*** denotes well-worth reading in full at source (even if excerpted extensively here)
Economic and Market Fare:
....... We find the following to be the base-case now:
- The Fed will hike by 25bps to try and regain control of the narrative
- The Fed will soon thereafter admit to it being a mistake and communicate an end-date for QT
- Emergency cuts are in play already before the May meeting, if the crisis accelerates
- 200 bps worth of cuts to arrive before 2024
When it comes to the Morgan Stanley house view, it's not just Michael Wilson that is borderline apocalyptic, most recently warning on Monday of a "vicious" end to the bear market, one which drags stocks to fresh cycle lows: it appears that the bank's global head of research, Katy Hubary, is not too far behind.
In her latest weekly closely read "Charts that Caught my Eye" report (available to pro subs here), she writes that there has been a lot of market debate over the past year about whether yield curve inversion, which historically has been a precursor of US recessions, meant that a recession was inevitable this time, in light of key idiosyncrasies in the current environment.
She then points to an "interesting section" of the bank's Cross-Asset Strategy team’s latest dispatch which examines the confluence of five macro developments that, like inversion, are consistent with a strong economy that is starting to slow and leads to a sharp drop in risk assets:
- S&P 500 forward earnings are declining relative to three months ago;
- The yield curve is inverted (or has been over the last 12 months);
- Unemployment is below average;
- US Manufacturing PMIs are below 50; and
- More than 40% of US banks, on net, are tightening lending standards.
Pointing to the chart below, which shows that these five events tend to cluster just before major market crises (2007, 2001) that "all five are in place today, which is rare" .....
The Fed’s actions to stave off the banking crisis should not be taken as a loosening in financial conditions – far less QE – and in fact tighter conditions should be expected.
The banking crisis led to an almost $300 billion rise in the Fed’s balance sheet last week, reversing almost half of the decline since QT began last June. But even more relevant is the change in reserves. Reserves are generally higher velocity, and therefore the true economic and financial impact from QT comes from the changes in reserves. Reserves are now actually higher than they were before QT began. ....
via the BondBeat: Donovan: What is profit-led inflation?
- Developed economies have had three waves of inflation since the pandemic: transitory inflation for durable goods; commodity inflation; and finally profit margin-led inflation.
- Profit margin-led inflation is not caused by a supply-demand imbalance. Profit margin-led inflation is when some companies spin a story that convinces customers that price increases are "fair," when in fact they disguise profit margin expansion.
- Technically, companies are able to use stories to reduce their customer's price elasticity of demand.
- Raising rates to reduce demand will eventually squeeze profit margin-led inflation, but it is a crude and unnecessarily destructive policy approach. Convincing consumers not to passively accept the price increases is a potentially faster and less destructive way of reversing profit margin-led inflation. Social media might have a role to play in this process.
… The leap up in US retailers’ profits as a share of GDP is exactly what is expected in a profit-margin inflation episode. For over a decade, pricing power was moderate, and the amount of profit retailers took was fairly steady. But in the second quarter of 2021, as the economy reopened, US retailers were able to persuade consumers to accept far higher prices. At the same time, retailers were able to keep down wage costs, and so profit margins exploded.
Prometheus: Cyclical Outlook
Tightening Liquidity + Recession Signal = Short Equities?
.................... While many today have been focused on the here-and-now of the financial system, our systematic approach has kept us abreast of economic developments, where we see further evidence of recessionary conditions emerging. Below, we show our monthly estimates of real GDP along with official GDP data. Additionally, we offer a projection for real GDP based on historical analogs. Finally, we offer in the shaded areas our systematic regime recognition of recessionary conditions, which allows us to estimate impending recessions:
.............. The combination of these factors leads us to believe that the criteria for future recessionary conditions have been met. Now, while many may suggest that the labor market has not indicated recession, we think it is important to recognize that by the time labor markets have confirmed recession, the opportunity to profit from it in markets is long gone. Therefore, to profit from recessionary conditions, we need to be positioned before labor market weakness, not after. Below, we show one of our Prometheus Cycle Strategies, which applies the concepts discussed here to trade markets. The intuition of the strategy is straightforward; as recessionary conditions as described above build, we seek to short stock markets; otherwise, we remain long. We show the cumulative performance below: ...
As we can see, this approach has been an able guide in navigating recessions. This strategy has turned short this month. Keep in mind this strategy only trades real growth contractions— not inflation, liquidity, or other factors. Based upon our construction of this regime recognition, it is unlikely we will experience whipsaw in the recession signal, i.e., it is highly likely to persist. If so, forward-looking equity returns are likely to be weak at best, significantly negative at worst. Until next time.
Federal Reserve Chair Jerome Powell and his entire team should be cognizant of the fact that rents have been declining for many months. Despite this, Powell has been examining laggard data that persistently appears inflated.
