KBRA Financial Intelligence

3 Things in Credit: Debt Build-Up, Travel Blues, Jackson Hole

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

With the Democratic convention and Republican counterprogramming in full flight, it’s a political week. This tidbit on the state of American politics caught my eye, embedded in a long interview conducted by The New York Times with Joe Manchin, outgoing independent senator from West Virginia.

“It just doesn’t make any sense to me at all that you can’t find that moderate middle, to where people say, “Yeah, that’s how I live my life.” You expect us to do the right thing. [Yet], When someone talks common sense, no one gets excited. No one sends money at the fundraisers. But if you say something stupid and crazy, I guarantee you you’ll be flooded.” I guess that explains all the crazy.

This week, our 3 Things are:

1. Debt buildup. Keep an eye on the public sector.

2. Travel blues. An upcoming grounding.

3. Jackson Hole. A lot of topics, one course of action.

Alright, let’s dig a bit deeper.

Debt build-up.

Don’t borrow trouble. That 1850s chestnut is on a lot of investor and issuer minds these days as we normalize. Has the economy borrowed trouble? Let’s gather some data and decide.

On the consumer front, in the aggregate, consumer debt is at all-time highs—$17.8 trillion at June 30, according to the Fed. But let’s put that in perspective. As a percentage of household net worth, we’re at a low 12%, a level we haven’t seen since the 1970s. And we’re half of what we had at the peak in the GFC. As a percentage of GDP, consumer debt has steadily reduced from its peak during the GFC of 98% to 71% today. That figure is not too far above the long-term average of 60%. In terms of burden, the Fed’s Household Debt Service ratio is currently 10%. That’s up from its all-time low of 8% set just prior to the rate rise but below its long-term average of 11%.

Now, to be clear, all is not well with the U.S. consumer. We’ve talked often about the vulnerability of lower income and asset households in our “Two Economies” theme, something that is plainly evident in the elevated delinquency and charge-off rates. But in the aggregate, the consumer’s balance sheet is in good shape.

What about businesses?

Business debt as a percentage of GDP has moved steadily higher over the past 50 years—that’s all part of the financialization of the economy. That ratio peaked at 61% in the pandemic as firms took advantage of federal intervention by accessing liquidity at ultra-low rates. The ratio has come down to 49% as more expensive debt has been taken out or matured. That’s back into the 40% to 50% range we’ve seen since the mid-1990s. And as a percentage of the market value of equity, we’re at 43%, just above the long-term average. Debt to EBITDA, using data for the S&P 1,500 (that includes small-, mid-, and large-cap firms), of 1.6x is below its long-term average of 2.4x. So, in the aggregate, we’re in pretty good shape.

So, all is well, right? Not so fast.

One significant risk to risk assets is government debt, the federal source of relief for both the GFC and COVID-19. Debt to GDP in the U.S. has soared to 99% (excluding debt the government owes itself)—double where we were pre-GFC. The Congressional Budget Office expects this ratio to rise to 122% in 2034. The fiscal deficit today is a high 7% of GDP. Needless to say, these are levels that assure a return of bond vigilantes to markets, especially given that neither side of the political aisle is talking at all about fiscal discipline.

So, two takeaways of our debt discussion: (i) the consumer, the engine of economic growth in the U.S. in the aggregate, is in good shape but there are enough over-levered consumers that will serve as a modest drag on economic growth; and (ii) there is concern, appropriate or misplaced, over the U.S. fiscal situation that will likely keep Treasury market volatility elevated over at least the medium term.

Alright, on to our second Thing—Travel blues.

We did talk a while back about how the travel business was in good shape. Changing consumer preferences from goods to experiences, plenty of stimulus-fueled excess savings, and pent-up demand from being cooped up during the pandemic played right into the travel wheelhouse. Much of the sector was up the upswing.

