Macro Commentary
We all know that people (and markets) tend to have short memories and, thus, repeat the mistakes of the past. But are we already back there again? On Thursday, the credit monitoring agency Experian released data on the state of auto loans in the United States. Here are the quick statistics from the report. The total amount of auto loans surpassed $1 trillion for the first time, a 10% increase from the same period last year. The average auto loan for a new car is more than $30,000. The average monthly auto payment is more than $500 which is also a record. Jamie Dimon, the respected chief executive of JP Morgan who helped his bank navigate the recent banking crisis better than most, remarked that “someone is going to get hurt” in the auto loan space. Part of the statistical change is the rise of leasing which reached its highest level on record at 31.1% of all new vehicle transactions in Q1 2016. The author of the Experian report remarked that “many consumers [are] exploring options to keep their monthly payments affordable.” Combine rising automobile costs with the cash crunch the student debt market has put on many US workers and recent articles we have seen discussing people reprioritizing consumption to meet housing costs (rent and mortgage payments) and you have a squeeze from three of the largest obligations of most people.
Again, the consumer is increasing leverage and thinking more about the monthly payment amount as opposed to the aggregate debt they accumulate (which is, in effect, the aggregate amount of consumption they have pulled forward against future earnings). The weaker than expected jobs report on Friday that showed fewer than expected jobs added in the prior period, a shrink in the number of people working, and no improvement in wage growth does not bolster confidence that future wages will be stronger to pay off the debt. Thus stands the reason that expectations for a Fed rate increase in June has come down. But, as stated in the frustrations of European Central Bank President Mario Draghi (whose bank took no action in a meeting this week), central bank policy does have its limits.
In a testament to the fact that people around the world are the same, we can again look to the repetition of financial mistakes. This time we turn attention to China. In a recent report from the China Central Depository and Clearing Company, the outstanding value of “wealth management products” or WMPs has exploded from 7.1 trillion yuan three years ago to 23.5 trillion yuan in 2015. Using today’s exchange rate of 6.55 CNY/USD for both periods, implies an increase from $1.1 trillion to $3.6 trillion in US dollar terms. The demand for these products is derived by investors’ stretch for yield as tends to happen when the “safe” return is not perceived as enough. WMPs are securities sold by banks to investors and take the proceeds to invest in bonds, stocks, and derivatives to create a return. There are several risk levels and “guarantees” on the securities, though most are still viewed by the public as implicitly backed by the bank or the local government. Think securitized products like collateralized debt obligations (CDOs) in the US prior to the financial crisis. Much of this issuance and investment is done off bank balance sheets. Think of the term “shadow banks” used before. Recently, WMPs have started to invest in each other presumably because there is not a sufficient amount of quality assets to buy. Now there is the complexity that comes with layers of risk intermingled based upon the same assets. Think CDO-squareds. Most of these products have short durations of six months or less so that financing needs to be rolled to support the assets. Short-term funding on long-term assets, think Bear Stearns. So despite the cultural differences between the Communist/quasi-Capitalist People’s Republic and the Free-Market (kind of) United States, people are really people.