Fantasy

Markets are heading for the moon, apparently based on a very small downtick in CPI inflation last month. Mostly this was due to a 3.5% drop in the energy price component, as Biden cranked up the pumps draining the SPR and the price of gasoline fell 11.7%.

Meanwhile, back in the real world, “the Atlanta Fed’s Wage Growth Tracker was 6.4 percent in March, up from 6.1 percent in February. For people who changed jobs, the Tracker in March was 7.3 percent, compared to 6.7 percent in February.”

On April 2 OPEC+ announced a major cutback in production so that USO, the oil ETF, is already up 5.6% this month. Two weeks ago, commercial traders were at their lowest net short position as a group since 2016. This means that they are not willing to take those prices for their future deliveries.

And of course the federal deficit spend continues to rise. As of the end of March, the first 6 months of FY23, the cumulative deficit was $1.1 trillion, compared to $668 billion in the same period last year.

In other words, good luck with the moonshot. The fall back to earth will be a Deusy.

Edit: Added the price change of gasoline in context.

Honne And Tatemae

There are many financial conditions indexes, but in general terms they represent the cost and availability of credit and equity financing, interpreted as relatively “tighter” or “loose, easy”. Markets were surprised that Powell appeared unconcerned that these indexes showed that financial conditions were more or less unchanged by the Fed’s rate and QT actions. His unconcern was interpreted as conceding that the bulls were right in believing that rates would soon come down.

My interpretation was that he simply didn’t think it was a problem. One of the Fed’s primary concerns is to keep financial markets functioning normally, and the indexes show that they are. However, it is important to remember that the Fed is very well informed. The Japanese have words for this, “honne” and “tatemae”. “Tatemae” is the outward appearance of conformance to society’s norms and rituals, while “Honne” is what is really going on behind the scenes. In this case, the “Tatemae” is the traditional information bureaucracy – the BLS, BEA, and even the Fed itself – and the ritual announcements of  lagged and often politicized estimates of economic data. The “Honne” is that the Fed uses all kinds of information services and is very much in touch with the high-frequency data that is gathered by state governments, industry associations and many other private services. The recent callout of the BLS by the Philly Fed shows that the Fed has little faith in the BLS. Powell knows that the economy is either on the verge of recession or already in one regardless of the NBER’s view. He knows that deflationary collapses are underway in markets like housing and used cars. He probably also expects that taking down inflation, as happened in the GFC, will likely require a severe correction in financial markets, probably worse than the GFC. But I am of the opinion that  he is willing to be wrong about that, so if markets are right to “look through” the recession to a return to low inflation he would be perfectly OK with that. He did warn that no rate reductions should be expected in 2023, nor would he back off prematurely, but this was widely ignored.

Edit: This morning’s employment report demonstrates the useless, erratic nature of the BLS data.

What If?

The stock and bond markets are depending on the recession to “force” the Fed to “pivot” back to money printing and ZIRP. The economy is addicted to free money and is slowing rapidly now that it has been withdrawn. The bond market has already priced in disinflation and Fed easing, and the stock market has been buoyed accordingly, proceeding from short squeeze to short squeeze since June of 2022.

But what if Powell has decided that the QE policies that have yielded only $1 of GDP growth for every $10 of fresh debt are toxic and the addiction must be broken, no matter what the symptoms of withdrawal might be? That his legacy will be having returned the economy from dependence on continuous stimulus to sustainable growth? To say nothing of reducing the Fed-induced income inequality that is being exacerbated by inflation? That would certainly earn him a niche in the financial Hall of Fame, perhaps next to Paul Volcker.

Kumquat

Recession is here. The official dating will come later, much later. But the economy is slowing quickly. Commodity prices are falling due to lack of demand. Property – real estate – is slowing. China is struggling with Covid – and trying to infect the rest of the world with whatever variants they have incubated over the last couple of years. Europe is struggling with the Ukraine war and self-inflicted wounds from sanctions and immigration.

But equity markets don’t care. The S&P 500 looks to be making a bottom at a level that was the May bottom. The Dow seems to be heading for all time highs. Only the NDX seems to be close to a new low as some hypervalued “tech” stocks have been clobbered.

