Sive Morten
Special Consultant to the FPA
- Messages
- 17,154
Fundamentals
Despite that we're starting the new year, guys, there are not too many things to discuss as market remains quiet in "dead" season between Christmas and New Year's Day. Just few statistics data have been updated. Still there are few things that become more evident as crisis starts showing its "structural" background, not cyclical. While 2022 year has passed under the sign of the struggle against inflation, the 2023 prepares new challenges, that seem more difficult to resolve. Everybody knows that to defeat inflation you have to rise rates (at least its monetary component) but what to do now with negative events in construction, big skew in corporate finances, all time high public consumer loans and breaking of the balance in interest rates structure (between Fed and commercial banks) inside the US - are just a few questions that yet to be answered. And not only answered but somehow demand the solution as it directly impacts the economy.
Market overview
There are few events are worthy to mention this week. First is European Central Bank President Christine Lagarde indicated borrowing costs will increase again, saying this is required to temper soaring consumer-price growth. The ECB raised interest rates by 250 basis-points this year and policymakers including Lagarde have said more hikes are to come, with markets and economists expecting half-point steps at the next two meetings. She also highlighted the ECB’s ever-watchful eye on inflation.
At the same time, ECB is cutting liquidity with the record tempo. The ECB's balance sheet has shrunk by almost 800 billion euros in 5 weeks. In the week to November 25, the reduction in the balance sheet amounted to 298 billion euros, and in the week to December 23, the balance shrank by a record 491 billion euros.
The entire reduction in the balance sheet is due to the repayment of loans taken by the Eurozone banking system during the pandemic and aggressive lockdowns. Holding of these loans has become unprofitable for banks. There is no sense in paying 2.5% on excess 1.6 trillion euros, which are not used in the real economy.
The tension in the debt markets increases again at the end of the year – rates are rising, liquidity is less and less, the lack of confidence is more and more obvious.
Second important issue that is worthy to mention is Initial claims changing. But we're mostly watching for continues claims. Although employment data is strongly manipulated, and numbers per se are not important, but tendency is the one that we have to pay attention to. Last week of 2022 has not become a surprise either.
The Labor Department found that the number of people receiving benefits after an initial week of aid rose to 1.710 million in the week ending Dec. 17. Those so-called continuing claims, a proxy for hiring, have drifted higher since early October.
United States Continuing Jobless Claims
Another important indicator is a length of work week. It keeps dropping which also suggests sign of recession. Currently it is a bit skewed by holidays, but in Jan-Feb there should be more realistic data.
Also it is worth to mention interesting tendency that looks absolutely contradictive. While it was reported positive GDP and even upside revision of IIIQ numbers, we have drop of companies' revenues on a background of inflation. This is bad combination. As we've shown few times, inflation supposedly is higher than it was reported around 6.5-7%. GDP is mostly book keeping term that could be "slightly adjusted" when needed. With this background we see that as Service companies as manufacturing ones are loosing revenue. With adjustment to inflation the real decrease of revenues is probably higher.
The Fed does the same as ECB - dries liquidity with high tempo. The real money supply in the United States is shrinking at a record pace in history – minus 6.6% YoY compared to the previous anti-record in April 1980 (minus 6.5%) But it is still very far from the complete disposal of the excess money supply formed during the period of monetary and fiscal madness of 2020-2021. Compression should occur for another 13-14%
The deviation of the real money supply from the trend of 2010-2019 by September 2021 was over 25%, the money supply has been declining in real terms for the last year. There are two recycling mechanisms – inflation and forced withdrawal of money supply from the economy/financial system. Now the first mechanism is mainly operating. It is important to note that there is a de-synchronization of expenditures of the population and the money supply in real terms. Usually, with a decrease in M2, expenses also fall (according to the experience of the inflation crisis of the 70s-80s), but now this is not happening.
The out-of-sync is due to record lending rates of the population and record low savings rate as an attempt to compensate for falling incomes and inflationary absorption. However, there is a very limited margin of safety of such a compensation mechanism.
Indeed, as we've shown last time, Fed has limited margin of safety, and already has spent ~ 50% of US Treasury reserves on markets' support since October 2022. They has approximately $350 Bln more that should be enough until March-April, but then the inflation rate will become the hot topic. If 5-5.25% rate doesn't hold inflation but reserves will be spent already, this could force them to turn back to easing again. And big banks already build plans on how and when this should happen. There will be no problems if inflation drops at least to 3-3.5% but what if remains at current levels? We sure with 90% that it remains high. Just because we're in structural crisis, it is not cyclical.
