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THE DAILY EDGE: 24 JUNE 2022: “A Remarkable Drop In Demand In June”

US economy slows sharply in June amid renewed downturn in demand, but inflationary pressures cool

Latest ‘flash’ PMI™ data from S&P Global signalled the weakest upturn in US private sector output since January’s Omicron-induced slowdown in June. The rise in activity was the second-softest since July 2020, with slower service sector output growth accompanied by the first contraction in manufacturing production in two years.

The headline Flash US PMI Composite Output Index registered 51.2 in June, down from 53.6 in May. The decline in the index reading signalled further easing in the rate of expansion in business activity to a pace notably slower than March’s recent peak. Although service providers continued to indicate a rise in output, it was the weakest increase for five months.

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Manufacturers fared worse, with factory production slipping into decline as the respective seasonally adjusted index fell to a degree only exceeded twice in the 15-year history of the survey, at the height of the initial pandemic lockdowns in 2020 and the height of the global financial crisis in 2008.

Weaker demand conditions, often linked to the rising cost of living and falling confidence, led to the first contraction in new orders since July 2020. Decreases in new sales for goods and services in June were the first recorded since May and July 2020, respectively.

Similarly, new export orders contracted at the steepest pace since June 2020 as foreign customers paused or reduced new order placements due to inflation and supply chain disruptions.

Inflationary pressures remained marked in June, as input costs and output charges rose substantially again. Although the pace of input price inflation eased to the slowest for five months, it was sharper than any seen S&P Global Flash US PMI Composite Output Index before April 2021. Alongside food, fuel, transportation and material price hikes, firms often mentioned that wages had increased to entice workers to stay, which added pressure to operating expenses.

At the same time, output charges rose at the softest pace since March 2021. Firms continued to highlight the pass-through of higher cost burdens to clients, but increasingly, firms stated that offers or discounts were being offered to encourage customer spending and ward off competitors.

Manufacturers and service providers alike registered slower increases in employment midway through 2022, as the rate of total job creation eased to the slowest since February. Despite ongoing reports of challenges hiring or retaining staff, weaker client demand and reduced pressure on capacity led to some firms not replacing leavers.

Backlogs of work across the private sector decreased for the first time in two years in June. The pace of decline in outstanding business was only marginal, but marked a stark turnaround from the sharp accumulation of pressure on capacity in May for goods producers and service providers alike. Declines in new orders reportedly allowed firms to work through backlogs of orders successfully.

Finally, business confidence slumped to one of the greatest extents seen since comparable data were available in 2012, down to the lowest since September 2020. Manufacturers and service providers were far less upbeat regarding the outlook for output over the coming year than in May, principally amid inflationary concerns and the further impacts on customer spending as well as tightening financial conditions.

At 51.6 in June, down from 53.4 in May, the S&P Global Flash US Services Business Activity Index signalled another softening in the rate of output expansion at service providers. The pace of increase was the slowest since January’s Omicron-induced slowdown and only modest overall.

Weaker growth in business activity was driven by a solid fall in new orders. Client demand dropped for the first time since July 2020, and at the steepest pace for over two years. Total new sales were also weighed down by the quickest decrease in new export orders since December 2020.

Average cost burdens increased at a marked pace in June, as supplier, material, fuel, transportation, and wage bills soared again. The rate of input price inflation was the softest for five months and eased notably from May, but was much quicker than the series average. Similarly, the pace of output charge inflation softened and was the slowest since March 2021. Although firms continued to pass-through hikes in costs to clients, some mentioned concessions were made to customers.

Service providers signalled a notable change in pressure on capacity during June, as backlogs of work fell for the first time in two years. As a result, the rate of job creation eased to the softest in four months.

Meanwhile, inflationary pressures, hikes in interest rates and weaker client demand all dampened service provider expectations for output over the coming year. Sentiment remained positive, but was at its lowest level since September 2020.

At 52.4 in June, down from 57.0 in May, the S&P Global Flash US Manufacturing PMI indicated a slower improvement in operating conditions across the goods-producing sector. The overall upturn was the weakest for almost two years as contractions in output and new orders weighed on the headline figure.

Declines in production and new sales were driven by weak client demand, as inflation, material shortages and delivery delays led some customers to pause or lower their purchases of goods. The falls were the first since the depths of the pandemic in mid-2020, and were accompanied by a renewed decrease in foreign client demand.

