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I'm your host, Zach Griffiths, head of U.S. Investment Grade and Macro Strategy. And today, I'll be chatting with our fearless strategy leader, Winnie Cesar. I know you're all very familiar with her about our views for the U.S.
consumer and how it fits into our market calls for the remainder of 2025 and into 2026. Winnie, thanks for letting me interview you for a change. I'm looking forward to an illuminating discussion to share with our listeners and viewers now. Yeah, thank you, Zach.
I don't know that fearless leader is particularly appropriate for 2025. It feels like I'm living in constant fear of the next headline that is about to come up and all of the work that we've done on whatever topic, but we're doing our best. It's been a fearful year for strategists and analysts alike, but we're doing our best, and that's what we're going to bring to you all today. So, Winnie, I know you have been doing a lot of work in particular on the all-important U.S.
consumer and using that to frame our view of economic fundamentals and how they're likely to drive credit fundamentals going forward. So before we get into some of the bigger picture market considerations, how would you describe the state of the U.S. consumer today? Well, to have a Charlotte restaurant shout out, I think the state of the consumer is one of confusion.
State of confusion. It has been a really interesting exercise. I've been doing a lot of work on the consumer. I'm giving a presentation at a conference this week on the topic of consumer trends.
And frankly, I'm a credit strategist. I'm not an economist. I'm not a retail analyst. I don't know why I'm talking about the consumer.
But I think being a strategist, I do have kind of a unique viewpoint where I get to pull from a bunch of different places to try and cobble together a better picture of the consumer. And of course, this is a topic that comes up all the time with clients lately. It's really become an increasing area of focus in the past couple of years. We've seen so many changes in consumer spending patterns, first during the pandemic, and then the years immediately following.
So now we are somehow more than five years removed from the outset of the pandemic. It feels both like yesterday and decades ago all at once. And I do have to say that it seems that the current state of the consumer is still not straightforward. It's not good, not bad, maybe not ugly.
But a lot of that outside strength that we'd observed during 2021 to 2024 is definitely showing some signs of waning. And I think the big question that everyone's trying to answer is, are we going back to 2019, which was a reasonably fine year for the consumer, a good year, in fact? Are we going back to 2008, 2009? Are we going back to something in the middle?
So I think first we need to set some context about why so many people care about the consumer. Why does consumer health matter so much to the U.S. economy? And that's because just shy of 70%, 70, 7-0 of U.S.
GDP is consumer-driven. And since the recovery from the pandemic, personal consumption has been growing at a really strong pace above what we had in 2011 to 2019. So this is really important on its own, right? If we have a growing consumer economy, great, we love to see it.
But we also saw, at the same time, a pretty significant deceleration in the industrial side of the economy. Things like business-fixed investment, especially outside of the AI and tech world, have really lagged prior trends. The U.S. housing market has seen a wild mix of forces that's resulted in less spending on the residential side of things.
And this means, in totality, that the outsized consumer spending was a big driver of those punchy GDP prints in recent years. Helped the Fed avoid a recession as it was hiking rates. And other sectors went through their fair share of challenges, right? We had crypto blow-up.
We had tech blow-up. We had Korean insurance companies blow-up. We had all of these things, regional banks. And the consumer just held in.
And some of those factors that really supported the consumer, you know, we had the wealth effect from high housing Now, of course, we have some things that people talk a lot about and get a lot of attention. Buy now, pay later. That has been a big one. But when we look at more measurable things, because a lot of that buy now, pay later stuff isn't reported anyway, where we take debt service ratios, for example, in aggregate, they're still way below levels of the pre- and post-create financial crisis period.
Our financials team has also given a ton of air time to the concept of bending the curve in delinquencies. This was a new one to me. And in short, there was a lot of loan and credit card borrowing growth right after the pandemic. And with this, we saw a subsequent uptick in delinquencies on a little bit of a delayed basis.
And people got worried about that. Like, oh, you know, we saw more credit card borrowings and we're seeing delinquencies. But since that increase, delinquency rates on credit cards and auto loans have started to move lower again. So that kind of seasoning of these existing loans and borrowings is showing more normalized patterns more recently.