US interest-rate strategists mostly expect that Treasuries will extend their recent rally, dragging yields lower and steepening the curve in the second half of 2023 so long as labor market conditions soften and inflation ebbs. The most bullish forecasts among those published by primary dealer firms — including predictions from Citigroup Inc., Deutsche Bank AG and TD Securities — anticipate that the Federal Reserve will cut its overnight benchmark in 2024. Goldman Sachs Group Inc., which predicts that inflation will stay unacceptably high and that the US economy will avoid a deep recession, has the most bearish forecast.
In addition to the outlook for policy and inflation, expectations about Treasury supply are a key factor shaping forecasts. The supply of new US debt shrank in 2022 but could resume growing if the Fed continues to shed its holdings. Here we mostly should keep an eye on 2-year yield because it better reflects Fed fund rate dynamic.
Every bank gives some comments to forecast, you could read it by link above. The most common comments Citi gives:
JP Morgan suggests that -
In general, the appetite for the dollar was also helped by haven flows, among other factors, as concern about the tightening of global policy weighed on riskier assets along with heightened geopolitical tensions and ongoing concerns around Covid. The possibility of a US recession, risks around China’s Covid reopening, and the possibility of further declines in stocks, of course, have the potential to re-invigorate the appeal of the US currency at some point. For now though, the trend is down, and all eyes will be on how the economic and market landscape plays out in early 2023.
Conclusion
So, let's call it a day, to not bother you too much on Holidays. In general, we could say that negative processes in the global economy are developing evenly and consistently, almost without paying attention to calendar features. This does not correspond to the logic of cyclical crises, which usually accelerate first, and slow down to a minimum second.
We consider it important to recall this once again, since any public references to the crisis (which is called exclusively a "recession") appeal precisely to its cyclical nature. This inevitably affects everyone who is forced to make decisions related to the economy, from entrepreneurs to officials, and greatly disorienting these people.
In this regard, we remind you once again: the current crisis is of a structural nature. This determines its features and duration, and understanding this gives a very serious advantage, both competitive and intellectual, to those who have figured out the situation
We rare take a look at something outside of the US and EU, but to show you the global nature of this crisis, take a look at some data of Asia Pacific countries:
In general you could continue this sequence and take a look at performance of other countries, such as Australia by yourself - you will see more or less the same picture across the Globe. The same is about Real Estate market. For example - How UK House Prices Could Fall by 30% or Euro zone business lending growth slows sharply in November.
Officials in almost all countries are showing optimism. The reality, as we can see, is different a bit — the structural crisis continues evenly and inexorably, as it should according to theory. Entrepreneurs already feel something is wrong, but households are also beginning to realize that things are not going well. In any case, the University of Michigan shows record dissatisfaction with the situation:
Life expectancy is dropping either:
Of course we could accuse the Covid -19. But even indirect indicators demonstrate that the situation in the United States (and therefore around the world) is far from optimal. Actually, we show you these graphs to show that, albeit slowly developing, the structural crisis has an extremely negative impact on all components of human life.
It should be noted that the structural crisis can show itself in completely different spheres. So, from September 2021 to June 2022, inflation grew in the United States. But as soon as they began to fight it seriously, industry, construction and retail sales began to fall. Now the US monetary authorities believe that a drop in household demand (that is, in fact, a drop in GDP) is not as dangerous as an overheated economy (high inflation). They do not understand that their target to put inflation down to the required 2% will most likely fail, since the structural component does not respond to the tightening of monetary policy.
Thus, if we continue to fight inflation by tightening monetary policy, then inflation will not fall to the required values, and economic indicators will actively deteriorate. And if this deterioration frightens the political authorities and they begin to maintain the standard of living of the population, then the economic pendulum will swing in the other direction, inflation will begin to rise again, the crisis will begin a new round. In fact, with the anticipation by big banks of Fed easing leads us to this conclusion. Although as Fed as big banks suggest that inflation should decrease by this moment, and this is major difference to our view. In the new 2023 year we will see how events will develop.
Concerning EUR - we suggest that this is temporal growth as EU is an absolute loser of 2022, together with Ukraine and Russia, while major winners are US and China. EUR rate change is going to be faster in Feb and March with two of 0.5% change, while Fed supposedly will change rate for 0.5 and 0.25% correspondingly. But, as this was evidently said, mostly the new balance is priced in. Closer to the end of the IQ 2023 problems start grow as a snowball and could become a real headache for the ECB. Europe could get fruits of tightening earlier than market suggests.