The latest CoreLogic report adds to the mounting evidence of leading rental market indicators showing rent inflation has been cooling for the ninth consecutive month in January, as the yearly growth rate slid to the lowest point since 2021. ...
In an uncertain economy, companies post ads for jobs they might not really be trying to fill
***** Keen: The Fractured Fairy Tales That Led To Today’s Banking Crisis
Mitchell: Former Bank of Japan governor challenges the current monetary policy consensus
Bubble Fare:
In the latest IMF Finance and Development journal (March 2023), there is an interesting article by the former governor of the Bank of Japan, Masaaki Shirakawa – It’s time to rethink the foundation and framework of monetary policy. It goes to the heart of the complete confusion that is now being demonstrated by central bank policy makers. With their ‘one trick pony’ interest rate attacks on inflation, not only have they been inconsequential in dealing with that target (the so-called price stability responsibility), but, in failing there, they have undermined the achievement of the other central bank target (financial stability) and probably worsened the chances of sustaining the third target (full employment). Sounds like a mess – and it is. We are witnessing what happens when Groupthink finally takes over an academic discipline and the policy making space. Blind, unidirectional policies, based on a failed framework, steadily undermining all the major goals – that is where we are right now. And not unsurprisingly, those who have previously preached the doctrine are now crossing the line and joining with those who predicted this mess. ........
Bubble Fare:
***** Hussman: Edge of the Edge
The simplest thing that can be said about current financial market and banking conditions is this: the unwinding of this Fed-induced, yield-seeking speculative bubble is proceeding as one would expect, and it’s not over by a longshot.
I expect that FDIC-insured, and even most uninsured bank deposits will be fine. I also expect that hedged investments will be fine. In contrast, a great deal of market capitalization that passive investors count as “wealth” will likely evaporate, possibly including steep losses to bank shareholders and unsecured bondholders. Investors and policy-makers have confused speculation and extreme valuations with “wealth creation,” but it never was. A parade of seemingly independent “crises” will emerge as this bubble unwinds, including bank failures, pension strains, and market collapses, but they all have the same origin.
The chart below shows our estimate of likely 12-year total returns for a conventional passive investment mix invested 60% in the S&P 500, 30% in Treasury bonds, and 10% in Treasury bills, along with actual subsequent total returns. At present, this estimate stands at just 1.03%, matching the level of August 1929. By contrast, the average return for this conventional portfolio mix across history is just over 7% annually, which is where current pension return assumptions stand. That’s another way of saying that investors are setting their return assumptions based on average historical returns, ignoring the valuations that actually drive those returns. As explained in more detail at the end of this comment, I continue to expect a loss on the order of -58% in the S&P 500, from current levels, over the completion of this cycle. Nothing in our investment discipline relies on that outcome, but having correctly anticipated the extent of the 2000-2002 and 2007-2009 collapses, it’s best not to rule it out.
Notice that by late-2021, a decade of speculation by yield-starved investors had driven prospective investment returns to negative levels. That’s something that didn’t even occur at the 1929 and 2000 extremes. The sudden crises and financial strains emerging today are just the consequences of the extreme valuations and inadequate risk-premiums engineered by reckless zero-interest rate policies. .........
.......... In addition, during today's press release, Powell asserted that Silicon Valley bank collapse was an "outlier". So he is ignoring all of the dominoes falling, exactly as the Fed did in September 2008 when Lehman failed
As we know, Treasury Secretary Janet Yellen was there in that exact same FOMC meeting back in September 2008. Today, in her testimony to Congress, after weeks of vacillation she said that there is no plan to implement blanket FDIC insurance: .......
Banking Fare:
Lessons should be drawn from how the crisis at the bank developed
The incompetence of our financial regulators, most of all the Fed, is breathtaking. The great unwashed public and even wrongly-positioned members of the capitalist classes are suffering the consequences of Fed and other central banks being too fast out of the gate in unwinding years of asset-price goosing policies, namely QE and super low interest rates. The dislocations are proving to be worse than investors anticipated, apparently due to some banks having long-standing risk management and other weaknesses further stressed, and other banks that should have been able to navigate interest rate increases revealing themselves to be managed by monkeys.
What is happening now is the worst sort of policy meets supervisory failure, of not anticipating that the rapid rate increases would break some banks.1 Here we are, in less than two weeks, at close to the same level of bank failures as in the 2007-2008 financial crisis.
As we’ll explain in due course, the regulators’ habitual “bailout now, think about what if anything to do about taxpayer/systemic protection later” is the worst imaginable response to this mess. For instance, US authorities have put in place what is very close to a full backstop of uninsured deposits (with ironically a first failer, First Republic, with its deviant muni-bond-heavy balance sheet falling between the cracks). But they are not willing to say that. So many uninsured depositors remained in freakout mode, not understanding how the facilities work. Yet the close-to-complete backstop of uninsured deposits amounted to another massive extension of the bank safety net. ...............