Average cost burdens continued to rise substantially and at a historically elevated pace in June. Hikes in vendor, material and fuel prices all spurred on inflation. Nonetheless, the rise in input prices was the slowest since April 2021. At the same time, efforts to entice customers to make purchases led to the softest rise in output charges since January. The rate of charge inflation was faster than in any period before May 2021, however.

Vendor performance deteriorated to the least marked extent since January 2021 in June. That said, weaker client demand led to a contraction in input buying and reduced efforts to stockpile materials and finished goods.

In line with a renewed fall in backlogs of work, manufacturers expanded their workforce numbers at the softest pace since February. Firms were able to work through their outstanding business as new orders declined.

Lastly, goods producers registered the lowest degree of confidence in the outlook for output over the coming year for 20 months in June. Despite hopes that demand will improve and investment increase, concerns regarding inflation, interest rates, supply chain disruption and the health of the wider economy weighed on expectations.

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

“The pace of US economic growth has slowed sharply in June, with deteriorating forward-looking indicators setting the scene for an economic contraction in the third quarter. The survey data are consistent with the economy expanding at an annualized rate of less than 1% in June, with the goods-producing sector already in decline and the vast service sector slowing sharply.

“Having enjoyed a mini-boom from consumers returning after the relaxation of pandemic restrictions, many services firms are now seeing households increasingly struggle with the rising cost of living, with producers of non-essential goods seeing a similar drop in orders.

“There has consequently been a remarkable drop in demand for goods and services during June compared to prior months.

“(…) Business confidence is now at a level which would typically herald an economic downturn, adding to the risk of recession.

“A corollary of the drop in demand was less pressure on prices, with the survey’s inflation gauges for firms’ costs and their selling prices falling sharply in June to suggest that, although still elevated, price pressures have peaked.”

Two days ago, I posted World Economics’ Sales Managers Index for the U.S. which showed that “sales growth fell sharply in June”:

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Here’s WE’s comments on its June survey results:

The United States economy is slowly tipping into recession according to the latest data from the Sales Managers Monthly survey.

Sales managers are very much the “front line” in terms of sensitivity to changing business conditions. Sensitive to contractual negotiations being deliberately slowed down. Sensitive to expected contracts “in the bag” being suddenly cancelled. And most of all sensitive to “budgetary problems” being increasingly cited as reasons for sales negotiations faltering.

Recall that Target, Walmart and several other retailers reported very weak sales in April and May.

Sales managers instruct their purchasing managers based on what they see on the front line and their current inventory position.

Yesterday’s purchasing managers survey confirms the SMI’s findings of weak domestic and foreign client demand and noted that:

  • several previous orders have been paused and/or cut;
  • goods producers are discounting…
  • …and reducing input buying, stockpiling and hiring.

These real-time surveys confirm that the goods sector is in recession.

More consequential is the “solid fall in new orders” from service providers as “client demand dropped at the steepest pace for over two years”. Demand for services, supposed to offset poor goods demand, has also been weak lately. Mentions of renewed discounting and soft jobs growth add to the evidence that the services sector is also getting hit by the squeeze on real incomes.

The Eurozone and U.K. PMIs reveal similar trends in demand for services.

The only silver lining is that reduced demand and backlogs at overstocked and overstaffed businesses are having their usual effect: “although still elevated, price pressures have peaked”.

On June 30, we get consumer spending and PCE inflation for May. Starting in mid-July, we will get real-time info from corporate earnings releases and conference calls.

If S&P Global’s Chris Williamson is right (“Business confidence is now at a level which would typically herald an economic downturn”), the July 26-27 FOMC meeting will be quite challenging with the Fed realizing that the economy, far from being “very, very strong”, may actually be “in a downturn” with perhaps the first signs of slowing but “still elevated” inflation while wages are “soaring”.

  • BTW:

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Data: Indeed; Chart: Axios Visuals

fredgraph - 2022-06-24T091230.960

Lawmakers pressed Federal Reserve Chairman Jerome Powell over how the central bank would manage trade-offs it could confront if its interest-rate increases slow the economy sharply but don’t reduce inflation quickly.

Mr. Powell on Thursday said that in such a scenario, the central bank would be reluctant to shift from raising rates to cutting them until it saw clear evidence that inflation was coming down in a convincing fashion.