Panic Buying

Panic buying this morning resulted from this morning’s CPI report. Core inflation was reported at 0.2% for the month and 6.0% y-o-y, down from 6.3% in the previous report. This disinflationary update resulted almost entirely from falling energy prices, courtesy of Biden’s draining of the SPR, with some help from used car prices. Anyone who thinks that falls in energy prices are sustainable in the face of suppression of the use of fossil fuels is probably still checking to see if the Tooth Fairy has been.

What Happens Next

Well 2022 is just about over. I traded badly this year but that is behind me, I hope. Especially annoying since I have been expecting this bubble to burst for a long time. The big question is, where do we go from here. Some thoughts:

• Housing. Sales volumes are falling very rapidly because affordability is poor, but prices are holding as sellers are reluctant to drop their expectations. In the last housing bubble pop, it took a year and a half for this process to work through so that sellers finally acknowledged that prices could actually fall. This means that housing costs, which make up a disproportionate share of CPI, will be sticky.
• Employment. The pandemic significantly reduced the labor pool as many people retired or just dropped out. In China, the pandemic and measures to suppress it have badly damaged the economy and look to continue to do so. It seems likely that the offshoring that reduced labor demand in the US is over, and will be replaced by onshoring and relocation of production. Either way, labor demand is likely to remain relatively strong well after consumption growth falls. Labor looks to reclaim at least part of the loss of its share of economic output, at the expense of capital, i.e. profits.
• Energy. The idiocy of belief that minor reductions in CO2 output will have a material affect on the climate is hampering investment in energy sources. Of course this will throttle growth in energy production and keep prices high, even as a slowing economy will reduce demand for other commodities. I was amused to find that DNA recovered from northern Greenland revealed that during the region’s warm period, when average temperatures were 20 to 34 degrees Fahrenheit (11 to 19 degrees Celsius) higher than today, the area was filled with an unusual array of plant and animal life, including aurochs and mastodons. Then of course there are the (hopefully temporary) supply constraints that have been caused by the sanctions on Russian production.
• Food. The good news is that more CO2 in the atmosphere helps food production. But modern farming depends heavily on diesel fuel for big equipment and natural gas for fertilizer production. Fossil fuel prices directly affect food prices, because even though yields may be good, farmers will not plant crops on which they cannot make a profit. In addition to high prices, shortages of some crops will develop as farmers pivot to crops which require less of these costly inputs.
• Interest Rates. It seems that no-one believes that Fed Chair Powell will actually carry out the attack on inflation that he has outlined. Some argue that a recession will “force” him to abandon his current goals and resume ZIRP and QE, redefining his goals in the process to accept a higher level of inflation on an ongoing basis. Others believe that the recession will cause inflation to fall quickly and make the question moot as his goals, such as positive real rates across all maturities, will be automatically met.It is certainly true that this long-suppressed business cycle is moving fast, but there is a long way to go to normal. My personal view is that his vision for his legacy is an economy that does not depend on massive growth of debt relative to GDP as has been the case in recent years, and he will do “whatever it takes” to get there

In summary, inflation will prove sticky although not runaway, and Powell will accept a recession. But as the recession gains hold, it will accelerate as defaults reduce credit availability regardless of Powell.

Central Heating Poverty

When I was growing up in the UK, our house had no central heating.  It was rare. In cold weather, I had a hot water bottle in my bed to take the chill off. Other than that, there was no heating in the house overnight. When I was old enough, it was my job, first thing in the morning, to light the fireplace in the living room, which burned coke. The black stuff, not the white stuff. There was a gas poker that was used for a few minutes to light off the coke. Until age 11 I went to school in shorts year round, long trousers being the exclusive privilege of the upper forms.

We had a gas cooker and water heater, electric lights and refrigerator, plus a few small electric appliances such as a vacuum cleaner. The gas supply was not natural gas, it was made from coal and, unlike natural gas, was highly toxic. It was common that people, especially those living in flats (apartments), would have a coin-operated gas meter that needed to be fed to provide gas.

I couldn’t find data earlier than 1970, at which time adoption of central heating was at 30% of households and rising steeply. By 1990, it was 79% and by 2018, it was at 95%. (Statista). Almost all of that is based on natural gas. So now there is widespread panic about fuel poverty in the UK, as there is a shortage of natural gas. The government can print money, and even generate hot air in small quantities. But not natural gas. So, folks, you are going to have to turn down the central heat. Or off. But I can testify that you will survive.  Got eiderdown?

When I was 14, the family moved to Canada. Now, there, winter is a more serious matter.