.................
Of course, the Fed could have addressed the problem of interest rate increase overshoot directly by cutting interest rates by 50 basis points and making noises that quantitative tightening was on hold for the moment. But panic is too far advanced for that sort of simple intervention to now have much impact.
Finally, back to a main point, that yet more subsidies of banks will simply enable more incompetence and looting absent getting bloody-minded regulators, a prospect that seems vanishingly unlikely.
Elizabeth Warren is again taking up her bully pulpit of calling for more bank reform, but technocratic fixes are inadequate with a culture of timid enforcement. The only remedy in all the years I have read about that might have a real impact quickly creates real skin in the game. It proposed by of all people former Goldmanite, later head of the New York Fed William Dudley.
Dudley recommended putting most of executive and board bonuses in a deferred account, IIRC on a rolling five-year basis. If a bank failed, was merged as part of a regulatory intervention, or wound up getting government support, the deferred bonus pool would be liquidated first, even before shareholder equity. Skin in the game would do a lot more to curb reckless behavior than complex new rules. Of course, Dudley’s proposal landed like a lead balloon.
DiMartino Booth: Too Small to Not Fail
A Short History of the World
................................. As I often quote, the global nonbanking financial sector was $220 trillion as of the end of 2020; that compares to $180 trillion in the regulated conventional global banking sector.
How are we to have any inkling as to what the effect of high interest rates, illiquidity and a global recession is in a mammoth sector that regulators can’t even see? Private capital is exponentially more dependent on ZIRP. We’ve only just begun to see risk bubble to the surface in the lowest rated publicly traded credit. The default and bankruptcy cycles have barely started.
What is visible is the deep freeze securitization is entering, which poses an existential risk to the U.S. auto and commercial real estate markets. ........................
Yves here. This is deceptively important post. We’ve regularly mentioned that mainstream economists and the monetary economists at the Fed and presumably many other central banks adhere to the “loanable funds” theory of investment and lending. That model posits that loans come from a pre-existing pool of savings. The credit view, which the Bank of England, and even Greenspan and Bernanke have effectively admitted is how things really work, is that banks create loans out of thin air, and simultaneously, the related deposit. The check on this process is the cost of money (the central bank’s policy rate). This model, unlike the loanable funds story, explains how central bank policy influences credit and money supply growth.
Recent research has shown that the stance of monetary policy can influence financial stability. This column provides an explanation for the effects of monetary policy on credit growth based on a ‘credit creation theory of banking’. In this framework, ‘funds’ are liquid bank deposits created by the banking system independently of private saving(s). The central bank policy rate has a direct effect on credit supply by influencing the refinancing costs of banks. This provides a clear mechanism through which central banks can influence bank lending and financial stability. .............
Quotes of the Week:
StenoLarsen: First, “there is nothing to see here, but we are monitoring the situation closely”. Second, “this bank is an outlier, and the system is fine”. Third, “we will add liquidity as a safeguarding measure, but we don’t see broad-based risks.” We are slowly but surely seeing the first stages of the crisis playbook unfolding and the next steps are likely to follow in coming weeks even if central banks are not admitting to it yet.
Levitin: There's talk about removing the FDIC deposit insurance caps in response to the "Panic of 2023"®. There's a refreshing realism about such a move. But let's also be clear about the distributional impact of such a move: it's a huge cross-subsidy from average Joes to wealthy individuals and businesses.
Levitin: The idea that regulators simply will not order abandon ship until the bow is below water is reinforced by the history of regulatory (inaction) on all sorts of other legal violations by banks, be it for AML or consumer protection. Exhibit A here is Wells Fargo, a repeat recidivist, still having a charter. If regulators will not take away the charter of a bank that engages in repeated and egregious violations of law, when will they ever do so?
Charts:
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(not just) for the ESG crowd:
Summary for Policymakers
The failure of the Swiss bank leaves a hole in the debt-for-nature market that analysts said could one day exceed $800 billion.
The collapse of Credit Suisse isn’t just worrying for the global financial system. It’s a banking crisis that also has real consequences for the fight against environmental degradation.
Before its rescue by Swiss rival UBS, Credit Suisse had quietly become a major player in an obscure market that purports to help developing countries ease their debt burdens in exchange for protecting nature. Known as debt-for-nature swaps, the complex financial instruments help governments restructure their debt to raise money that can be used to fund conservation efforts.
Credit Suisse was the sole structurer and arranger of the world’s largest debt-for-nature swap, a $364 million deal that it orchestrated in 2021 along with The Nature Conservancy, a charity, for Belize. Last year, it sealed another $150 million deal for Barbados. ....
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