Two years ago, the number of banks exceeding the FDIC’s CRE loan concentration guidelines was about 300. Today there are almost 700, see chart below.
In other words, US banks have become much more vulnerable to a decline in commercial real estate prices.
Our latest credit market outlook is available here.
Households still have plenty of excess savings left, see chart below. That is the reason why consumer spending remains so strong, in particular consumer spending on services such as airlines, hotels, restaurants, etc.
May’s employment report revealed some mixed messages but still showed stronger-than-expected job growth, an indication that the economy is still holding strong. The consensus is still expecting a recession, but we’re not there yet. One important reason why is because of household savings levels. Households were able to save roughly $2 trillion during the pandemic and half of that still hasn’t been spent. That could explain why consumer spending is holding strong.
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Consumer spending on goods is significantly higher than before the pandemic, and consumer spending on services is only modestly higher, see chart below.
The implication for markets is that there are still upside risks to consumer spending on services. And hence upside risks to service sector inflation.
Goods inflation is coming down and approaching pre-pandemic levels. Service sector inflation is still not showing signs of moving lower, see chart below.
The debate in markets is whether a significant increase in the unemployment rate is needed to get service sector inflation down, and this new Fed paper says that the labor market is not a key driver of service sector inflation.
In other words, there is a risk of inflation becoming more sticky even if the labor market starts weakening.
Inflation has been more sticky than the FOMC expected when they published their latest forecast in March, see chart below.
This argues for higher costs of capital for longer, which increases the probability of a harder landing.
Put differently, sticky inflation requires more demand destruction, which increases the downside risks to corporate earnings.
Delinquency rates for credit card borrowers are approaching 2008 levels across all age categories, see chart below.
