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Wednesday, March 8, 2023

2023-03-08

 *** denotes well-worth reading in full at source (even if excerpted extensively here)


Economic and Market Fare:


Yes: Federal Reserve Chairman Powell was very hawkish at his Congressional testimony on Tuesday and Wednesday. He clearly signaled (again) that once Fed overnight policy rates reach a peak, they would not be declining for a while. He additionally signaled that the peak probably will be higher than previously signaled (I’ve been saying and thinking 5% for a while, but it’s going to be higher), and even signaled the increasing likelihood of a return to 50bp hikes after the recent deceleration to 25bps.

This latter point, in my view, is the least likely since all of the reasons for the step down to 25bps remain valid: whether the peak is 5% or 6%, it is relatively nearby and the confidence that we should have that rates have not risen enough should therefore be decreasing rapidly. Moreover, since monetary policy works with a lag and there has been very little lag since the aggressive tightening campaign began, it would be reasonable to slow down or stop to assess the effect that prior hikes have had.

But here is the bigger point, and one that Powell did not broach. There is really not much evidence at all that the Fed’s hikes to date have affected inflation. It is completely an article of faith that they surely will, but this is not the same as saying that they have. ....



The credit and the stock markets are telegraphing a message of caution on how global financial assets and the economy may evolve.

The spread between BBB rated dollar-denominated corporate debt and the earnings available on the S&P 500 Index of stocks is now above zero for the first time since the global financial crisis. The average yield on investment-grade bonds is 5.77%, compared with an estimated earnings yield of 5.42% on the S&P

The differential is typically negative, reflecting the higher risk of capital that is invested in equities even as corporate bond yields stay elevated. However, when speculative money flocks into equities, it turns positive, suggesting that investors may be overlooking the risk embedded in stocks.

The spread turned positive during the days of the dot-com boom, peaking at about 470 basis points before the bubble burst. It again turned positive in the run-up to the financial crisis, reaching almost 215 basis points. Neither of those movies ended well.




Half a million jobs were added according the the January employment report, yet the raw data suggests it was more a case of warm weather reducing the ususal seasonal firings with favourable seasonal adjustments providing an additional boost. February is likely to revert to the 200k trend with downside risks for coming months as lay-offs rise .....

.... This first thing to say is that the US economy certainly didn’t add 517,000 jobs in January. January is a month where millions of people lose their jobs. ......



***** Prometheus: Month In Macro
February Edition

....... As we have mentioned here previously, we are at a complex junction in the macroeconomic cycle. Initial conditions have been met to expect contractionary GDP over the next six months. The most recent data has run counter to these expectations. However, after a thorough assessment, we think it makes sense for us to maintain our expectations for contractionary GDP. The transition into a contraction is not something that can be perfectly estimated. Still, we have a solid understanding of the pressures in place and how conditions will likely transpire. This is not a time for excessive risk-taking and is unlikely to be the beginning of an acceleration in cyclical activity. Patience pays. We discuss all this and more in the pages that follow. ........
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Above, we showcase our measure of the slack in building permit relative to its economic cycle peak. As we can see, the current weakening of permits is consistent with pressures that lead to a contraction in economic activity. We see further indications of this weakening of the construction sector in the form of unstarted projects. While permit activity can often occur as expectations for activity and financing remain positive, the spending impact occurs when these projects are initiated. As economic conditions and demand fall short of expectations, unstarted projects rise, i.e., construction slack rises. We show our tracking of this construction slack below: 


Calculated Risk: Pandemic Economics, Housing and Monetary Policy: Part I

Pandemic economic outcomes were frequently largely unexpected. 
For example, early in the pandemic, there was a shortage of toilet paper. Since there are two supply chains for toilet paper - one residential and the other commercial - and many more people were using the bathroom at home instead of at the office, there was a shortage of residential toilet paper. This led to some hoarding too and that exacerbated the shortage. 

More generally, in 2020, we saw a surge in spending on goods as many services were shut down. With fiscal policy supporting incomes, the increase in demand for goods eventually led to an increase in prices as inventories were depleted. ....

.... Clearly Powell believes service-related price increases will not as transitory as goods and commodities and will require “some softening in labor market conditions”. The FOMC is clearly committed to further raising rates to curb inflation.

..... The Economic Fireworks have been in Housing!

........ In Part II, I’ll discuss what I think will happen with housing going forward and - since housing is the key transmission mechanism for monetary policy - the implications for Fed policy. I’ll suggest some out of consensus possibilities!