“We’re going to want to see evidence that it really is coming down before we declare any kind of victory,” he told the House Financial Services Committee. (…)

“In that hypothetical situation, that would be a setting in which inflation could be expected to come down,” Mr. Powell said, which could meet a test the Fed has established to slow or stop rate rises. But he added, “I think we’d be reluctant to cut.” (…)

Typically, the Fed focuses on so-called core inflation, which excludes food and energy prices, because officials believe that measure provides a better gauge of underlying price pressures. But Mr. Powell said the Fed might be less willing to look past higher prices at the pump because that could push up consumers’ inflation expectations.

“There are some small signs, concerning signs” that inflation expectations are rising, Mr. Powell said. “And we just can’t allow that.” (…)

Fingers crossed America’s Cash Hoard Could Cushion a Downturn Americans have something that they usually lack heading into a recession: A lot of cash

(…) Federal Reserve data show that as of the end of the first quarter, U.S. households held $17.9 trillion in cash and cash equivalents, up a bit from the fourth quarter and much higher than the $13.7 trillion they had at the end of the first quarter of 2020. Indeed, before the pandemic, U.S. households never experienced anything like the increase in cash they have experienced over the past two years, and this remains true even after adjusting for the run up in inflation. (…)

People in the top 10% by wealth held 32% more in cash and cash equivalents in the first quarter from two years earlier, but people in the bottom half held 45% more. Cash held by households in all but the lowest income quintile rose sharply. It rose sharply for white, black and Hispanic households. It rose for college graduates and high-school graduates. It rose for millennials and Gen Xers and boomers. (…)

Meanwhile, after shooting higher when the pandemic hit, the saving rate—the portion of take-home pay that doesn’t get spent—has fallen recently, hitting 4.4% in April, which compares with a prepandemic average of 7.6%. But Barclays economists calculate that even in a scenario where inflation remains at its recent highs, it would take at least until the end of 2023 for such undersaving to drain off the excess cash households have built up. (…)

Will they spend it? How quickly?

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Source: Bank of America Institute; h/t @SamRo and The Daily Shot

‘Coast to Coast’ Housing Correction Is Coming, Says Moody’s Chief Economist

A housing correction will reach from “coast to coast” in the US, but it will fall short of a crash, according to Mark Zandi, chief economist at Moody’s Analytics.

With the Federal Reserve introducing the biggest increase in interest rates in years to combat rising inflation, home prices will likely fall in the housing markets that are most “juiced,” says Zandi. Regions with signs of significant speculation, namely in the Southeast or Mountain West, can expect the pendulum to swing back. Cities and states due for a correction include Phoenix and Tucson in Arizona, the Carolinas, northeast Florida, and above all, Boise — “the most overvalued market in the country,” per Moody’s analysis.

If and when it comes, a drop in housing prices isn’t going to bring much immediate relief to renters, Zandi cautioned. With the supply of starter homes for buyers so limited, and interest rates rising, would-be buyers will have limited options to move from leases to loans. Rising permits and construction for multifamily housing will relieve pressure some, causing rent growth to increase less rapidly. (…)

Despite the broad reach of a looming price adjustment, a crash is unlikely, he says, for three reasons:

  • Housing vacancy rates are at an all-time low. Vacancy rates reached historic highs before the financial crisis more than a decade ago that led to the Great Recession.

  • The quality of mortgage underwriting is high. Most loans are “plain vanilla” 30-year or 15-year fixed-rate products, with no sign of the subprime or negative amortization activity that precipitated the foreclosure crisis.

  • While some markets are marked by speculation and flipping, nationwide the evidence for flipping is low.

“I just don’t see the the kind of mortgage defaults and distressed sales that would be necessary for big declines in housing values. That’s when you get crashes, when you have lots of foreclosures and a lot of distressed sales,” Zandi says. “That’s just not going to happen.”

  • Netflix fires another 300 employees as it seeks to bring costs under control amid uneven subscriber growth. It’s the second round of cuts in the past two months.
Fed says U.S. banks can weather severe downturn comfortably The results of the Fed’s annual “stress test” exercise showed the banks have enough capital to to weather a severe economic downturn and paves the way for them to issue share buybacks and pay dividends.
China Lockdowns Impacted on 38% of Companies in June, Compared with 49% a Month Earlier

The June Sales Managers Index continues to illustrate the heavy toll being taken on the Chinese economy by continuing Government attempts at preventing the spread of Covid.

