Month: March 2023

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

As if the 2020s haven’t been strange enough, the United States military recently shot down several UFOs. Equally bizarre as the possibility of aliens, some investment analysts are projecting an economic no landing scenario. They believe economic activity will easily absorb significant headwinds and chug along.

The last few years have been humbling for economists, the Fed, and investment professionals. In late 2021 no one expected the Fed would raise rates by over 4% within a year and inflation would approach levels last seen 40 years ago. In hindsight, had we or any economist foreseen the future, a recession prediction would have been appropriate. Such has yet to happen, but that doesn’t mean a recession won’t happen. Unfortunately, current monetary policy all but ensures the economic cycle will play out as it always does.

While the economy may seem unpredictable, the economic future is predictable. The no landing scenario assumes economic cycles have ceased to exist. The economic cycle is alive and well. But timing its ups and downs with unprecedented amounts of fiscal and monetary stimulus still flowing through the economy and markets is proving incredibly challenging. 

What is a No Landing Scenario

Unlike a soft landing that envisions the Fed action’s dampening economic growth, the no landing scenario believes the economy will continue to grow at or above the trend growth rate. Such optimism assumes that the Fed’s restrictive monetary policy will not cause the economy to stumble.

GDP, as graphed below, in dollar terms (orange line), paints the picture of an economy constantly growing and essentially free of cycles. However, viewing annual growth rates (blue line) and the trend (dotted blue line), we find that GDP cycles regularly, and the growth trend is steadily declining. To forecast a no landing means you believe the blue GDP growth rate line will flatten and stay linear.

That did occur, to a degree, following the financial crisis (2010-2018), but the Fed pegged interest rates to zero and resorted to multiple rounds of QE at the first sign of trouble. The monetary conditions during that no landing period versus the current period are polar opposites. 

What Drives the Economy?

The economy’s trend growth rate is around 2.0%, well below the rates of prior decades. The Fed predicts the long-run growth rate (beyond 2025) to be 1.8%.

Growth is and has been declining for decades. The two leading factors supporting economic activity, productivity, and demographics, contribute less and less each year to economic activity.

In Capital Neglect is Killing Capitalism, we elaborated on the importance of productivity growth and how the Fed’s aggressive monetary policy in years past has stifled productivity growth.

Not surprisingly, GDP growth followed the declining path of productivity growth. As we share below, it’s possible GDP could run much higher if the pre-1970 productivity trends continued. 

The following graph, also from the article, shows how the trend in productivity growth changed about 50 years ago.

In addition to declining productivity growth, demographic trends in the U.S. and other developed countries are problematic. Population growth among the world’s leading economies is growing at a trickle and, in some cases, starting to decline. Consider the following population growth rates for the top five economies:

• United States +0.1%

• China +0.1%

• Japan -0.5%

• India +0.8%

• Germany 0.0%

Equally alarming is the increase in the elderly population as a percentage of the entire population. For example, the chart below from the United Nations shows the dramatic shift in China’s population between 2015 and forecasts for 2040.

Similar, albeit less severe shifts are expected in the U.S. Declining population growth, and a growing financial dependency by the baby boomers will reduce GDP.

Barring any trend changes in productivity or demographics, we should expect GDP growth to continue to drift lower.

Fed Juice Counteracts Productivity and Demographics

The Fed uses monetary policy to boost the economy and counter the aforementioned deteriorating economic building blocks. Lower interest rates and the accompanying debt-driven consumption grew the economy above its natural growth rate. However, in the wake of this strategy lies a highly leveraged economy that is exceptionally vulnerable to higher interest rates.

The table below shows that debt as a percentage of GDP has risen from 210% to 275% this century. Over the last 22 years, GDP grew by $16 trillion while debt increased by $52 trillion. Is that sustainable?

The more leveraged an economy, the more sensitive it is to interest rate changes. Reducing interest rates makes servicing the debt and repaying the principal easier. However, higher interest rates make servicing and repayment more costly.