Things are changing. Among the larger airlines reporting earnings in the latest quarter, Delta, United, American, and Southwest all had double-digit negative year-over-year bottom-line results, due to higher costs and intense competition. Hotels had better comps, but there were some concerning stock reactions. Airbnb underperformed the S&P on the day of announcement by 13% due to downbeat guidance due to slowing demand from U.S. guests. The firm mentioned that Thanksgiving and Christmas bookings are looking to be weaker than expected. Marriott underperformed by 6%, as it adjusted its guidance modestly lower due to weaker demand in China. Booking firm Expedia took down its full-year outlook for the second time this year as consumers are beginning to trade down and shorten stays. And Disney cited “economic uncertainty” as a reason for why demand at its theme parks has dropped and is likely to stay that way.

Meanwhile, visits to websites of top travel brands in accommodation, airlines, and cruise lines all fell meaningfully in July, according to Similarweb. And over at the Conference Board, surveys of consumers indicate that over the next six months, when asked if they intend to spend more or less than this month on lodging for personal travel, a net 4.8% more Americans intend to spend less than more; on air and train fares, a net 8.4% intend to spend less. Those planning an overseas trip in the next six months is at the lowest level since 2022.

All of this supports an overarching theme of economic slowdown weighing on consumer discretionary spend.

Alright, on to our third Thing—Jackson Hole.

In case you fell asleep on the beach, it’s the week of Jackson Hole, the western-themed prom for central bankers and the economists that follow them. This year’s theme is “Reassessing the Effectiveness and Transmission of Monetary Policy.” A worthy topic for sure, given the debate around this story—one that has roiled markets for the better part of two years now.

All of the attention among market participants, of course, will be on Jay Powell’s Friday speech and what he will signal about the Fed’s dual mandate, inflation versus growth, and the policy response, i.e., the magnitude and pace of upcoming rate cuts.

The leadup to the event has been full of newsworthy items: a much weaker-than-expected July jobs print (and calls for dramatic rate cuts among the excitable), well-behaved inflation readings, and acknowledgment that nonfarm payroll data is materially off the mark. We expect Powell’s remarks to tilt toward dovish, especially in light of growing signs of weakness in the labor market and housing activity, and consistent with the tone building within the FOMC, as expressed in the latest minutes. We are not expecting anything that rises to the level of a surprise.

There is broad consensus around rate cuts beginning in September. Our view on rate cuts is three in 2024, with one 25-bp move in each of the September, November, and December meetings. A 50-bp cut in any one meeting risks, in our opinion, sending an unnecessarily alarming signal (unless the FOMC sees something we don’t). Elevator up, escalator down.

But one piece out this week from Yardeni Research is sticking to the no-cut scenario. Ed and his chief markets strategist Eric Wallerstein say that not enough attention is paid to the credit cycle, as opposed to the business cycle. That got my attention.

Recessions, according to the researchers, are caused by credit crunches that occur when monetary tightening causes something in the financial system to break. Banks and markets, presumably, stop lending to a wide range of borrowers, causing consumer spending and business capex to fall off. Businesses then lay off workers and you have recession. Makes sense.

The authors believe that the economy is less rate sensitive than it was in the past, which, to their reasoning, renders the long and variable lags of monetary policy a “myth.” To them, it’s really just about credit crunch. No credit crunch, no need to cut rates.

We are onboard with the credit crunch argument, although we would add that this is not just about banks. After all, markets—public and private—are more important to credit flowing in the U.S. than banks.

But we do not agree that the level of rates is a secondary consideration. Higher for longer will eventually tip an economy into recession. Look no further than the impact already on interest-sensitive businesses and consumers. It’s time to cut rates or we will eventually have a credit crunch.

So, there you have it, 3 Things in Credit:

1. Debt buildup. Train your concern on the public sector. Bond vigilantes are sure to enforce guardrails around any fiscal impulse.

2. Travel blues. A stimulus-fueled sector is coming down to earth.

3. Jackson Hole. Expect a dovish tilt.

As always, thanks for joining. We’ll see you next week.