Americans’ Piggy Banks Are Running Low

Here are some of the biggest stories from last week:

• Chinese banks lowered interest rates by less than expected, prompting several economists to slash their 2023 growth forecasts.
• US consumers are nearing a pivotal moment as the excess savings they built up during the pandemic dwindles.
• Business activity in the eurozone declined by far more than expected in August.
• The bond market selloff resumed last week, with some key US bond yields hitting multi-year highs.
• S&P Global Ratings downgraded and lowered its outlook for several US banks.

Dig deeper into these stories in this week’s review.

Macro

Chinese banks reduced a key lending rate at the start of last week but, contrary to market expectations, kept another one steady. The moves highlight the dilemma facing policymakers as they try to boost borrowing while dealing with a decelerating economy, a liquidity crisis in the property sector, and a declining yuan. The one-year loan prime rate, which is determined by banks and is a reference for lending in China, was lowered by 10 basis points to 3.45%. The equivalent five-year rate, which feeds into mortgage rates, was kept steady at 4.2%. Economists had unanimously projected 15-basis-point cuts to both the one-year and five-year rates.

The less-than-expected cuts bewildered investors and China watchers last week. After all, policymakers are under increasing pressure to lower interest rates and boost domestic demand following a series of disappointing economic data in the past few weeks. Despite lifting pandemic restrictions eight months ago, growth in the world’s second-biggest economy has been held back by a property market slump, falling exports, and soaring youth unemployment.

So what’s happening exactly? Well, economists at Goldman Sachs reckon that protecting banks’ net interest margins was the main motivation behind the smaller-than-expected cuts, with policymakers prioritizing a healthy banking system to help absorb economic shocks and to deleverage the property sector. Other Wall Street economists weren't swayed by justifications and revised their annual growth projections for China downward following the disappointing rate cuts. Citi, for example, lowered its full-year forecast for 2023 to 4.7%, while UBS cut its growth estimate to 4.2% – both below the government’s official target of around 5% expansion. These came a week after JPMorgan and Barclays revised down their growth estimates (also below China’s official goal).

Elsewhere, US consumers are nearing a pivotal moment as the surplus funds they built up during the pandemic peters out. Americans' savings grew substantially in 2020, driven by stimulus checks, government benefits, and reduced spending on activities like restaurant meals and vacations. That excess cash has allowed US consumers to continue spending despite sky-high inflation, shielding the economy from a recession even after the Fed hiked interest rates at the fastest pace in four decades. But according to a recent assessment by the San Francisco Fed, the additional savings accumulated by Americans during the pandemic are likely to be depleted this quarter after using up nearly $2 trillion over the past two years.

As the cash cushion shrinks, households face a dilemma: either reduce their spending or continue it by incurring more debt. But with credit becoming more expensive and harder to get due to the Fed’s actions, Americans will most probably have to curtail their outlays. That's not good news for the US, considering consumer spending constitutes over two-thirds of the economy. To be sure, not everyone is convinced. Some economists hold a more optimistic view, believing that falling inflation and a robust job market will equip consumers with the means to continue spending, even as their savings shrink. Time will tell who ends up being correct, but if American households do end up tightening their purse strings, then that might just be the trigger that propels the US economy into the much-discussed recession.

Finally, over in Europe, new data out last week showed business activity in the bloc declined by far more than expected. The eurozone composite Purchasing Managers' Index (PMI) dropped from 48.6 in July to 47.0 in August – its lowest reading since November 2020. That was well below the 50 mark separating growth from contraction, and came in much worse than economist expectations for a slight dip to 48.5. Services activity shrank for the first time since late 2022, defying expectations for continued expansion in a sector that had until recently seen robust demand. The figures were particularly bad in Germany, where overall activity declined at the fastest pace since the first wave of the pandemic brought Europe’s biggest economy to a halt in May 2020. The poor data prompted traders to fuel bets that the European Central Bank will pause its rate-hiking campaign in September.

Bonds

Last week brought more pain for fixed income investors as several key US bond yields hit multi-year highs on Monday. The 10-year Treasury yield, for example, rose to as much as 4.35% – a level last seen in late 2007 – while the yield on inflation-protected Treasuries with similar maturities pushed over 2% for the first time since 2009. The latter, also known as the real 10-year yield, is seen as the true cost of money, and it’s moving closer to levels that would materially restrict economic activity.

Several factors are driving the latest selloff. First, a persistently resilient US economy is raising the prospect of interest rates remaining elevated for some time, even after the Fed concludes its rate hikes. Second, the US government’s budget deficit (the gap between its outgoings and its revenue) is ballooning, forcing it to sell more bonds. But that only exacerbates the US's already swelling debt pile at a time when interest rates are a lot higher, leading to steeper interest payments and a further widening of the budget deficit. That leads to a vicious cycle of even more bond sales, with even higher interest payments, and so on – ultimately, putting downward pressure on bond prices.

Third, Japanese investors – the biggest non-US holders of Treasuries – are reducing their global bond holdings in favor of domestic ones after the Bank of Japan last month signaled it would allow 10-year yields to go as high as 1%, instead of the previous 0.5%. And fourth, Fitch Ratings’ decision earlier this month to downgrade US government debt one notch highlighted the booming deficits that are at the heart of the bear case for Treasuries, further dampening investors’ appetite for the world’s biggest bond market.

Stocks

Two weeks after Moody’s Investors Service spooked investors by cutting the credit ratings of 10 US banks, S&P Global Ratings downgraded and lowered its outlook for several others, pointing to a comparable set of challenges that’s making life difficult for lenders. S&P last week reduced the ratings by one notch for KeyCorp, Comerica, Valley National Bancorp, UMB Financial Corp, and Associated Banc-Corp, while downgrading its outlook for River City Bank and S&T Bank to negative.

The downgrades come as higher interest rates force banks to shell out more for deposits and push up the cost of funding from other sources. What's more, those higher rates are eroding the value of banks’ assets and complicating refinancing efforts for commercial real estate borrowers, especially as the demand for office space falls. Taken altogether, lenders' balance sheets have deteriorated significantly in recent months, prompting the credit downgrades from Moody’s and S&P.

This week

• Monday: Australia retail sales (July).
• Tuesday: Japan unemployment rate (July), US consumer confidence (August). Earnings: Hewlett Packard.
• Wednesday: Eurozone economic sentiment (August). Earnings: CrowdStrike, Salesforce.
• Thursday: Japan retail sales (July), eurozone inflation (August) and unemployment rate (July). Earnings: Broadcom.
• Friday: US labor market report (August), Canada economic growth (Q2).