The revenge of the yield curve

Good morning. The Citigroup equity strategy team’s Levkovich sentiment index, which we discussed briefly last week, has risen enough to touch “euphoria” territory, just the sixth time it has done so in the past 34 years. The reason? Mementum. One component of the Levkovich is the volumes of trades that take place off the major exchanges (so-called “trade report facility” volume). Most of these trades are retail, and volumes tend to rise when meme stocks get going. Citi thinks this reflects a financial system “still awash in liquidity.” Perhaps. But surely we can be comforted that GameStop, which was at $17 before the notorious Roaring Kitty tweet, is now back to $22, after peaking at $78 on Tuesday. Not convinced everything is back to normal? Email me: robert.armstrong@ft.com. 

I’m at the FT’s Business of Luxury Summit this week, so there will be no Unhedged newsletter tomorrow, and for the rest of the week readers will be in the more-than-able hands of Harriet Clarfelt, Sujeet Indap, and Jennifer Hughes. 

Jim Grant thinks that the yield curve is not finished with us just yet

Jim Grant, the well-known Wall Street gadfly and principal author of “Grant’s Interest Rate Observer,” was never a fan of the hyper-loose US monetary policy that prevailed, with only one brief interruption, from 2009 to 2022. He believes that rates are a price like any other, and that government price setting leads to trouble. Artificially low rates, on his view, led to the proliferation of financial vice: inflation, fragile balance sheets, unsustainable valuations, wobbly banks, misallocation of capital.

So it makes sense that he — like Unhedged — has been surprised by the fact that the return of higher rates (forced upon the government by inflation) has not caused a recession. Bad policies lead to trouble; we had a bad policy; where’s the trouble? The historically reliable signal that problems are on the way, the inverted yield curve, appears to have lied to us this time.

In a recent piece for the Observer, Grant laid out some of the familiar reasons why the economy has proven surprisingly rate-resilient. Many companies, particularly big ones, are net interest earners, not payers; most mortgage-paying households have locked in low rates; there are more companies with capital-light business models.

When I spoke to Grant last week, he put special emphasis on the fact that many companies, faced with debt maturities, now have more options besides refinancing at a much higher rate (or defaulting): payment-in-kind agreements, debt exchanges, amended loan agreements. “We have perfected and institutionalised the means of procrastination.” But delay does not solve problems. If rates stay high enough for long enough, they will do “substantial damage” he says. And there are signs of rising stress already: rising bankruptcy filings, credit deterioration at several business development companies, declining interest coverage ratios, and so on. 

Unhedged is sympathetic to Grant’s view. There is a chance that the market’s (unshakeable) confidence that rates will be much lower within a year or two might not be vindicated. If it is not, the yield curve likely will be. 

What is good for Walmart is not necessarily good for the country

Walmart is thriving. The company expects sales to grow in the mid-single digits this year, driven by increasing sales at existing stores. The profit growth target is a bit faster than that. Reporting quarterly earnings last week, it nudged those targets up. The shares rose 7 per cent and are at an all-time high.

Walmart’s value proposition is that it is cheap. So anyone interested in treating Walmart as a barometer of the health of the American consumer has some difficult discrimination to make. Is Walmart doing well because Walmart customers are prospering, and therefore spending more? Or is Walmart doing well because consumers are under stress, and thrift is sending them to Walmart?

The question is particularly interesting in light of last week’s retail sales report, which was weaker than expected. Total sales were unchanged from the month before, meaning that, in real terms, sales were down. Pantheon Macro’s Ian Shepherdson considers this evidence that “the trend rate of growth of consumers’ spending on goods looks to be softening markedly,” though it should be noted that real retail sales data is very noisy month to month:

If Walmart is seeing changes in consumer behaviour, though, they are keeping quiet about it. Asked repeatedly about this on the quarterly call, executives came back to the word “consistency”. Lower income consumers are spending more of their money on basics, and more higher income consumers are showing up at Walmart, but these trends have been in place for a while. The CFO commented that “Many of the value seeking behaviours we witnessed last year have continued”:

Many consumer pocketbooks are still stretched, and we see the effect of that in our business mix as they’re spending more of their paychecks on non-discretionary categories and less on general merchandise. This merchandise mix remains a headwind to margins, but it’s consistent with our expectations

Last year the consumer economy swung around wildly in a series of shocks. The changes now are so gradual they are not easy to track.

One good read

On Cyril Ramaphosa.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.