So I would say overall, the data are really mixed. They're confusing. There are some signs of weakness. There's the reality of inflation over the past few years that has put a major dent into wallets.
And while prices have stopped increasing at the rapid rate of 2022 and 2023, the absolute price of stuff is really high, right? We did a little analysis of a Chick-fil-A sandwich entree. This is something near and dear to my heart. My kids love Chick-fil-A.
That price is up 53% since 2019. And that's a 7.4% annualized rate. Like, how can we afford to eat Chick-fil-A more than once a week? It's very expensive.
And then when we look at things like the average monthly finance payment on new cars, that's almost $750 per month. $250 a month like that is really expensive. So overall, Zach, you know, a very long answer to your relatively short question is the state of the consumer is still really confusing. Two great references in there for me, the Charlotte State of Confusion restaurant and Bending the Curve.
Last time I heard that prominently, I believe we were being sent home from Wells Fargo, expected to be two weeks. Yep. And we didn't come back for another couple of years. So I literally never went back.
You never went back. I went back for a brief time. That's right. OK, so it sounds like the consumer has certainly been holding up on a macro level, but some of the underlying trends are a little more confusing or various parts that maybe historically pre-COVID have moved together are moving in different directions at various times.
So I want to attack this from the labor market perspective, as that has been front and center for markets for the better part of a month and a half or so following the very week July payrolls report released in early August, another week August payrolls report released last week, and the preliminary benchmark revisions released earlier today, we're recording this on September 9th, also came in much weaker than expected. So what is your assessment of the labor market and how does that fit into our consumer expectations as we look ahead? Well, I mean, Zach, you are the economist, so you've taught me everything I know here. And the labor market really is the big elephant in the room at this point.
You know, if people have jobs and generally expect that they'll keep those jobs, then they're probably going to continue to spend at least at a reasonable pace. Maybe there'll be a little bit of an increase in savings if people feel like the broader economic environment is somewhat uncertain, but usually people don't just like stop spending when they're still employed. And even with the somewhat nasty payrolls reports for July and August, recent downward revisions to the 12-month period, which was really big, the unemployment rate is still really low from a historic standpoint, only 4.3%. Now, this is up almost 100 basis points from that 3.4 that we ticked in April 2023, but still more than 100 basis points below the 30-year average of 5.5% and well below some of those levels that we ticked in the 1970s during speculation.
There are some pretty important things to keep in mind about the labor market. So first, we've seen job growth really concentrated in a handful of sectors, looking at the monthly data lately that's been especially true of health care. Second, we have some recent data showing that for the first time since early 2021, when we look at the level of employed people and add the number of open jobs, that's now a little bit less than the civilian labor force. So that does show that some of the slack that the Fed was presumably trying to take out of the labor market by hiking rates has been taken out.
And then finally, and this is something that I started to notice before the July and August payrolls reports were materializing in a not great way, labor force participation has been trending lower. And it's down at about 50 basis points from its peak in November 2023. This may not sound like a lot, but it really has meaningful implications for spending and can be really informative about how people are viewing the labor market. You know, if you have people who are frustrated because they can't find a job and they're dropping out, that means your labor force participation is coming down.
Another aspect of the labor market that I think is a little bit concerning is how people are thinking about their own jobs, both current jobs and prospects. We're definitely seeing a trend higher in the percentage of people who fear losing their job and optimism around finding a job is trending lower. Now, this is true both for recent college graduates, people in lower income or paying cohorts. And that really shows just kind of how pervasive some of the concern around the labor market has become.
We saw a major increase in the unemployment rate for some of these recent college grads. And we're hearing a lot of management teams from companies like Amazon and Salesforce start to announce some headcount reductions or fewer workers needed because of AI adoption. Now, how much of that is reality and how much of it just is kind of lip service to we're not hiring as much? That's much more difficult to parse out, but it's something that we're definitely observing.
And then the data around those who are already unemployed, I think it's actually pretty worrisome. When we look at the four-week average of continuing jobless claims, it's trending higher and now stands at the highest level since 2022. The average and median weeks that people are unemployed is creeping up. And while those numbers are not big, you know, a two-week extension in unemployment, that's a long time to not have any income and definitely material for the broader economy.
