion from consumer spending every month, or roughly $100 billion a year, and this will mainly have an impact on younger households, see chart below.
Last week, as expected, the Federal Reserve raised interest rates by 25 basis points. Fed Chairman Jerome Powell didn’t give any specific forward guidance, except to say they don’t expect to cut rates in 2023. Another important event last week came from Japan. The Bank of Japan signaled that it will exit yield curve control after many years to help address high inflation levels. The implication is that we will ultimately begin to see the level of government bond rates go up in that country. This could prompt Japanese investors—who currently own more than a trillion dollars of US Treasuries—to shift their focus to their own country if they begin to see higher yields in their own backyards.
This presentation may not be distributed, transmitted or otherwise communicated to others in whole or in part without the express consent of Apollo Global Management, Inc. (together with its subsidiaries, “Apollo”).
Apollo makes no representation or warranty, expressed or implied, with respect to the accuracy, reasonableness, or completeness of any of the statements made during this presentation, including, but not limited to, statements obtained from third parties. Opinions, estimates and projections constitute the current judgment of the speaker as of the date indicated. They do not necessarily reflect the views and opinions of Apollo and are subject to change at any time without notice. Apollo does not have any responsibility to update this presentation to account for such changes. There can be no assurance that any trends discussed during this presentation will continue.
Statements made throughout this presentation are not intended to provide, and should not be relied upon for, accounting, legal or tax advice and do not constitute an investment recommendation or investment advice. Investors should make an independent investigation of the information discussed during this presentation, including consulting their tax, legal, accounting or other advisors about such information. Apollo does not act for you and is not responsible for providing you with the protections afforded to its clients. This presentation does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product or service, including interest in any investment product or fund or account managed or advised by Apollo.
Certain statements made throughout this presentation may be “forward-looking” in nature. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such statements. Forward-looking statements may be identified by the use of terminology including, but not limited to, “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology.
Total employment in the US economy is currently around 156 million, and we estimate that total employment of companies in the high yield index is 11 million, and total employment of companies in the leveraged loans index is 8 million, see chart below. With interest rates staying high for at least another year, the downside risks to employment continue to be meaningful.
With yields going up in Japan, the risk is that Japanese investors will now begin to sell US fixed income and start buying higher-yielding Japanese fixed income.
This is a big deal for global fixed income markets because Japanese investors are the biggest foreign holder of US Treasuries, and they also own significant amounts of US credit.
Our updated BoJ YCC exit chart book is available here, a few key stats:
All other central banks in the world, including the Fed, ECB, BoE BoC, and RBA, have aggressively raised short-term interest rates to get inflation under control. The BoJ has not raised short-term interest rates, and abandoning YCC is the BoJ’s response to high inflation. The BoJ YCC policy started in 2016.
The Fed has used the Taylor Rule framework for decades to understand what the Fed funds rate should be, and inserting the current level of inflation and unemployment into the Taylor Rule shows that the Fed funds rate today should be 9%, see chart below and our Daily Spark here.
The ongoing gap between the Fed funds rate predicted by the Taylor Rule and the actual Fed funds rate raises the question whether the Fed remains behind the curve. In other words, if the economy reaccelerates over the coming quarters with higher consumer spending and a boom in housing, it will increase the risk that the Taylor Rule was right and that the Fed will have to continue hiking.
In sum, for markets to continue to trade higher, the soft landing must be a soft landing, not a reacceleration, because if housing and consumer spending accelerate from here, the Fed will have to raise rates a lot more.
Fed hikes continue to slow down hiring for both small firms and for the broader economy, see charts below. The labor market is softening with hours worked, the number of job openings, and the quits rate all declining.
This is how monetary policy works; higher costs of capital slow down capex spending and hiring, and with rates staying at these levels for a couple of years, this process is going to continue.
That is why the consensus expects negative nonfarm payrolls for six months from October 2023 to March 2024.
Since the Fed started raising interest rates, we have seen an increase in downgrades of loans and a rise in the share of loans trading at distressed levels, i.e. below 80, see charts below. This is the monetary policy transmission mechanism at work; higher costs of capital are having a negative impact on the economy.
Markets are not taking the ongoing rise in default rates for HY and loans seriously, see charts below, and many investors argue that “this is just a normalization,” or “these are companies nobody has heard about.”
The reality is that more and more companies are defaulting because the cost of capital is higher, and Fed Chair Powell says that interest rates will stay at these levels “for a couple of years,” so tight monetary policy will continue to have a greater negative effect on the economy and capital markets.
In fact, higher costs of capital is precisely how monetary policy works: By making it more difficult to get financing.
In other words, Fed hikes are biting harder and harder, and all investors should have a view on how high they think default rates will go during this cycle, see again charts below.
What could be the aha moment in markets? Once there is a default by some household name in credit, we will likely see an overnight change in market sentiment from bullish to bearish.
China accounts for more than 50% of global coal consumption, see chart below.
The economy continues to gradually slow down as the impacts of the Federal Reserve’s interest rate hikes ripple through—with increasing effects on consumers, capex spending, and corporate financings. Several leading indicators (from small business hiring plans, Google searches, to WARN notices) tell us that jobless claims are inching upwards. This week, we’ll be closely tracking the FOMC meeting during which the Fed is expected to hike interest rates by 25 basis points. Given that inflation is trending downwards and growth is slowing, it will be particularly interesting to hear what Chairman Jerome Powell says about the September forward guidance.
This presentation may not be distributed, transmitted or otherwise communicated to others in whole or in part without the express consent of Apollo Global Management, Inc. (together with its subsidiaries, “Apollo”).
Apollo makes no representation or warranty, expressed or implied, with respect to the accuracy, reasonableness, or completeness of any of the statements made during this presentation, including, but not limited to, statements obtained from third parties. Opinions, estimates and projections constitute the current judgment of the speaker as of the date indicated. They do not necessarily reflect the views and opinions of Apollo and are subject to change at any time without notice. Apollo does not have any responsibility to update this presentation to account for such changes. There can be no assurance that any trends discussed during this presentation will continue.
Statements made throughout this presentation are not intended to provide, and should not be relied upon for, accounting, legal or tax advice and do not constitute an investment recommendation or investment advice. Investors should make an independent investigation of the information discussed during this presentation, including consulting their tax, legal, accounting or other advisors about such information. Apollo does not act for you and is not responsible for providing you with the protections afforded to its clients. This presentation does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product or service, including interest in any investment product or fund or account managed or advised by Apollo.
Certain statements made throughout this presentation may be “forward-looking” in nature. Due to various risks and uncertainties, actual events or results may differ materially from those reflected or contemplated in such forward-looking information. As such, undue reliance should not be placed on such statements. Forward-looking statements may be identified by the use of terminology including, but not limited to, “may”, “will”, “should”, “expect”, “anticipate”, “target”, “project”, “estimate”, “intend”, “continue” or “believe” or the negatives thereof or other variations thereon or comparable terminology.
