Trends We're Tracking: The Service Economy, El Niño, and the end of LIBOR

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Divergence between service and physical economies

We are facing a looming recession that is not only the most anticipated one in history but might also be the most elusive. Again and again, economic data have turned out more resilient than expected. Much of this is due to the divergence between the service economy and the physical economy. On the one hand, traditional economic indicators, most of which are related to the physical economy such as manufacturing data and retail sales, continue to deteriorate. For example, ISM Manufacturing Index has been below 50 for seven months in a row since last November. Almost all retailers have slashed their outlook recently as retail sales continue to struggle. On the other hand, companies involved in the service economy are prospering. For example, airlines, hotels, and cruise lines are doing particularly well thanks to the strong demand that is usually seen during the height of an economic expansion. As much fewer data are collected and analyzed related to service economy than physical economy, its impact on the overall economy has often been underappreciated. In addition, the pandemic has seemed to cause a permanent change in consumers’ behavior as more and more consumers are willing to spend on personal experience than on physical goods. Ultimately, it looks like the rising popularity of YOLO (You Only Live Once) and FOMO (Fear Of Missing Out) during the pandemic have some staying power.¹

A shift from La Niña to El Niño may cost trillions

El Niño and La Niña are two opposing climate patterns in the Pacific Ocean that can affect weather globally. While for the last three years La Niña prevailed, in 2023 El Niño is getting stronger. As climate change is expected to accentuate the intensity of El Niño, associated extreme weather events can have a profound impact on the environment, ecosystems, and economies. Last time we experienced El Niño during 2015-16, it caused record-setting tropical hurricanes in the Pacific, extreme drought in Africa and Central America, and crop failures across Southeast Asia.

A recent study conducted by Dartmouth Earth system scientists, Christopher Callahan and Justin Mankin, found that El Niño persistently reduced economic growth and climate events in 1982-83 and 1997-98, and resulted in global income losses to the tune of $4.1 trillion and $5.7 trillion, respectively. And all together, the events catalyzed by global warming are estimated to cause $84 trillion in economic losses in the 21st century. As we step into the second half of 2023, it is looking like macroeconomic analysis will need to factor in climate risk a lot more.^2,3,4,5,6

The end of LIBOR

LIBOR is set to be retired in June after several decades of being the go-to lending rate for banks all over the world. LIBOR was created in 1960s and by 2012 it was used on over $550 trillion of contracts, more than seven times global GDP. The rate was created by a syndicate of lending banks that self-reported their cost of borrowing, from which the average plus a spread for profit would be the loan’s interest rate. As with any system where the inputs and outputs are subjective, LIBOR’s downfall was brought on by market manipulation and a loss of faith in system.

Replacing LIBOR will be a set of five new benchmarks, one for each of five currencies represented in LIBOR. The Secured Overnight Financing Rate (SOFR) for the dollar, the Sterling Overnight Index Average (SONIA) for the pound, the Tokyo Overnight Average Rate (TONAR) for the yen, the Euro Short-Term Rate (ESTR) for the euro, and the Swiss Average Rate Overnight (SARON) for the swiss franc. All rates are no longer determined by reporting banks, but instead based on the borrowing costs of a large number of real transactions.⁷ 

Failure to launch

Compared to previous generations, it is taking increasingly longer for young Americans to start their lives. Looking at 2021 data from Pew research, it shows that, compared to 1980, the percentage of 25-year-olds living outside their parents’ home dropped 16%, being married dropped 41%, and 22% fewer had children. Student loan debt, rapidly increasing housing costs, and pandemic induced economic fears have all hurt the prospects for people born between 1981 and 1996. The data is further stratified along gender lines. Compared to young men, young women are faring much better. There has been a 6% increase in the percentage of young women who were financially independent in 2021 compared to 1980, while there was a 13% decrease among young men.⁸

Sources:

1. https://www.wsj.com/articles/why-the-u-s-remains-far-from-recession-5d07fe49
2. https://www.science.org/doi/10.1126/science.adf2983
3. https://www.washingtonpost.com/weather/2023/05/18/el-nino-economic-impact-climate-change/
4. https://www.bloomberg.com/news/articles/2023-05-18/economic-losses-from-extreme-weather-is-severely-underestimated?
5. https://www.wsj.com/articles/how-el-nino-could-scramble-commodity-markets-8d5e36ba
6. https://www.bloomberg.com/news/articles/2023-05-29/india-likely-bracing-for-el-nino-impact-on-monsoon-hussain-says?
7. https://www.economist.com/finance-and-economics/2023/05/18/libor-will-at-last-be-switched-off-in-june
8. https://www.bloomberg.com/news/articles/2023-05-26/young-us-adults-are-taking-longer-to-reach-financial-independence