We can think of higher interest rates as a tax on the economy. The Fed’s juice of years past, low-interest rates, is being replaced with the highest interest rates in fifteen years. High-interest rates are stifling new debt creation. More importantly, borrowing to repay old debt introduces a financial shock to the borrower and a tax on the economy.

Current Scenario

If the expected growth rate is sub 2% and higher interest rates are and will be extracting a heavy tax on the economy, why is the economy running hot? The answer likely lies in the pandemic-related stimulus and the psychology of consumers. Both stimulus and irregular consumer behaviors support extra growth.

While the no landing crowd likes to think the relatively high economic growth is sustainable, we got news for them. The means supporting such strong economic growth is not likely to continue.

The blue line below shows that personal savings have fallen to a 12-year low. The growth of credit card debt has swelled to a 25+ year high. Unless wages spike higher, many consumers will cut back as savings deplete and credit card limits are reached. Further, higher interest rates on credit cards will reduce their spending ability.

We remind you personal consumption accounts for nearly 70% of economic activity.

Is this Time Different?

The no landing scenario crowd assumes this time is different. Therefore, by default, they argue the graphs and bullet points below are irrelevant.  

• A recession occurred every time the 10-year/ 3-month yield curve inverted and then un-inverted.

• Fed rate hikes have preceded each of the last ten recessions.

• Except once, in 1965, every time the ISM manufacturing index fell below 45, a recession occurred.

• A recession occurred each time the Philadelphia Fed Index was at its current level.

• A reading of over 50% of Deutsche Bank’s recession probability gauge preceded each recession.

• The current level on the 85-factor Chicago Fed National Activity Index (CFNAI) and the OECD leading indicators are commensurate with prior recessions.

Summary

Maybe UFOs have wealthy aliens onboard wanting to buy a lot of stuff and boost our economy. Most likely, those forecasting a no landing have a false sense of optimism as the economy has thus far proven resilient.

Time is not on the no landing scenario’s side. With every passing day, the effect of yesterday’s interest rate hikes will weigh more on the economy. As we wrote in Janet Yellen Should Focus on Hope, understanding the progression of economic activity deterioration and the time lag between monetary policy changes and full consequences helps us appreciate that a no landing scenario is a pipe dream.

We hope for a soft landing but fear the more typical hard landing is the likely course. We caution those who believe the economy is unaffected by interest rates. It is dangerous to believe this time is different!

Washington’s pressure campaign to dissuade China from deepening its ties with Moscow continues to come to naught, and America’s lack of influence over the situation was on full display Wednesday as Belarusian president and close Putin ally Alexander Lukashenko traveled to Beijing in a state visit.

Chinese leader Xi Jinping greeted Lukashenko in Beijing’s Great Hall of the People, after which they discussed deepening their countries’ “all-weather comprehensive strategic partnership”. During the visit the Belarusian leader received the honors of a ceremonial 21-gun salute, performed by China’s People’s Liberation Army in Tiananmen Square.

“The China-Belarus friendship is unbreakably strong,” Xi told Lukashenko, according to Xinhua. He’s the first European leader to visit China on a state visit since Xi secured his third term last year, CNN has noted. “China and Belarus are the joint guarantors of international justice,” Xi declared.

In the meeting Lukashenko reportedly praised China’s 12-point peace plan for solving the Ukraine crisis, saying he “fully supports” the initiative.

Xi during the visit described the ‘position paper’ as follows: “China’s paper on the political solution to the Ukrainian crisis has been released.” He said further according to a state media readout, “The core of China’s position is to promote peace and talks. We must stick to the direction of political settlement, abandon all Cold War mentality, respect the legitimate security concerns of all countries, and build a balanced, effective, and sustainable European security architecture.”

Xi also lashed out at the West, albeit without naming names, as Politico notes: 

He also blamed “certain countries” — a veiled reference to the West — for “politicizing and instrumentalizing the world economy” during the “Ukraine crisis,” calling on them to “genuinely commit to [steps] conducive to a cease-fire and peaceful resolution.”