Does persistently loose monetary policy breed financial fragility? And if so, why? Scholars and policymakers alike blamed loose monetary policy for the boom-bust that culminated in the Global Financial Crisis (Geithner, 2009; Taylor, 2011) and warned again in its aftermath “that a long period of low interest rates. . . could undermine financial stability” (Bernanke, 2013; Stein, 2013). However, despite the large adverse macroeconomic (Cerra and Saxena, 2008; Reinhart and Rogoff, 2009; Jorda, Schularick, and Taylor ` , 2013) and political (Funke, Schularick, and Trebesch, 2016; Doerr, Gissler, Peydro, and Voth ´ , 2022) consequences of financial crises, there is no systematic empirical study that analyzes the link between the stance of monetary policy and macro-level financial stability. 

This is not to say that the question has been ignored by the literature. On the contrary, there have been many micro-level empirical studies (to be discussed shortly) showing the causal effect of loose monetary policy on increased risk-taking by financial institutions and households. Such behavior by individual financial market participants can be theoretically justified (as we note below). However, it is unclear how individual actions aggregate up. We still do not know if this well-identified, micro-level evidence translates into measurable, or even dangerous, macro-level financial instability (Boyarchenko, Favara, and Schularick, 2022). This study fills this gap in the literature using macro-financial data for advanced economies over the past 150 years. 

How do we know if interest rates are “too low for too long”—or, more specifically, if monetary policy is too loose? Ever since Wicksell (1898), macroeconomists have generally understood the equilibrium or natural real rate r∗ to be that which leaves a fully flexible economy at full employment with stable inflation. Thus, as in the literature on policy rules, deviations of the real policy rate from the natural rate are a measure of monetary policy stance, or stance = r – r∗. A loose monetary policy is when stance < 0. Thus, to operationalize this idea, an important element of our study is to put together, as a first step, measures of r∗ for the very long run. Building on that, we are the first to show that, as a causal matter, a loose stance has strong implications for medium-term financial instability ......


Sellers’ Inflation, Profits, and Conflict: Why Can Large Firms Hike Prices in an Emergency?
Abstract
The dominant view of inflation holds that it is macroeconomic in origin and must always be tackled with macroeconomic tightening. In contrast, we argue that the US COVID-19 inflation is predominantly a sellers’ inflation that derives from microeconomic origins, namely the ability of firms with market power to hike prices. Such firms are price makers, but they only engage in price hikes if they expect their competitors to do the same. This requires an implicit agreement which can be coordinated by sector-wide cost shocks and supply bottlenecks. We review the long-standing literature on price-setting in concentrated markets and survey earnings calls and compile firm-level data to derive a three-stage heuristic of the inflationary process: (1) Rising prices in systemically significant upstream sectors due to commodity market dynamics or bottlenecks create windfall profits and provide an impulse for further price hikes. (2) To protect profit margins from rising costs, downstream sectors propagate, or in cases of temporary monopolies due to bottlenecks, amplify price pressures. (3) Labor responds by trying to fend off real wage declines in the conflict stage. We argue that such sellers’ inflation generates a general price rise which may be transitory, but can also lead to self-sustaining inflationary spirals under certain conditions. Policy should aim to contain price hikes at the impulse stage to prevent inflation from the onset.


hmmm, wasnt expecting this:



Leading venture capital players are predicting a “mass extinction event” for early- and mid-stage startups that will make the global fiscal collapse in 2008 “look quaint” by comparison. According to Globest, a new survey has found that 81% of early-stage startups are facing a failure in 2023 because—as of the end of October—they had less than 12 months of capital left to keep going because VC funds turned the spigot off last year on a flood of seed funding.


Brokerages report significant losses and assets in distress


  1. China’s economic development model resembles that of Japan over 30 years ago with high savings, and high investment, but with restrained consumption and rigid institutions weighing increasingly on macroeconomic success.
  2. China’s chronic over-investment and misallocation of capital, particularly in the property sector, pose a potentially bigger economic problem than Japan’s banking crisis in the 1990s.
  3. China has some advantages over Japan, such as a state-owned financial system that can prevent significant banks from failing and a closed capital account that can protect the country’s banking system  and the economy from the risk of significant capital flight. This however might not prevent China from taking the same economic trajectory Japan has.
...................................... Both countries’ economic tipping points were heralded by rapid ageing, as measured by the peak in the support ratio (of working age adults per retiree), but the effects are more immediate in China at much lower levels of income per head. Cue ‘getting old before you get rich’ debate.