Disintegration

The world is disintegrating. Trust has been lost, both within countries and between countries. Without trust, economic relationships cannot operate.

China

China is a poor country, despite the glitz and glamor of its big cities and its showpiece infrastructure, with a per-capita annual GDP of about USD 11,000.

Chairman Xi presented his plan for world domination at the opening of the party congress. Not going to happen, sir. Your country is an economic and social house of cards that is in the process of collapsing. The housing market, investment of choice for the masses, is a bubble bursting and desperate local governments are even buying their own land use rights from themselves or one another because retail buyers have left the building. So to speak. Your Covid-zero policy has shaken the people’s faith in the benign CCP, while wreaking destruction on millions of small businesses. Unemployment is high and rising, college graduates cannot find jobs. Biden’s withdrawal of support for your semiconductor industry has condemned it to a bleak future without the production technology that your people cannot build. Export demand from the rest of the world is shrinking fast. Sir, your country is likely heading for a deep economic depression and social turmoil. This will further weaken China’s positioning for the world hegemony which you desire.

United States

In the USA, we live in a world now that George Orwell and Aldous Huxley would readily recognize. The state has commandeered the legacy media, as well as the new social media, to not only put out the “progressive” state’s version of reality but to identify, spy on, ostracize and  punish critics and dissenters.

President Biden, your “progressive” policies are not working. Democrat-run inner cities are being abandoned to crime and homelessness. Illegal immigrants are flooding in without any prospects for employment or training. You are continuing to feed the inflation which is mostly damaging the people you claim to represent. Your support for expansion of NATO triggered the invasion of Ukraine, with severe economic and social consequences.

You and your Democratic predecessors, notably Hillary Clinton, have created a deeply divided society, with those who have drunk the purple Kool-Aid and accept the state’s lies and propaganda on one side, and those with a more traditional view of reality on the other. Neither side trusts the other, respects the other’s views, or is willing to compromise. Both sides are preparing for more direct conflict as the sporadic clashes increase in frequency and severity. This is a recipe for a failing state with extremism on both sides. Negative economic consequences are to be expected.

Europe

Neither China nor Europe are democracies – by design. The architects of the European Union claimed that, since democracy had enabled Hitler, it could not be a part of the EU’s structure. As a result, bureaucrats who suffer no consequences for their failures and care little for the fate of the citizenry run the EU. Ursula van der Leyen is no less of an autocrat than Xi. Deep rifts have emerged as democratically elected governments have resisted the orders of the bureaucrats. These rifts are between rich north and poor south as well as conservative east and “progressive” west. It is only a matter of time before a second country leaves the EU, and that will spark a rush for the exits.

The coming winter is going to be hard, as the bureaucrats’ energy policy has been disastrous. Immigration policies have resulted in shocking increases in crime, with many countries reporting zones where the police dare not go in fear for their lives. Mario Draghi’s “whatever it takes” has left a legacy of irresponsible debt, as in the USA. As  interest rates increase, this is going to be a huge problem

Russia and Ukraine

Russia’s invasion of Ukraine has no winners. Regardless of the outcome, the invasion is an economic disaster for both of them. Their economies depend heavily on the export of commodities, such as food, energy and metals. The volumes of these commodities are large, and their absence are also a problem for the countries that have come to depend on them.

Conclusion

I could go on, but it is time to recognize that the future is not bright. Economies will get worse. Much worse. Be careful out there. Don’t focus on the narrative of the “Fed pivot.” The Fed is irrelevant.

Dummies?

When seeming professionals propose ideas that are internally contradictory I really start to question professionalism in the financial services industry.

The idea proposed was that since inflation was caused by limited supply, which the Fed cannot control, the Fed would simply raise its inflation target and resume easy money to resume growth, driving stocks to infinity and beyond.

Excuse me, but doesn’t limited supply itself limit growth?

Since when has the Fed ever been able to control supply? The money printers go b-r-r-r but there are no gas wells or potash mines at the Fed building. The Fed’s manipulations are intended to control demand.

And by the way, how is the economy to grow when businesses wanting to expand cannot hire the employees that they need?

The bubble is still with us.

Germany

The situation in Germany just went to Defcon 2. Toilet paper manufacturers warned of a coming shortage. History says this is the one thing that triggers revolution and regime change. People will put up with many hardships, but lack of TP is unacceptable. Heads must roll. The Soviet Union’s fall was triggered by this, to say nothing of Venezuela.