Additionally, “Xi made no reference to Zelenskyy’s call for a meeting.” Zelensky had floated the idea of an in-person meeting with the Chinese leader while saying that he’s glad that Beijing is finally talking about the Ukraine war and ways to achieve peace. 

Another key outcome of Wednesday’s meeting along with the signing of economic and industrial cooperation agreements, was Lukashenko’s proposal of a unified Russia-China-Belarus industrial policy. 

He called on the Chinese side to enact close cooperation in mechanical engineering and the implementation of joint enterprises, specifically “founding joint ventures in the field of machine tool construction, electric transport, and production of parts for agricultural machinery in both Belarus and China.”

President Xi Jinping held a welcoming ceremony for Belarusian President Alexander Lukashenko in Beijing on Wednesday afternoon. pic.twitter.com/h6MnJAVFQL

— Caoli 曹利 (@Cao_Li_CHN) March 1, 2023

Crucially, some of these areas may include dual purpose tech development, usable in the defense industry. This is sure to grab the Pentagon’s and Biden administration’s attention, especially after the past week saw Secretary of State Antony Blinken issue repeat warnings against China getting in bed with Russia militarily. But now it seems Lukashenko is precisely calling for greater coordination in this area, albeit perhaps under the radar, given the appeal for unifying industries. The Kremlin is meanwhile said to be preparing to host a near future Xi visit to Russia – which will be a huge shot across the bow to Washington, given the symbolism of it happening as the war in Ukraine rages.

* * *

In a note this week, Rabobank highlights the important Xi-Lukashenko meeting and how it fits among some alarming global trends…

First, the new US House committee on the Chinese Communist Party’s threat to America is underway: as I type, witnesses are pushing for a massive increase in US military spending; an urgent investment in Taiwan’s defences; preventing US supply-chain vulnerabilities stemming from China; breaking China’s Great Firewall; and blocking Chinese investment in US agri. Second, the word on the street is that if the White House executive order to impose capital controls on US firms investing in China is more limited than first floated, Congress will impose its own tougher version. Third, the Wall Street Journal reports the US may revoke export licenses for Huawei. Fourth, any US chipmaker given part of the $39bn Federal funding for onshoring is to be banned from expansion in China for a decade.

But it gets worse. Ignored by the mainstream media and most of social media despite officially running in 2024, and some polls showing he could win, former President Trump just launched his trade plan that “takes a SLEDGEHAMMER to Globalism” via “Universal Tariffs” – “Total Independence From China” – “Patriotic Protectionism” – “Reviving Mercantilism for the 21st Century”. In short, his proposed “America First” policy would phase in a system of universal, baseline tariffs on most foreign products, the revenue from which would reduce taxation on firms producing in the US. Moreover, tariffs “would increase incrementally depending on how much individual foreign countries devalue their currency.”

Honestly, I am not shocked. I am sure no other markets Daily uses the word “mercantilism” as freely as this one has for around a decade – I had to explain the word in 2015, and then how pre-WW2 US presidents were mercantilists; when Trump floated his first tariffs, I argued phasing them in to allow onshoring FDI before imported goods got more expensive would be logical; ‘Weaker currency = higher tariffs’ was factored into our report on ‘Balance of payments -and power- crises’; and clearly there is still US momentum to change things even if means breaking things, which we factored into our ‘The World in 2030’ report  – which we may arrive at early; moreover, as argued last year, and this, ‘Bretton Woods 3 Won’t Work’.

As Twitter discussions over this topic continue in less Trumpian size-100 font-all-caps-bold-underlined form, I think @matthew_pines summarizes things, and the arguments in this Daily since 2014, when he notes:

“A key function of the economic system post China-in-WTO has been to allow western capital to (1) arbitrage labor costs & (2) grow FIRE sector to direct resulting USD mercantilist surpluses into scarce, desirable assets (NYC real estate, Ivy degrees, UST/Agencies, farm land).