Unlike Japan, China is a geopolitical rival of the US and other liberal-leaning democracies, and faces a hostile external environment, comprising export controls, including most recently on high-end semiconductors on which China is heavily dependent, sanctions, and other commercial restraints.

Finally, and interestingly, until the Japan bubble burst in 1990 and even afterwards, Americans regarded Japan as an innovative, long-term thinking nation that was economically superior and technologically more advanced. Racked by resentment and worry, officials and commentators feared it would go on to overwhelm and overtake their own country.

It didn’t quite work out that way for Japan. Bearing in mind the striking familiarities between the structure and behaviour of 1990s Japan and 2020s China, and even some of the differences, it might not for China either.



Bubble Fare:

Coppola: Lessons from the disaster engulfing Silvergate Capital

This is the story of a bank that put all its eggs into an emerging digital basket, believing that providing non-interest-bearing deposit and payment services to crypto exchanges and platforms would be a nice little earner, while completely failing to understand the extraordinary risks involved with such a venture. 

On 1st March, Silvergate Capital Corporation announced that filing of its audited full-year accounts would be significantly delayed, and warned that its financial position had materially changed for the worse since the publication of its provisional results on January 17th, when it reported a full-year loss of nearly $1bn. The stock price promptly tanked, falling 60% during the day ...

.......... And it reveals an underlying fragility that raises serious questions about the business models of banks involved with crypto. .......



Quotes of the Week:

Mish: A Fed study shows the obvious... But Fed presidents never believe the few studies that ever make any sense...


UBS' Donovan: In the US today, a non-economist will attempt to explain to a collection of non-economists the extraordinary complexity of an economy undergoing dramatic structural change. The questioning will be mainly partisan point scoring. The question Fed Chair Powell needs to be asked is “what do you think you are doing?”. Powell has yet to explain how raising rates will tackle profit-led inflation. Pursuing higher unemployment seems an ineffective response…


DB's Reid: Bear in mind that on all the previous occasions that the 2s10s has been more than -100bps inverted since data is available from the early 1940s (1969, 1979, 1980 and 1981) a recession has either been underway, or has occurred within a maximum of 8 months. To highlight the rarity of such an occurrence, there have only been 7-month end closes lower than -100bps in 80 years of available data. So we are in rarefied air.


Rosie1: Equities are reversing course today but come on. Show me one thing in Powell’s testimony that we didn’t already know. Him saying nothing new is more impactful for Mr. Market than five successive quarters of negative EPS growth?


Boockvar: While Jay Powell continues to feed the rates market more gummies, not appreciating the time delay feature, nor the shock of a vertical rise in rates in just one year and that positive real rates for a while will itself be a continued form of monetary tightening, the Bank of Canada is expected to sit on its hands today, keeping its overnight rate at 4.5%.


Rosie2: Powell’s hawkish tone and Macklem’s conditional pause (on display at 10 AM) means it’s hunting season for loonies.


Thorne: Fed is walking the global economy into a credit crisis.



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*** excellent thread, recommend reading in full...


Vid Fare:


couple of great quotes just from the first 3 minutes:
"he's gone from transitory to disingenuous"
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"it is AMAZING to me the damage that central bankers are going to do"



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(not just) for the ESG crowd:

Is Larry Fink a threat to democracy?



There’s a big push among many resource-producing nations to move down the supply chain, taking advantage of the near- and re-shoring craze. 

Rather than merely supplying the raw materials upstream in the supply chain, for example, the resource producers are looking to move into higher-value-added activities, such as manufacturing batteries, and eventually, the EVs that pack those lithium batteries.

Bloomberg reports that the Chinese carmaker Chery Inc. is looking at building a $400 million EV and battery plant in Argentina to secure Andean lithium supplies, which reflects a global trend by resource-rich nations to move away from just being just merely suppliers of the commodities, the inputs into higher valued added downstream products. ...



With many automakers transitioning from petrol-powered vehicles to electrified ones, Porsche and Ferrari are pursuing a new strategy by concentrating on the advancement of eFuels to preserve gas-powered engines. This decision follows the European Commission's delay last week of the proposed 2035 ban on new internal combustion engine vehicles as the commission prepares to carve out a role for eFuels after 2035.







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