For the first time in 20 years, the consensus is now predicting that long rates will go down, see chart below.
Apollo Academy members are split on the outlook for the US economy in the next three quarters regarding the potential for a soft or a hard landing. But a combined majority believes that inflation will remain above the Fed’s 2.0% target through 2024, while a large majority predicts that interest rates—as measured by the 10-year Treasury yield—will be between 3.0% and 4.0% at the end of next year.
The results reflect the answers to three poll questions presented to Apollo Academy members participating in my live class on the mid-year outlook for the economy and capital markets on June 28, 2023. The accompanying charts below provide details.
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The US economic outlook has deteriorated compared to six months ago. Most people now believe that we’re in for a period of negative growth over the next three quarters. The question is whether the economy is in for a soft landing or a hard one. Either way, we think high inflation will keep the cost of capital elevated until 2024.
- The outlook for the US economy worsened in the past six months; the consensus view now points to negative Gross Domestic Product (GDP) growth over the next nine months. Why? Because just as the Federal Reserve’s aggressive rate hikes seemed to be cooling economic activity as intended, a side effect erupted: The collapse of Silicon Valley Bank in March put pressure on regional banks to tighten lending standards, further reducing the availability of credit, especially for small- and mid-size businesses.
- The main question today is whether we will experience a soft landing or a hard landing.
- The argument for a soft landing is that the commercial real estate sector (CRE)—which depends in no small part on regional-bank lending—is much smaller than residential housing, and hence the negative effect of CRE market dislocation would be smaller than during the Global Financial Crisis (GFC) in 2008. Also, the US banking sector’s share of total lending to corporates and consumers is now smaller than it used to be.
- The argument in support of a hard landing is that the lagged macro effects of the ongoing banking turmoil are larger than the consensus thinks. Inflation is also stubbornly high because of continued labor shortages and a recovering housing market, and that means higher rates for longer.
- We agree that a recession is coming, with the odds currently tilted towards it being deeper or longer than the consensus expects (we see a 60% chance of a hard landing).
- With inflation still at an annualized 5% (because of tight labor markets and a recovering housing market), we expect the Fed will need to destroy more demand in the economy to get price increases down to its 2% target. If so, the cost of capital will likely stay higher for longer than the market is currently pricing. We now expect the Fed will only start cutting rates in 2024.
- In this environment, portfolio positioning, in our view, argues for exposure to asset classes that have historically shown lower levels of volatility relative to public equities and lower sensitivity to inflation, such as private equity, private credit, and real assets. Investors who can act as providers of capital—especially debt and equity financing—can benefit from opportunities generated by an environment where regional banks remain under pressure and primary high-yield issuance continues to face headwinds.
The information herein is provided for educational purposes only and should not be construed as financial or investment advice, nor should any information in this document be relied on when making an investment decision. Opinions and views expressed reflect the current opinions and views of the authors and Apollo Analysts as of the date hereof and are subject to change. Please see the end of this document for important disclosure information.
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Certain information contained herein 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 information. 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.
The Standard & Poor’s 500 (“S&P 500”) Index is a market-capitalization-weighted index of the 500 largest U.S. publicly traded companies by market value.
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Weekly data for corporate bankruptcy filings has started to meaningfully deteriorate in recent weeks, see chart below. The faster speed of slowing in the weekly data is not consistent with the gradual rise in the monthly default rates seen in HY, IG, and loans.
The quality of auto loans and mortgages originated today is significantly higher than auto loans and mortgages originated before the GFC in 2006, see charts below.
The Fed’s monthly survey of households shows that consumers are not worried about losing their jobs, see chart below.
We’re still in an overheated economy, but we’re less overheated than we were a few months ago with slowdowns happening in the labor market and in manufacturing. In the week ahead, we’ll be tracking the release of PCE inflation data for May. The consensus is expecting core inflation to come in at 4.7%—the same level as the month prior. In broad terms, housing makes up over 40% of consumer spending, so it’s important when tracking inflation to monitor whether home prices are going up or down. If home prices rise, and the housing market continues to rebound, that could put upward pressure on inflation—potentially putting the Federal Reserve in a position to raise interest rates for longer to get inflation under control.
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.
Manhattan rents just reached a new record high at $4,360, and accelerating rent inflation is a problem for the Fed because housing has a weight of 40% in the CPI basket, see chart below.
Twenty-five percent of all US government debt outstanding has been added since the beginning of 2020. And with higher debt levels and higher interest rates, debt servicing costs have increased from $1 billion per day in 2020 to almost $2 billion per day in 2023, see charts below.