Life is gradually returning to many areas, but the impact, even in areas not locked down, has been severe, and continues to cause difficulties for many companies.

China Lockdowns Impacted on 38% of Companies in June, Compared with 49% a Month Earlier

Manufacturing has been particularly badly affected with factories unable to operate entirely closed off from supply chains. The Manufacturing Market Growth Index came in close to a 25 month low in June, with a reading of 46.4.

Business Confidence in the Manufacturing sector registered a 28 month low in June, and the Staffing Levels Index and overall Manufacturing Sales Managers Indexes also registered sub 50 levels, indicating continuing recession in activity.

The low level recorded by the Staffing Levels Index is particularly significant as the Index records year on year growth (or decline in this instance), as opposed to month-on-month changes.

The Services sector did a little better, with Business Confidence back into the >50 positive growth zone. However the more general Services Market Growth Index stayed low with a reading of 46.8 indicating further contraction in service sectors throughout China.

Canada needs 5.8 million new homes by 2030 to bring prices down to affordable levels, CMHC says

Canada needs an additional 5.8 million homes by the end of the decade to help lower average home costs and ensure households are not spending more than 40 per cent of their disposable income on shelter, according to a new government report.

That target blows past the current projection of 2.3 million new homes by 2030, according to the Canada Mortgage and Housing Corp. report, and would require building of new homes to more than double from current levels.

Although home prices nationally are starting to drop due to a sharp jump in interest rates and borrowing costs, they are still at least 50 per cent higher than two years ago. As of May, the price of a typical home across Canada was $822,900, with values well above $1-million in the Vancouver and Toronto regions. (…)

The report laid out targets for home prices to be considered affordable by 2030. For example, in Ontario, the average home price should be $551,000 so that housing costs for the average household are affordable at under 40 per cent of the household’s disposable income. Last year, the average home price in the province was $871,000. (…)

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(The Globe And Mail)

Stock Funds See Exodus as Recession Fears Grip Investors

About $16.8 billion exited global stock funds in the week through June 22, with US equities seeing their first outflow in seven weeks at $17.4 billion, Bank of America Corp. said, citing EPFR Global data. Bonds saw redemptions of $23.5 billion, while investors moved $10.8 billion to cash and $0.6 billion to gold, the data show.

Bank of America’s custom bull and bear indicator remains at “maximum bearish,” strategists led by Michael Hartnett wrote in a note, which is a buy signal for stocks. For the year, investors have bought $195 billion of stocks and sold $193 billion of bonds, meaning capitulation has not been reached for equities, they said. (…)

Hartnett said last week that based on past bear markets — defined as a 20% drop for the index from recent highs — the current one for the S&P 500 would end in October with the index at 3,000 points. That’s 21% below current levels.

Morgan Stanley strategist Michael J. Wilson also sees the index dropping to 3,000 to fully reflect the scale of economic contraction. And Societe Generale SA’s Manish Kabra said this week that a 1970’s style shock amid stagnation with higher inflation could send the index crashing more than 30% from current levels.

By trading style, US small cap and large cap stocks led outflows. By sector, materials and energy saw the biggest redemptions. Technology, communication services and real estate had inflows.

THE DAILY EDGE: 12 MAY 2022: Not A Good Day (Year)!

Note: I started blogging January 3, 2009. I do not recall having posted such a broadly frightening post. Inflation, China, commodities, currencies, cryptos, valuations…Sad smile

Inflation Slipped in April, but Upward Pressures Remain U.S. inflation eased slightly in April, dropping for the first time in eight months as energy prices moderated.

U.S. inflation edged down to an 8.3% annual rate in April but remained close to the fastest pace in four decades as the economy continued to face upward price pressures.

The Labor Department’s consumer-price index reading last month marked the first drop for inflation in eight months, down from an 8.5% annual rate in March. The decline came primarily from a slight easing in April gasoline prices, which have since reached a new high. Broadly, the report offered little evidence that inflation was cooling. (…)

Airline fares surged 18.6% in April from a month earlier, the fastest rise on record. The cost of full-service restaurant dining rose 0.9% from March, the biggest gain since last October. (…)

Used car and truck prices were up 22.7% on the year in April, down from a 35.3% rise in March. But new vehicle prices were up 13.2% from a year ago in April, the largest 12-month increase since 1949. (…)

