Full faith and credit.

That phrase is often used to reassure holders of US Treasuries that yes, the US pays its debts. But it also does a pretty good job describing two critical pillars upon which any modern economy rests: faith, because without faith in the system of governance that underlies an economy individuals will have less incentive to participate in it; and credit, because a functioning system of extending and repaying loans is the mechanism through which economic growth and innovation are financed.

Both of these pillars took a minor hit last week.

Let’s start with “faith.” In a surprise announcement on Tuesday,¹ ratings agency Fitch downgraded US debt from AAA (it’s highest,) to AA+ (second-highest.) Fitch blamed an increasingly perilous US fiscal position, a rising debt-to-GDP ratio and “an erosion of governance,” as the immediate causes for its downgrade, citing a complex budgeting process and serial debt-ceiling crises like the one we endured earlier this year as evidence of the latter.

In some ways, the announcement probably doesn’t matter that much. After all, Fitch’s downgrade simply places the US on the same tier upon which fellow ratings agency Standard & Poor’s has held US Treasuries since 2011. In terms of market impact, pundits were quicker to blame a big (but also entirely predictable) surge in new Treasury issuance for the moderate spike in longer-term yields and steepening of the yield curve that occurred last week. (And for what it’s worth, I distinctly remember that S&P’s downgrade more than a decade ago actually represented a tailwind for US Treasuries as a flight-to-quality bid lifted prices for the very asserts that were causing the volatility in the first place. That felt hugely ironic to me at the time and still does today…and I can’t help wondering if that same dynamic kept things more stable last week, too.)

But on the other hand, Fitch’s move means that at least technically the company’s credit analysts have less faith in the ability of the US government to pay back its debts than they do in the governments of Australia, Singapore, and almost every developed country in Western Europe. Even Microsoft – a private company – is now deemed more creditworthy by Fitch than the whole of the United States. Market impact or not, that should deeply embarrass anyone on either side of the partisan divide who is in a position to influence policy.

But enough of that – let’s move on to something that, at least in my view, has a better chance of influencing the economic narrative in the near-term: credit. As mentioned in last week’s Perspective, one of the easy-to-miss data releases on last week’s docket was the Fed’s quarterly Senior Loan Officer Opinion Survey, or “SLOOS” for short. Here are the results: as of the end of July, lending standards were at the tighter end of the spectrum for virtually all types of loans, were tighter than they were three months ago, and are expected to tighten even further throughout the remainder of 2023.² Demand, too, was lower for just about every type of loan (besides consumer credit cards – more about that below.)

Unlike the surprise downgrade by Fitch, these results were hardly a shocker. A full 5.25% of Fed-sponsored rate hikes have made most observers a little less certain about the economy’s near-term prospects and bankers are understandably scrutinizing would-be borrowers a little more closely as a result. In the meantime, borrowers themselves are far less likely to seek out new loans when borrowing rates are far higher than they were 18 months ago.

Again, not a shocker. That, after all, was part of the point with all the Fed rate increases in the first place: to slow credit creation enough to in turn slow the economy enough to bring inflation under control. And it seems to be working. But even though recession predictions are now falling faster than the number of teams competing in the PAC-12, if borrowing standards become too tight, or if demand for new loans falls too much, then those same recession calls that have fallen dormant will be right back in the headlines. And that uptick in demand for credit card borrowing buried deep inside the SLOOS? It’s hard not to see that as an ominous sign, too.

So both “faith” and “credit” took a hit last week, and it’s probably not great news for the economy at the margin. But that other element of the economy that everyone’s so focused on right now – jobs – really didn’t suffer any major blows at all. Part of that has to do with companies generally feeling a little more hopeful than they did even a month or two ago – consider this line, from last week’s manufacturing PMI survey from S&P Global: “(manufacturing) companies expanded employment at a faster rate amid greater confidence in the outlook…” which seems somewhat at odds with reality because new order activity took another leg down in that same survey.³ Meanwhile, the services version of the S&P PMIs continued to moderate: “the service sector remains the main engine of growth in the US economy, there are signs of the engine sputtering…”⁴

But despite all that, the US economy still added 187,000 jobs in July and unemployment ticked back down to 3.5%, once again falling very near its Vietnam-era low.⁵ Layoffs moderated, too, with outplacement firm Challenger Gray and Christmas reporting a 40%-plus decline in the number of new layoff announcements compared to last month.⁶ And then there was job openings, which hardly changed at all after creeping back toward the 10-million mark that made everyone so breathless earlier in this cycle.⁷ Sure, the number of quits decline a little bit, but the number of open positions for each person who quits their job for greener pastures remained a far-higher-than-normal 2.4. Almost any way you slice it, the jobs market remains unnaturally tight. Probably too tight for the Fed to really begin to breathe easy despite a few Fed comments to the contrary.