And then finally, the number of discouraged workers, those are people who drop out of the labor force, is also showing an upward trend, although that number is very, very volatile overall. So a lot of moving pieces here as well. I think it's interesting when you bring up the unemployment rate average over a longer run, we're still well below that. And I think there's a lot of shifting dynamics, not just for the consumer or labor market, but really across the economy where some of these historic norms pre-COVID really aren't returning.
And there are some, I'd say, demographic challenges and shifts that are still at play that kind of get glossed over sometimes with the day-to-day volatility. So, I mean, coming into this year, I think it's safe to say that we were both more concerned about tariffs and inflation compared to the labor market. And with that, our Fed call was for no cuts this year at all. And I think it's safe to say we've both been pleasantly surprised on the inflation front so far in the face of tariffs, and maybe there's a timing issue there, and we don't want to signal the all-clear when maybe it's taking more time than we had anticipated for it to show up in the data.
But developments in the labor market appear more concerning and seem to have moved in a pole position for Fed policymakers with respect to the dual mandate. So can you outline for our listeners and viewers how this has affected our thinking about the Fed going forward and how it's kind of shifted our call pretty dramatically? Yeah, it really has shifted our call. And I'm not going to lie, this has caught me up at night recently, for sure.
Like, trying to figure out how the Fed is going to play this economy is really tricky because I don't think it's, you know, late enough to say we can say all-clear on inflation. That's not coming. We've seen some signs of re-inflation on the good side of things. We've seen some signs of inflation taking a bit higher just kind of in general.
But at the same time, the magnitude of the labor market weakening has been really significant. Now, I would say coming into the year, we did have concerns about the labor market. But we realized that the mechanics of the math of how we calculate the unemployment rate in the U.S., combined with the realities of changing immigration policy, demographics, you know, if we have an aging population, then presumably more people are going to be retiring. Those things mean that a real significant increase in participation rates, it seems unlikely.
And that could definitely keep the unemployment rate somewhat artificially low if you have fewer people participating. We have definitely seen on the inflation side some re-inflation on goods. But I think what's maybe surprised me the most is services has made a bit more progress this year, helping to mitigate some of that. When I look at this ring of data that we have recently, kind of putting everything together, the unemployment rate has increased by about 10 basis points each month for the past two months.
The breadth of job gains across sectors has been much more concentrated, which is not great. And inflation has, you know, picked up, but just pretty modestly in recent months. And when we think about the data as a whole, unemployment is a little bit higher than where we were last September, ahead of the Fed's 50 basis point rate cut, while core inflation, at least so far, and assuming that consensus expectations are met for this week's CPI call, is about 30 basis points lower. So these two things are definitely moving in a level or a direction that the Fed could at least take note of.
I know inflation were not at the 2% target, but there is a pretty significant magnitude of erosion in the labor market lately that is definitely getting a lot of air time. And I would imagine that Fed policymakers, you know, had they had the July data at their July FOMC meeting, you know, the meeting minutes may look very different. The policy decision may have looked very different. And so to say that maybe the Fed's going to cut 50 basis in September, that could just be a realization that maybe they should have cut 25 basis points in July and another 25 basis points in September.
And then just looking back to last year, you know, a lot of people are saying the market's not pricing in 50 basis points. Last September around this time, the market was also not pricing in 50 basis points. We do need some help from the CPI print a little bit later this week, ahead of next week's Fed meeting. But I think that it's reasonable to expect that we might be able to see a jumbo rate cut coming out of the Fed, because really, what does 25 basis points do?
I don't know that it does that much from, you know, a changing corporate policy perspective. Yeah, I think you make a lot of great points there, Winnie, but I zero in on the fact that we did have two dissents at the July meeting with Christopher Waller and Michelle Bowman preferring to cut 25 basis points. And I agree if they had some of the data that we've gotten even over the past week looking at what the payrolls were in August and July for that matter, as well as the downward revisions. And it's important to know, I think there's been a lot more focus on the revisions this year than any year in recent past.
