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1. US Consumer Delinquency Concerns Surge to Highest Level Since 2020 (Peak Covid)

• As more households struggle with debt payments, the reliance on debt-fueled spending to drive growth could lead to a significant downturn if defaults increase.
  
• U.S. household debt has surged to over $17.8 trillion, with delinquency rates climbing to the highest levels since 2020, signaling potential economic trouble ahead.

What you need to know: US consumers are increasingly worried about missing debt payments, with the likelihood of delinquency reaching 13.3%, the highest since April 2020, according to a Federal Reserve Bank of New York survey¹. This concern is particularly pronounced among those earning less than $50,000 a year and those with only a high school education. Additionally, consumers perceive credit access as more limited than a year ago, and expectations for household spending growth have fallen to a three-year low.

Why it matters: This follows a recent New York Fed report revealing that auto loan and credit card delinquencies have reached their highest levels in over a decade. Thus, more households are stressing about missing further debt payments at a time when delinquencies are already at their highest in over a decade.

Now the Dunham Deep Dive: They say the American consumer is a force, driving U.S. and global growth.

Headlines like “Surprise Jump in Retail Sales Casts Aside Recession Fears” from the Washington Post and “US Retail Sales Beat Forecasts, Defying Calls of Weaker Consumer” from Bloomberg echo this sentiment.

In short, Americans keep spending. That spending fuels sales, growth, and economic demand.

But here’s what worries me.

No one’s asking how this spending happens. It’s debt - mountains of it.

For years, Americans have stacked up loans, pushing household debt to over 17.8 trillion as of Q2 2024 - a staggering 26% increase since Q4 2019² (especially credit card and auto loans).

All this debt-fueled spending might boost the economy now, but it comes at a price. Sooner or later, those bills need to be paid - or worse, they won’t be.

As more households worry about - and actually miss - payments, it’s time for mainstream economists to take a hard look at how this will impact the economy.

Because if debt is what pushed spending growth higher, then without it, the economy will surely sink.

Figure 1: Bloomberg, August 2024

2. China’s Property Crisis Set To Deepen – Here’s Why

• New home prices in June dropped 4.5%, the fastest fall in nine years, signaling deepening troubles for the property sector.
  
• As home prices sink and 70% of Chinese household wealth is tied to real estate, the ramifications of this downturn could ripple across the global economy, echoing the 2008 financial crisis.

What you need to know: China's housing market is facing significant challenges as new home prices in June fell 4.5% - the steepest drop in nine years - hitting their lowest level since June 2015. This decline is deeper than the 3.9% drop in May and now down 8% from 2022 peak levels³, with no end to decline in sight.

Why it matters: Concerns are rising as China's economy shows signs of strain. For the first time in nearly two decades, loans to the real economy have contracted. Home prices dropped steadily month-to-month but fell faster over the year. New home starts plunged by 20%, a clear sign of weak consumer demand. Confidence is low, and the outlook is grim.

Now the Dunham Deep Dive: No surprise, but the Chinese government’s efforts to restart the economy and boost consumer confidence have failed.

In fact, the data shows things are getting worse. A clear sign of this is the collapse in bank lending, now at its lowest in nearly 15 years⁴, as credit demand dries up - no one wants a loan if deflation is building, making debt more expensive in real terms.

To make matters worse, home prices keep sinking.

Why does this matter? Chinese real estate is the world’s largest asset class, with roughly 70% of household wealth tied up in it⁵.

Thus, as the real estate market crumbles, the impact could be massive - not just for China, but for the entire global economy (remember, China is the second largest economy in the world – meaning any weakness would impact many countries that depend on Chinese buying).

So beware, China’s 2008 moment may only deepen going forward.

Figure 2: Bloomberg, August 2024

3. How The Infamous Yen-Carry Trade Blew Up In Investors Faces

• The Bank of Japan’s rate hike and weakening U.S. growth triggered a violent unwinding of the yen-carry trade, forcing investors to dump assets and destabilizing global markets.
  
• With the yen-carry trade estimated at $4 trillion, the sudden shift could leave investors scrambling to cover up to $1.1 trillion in borrowings, fueling ongoing market turbulence.

What you need to know: A slight policy shift by the Bank of Japan (BoJ) via raising interest rates, coupled with renewed fears of a U.S. recession, unleashed chaos in markets as the yen-carry trade unraveled violently. The rapid unraveling—and equally swift fade—reveals the fragility of markets dependent on a strategy that hedge funds used to fuel billions in global bets.

Why this matters: The yen carry trade allowed investors to borrow yen at low interest rates and invest in higher-yielding assets globally (such as the U.S.), generating substantial profits. This strategy has a significant impact on global financial markets, as large-scale unwinding can trigger sharp market fluctuations and destabilize currencies. But when the BoJ raised interest rates, and weaker than expected U.S. growth spurred hopes of the Fed cutting interest rates, it quickly caused this massive cross-border trade to unwind – leading to market dumping.

“The yen carry trade remains the epicenter of everything in markets right now,” said David Lutz, head of ETFs at JonesTrading⁶.

Now the Dunham Deep Dive: As mentioned already, a carry trade involves borrowing money from a country with low interest rates to invest in higher-yielding assets elsewhere.

For years, Japan has been the go-to source for cheap money, with rates near zero or even negative. This led to the infamous yen-carry trade, where investors borrowed yen for next to nothing, converted it into U.S. dollars, and bought U.S. stocks or bonds - making thick profits.

Because of this, the yen-carry trade is massive, with analysts estimating it could total as much as $4 trillion.

So, how did it recently unravel?

Well, when the Bank of Japan unexpectedly raised interest rates, borrowing yen became more expensive. At the same time, poor U.S. data led markets to price in more Fed cuts, squeezing the profits from the carry trade. But most crucially, the yen surged in value - up over 7.5% since July 10^th – which is a huge move for a currency.

This surge killed the carry trade, forcing investors to dump U.S. stocks to get hold of the strengthening yen.

• Imagine borrowing an ounce of gold when it's cheap, selling it for cash, and then needing to buy it back when the price skyrockets. You’d end up with less money than you started with. That’s what happened here.

Now, investors might need to find up to $1.1 trillion to pay off their borrowings, according to Reuters and TS Lombard. This suggests that the turbulence from the global carry trade, especially with Japan, isn't going away anytime soon.

Beware.

 Figure 3: Yahoo Finance, August 15, 2024

Anyways, who knows what will happen? Maybe this is just noisy data.

As usual, just some food for thought.

Have a great rest of your weekend.

Sources:

1. US Consumers Increasingly Concerned About Falling Behind on Bills - Bloomberg
2. Household Debt and Credit Report - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)
3. China home prices down 8% from peak, with no end to decline in sight - Nikkei Asia
4. China new loans hit 15-year low in July, more policy steps expected | Reuters
5. Real Estate Made China Rich. Now It's Looking More Like Kryptonite. - Business Insider
6. Carry-Trade Blowup Haunts Markets Rattled by Rapid Unwind - Bloomberg

Disclosures:

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.

Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information.  This document is provided for information purposes only and should not be considered as investment advice.

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