Finally, one more thing before we move on. As we’ve discussed in these pages before, the Fed almost always tightens monetary policy until something breaks. So far, most of us have been holding out hope that this tightening cycle’s collateral damage was the mini regional banking crisis that seems, for now at least, to be contained. But last week also brought another potentially ominous development: the bankruptcy of trucking firm Yellow and the 30,000 jobs it will reportedly take with it.

The company has had struggles of its own recently, some of which undoubtedly had to do labor woes, stress among some of its customers and so on. But also at work was an inability to secure new financing – again, not necessarily unusual for a company that finds itself against the ropes. But the one-two punch of a weak demand environment and trouble securing adequate financing in an increasingly credit-constrained (and higher-rate) environment feels enough like a recipe for further troubles that I have to wonder whether there are other, similarly challenged firms watching this unfold and wringing their hands anxiously. If so, it would be easy to conclude that all this talk of “recession, avoided,” is premature.

But for now, “faith” and “credit” are both still WAY more than half full. Let’s just hope it stays that way.

What to watch this week

It’s “inflation week,” when both consumer prices (CPI) and producer prices (PPI) are scheduled for release. Back when inflation was running at an excessively boring 1- to 1.5% for years at a time, the release of inflation data used to be a non-event. But these days, both releases get almost as much attention as a Taylor Swift concert announcement and sometimes enjoy the same marquee billing as The Barbie Movie. That should be starting to change now that inflation seems to be well on its way back to boring, but we probably can’t afford to re-ignore it until inflation trends itself way back all the back to the Fed’s 2% target. Until then, an unexpected uptick could still do serious damage to the market’s psyche, so we still have to care (besides, Jerome Powell said himself that the Fed is still paying close attention, so there’s that...)

Next down the list of things to worry about are two releases designed to measure confidence: the NFIB’s small business sentiment index on Tuesday and the University of Michigan’s preliminary read of August consumer sentiment on Friday. Both have improved notably in recent months, but, like inflation data, will still be worth close scrutiny. In the case of the NFIB report, one nuance of last week’s ADP payroll report that didn’t get much attention was the recent tendency for small businesses to carry much of the load on new hiring activity (on balance, large businesses with more than 250 employees actually shed around 14,000 workers in July, while those with fewer than 50 collectively added more than 130,000.8) That’s a lot of pressure to put on small businesses, meaning that a reversal in recent improvements in small business sentiment recorded by the NFIB’s index could have an important read-through into future labor market trends.

In the case of the UofM data, the story is even more straightforward. As we’ve mentioned in the past, consumer confidence correlates pretty closely to gasoline prices. Given that retail gas prices recently plateaued at their highest level since last October, it’s fair to wonder whether that will reflect in Friday’s consumer sentiment report. If so, there’s an obvious read into the consumer spending that has underwritten economic growth more generally during the last few quarters.

Which brings us to this week’s entry into the “I don’t normally care, but maybe I should” column: the weekly petroleum inventories release from the US Energy Information Administration. Gasoline inventories are currently running below 5-year averages on both a nationwide basis and in three of the five regions tracked by the EIA. That, plus an increased lack of willingness by OPEC and OPEC-plus members to bend to the desires of oil-consuming countries like the US, means that further stress on petroleum inventories – and the impact they could have on prices – are suddenly relevant again by virtue of the impact they might have on consumer confidence (and therefore spending.)

Finally, with most of the market’s biggest divas (and much of its market cap) having already reported, it’s easy to forget that earnings season is still underway. This week will represent the peak in terms of the number of companies reporting, with roughly 1,700 on the schedule for this week (including more than 400 each on Tuesday, Wednesday and Thursday). Highlights include Disney (always good for a tidbit or two on media and travel demand – two recent bright spots for the economy) on Wednesday and Chinese online giant Ali Baba on Thursday. BABA could be the more interesting of the two given the trouble China has had kick-starting its economy after the formal end of “zero COVID” roughly eight months ago. A much-anticipated surge in Chinese economic growth mostly failed to develop as the most restrictive pandemic policies ended, leading some economists to call for additional efforts to stimulate demand in China. As perhaps the biggest online brand in China (and certainly one of the most important Chinese conglomerates to list on US exchanges and therefore subject to its reporting requirements,) BABA’s results could provide an important glimpse through the window into fundamentals of the Chinese economy – one that has increasingly gained status as a source of global growth more broadly.