(1) has just about reached its limit, and (2) will face headwinds (if not outright reversal) for national security and domestic political reasons. What new system will result? TBD, but these shifts typically don’t happen smoothly (or peacefully)…”

That’s as this weekend’s National People’s Congress in Beijing is set to see an overhaul of China’s government agencies, including the PBOC, key industries and sectors, bringing them all directly under the CCP in a “relatively intensified” manner, in Xi’s words. What this means is the CCP, not state institutions, will be running things openly from hereon out. These changes will affect the interests of many, he added. And not only in China.

Meanwhile, things are already the opposite of smooth and peaceful in Russia-Ukraine. Look at headlines like: ‘Lukashenko Proposes Unifying Russia, China, and Belarus’ Industrial Policies’; or ‘Russia’s Medvedev floats idea of pushing back Poland’s borders’; or ‘Putin orders tighter security at Russia-Ukraine border after spate of drone attacks’.

Oil prices are considerably lower again this morning after a major rollercoaster ride higher last night and back down again this morning. This price action follows another big crude build reported by API, and hawkish policy fears sparked by German inflation and US PMIs (prices jumped) all offsetting buying pressure after China reported big jumps in its manufacturing data.

“Oil prices have fallen for the month due to an extremely warm winter in the U.S. and Europe,” Jay Hatfield, chief executive officer at Infrastructure Capital Management, told MarketWatch.

“In addition, recent mixed data on inflation and associated hawkish [Federal Reserve] commentary have been a headwind for oil as the dollar strengthened and stock prices came off of highs.”

Overhanging the market is uncertainty around the global economic outlook as the Federal Reserve and other major central banks continue to push interest rates higher in a bid to rein in inflation, and the signs from week-after-week of inventory increases remains an ominous one.

API

• Crude +6.203mm (+350k exp)

• Cushing +483k

• Gasoline -1.774mm (-300k exp)

• Distillates -341k (-700k exp)

DOE

• Crude +1.166mm  (+350k exp)

• Cushing +307k

• Gasoline -874k (-300k exp)

• Distillates +179k (-700k exp)

Crude stocks rose for the 10th straight week and inventories at the Cushing Hub rose for the 9th straight week. Gasoline inventories drewdown for the 2nd week in a row…

Source: Bloomberg

US Crude inventories are at their highest since May 2021…

Source: Bloomberg

Stocks at the Cushing Hub surged to their highest since June 2021…

Source: Bloomberg

Before we move on, it’s worth reflecting once again on the so-called “adjustment factor” that is used to fudge the numbers in the crude inventory process… it just hit a new high…

Source: Bloomberg

US Crude production was flat at cycle highs despite the drop in rig counts…

Source: Bloomberg

WTI was hovering around $76.75 ahead of the official data and bounced on the smaller crude build (smaller than API reported and BBG’s whisper number of +3mm)

WTI has traded in a broad range between $72 and $83 for the last 3 months.

The US has added around 62mm barrels to its total inventories in the last 10 weeks – that’s on par with the collapse in 2020 and 2015’s chaos…

If Dr.Oil is right, the world is in recession already.

Speaking at a question-and-answer session in Sioux Falls, South Dakota, Minneapolis Fed President Neel Kashkari, who is a voter on the FOMC in 2023, said that he has not yet decided if he will back accelerating the central bank’s interest-rate increases when officials meet later this month, amid signs inflation is not cooling as hoped, and explained why the Fed will not stop until it has started a recession as follows: “if we declare victory too soon, there will be a flood of exuberance and we will need to do even more work.”

“I’m open-minded, at this point, about whether it’s 25 or 50 basis points,” Kashkari said, but noted that to him it is “much more important than whether it’s 25 or 50 is what we signal in what’s called the dot plot,” even though Powell explicitly tried to talk down the predictive power of the dot plot after the Fed’s catastrophic experience in predicting ‘Transitory inflation’ in 2021.