Despite that we're starting the new year, guys, there are not too many things to discuss as market remains quiet in "dead" season between Christmas and New Year's Day. Just few statistics data have been updated. Still there are few things that become more evident as crisis starts showing its "structural" background, not cyclical. While 2022 year has passed under the sign of the struggle against inflation, the 2023 prepares new challenges, that seem more difficult to resolve. Everybody knows that to defeat inflation you have to rise rates (at least its monetary component) but what to do now with negative events in construction, big skew in corporate finances, all time high public consumer loans and breaking of the balance in interest rates structure (between Fed and commercial banks) inside the US - are just a few questions that yet to be answered. And not only answered but somehow demand the solution as it directly impacts the economy.
Market overview
There are few events are worthy to mention this week. First is European Central Bank President Christine Lagarde indicated borrowing costs will increase again, saying this is required to temper soaring consumer-price growth. The ECB raised interest rates by 250 basis-points this year and policymakers including Lagarde have said more hikes are to come, with markets and economists expecting half-point steps at the next two meetings. She also highlighted the ECB’s ever-watchful eye on inflation.
While such rate aggression comes just as an economic downturn takes hold in the region, the ECB president highlighted that the “recession we feared is likely to be short-lived and shallow,” citing her institution’s most recent forecasts.
At the same time, ECB is cutting liquidity with the record tempo. The ECB's balance sheet has shrunk by almost 800 billion euros in 5 weeks. In the week to November 25, the reduction in the balance sheet amounted to 298 billion euros, and in the week to December 23, the balance shrank by a record 491 billion euros.
The entire reduction in the balance sheet is due to the repayment of loans taken by the Eurozone banking system during the pandemic and aggressive lockdowns. Holding of these loans has become unprofitable for banks. There is no sense in paying 2.5% on excess 1.6 trillion euros, which are not used in the real economy.
The tension in the debt markets increases again at the end of the year – rates are rising, liquidity is less and less, the lack of confidence is more and more obvious.
Second important issue that is worthy to mention is Initial claims changing. But we're mostly watching for continues claims. Although employment data is strongly manipulated, and numbers per se are not important, but tendency is the one that we have to pay attention to. Last week of 2022 has not become a surprise either.
The Labor Department found that the number of people receiving benefits after an initial week of aid rose to 1.710 million in the week ending Dec. 17. Those so-called continuing claims, a proxy for hiring, have drifted higher since early October.
United States Continuing Jobless Claims
Another important indicator is a length of work week. It keeps dropping which also suggests sign of recession. Currently it is a bit skewed by holidays, but in Jan-Feb there should be more realistic data.
Also it is worth to mention interesting tendency that looks absolutely contradictive. While it was reported positive GDP and even upside revision of IIIQ numbers, we have drop of companies' revenues on a background of inflation. This is bad combination. As we've shown few times, inflation supposedly is higher than it was reported around 6.5-7%. GDP is mostly book keeping term that could be "slightly adjusted" when needed. With this background we see that as Service companies as manufacturing ones are loosing revenue. With adjustment to inflation the real decrease of revenues is probably higher.
The Fed does the same as ECB - dries liquidity with high tempo. The real money supply in the United States is shrinking at a record pace in history – minus 6.6% YoY compared to the previous anti-record in April 1980 (minus 6.5%) But it is still very far from the complete disposal of the excess money supply formed during the period of monetary and fiscal madness of 2020-2021. Compression should occur for another 13-14%
The deviation of the real money supply from the trend of 2010-2019 by September 2021 was over 25%, the money supply has been declining in real terms for the last year. There are two recycling mechanisms – inflation and forced withdrawal of money supply from the economy/financial system. Now the first mechanism is mainly operating. It is important to note that there is a de-synchronization of expenditures of the population and the money supply in real terms. Usually, with a decrease in M2, expenses also fall (according to the experience of the inflation crisis of the 70s-80s), but now this is not happening.
The out-of-sync is due to record lending rates of the population and record low savings rate as an attempt to compensate for falling incomes and inflationary absorption. However, there is a very limited margin of safety of such a compensation mechanism.
Indeed, as we've shown last time, Fed has limited margin of safety, and already has spent ~ 50% of US Treasury reserves on markets' support since October 2022. They has approximately $350 Bln more that should be enough until March-April, but then the inflation rate will become the hot topic. If 5-5.25% rate doesn't hold inflation but reserves will be spent already, this could force them to turn back to easing again. And big banks already build plans on how and when this should happen. There will be no problems if inflation drops at least to 3-3.5% but what if remains at current levels? We sure with 90% that it remains high. Just because we're in structural crisis, it is not cyclical.