Maybe last year it got a little bit more focused, but those revisions apply to the March 2024 to March have gotten recently are in addition to the, I think, 911,000 downward revisions to that data almost another year prior. And so I think that those two things perhaps justifies the 50 basis points we got last September. And as you outlined, it certainly opens the door as long as we're not seeing signs of that inflation kind of re-accelerating, opens the door to 50 again. Our expectation now is for the Fed to cut a little bit more aggressively.
I've been thinking about the idea, if the Fed cuts 50 basis points in September and keeps going, do you think that that in itself could cause a shift in risk sentiment from the seemingly Teflon market that spreads stay tight, equities keep moving higher? Would that signal to the market that the Fed is more concerned and actually almost have an opposite of sort of what we've seen lately with expectations of more rate cuts being more of a positive for credit spreads and equities? Yeah, I mean, I think it's going to depend if we get a Wall Street Journal op-ed kind of talking to the market about what's going to happen at that Fed meeting next week. Yeah, I mean, there definitely is this interesting push pull around the Fed and market thinking about a Fed that is proactive versus a Fed that is reactive.
If we have a Fed that is perceived as proactive, that they are ahead of the curve, that they are able to stave off more damage to the labor markets, that they are still managing to their inflation mandate, that is an everything is awesome bull case scenario for markets for certain. I have been really surprised by how little the market has cared about these labor numbers that have not been good. We've been doing analysis, or I should say, Zach, you've done some really great analysis around, you know, reaction function of credit spreads to payrolls reports. And, you know, it basically played out mostly as we expected after that August payrolls report.
And so that's been kind of an interesting dynamic. And I think that's because the market still thinks that the Fed is positioned to be proactive, that not enough damage has materialized, that they're going to need to cut, you know, 50 basis September, 50 basis points at the next meeting, 50 basis points at the next meeting, or just, you know, going from four and a half percent to zero in a relatively short period. I'm a little concerned, though, that the lack of reaction is resulting from people not necessarily thinking critically enough about all of this mix of forces and why we're seeing some of the challenges in the labor market that we're seeing. In Q2 earnings season, there was a lot of airtime given to these earnings are coming in better than we expected.
But let's think about where expectations were, like pretty bad. A lot of companies have suspended guidance. And at the same time, Q2 earnings season, it didn't give you a lot of time to adjust to a lot of these different policies that have been implemented. So, you know, whether that's a particularly good indicator of, you know, the health of earnings is something that I have some questions around.
And when we think about the expectations for the trajectory of profit margins, that's a little bit concerning. You know, we saw a lot of commentary around the Q4 or second half 2025 impact of tariffs on margins and, you know, spending on AI and technology and all of these things. And what does that mean for profit margins going forward? And when management teams are worried about margins, that's where you start to see an acceleration in layoff announcements or pulling job openings off of websites because we're just kind of sitting on our hands for a little bit and we're not necessarily going to be pursuing any real aggressive hiring plans until we can get through to the other side of whatever it is.
So for now, I think that the market is really positioned as the Fed is being proactive. And that was our bull case scenario. And I think that markets would take it as, you know, a very bull case for a period of time. And last, you know, let's say we get a Fed 50 basis point rate cut and we don't see an immediate recovery in the labor markets.
And then people start to think, OK, where exactly are we going from here? It seems like your question or comment on how market participants really aren't thinking too deeply at what's causing this underlying labor market weakness and what it suggests for the future of underlying economic growth and then how that feeds into credit fundamentals. And that's very clear in market pricing. We haven't seen spreads wide at all.
I think there's a lot more focus in the financial press on just how tight even high yield spreads are. And I think that speaks to the thing that we keep coming back to here is the idea of so much cash still in the system. You have a ton of cash in very short dated cash like products that are earning interest in hundreds of billions annually. And that needs to be reinvested in the market.
And I think the other big thing is this optimism about AI. We were talking about this a little bit earlier, probably the two things that we at least here seem to have underappreciated or perhaps underestimated in terms of the market impact in 2025 when facing all these other big headline risks, whether it be U.S. institutions getting called into question and how political they are now or may become given some of the policy choices recently. And so I think there's a lot of cross currents.