“We’re not yet seeing much of a sign of our interest-rate increases slowing down the services sector of the economy and that is concerning to me,” he said. “Wage growth is at a level that it actually is too high to be consistent with our” 2% inflation target.

Some other highlights from Kashkari’s speech courtesy of Bloomberg:

• *KASHKARI: DON’T WANT RECESSION BUT SLOWING INFLATION IS JOB ONE
• *KASHKARI: DON’T OVERREACT TO ONE MONTH OF DATA
• *KASHKARI: I LEAN TOWARDS CONTINUING TO HIKE RATES FURTHER
• *KASHKARI: US ECONOMY IS NOT IN A RECESSION RIGHT NOW
• *KASHKARI: DON’T KNOW IF FED CAN ACHIEVE A SOFT ECONOMIC LANDING
• *KASHKARI: SOME GROUNDS FOR OPTIMISM BUT WE MUST COOL INFLATION

Perhaps the most interesting comment was Kashkari’s admission that if the Fed declares “victory too soon, there will be a flood of exuberance” and it will need to do even more work, a reference to the Fed’s catastrophic policy error during the Burns Fed. Of course, while Volcker managed to finally contain inflation when he hiked rates to 20%, he also sparked the worst recession since the Great Depression. Will Powell be able to do the same knowing he will be crucified – metaphorically we hope – by Democrats who can’t afford a surge in unemployment ahead of the Nov 2024 elections.

In any case, minutes from the January discount rate meetings showed that directors from the Minneapolis Fed favored a 50 basis point hike in that rate. Those votes are typically a proxy for how the president would like to vote on the federal funds rate at the upcoming Federal Open Market Committee meeting.

Separately, minutes from the Jan. 31-Feb. 1 FOMC meeting showed that “a few” participants favored or could have supported a 50 basis point hike. But Kashkari, despite his bombastic, hawkish rhetoric, decided to cover his ass, and to joined his colleagues in voting for the 25 basis point increase.

Authored by Jill McLaughlin via The Epoch Times,

Gov. Gavin Newsom ended his use of COVID emergency powers Feb. 28, three years after the virus first appeared in California.

The milestone ended 1,090 days of operating under special powers that allowed Newsom to make unilateral decisions about the state’s response to the pandemic.

“Throughout the pandemic, we’ve been guided by the science and data—moving quickly and strategically to save lives,” Newsom said in a press release.

“The State of Emergency was an effective and necessary tool that we utilized to protect our state, and we wouldn’t have gotten to this point without it.”

Rep. Kevin Kiley (R-Calif.) told The Epoch Times the separation of powers must be restored following the end of the emergency.

“From years of learning loss from students kept out of classrooms and countless businesses and jobs destroyed, to a loss of our basic freedoms, rarely in our history has a single person caused so much harm to so many,” Kiley said in an email. “We must finally begin to restore the separation of powers that is central to our constitutional form of government.”

Some policy experts thought the powers should have ended long before today.

“I think it’s wonderful that the state is finally coming to its senses and returning life to normal, and I’m looking forward to the federal government doing the same in May,” Marc Joffe, a policy analyst at the CATO institute, a libertarian think tank, told The Epoch Times.

“I think it should have been done a long time ago. An emergency really is something that should go on for a few weeks, not a few months or years.”

Although the state’s response allowed the distribution of stimulus funds, many residents and businesses criticized Newsom for issuing several mandates, including requiring masks, closing businesses, and locking down residents and schools.

Some policies implemented during the emergency were good, Joffe said, including allowing out-of-state doctors to practice in California, but they shouldn’t have been enacted using an emergency declaration, he said.

However, imposing lockdowns, mask-wearing, and vaccine mandates were an abuse of power, Joffe said.

In 2021, Newsom issued a mandate to require COVID-19 vaccines and testing in schools. The state withdrew the policy last April.