US interest-rate strategists mostly expect that Treasuries will extend their recent rally, dragging yields lower and steepening the curve in the second half of 2023 so long as labor market conditions soften and inflation ebbs. The most bullish forecasts among those published by primary dealer firms — including predictions from Citigroup Inc., Deutsche Bank AG and TD Securities — anticipate that the Federal Reserve will cut its overnight benchmark in 2024. Goldman Sachs Group Inc., which predicts that inflation will stay unacceptably high and that the US economy will avoid a deep recession, has the most bearish forecast.
In addition to the outlook for policy and inflation, expectations about Treasury supply are a key factor shaping forecasts. The supply of new US debt shrank in 2022 but could resume growing if the Fed continues to shed its holdings. Here we mostly should keep an eye on 2-year yield because it better reflects Fed fund rate dynamic.
Every bank gives some comments to forecast, you could read it by link above. The most common comments Citi gives:
JP Morgan suggests that -
But, some banks (RBC Capital) even suggest that 50 bp rate cut could happen as early as in II H of 2023. So, the major question is what inflation will be at the moment when Fed reserves exhaust. Some analysts also worry about it, and this is our opinion either.
In general, the appetite for the dollar was also helped by haven flows, among other factors, as concern about the tightening of global policy weighed on riskier assets along with heightened geopolitical tensions and ongoing concerns around Covid. The possibility of a US recession, risks around China’s Covid reopening, and the possibility of further declines in stocks, of course, have the potential to re-invigorate the appeal of the US currency at some point. For now though, the trend is down, and all eyes will be on how the economic and market landscape plays out in early 2023.
Conclusion
So, let's call it a day, to not bother you too much on Holidays. In general, we could say that negative processes in the global economy are developing evenly and consistently, almost without paying attention to calendar features. This does not correspond to the logic of cyclical crises, which usually accelerate first, and slow down to a minimum second.
We consider it important to recall this once again, since any public references to the crisis (which is called exclusively a "recession") appeal precisely to its cyclical nature. This inevitably affects everyone who is forced to make decisions related to the economy, from entrepreneurs to officials, and greatly disorienting these people.
In this regard, we remind you once again: the current crisis is of a structural nature. This determines its features and duration, and understanding this gives a very serious advantage, both competitive and intellectual, to those who have figured out the situation
We rare take a look at something outside of the US and EU, but to show you the global nature of this crisis, take a look at some data of Asia Pacific countries:
In general you could continue this sequence and take a look at performance of other countries, such as Australia by yourself - you will see more or less the same picture across the Globe. The same is about Real Estate market. For example - How UK House Prices Could Fall by 30% or Euro zone business lending growth slows sharply in November.
Officials in almost all countries are showing optimism. The reality, as we can see, is different a bit — the structural crisis continues evenly and inexorably, as it should according to theory. Entrepreneurs already feel something is wrong, but households are also beginning to realize that things are not going well. In any case, the University of Michigan shows record dissatisfaction with the situation:
Life expectancy is dropping either:
Of course we could accuse the Covid -19. But even indirect indicators demonstrate that the situation in the United States (and therefore around the world) is far from optimal. Actually, we show you these graphs to show that, albeit slowly developing, the structural crisis has an extremely negative impact on all components of human life.
It should be noted that the structural crisis can show itself in completely different spheres. So, from September 2021 to June 2022, inflation grew in the United States. But as soon as they began to fight it seriously, industry, construction and retail sales began to fall. Now the US monetary authorities believe that a drop in household demand (that is, in fact, a drop in GDP) is not as dangerous as an overheated economy (high inflation). They do not understand that their target to put inflation down to the required 2% will most likely fail, since the structural component does not respond to the tightening of monetary policy.
Thus, if we continue to fight inflation by tightening monetary policy, then inflation will not fall to the required values, and economic indicators will actively deteriorate. And if this deterioration frightens the political authorities and they begin to maintain the standard of living of the population, then the economic pendulum will swing in the other direction, inflation will begin to rise again, the crisis will begin a new round. In fact, with the anticipation by big banks of Fed easing leads us to this conclusion. Although as Fed as big banks suggest that inflation should decrease by this moment, and this is major difference to our view. In the new 2023 year we will see how events will develop.
Concerning EUR - we suggest that this is temporal growth as EU is an absolute loser of 2022, together with Ukraine and Russia, while major winners are US and China. EUR rate change is going to be faster in Feb and March with two of 0.5% change, while Fed supposedly will change rate for 0.5 and 0.25% correspondingly. But, as this was evidently said, mostly the new balance is priced in. Closer to the end of the IQ 2023 problems start grow as a snowball and could become a real headache for the ECB. Europe could get fruits of tightening earlier than market suggests.