And I think your point about thinking a little bit more deeply about what's driving this, the Fed being perceived as reactive, I think that could really flip like a switch in terms of resentment in the market. And so bringing that all together, Winnie, what does this all mean for spreads, credit spreads in the U.S., at least going forward from your perspective? Sure. So I think from a credit spread perspective, the number one thing that I have in mind is looking to the next 12 months, do I objectively think that the fundamental outlook is improving or eroding?
And it seems like we're coming from a period of, you know, peak profit margins, very strong profit margins, peak consumer trends, peak housing market prices, and moving into a period of a lot of question marks. And while that may not mean that we're going to see this massive downgrade cycle and massive default cycle, it probably means that credit spreads need to go through some adjustments. Your point around technicals, I think, is really important. And it comes up in every client call that I have.
They have a lot of cash. They've seen inflows. They're still cash in money market funds. And we want to respect that technical.
It helped us get some really key market calls correct in the past few years. And we don't want to underestimate the power of cash and the power of dry powder. And at the same time, liquidity is there for you until it's not. And the switch flips pretty quickly when people start to get worried about something or if an institution looks like it is entering, you know, a period of trouble.
And the exits close up very, very quickly. And so I think from a credit spread perspective, we came into this year expecting more volatility in spreads. We saw it in April. We saw, you know, maybe some blips of it after the July payrolls reports.
And I think that more credit spread volatility is probably still a reasonable base case expectation. That definitely means that there are going to be opportunities. But I think it also means that you need to look pretty critically at what's in your portfolio and think about the specific catalysts. That's something that I really took away from working with analysts on recent best ideas and trade recommendations.
Things were very credit catalyst driven. You know, we think there is a rating upgrade coming. We think there is a positive event risk from M&A or asset sales coming. Those are the places that you want to be putting cash to work right now.
Whereas the broad based data compression trade feels like that probably has less room to run and could, you know, kind of risk some offsides positioning. Our view is still that, you know, the Fed may have some challenging things to manage on their hands in the near term. We also have a lot of question marks around the composition of the Fed in the near term. You know, what does that look like?
If it changes significantly, how does the market think about it? How does the market think about Fed credibility? And I think that that adds up to expecting wider spreads is not necessarily a heroic call, although it's been a really painful one for a lot of this year. That is for certain.
I do want to give some airtime to that full case scenario, though. You know, if the Fed is able to execute, you know, another kind of soft dish landing and that they are proactively easing at a kind of slow and steady pace that the market feels good enough about, you know, maybe get some of that industrial side of the economy up and running again, get the chem sector out of the doldrums like it has been for the past couple of years, you know, keeps consumers feeling good about things, keeps the labor market feeling good. Then there is a reasonable case for IG spreads to break through 70 basis points, for high yield spreads to break through 250 basis points. That is not out of the realm of possibility.
And I do want to give that some airtime. I think before we get there, though, we probably go wider. And I cannot wait to be able to, you know, pound the table on another overweight credit recommendation. I hear you, Wendy.
And I think it's important to highlight, if you just think about the one week payrolls report we got last year, I think it was the July payrolls report released in August, you had IG and high yield spreads widened, maybe 19 basis points and 91 basis points respectively in that brief episode, if I recall, it kind of took place over the course of maybe two weeks. Where is that this time? I think we had maybe three basis points on IG on the one day and maybe 27 in high yield. And so that's just to highlight how the market really has not reacted to this weakening in the labor market, seemingly because it expects the Fed to move forcefully.
But again, I think your distinction between is it proactive, which I think is hard to argue with the weakness we've seen, again, even just over the past month and a half, or is it reactive, in which case maybe we got to be moving a lot lower in the policy rate a lot quicker than what's priced in. And I think that could cause risk sentiment to shift. But we'll be waiting to put on those overweight calls. So, Wendy, did we miss anything covering the consumer to the labor market, to the Fed, to credit spreads?
I mean, I feel like we covered a lot. We covered Chick-fil-A prices. We covered Charlotte restaurants. Clearly, my mind is on snacking right now.
I think I probably should hit our snack bin. All right. Well, we will leave it there then. Thank you all for tuning in to No More Risk Better.
Good luck out there. And we will catch you next time. Thank you. Credit Sites, Flamer, all price references correspond to the date of this recording.
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