The Daily Spark

After the housing bubble burst in 2008, construction of new homes declined more than 50%, and residential investment pulled GDP growth down by 1% for three years.

With commercial real estate construction being roughly 75% the size of residential investment, and fewer skyscrapers and shopping malls being built, the bursting CRE bubble could be a drag on GDP growth of around 0.75% over the coming three years. This should be compared with a 2% potential growth rate for the US economy (according to the CBO).

In other words, with the commercial real estate bubble bursting, we are likely to enter three years with low growth, similar to what we saw after the housing bubble burst in 2008. Put differently, once the Fed starts cutting rates later this year, interest rates will likely stay low for several years, and QE is likely to come back in 2024.

Immigration is a key reason the labor market is gradually moving from very overheated to less overheated.

Over the past 2½ years, immigration into the US labor market has increased by 4 million workers, and the working age immigrant population is now back at its pre-pandemic trend, see the first chart below.

High immigration contributes not only to solid job growth, including in leisure and hospitality, but also to increasing the participation rate and limiting the upside pressures on wages, see the second chart.

The bottom line is that high immigration is helpful for the Fed as it tries to cool down the labor market and slow down inflation.

Our employment outlook chart book is available here.

Weekly Fed data released every Friday at 4:15 pm shows how banks are responding to the SVB collapse and subsequent deposit outflows:

• The largest 2-week cutback in bank lending in US history (Chart 1)
• The largest 2-week cutback in bank lending to corporates in US history (Chart 2)
• Largest decline in lending to real estate on record (Chart 3)
• Largest decline in lending to multifamily construction on record (Chart 4)
• Cut back auto lending to consumers (Chart 5)
• Banks are selling mortgages and drawing on the Fed and FHLB system to meet immediate deposit demand (Charts 6 to 9)
• Since the Fed began to raise rates, total deposit outflows from the banking sector is now almost $1trn (Chart 10)

Fed hikes were already cooling the economy, and the latest weekly Fed data shows that the banking sector response since SVB is magnifying the speed of the slowdown. 

Our banking sector chart book is available here, and the bottom line is that the immediate risks in the banking sector are starting to fade, but the behavioral change in the banking sector is beginning to weigh on the economic outlook. In short, the credit crunch has started.

We just entered Q2, and the consensus expects essentially zero percent growth in GDP and earnings over the coming three quarters, see chart below. In other words, the consensus is saying that over the next 9 months, we will see no real growth in consumer spending, capex spending, and hiring. Nonfarm payrolls could be a bit higher than zero because of demographics, including immigration, but with the consensus expectation of negative growth in the third quarter, we could soon start to see nonfarm payroll prints around -100K to -200K.

During the pandemic, we were all at home buying things online and supply chains were constrained, and goods inflation went up. 

Then, when the pandemic was over, goods inflation came down, and service sector inflation went up as we started spending money on restaurants, hotels, and airline tickets. 

Now the service sector is in the process of cooling down, and as a result, service sector inflation is declining. Specifically, ISM services prices paid is a leading indicator for headline inflation, core inflation, core services inflation, super core services inflation, and average hourly earnings, see charts below. 

In other words, goods inflation normalized in 2022. And service sector inflation is normalizing in 2023. 

Combined with rapidly falling inflation expectations, see the last chart, the bottom line is that inflation is coming down to the Fed’s 2% inflation target, and the Fed can later this year begin to move the Fed funds rate down to the r-star level around 2.5%. 

In short, this inflation episode will soon be over.

A survey of 71 banks in the Dallas Fed district done after SVB went under shows a dramatic reversal in loan volumes, see chart below. This Fed survey was carried out from March 21 to 29.

The US Treasury publishes daily data for tax refunds, and the level of tax refunds to households tells us something about how much support there is to consumer spending, and the chart below shows that tax refunds in recent weeks have been running at a lower rate in 2023 than in previous years. Adjusting for inflation would lower the 2023 numbers even further.

The rally in the S&P500 since the beginning of the year has been driven by 20 stocks, the market cap of the remaining 480 stocks has basically not gone up, see chart below.

The implication for investors is that this market is not driven by broad-based higher growth expectations but instead by what has happened with rates, in particular after SVB went under.

European inflation is likely to move sharply lower over the coming months, see chart below.

Our weekly banking sector chart book is available here, key charts below:

1.) Since the Fed started hiking rates, deposits in banks have declined by $800bn, and assets in money market accounts have increased by $600bn, see the first two charts below.

2.) The share of households using mobile banking or online banking increased from 39% in 2013 to 66% in 2021, which has made it possible to move money in and out of bank accounts more quickly, see the third chart.

3.) Capital markets, including IG issuance and HY issuance, have, over the past week, started to slowly come back, see the fourth and fifth charts, but stresses remain in bank funding markets with the FRA-OIS spread still elevated, see the sixth chart.