Why Is the Economy Still So Strong?

Apollo Chief Economist

Why is the economy still so strong?

There are two reasons, lower interest-rate sensitivity and strong demand tailwinds.

Specifically:

A) Lower interest-rate sensitivity:

1) 40% of homeowners don’t have a mortgage, and 95% of mortgages are 30-year fixed that are not sensitive to the Fed raising interest rates.

2) During Covid, most firms termed out their debt at very low levels, and with the IG market having grown from $3 trillion in 2009 to $9 trillion today, see the second chart, the interest-rate sensitivity of corporate America has declined.

3) A growing share of capex spending is intangibles (R&D and software), which generally is less sensitive to Fed hikes.

B) Strong cyclical and structural demand tailwinds:

1) Fiscal spending, including the CHIPS Act, Inflation Reduction Act, and Infrastructure Act, is still a strong tailwind to growth.

2) Excess savings have recently started to rise again for higher income households, see the third chart.

3) Immigration has been unusually strong, supporting overall employment growth.

4) The Fed turning dovish in December 2023 has eased financial conditions significantly, which continues to boost consumer spending and capex spending.

5) Higher interest rates give higher cash flow to households that own fixed-income assets.

6) After 14 years of very low interest rates from 2008 to 2022, the demand for higher all-in yields remains extremely strong from insurance companies, pension funds, and retail investors, which has contributed to easy financial conditions that have been offsetting Fed hikes. The AI story has also boosted household wealth and eased financial conditions.

7) Corporates that got into trouble once the Fed started hiking have not been liquidating their assets but instead doing reorganizations and distressed exchanges, and this has kept many firms alive that would otherwise have gone out of business, see the fourth and fifth charts.

In summary, the economy is strong for two reasons:

A) Consumers and firms locked in low interest rates during Covid, which made the economy less sensitive to higher interest rates (i.e., bullet points No. 1 to 3 above), and

B) Strong demand tailwinds coming from fiscal, excess savings, immigration, and easy financial conditions (i.e., bullet points No. 1 to 7 above).

With this backdrop, it is not surprising that inflation and labor costs remain high, and these 10 forces will keep the economy strong for at least several more quarters. 

Eventually, the Fed will get inflation back to 2%, but it is increasingly clear that it will require a meaningful slowdown in the labor market and the housing market.

In short, GDP and earnings should remain strong for the rest of 2024.

Weekly data for same-store retail sales still strong
Source: Redbook, Bloomberg, Apollo Chief Economist
IG market is nine times bigger than HY and nine times bigger than the loan market
Source: ICE BofA, Bloomberg, Pitchbook LCD, Apollo Chief Economist. Note: Ticker used for HY is H0A0 Index and for IG it is C0A0 Index, and for Loans it is SPBDALB Index.
Inflation-adjusted pandemic savings across the income distribution
Source: FRB, Haver Analytics, Apollo Chief Economist
US bankruptcies: Fewer liquidations and more reorganizations
Source: S&P Capital IQ, Apollo Chief Economist. Note: Data till March 14, 2024. Bankruptcy figures include public companies or private companies with public debt with a minimum of $2 million in assets or liabilities at the time of filing, in addition to private companies with at least $10 million in assets or liabilities. Chapter 11 liquidation and Chapter 7 bankruptcy filings are categorized as liquidation, and other Chapter 11 bankruptcy filings as reorganization.
Distressed liability exchange transactions as a share of total defaults rising
Source: S&P, LCD Pitchbook, Apollo Chief Economist

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