Higher Yields Putting The Stranglehold On Consumption

Authored by Simon White, Bloomberg macro strategist,

The recent rise in yields will push mortgage rates higher which, along with consumer credit that has already been tightening, will squeeze consumption further. Higher-duration consumer discretionary and retailing stocks are likely to underperform.

With US rates nudging 2008 highs, the outlook for yield-sensitive consumption is darkening. Higher yields are leading to higher mortgage rates. This is not a fait accompli as it also depends on the mortgage spread, but the correlation between yields and spreads has become much less negative, and thus it is reasonable to expect higher yields will bring higher mortgage rates.

As the chart below shows, this points to further weakness in retail sales.

We’ll get July’s retail sales data later today. July is expected to show a small month-on-month improvement on June’s data, but as the chart above shows, the trend is manifestly lower.

A further headwind for consumption is from tighter credit. Credit did not tighten as much as expected in the wake of SVB’s failure, but the truth of the matter is that credit had already begun to be squeezed.

We can see that banks have become considerably less willing to make consumer loans over the last year, and this points to further downside in retail sales.

This outlook is not constructive for retail stocks. They are the fourth best performing US sector (GICS 2 sectors) year to date, after autos, semis and media. Moreover, the retail sector is high duration, and thus more exposed to higher rates.

Protection is relatively cheap though, with the XRT (retail ETF) having the highest put skew among the GICS 2 sectors.