By terminating the emergency, school vaccines will also no longer be required.

Most of the pandemic restrictions Newsom put in place have already been lifted but some had long-lasting effects. Schools were closed and required students and teachers to use remote learning for more than a year during the emergency, contributing to historically low test scores.

Public sentiment over the strict policies also fueled a recall effort launched in 2021 against the governor, which he easily won to retain his job with more than 60 percent of the vote.

Mike Netter, who spearheaded the recall effort, said the end of the emergency was well overdue.

“Today is a special day in California … California’s COVID-19 emergency is finally over,” Netter posted on Twitter.

“While every other state ended their emergency, Gavin Newsom continued using emergency powers that undermined fundamental principles of free government.”

During the declared health emergency, the governor used his powers to distribute federal stimulus funds for several programs, including $18.5 billion in direct payments to Californians, $8 billion for rent relief, $10 billion for small business grants and tax relief, and $2.8 billion to help residents with overdue utility bills.

Billions of dollars were also given to support hospitals, community organizations, frontline workers, and schools.

As of Feb. 23, California reported 11.1 million cases of COVID-19 and attributed 100,187 deaths to the virus. The state also administered more than 88.1 million vaccines, according to the state’s Department of Public Health.

Now California will use another strategy called the SMARTER Plan (pdf), to continue responding to the virus, Newsom said. The plan calls for continued use of vaccine recommendations, mask requirements for health care and long-term care facilities, and encouraging testing.

Newsom was one of only a few governors who continued operating under pandemic-era emergency powers this year.

…

New Mexico, Illinois, Rhode Island, and Texas governors have not yet ended their emergency orders despite public pressure to do so.

…

Read more here…

Despite the market’s ‘tightening’ of policy, February saw US Macro data surprising dramatically and serially to the upside and while many of the regional Fed surveys have signaled economic slowdowns, the national Manufacturing survey data from ISM and PMI today were expected to rise (but both to remain in contraction sub-50).

S&P Global’s US Manufacturing PMI February final printed 47.4, below the flash 47.7, but above January’s 46.9

ISM’s US Manufacturing February printed , versus expectations of 48.0, from January’s 47.4

Source: Bloomberg

That is the 4th straight month of US Manufacturing contraction (sub-50 prints) with S&P Global seeing slowing orders, weaker production, and prices re-accelerating. ISM data also showed a huge jump in Prices Paid, back above 50, while new orders rose but remain below 50 for the 6th straight month…

Source: Bloomberg

All of the ISM Manufacturing’s drivers were negative MoM…

Which is reflected in the respondents’ comments:

• “Expect the first half of 2023 in the U.S. to be slower than the second half. Expect slower orders throughout 2023 for Europe.”

• “A slowdown in new housing construction and concerns of a slowing economy have customers delaying purchases in an effort to destock.”

• “Business and new orders are softening, and customers are pushing out current orders.”

Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, said:

“US manufacturing remained under intense pressure in February. Although the PMI rose slightly, it continues to signal the steepest downturn outside of pandemic lockdown months since 2009.

“Moreover, some of the improvement in output could merely be attributed to faster supplier delivery times, which quickened to the greatest extent since 2009 to facilitate higher production and enable factories to work through previously placed orders. The worry is that new order inflows continue to fall sharply as many companies report disappointing sales, linked in part to a sustained trend towards cost-saving inventory reduction and low levels of confidence at their customers, both at home and abroad. None of this points to a healthy economic situation.

“There was some brighter news in that factory jobs growth picked up slightly amid reports of greater success in filling vacancies, and the improvement in supply chains helped reduce input cost inflation. However, rising wage pressures and efforts to raise margins meant average prices for goods leaving the factory gate rose sharply once again, the rate of inflation accelerating for a second straight month to hint at stubbornly high price pressures.”

So, slower growth and re-accelerating inflation – that’s not what The Fed ordered!