U.S. Consumer Spending: A Positive Surprise!

U.S. retail sales in March popped higher, while February revisions were positive.

U.S. Consumer Spending

After hibernating this winter, U.S. consumers appear to be opening their wallets again. March retail sales data were strong across the board – the only exceptions were spending on gasoline and electronics, which contracted month-over-month.

Fundamentals for consumer spending remain solid: the consumer deleveraging cycle is very mature, policy uncertainty has finally subsided, business confidence is improving, and the wealth effect is still positive, despite equity market volatility in recent weeks. Most importantly, job prospects are gradually improving and this is beginning to be reflected in overall consumer confidence, a pre-condition for more vigorous spending.

Overall, we expect the U.S. economy is on track for 3% growth or better over the next year.

Brazilian Banks: Not Out Of The Woods Yet

The carnage in Brazilian assets over the past three years has not spared the country’s banks. According to our EM strategists, bank stocks in Brazil have not yet priced in the economy’s most likely path toward recession and the ensuing negative effect on their profits, via a worsening of credit quality.

There are several reasons why we expect banks’ credit portfolios to deteriorate considerably:

  • Ongoing monetary tightening suggests that growth is about to relapse anew, which threatens to toss the economy into recession by the end of this year.
  • Borrowing among companies and households (domestic and foreign) has risen from 40% to 90% of GDP in 10 years.

Brazilian Banks Not Out Of The Wood Yet

  • Household debt servicing costs are elevated, taking up 22% of disposable income. The recent rate hikes and flagging income growth will only further depress households’ ability to service debt.
  • With respect to the corporate sector, even though businesses are not particularly leveraged, a recession will depress revenues and a rise in corporate defaults is likely.
  • Furthermore, the foreign debt rollover rate among Brazilian companies has dropped below 100%, a sign that foreign lenders are getting wary of their credit exposure to Brazilian debtors. We expect the rollover rate to drop further as foreign lenders seek to limit/curtail their exposure to Brazil. Given that Brazil runs a current account deficit of 3.7% of GDP, a lack of new foreign capital will put pressure on debtors’ finances and force them to delever. The outcome of deleveraging will be a further slump in the economy, resulting in additional credit quality aggravation.

Bottom Line: A marked deterioration in banks’ credit portfolios poses the largest threat to Brazilian banks. We continue to recommend that investors underweight Brazilian banks versus their EM peers.