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The list of downside risks to the global economy keeps growing, see overview below.
Source: Apollo Chief Economist See important disclaimers at the bottom of the page.
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Electricity prices for households are up 30% since the pandemic started, see chart below.
Source: FRB of St. Louis, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The FOMC started raising rates 16 months ago, and there are two different explanations for why Fed hikes have not yet slowed down the economy in a meaningful way:
1) The Fed has not raised interest rates enough.
2) The lagged effects of Fed hikes take longer than we think.
The Fed does not know if the continued strength in the economic data is because it has not raised rates enough or if the lagged effects of Fed hikes take longer than usual. As a result, the FOMC’s approach is to keep interest rates elevated until the economy starts slowing down. Against this backdrop, a soft landing is not an option because the Fed will keep interest rates high until they get the economic slowdown required for them to turn dovish.
Even if inflation comes down and growth is still strong, the Fed will continue to be hawkish because of worries about strong growth causing a re-acceleration in inflation. The implication for markets is that a recession is a pre-condition for the Fed to stop being hawkish.
Source: Bloomberg, Apollo Chief Economist. Note: 500bps monetary policy shock in 3Q23. See important disclaimers at the bottom of the page.
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There are two lessons from the 1970s for the Fed today, see chart below.
First, if the Fed turns dovish too quickly, then inflation and inflation expectations will not settle at 2%.
Second, if the economy re-accelerates, the Fed will have to raise rates a lot more.
The implication for markets is that the Fed will be keeping the cost of capital higher for longer than the market is currently pricing to ensure that the FOMC doesn’t repeat the mistakes made in the 1970s.
Source: BLS, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Supply chains are back to normal, but we are monitoring the rise in recent weeks in the price of transporting a container from China to the US. See chart below and this updated presentation.
Source: WCI, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The average number of dissents per FOMC meeting has been lower under Powell, see chart below.
Source: FRB, Bloomberg, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Since the Fed started raising rates, banks are much less willing to lend to consumers, and every day there are more and more consumers who have difficulties getting a credit card, auto loan, or mortgage, see the first chart below.
That is how monetary policy works. By raising interest rates, fewer households can borrow, which is why credit growth is slowing rapidly, see the second chart.
With consumers facing higher interest rates and tighter lending standards, the downside risk to nonfarm payrolls over the coming six months is significant, see again the first chart below.
Source: FRB, BLS, Haver Analytics, Apollo Chief Economist 
Source: Federal Reserve Board, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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The Fed is trying to slow down the economy to slow down inflation. Specifically, the Fed is trying to slow down hiring, capex spending, and earnings growth.
The tool the FOMC has available is the cost of capital. By raising the cost of capital, the Fed makes it harder for firms to get new loans and to finance existing loans that are maturing.
This monetary policy transmission mechanism first hits companies with high leverage and little or no cash flow, e.g., tech, growth, and venture capital.
This is exactly what is happening at the moment. Companies with high debt and little cash flow are being downgraded, and there are now significantly more downgrades than upgrades, see chart below.
With the Fed funds rate staying at the current level for a couple of years, high cost of capital will continue to create problems for more and more companies characterized by high leverage and low earnings.
Source: S&P Global Ratings, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Before the pandemic, the number of workers not at work due to illness was around 1 million people every month. When the pandemic began, this number jumped to 1.5 million. But over the past six months, it has declined back to 1 million, see chart below.
Combined with the normalization in the participation rate and the employment-to-population ratio, the bottom line is that Covid is no longer holding back labor supply.
In other words, the source of strong wage growth has over the past six months shifted from the Covid-induced reduction in labor supply to labor demand. The implication for the Fed is that more demand destruction is needed to get wage inflation under control.
Source: BLS, Haver Analytics, Apollo Chief Economist See important disclaimers at the bottom of the page.
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Weakest Links are loan issuers rated B-minus or lower with a negative outlook.
The number of US leveraged loan Weakest Links continues to increase, driven by higher costs of capital and costlier financing terms, see chart below.
This is how monetary policy works. Higher cost of capital makes it harder for more vulnerable companies to get financing.
Source: Pitchbook | LCD, Morningstar LSTA US Leveraged Loan Index, Apollo Chief Economist. Data through June 30, 2023. Note: SD and D – An obligor rated “SD” (Selective Default) or “D” has failed to pay one or more of its financial obligations (rated or unrated) when it came due. A “D” rating is assigned when Standard & Poor’s believes that the default will be a general default and that the obligor will fail to pay all or substantially all of its obligations as they come due. An “SD” rating is assigned when Standard & Poor’s believes that the obligor has selectively defaulted on a specific issue or class of obligations, but it will continue to meet its payment obligations on other issues or classes of obligations in a timely manner. See important disclaimers at the bottom of the page.
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