News of the week summary - 10/08/2023
Consumer spending stays strong amid economic tensions
In the face
of rising interest rates, persistent inflation, dwindling pandemic savings, and
a cooling labor market, one might expect consumers to tighten their purse
strings. However, data shows that household spending in the United States
remains resilient. In August, Americans spent 5.8% more than the previous year,
outpacing inflation. Notably, the experience economy thrived this summer, with
companies like Delta Air Lines and Ticketmaster reporting record revenues.
Economists and financial experts acknowledge that prioritizing short-term
experiences over long-term saving is common, but they argue that the current
environment differs.
Current factors such as a challenging housing market have made traditional savings goals seem unattainable for many. Additionally, the pandemic exposed the fragility of long-term plans in areas like health, work, and everyday life. In response, consumers (especially younger ones) are opting for once-in-a-lifetime experiences, fearing they might not have another chance. This shift might not be impulsive but rather driven by the fear of future regrets.
Bank of England to set-up a permanent lending facility for "shadow bankers"
The Bank of England is in the process of establishing a permanent lending facility aimed at non-bank financial institutions (NBFIs), including insurers and pension funds.
A permanent lending facility is a mechanism established by the central bank to provide ongoing lending support to financial institutions in times of stress or crisis. It serves as a reliable source of funding to help stabilize the financial system and ensure liquidity when needed.
This move comes as non-banks financial institutions have taken an increasing share of lending activity (this is also known as "shadow banking"), while not being subject to the same regulations and relations with the central banks as traditional banks.
The Bank of
England acknowledges that the risks stemming from non-bank financial
institutions are expected to grow in the coming years, echoing concerns raised
by global policymakers. The balance sheets of these NBFIs in the UK have
expanded significantly since the financial crisis, even outpacing the growth of
traditional banks.
The central
bank will initiate the design of this facility immediately, with a focus on
lending to UK insurance companies and pension funds, which are among the major
sellers of assets during financial crises. Eligible collateral for this lending
facility will include UK government bonds (commonly called gilts), with potential consideration of
other assets over time. This permanent lending facility is a
more effective approach than the improvised asset purchase schemes employed
during prior financial stresses. It aims to provide financial stability through
secured lending without causing confusion regarding the central bank's monetary
policy stance.
In addition to these measures, the UK Treasury and the Bank of England have plans to relax certain regulations for banks and insurers in an effort to strengthen the financial sector post-Brexit. This includes raising the threshold for the separation of retail and investment banking operations for banks and other regulatory reforms.
US companies' hiring slows
US
companies added only 89,000 jobs in September, marking the lowest figure since
early 2021, according to data published by the ADP Research Institute. This weaker-than-expected
increase in private employment suggests a slowdown in labor demand across
multiple industries. The leisure and hospitality sector drove the meager
September gain, compensating for job losses in professional and business
services, manufacturing, and trade and transportation. Notably, large
businesses reduced their payrolls.
The data underscores the moderating trend in the labor market, which has been pivotal in fueling consumer spending and economic growth. Some employers are becoming more cautious in hiring due to ongoing inflation and higher borrowing costs. The report had an impact on stock futures and Treasury yields, with reduced expectations of a Federal Reserve interest rate hike by year-end.
Using AI to beat markets has been difficult so far
Hedge funds
are increasingly turning to artificial intelligence and machine learning
to gain a competitive edge in the financial markets. However, while AI has disrupted various industries, it has yet to
conquer the complex world of financial investments.
The
Eurekahedge index, which tracks 12 AI-focused funds, has lagged behind the
broader hedge fund index by approximately 14% over the past five years. Only
45% of boutique AI funds outperform their self-measured benchmarks, according
to Plexus Investments. Despite this, AI and machine learning
can already compete with traditional fund managers. AI in finance aims to be generate consistent, incremental gains, rather than seeking extraordinary returns.
The promise
of AI in finance is primarily associated with machine learning (which is also the driving force behind ChatGPT), where computers
process vast datasets to make investment decisions. Some funds combine new AI
techniques with established investment theories to enhance their strategies.
The complex nature of financial markets means that AI is most effective when it
can discover patterns, even those that may not be intuitive.
Despite the potential of AI, there are challenges to its widespread adoption. One major hurdle is explainability, as investors want to understand the reasoning behind AI-driven investment decisions. Furthermore, AI's effectiveness can be affected by sudden market changes, as observed during the pandemic.
Resuming student loan payments could slow down the American economy
The US has been facing a critical question regarding the resumption of federal student loan payments after a moratorium provided financial relief during the pandemic. As the moratorium's end approaches, concerns arise about the potential drain on consumer spending. Some estimates suggest annual household cash flow could decrease by as much as $100 billion, resulting in a 1.5 percentage-point hit to fourth-quarter 2023 GDP growth.
However, a more nuanced assessment paints a different picture. During the moratorium, some borrowers continued to pay down their loans, so payments will not start from zero. The Biden administration introduced an income-based repayment program called SAVE, which offers easier payment terms compared to previous plans. Additionally, for the next 12 months, borrowers who fail to pay will not face credit score damage. High-income households, which hold significant student debt, may be better equipped to manage increased payments. Consequently, the impact on consumer spending may be less than one-for-one.
Though the resumption of payments is unlikely to trigger a recession, when combined with other factors like rising oil prices, auto workers' strikes, and a potential government shutdown, it could further fragilize the US economy.