A steady pickup in housing costs, which account for nearly one-third of the CPI, is also adding to inflationary pressure. Both tenant rent and so-called owners’ equivalent rent, which estimates what homeowners would pay each month to rent their own home, rose 4.8% from a year earlier, a pace last seen in the late 1980s and early 1990s. (…)

Core CPI was up 0.57% MoM after 0.32% in March. Two-month average: 0.45% or 5.4% annualized. The previous 2 months averaged 0.55%, 6.5% a.r.. Trending down, very slowly. We are far from the late 2020s.

fredgraph - 2022-05-11T103533.376

In April, MoM, rent +0.56%, owners’ equivalent rent +0.45%. Core services prices overall rose at their fastest pace since 1990 (+0.72%).

An analysis of inflation data needs to take two different perspectives: inflationary trends from a financial market viewpoint (interest rates, equity valuations) and inflationary pressures from an economic viewpoint (consumer squeeze, recession risk). The former focuses on core CPI while the latter must include the important food and energy components given their impact on discretionary spending power.

This ING chart tackles both concerns with none particularly encouraging.

  • Core goods inflation (orange) is cresting and could well eventually become negligible like before but core services inflation (yellow) is 50% higher than before and trending up. Core services prices jumped 0.7% in April, are up 6.7% a.r. ytd and 7.5% a.r. in the last 3 months. Shelter prices have been rising at a 6% a.r. in the last 3 months. The fundamental trend in inflation remains up as rising wages filter through services prices.

Contributions to annual US inflationunnamed - 2022-05-11T104544.471

Source: Macrobond, ING

No reason to expect an imminent turn in rent components

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  • Food and energy prices are adding 3%+ to core inflation with no signs of easing meaningfully. Food-at-home inflation was 10.8% YoY in April after having jumped 15.4% a.r. in the first 4 months of the year. Energy inflation is 30.3% YoY, in spite of -2.7% MoM in April, likely to reverse itself in May since gasoline prices are back to their February peak. “Essentials Prices” (food, energy and shelter) are up 8.6% YoY.

INFLATION ON ESSENTIALS (YoY)

fredgraph - 2022-05-11T114615.495

INFLATION ON ESSENTIALS (MoM)

fredgraph - 2022-05-11T114340.575

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Greg Ip:

Inflation Is Headed Lower—but Maybe Not Low Enough While supply disruptions are subsiding, without slower demand, inflation will still be too high for the Fed’s comfort to stop raising interest rates.

(…) Bottom-up analysis of the consumer-price index’s components, inflation-linked bond yields, and wage behavior all point toward inflation settling at roughly 4%. (…) But there are good reasons it will stay around 4% or even drift higher. (…)

The Korean War analogy is comforting because while the Fed did tighten monetary policy, it avoided a recession. Inflation shot from 2% in mid-1950 to 9.6% the following April, and was back below 1% by December 1952.

In 1973, the Arab oil embargo hit an economy already trying to cope with soaring food prices and strong demand. As an analogy for the present, this episode is a lot less comforting than 1951: Inflation peaked at 12.3% in 1974, and the Fed raised interest rates sharply, triggering a deep recession. Even so, inflation only fell back to 5% in 1976—then headed higher. (…)

And yet looking forward, the supply disruptions that have fueled so much of the rise in inflation are likely to get better, not worse. Gasoline prices hit another record this week but aren’t likely to rise much more since oil has stabilized around $100 per barrel. The queue of container ships waiting off the coast of California has shrunk by more than half, and freight rates have plummeted. About three quarters of China’s top 100 cities by gross domestic product have now either loosened restrictions to pre-Omicron levels or removed them entirely, according to Ernan Cui of the research firm Gavekal Dragonomics. One sign that goods shortages are subsiding is that manufacturing, retail and wholesale inventories, which plummeted 5% between the start of the pandemic and last September, are up 3% since.

(…) annual wage growth has accelerated from about 3.5% before the pandemic to between 5% and 6%. That is consistent with inflation of 4% if productivity maintains its recent, tepid pace, or 3% if productivity perks up. For the Fed to feel confident inflation is headed below 3%, it needs to see lower wage growth, which generally requires slower economic growth and higher unemployment, and it will keep raising interest rates until those things happen. If that means more carnage in the stock market—well, that’s a feature, not a bug.

What about housing and shelter inflation? Demand and supply dynamics don’t seem about to change markedly.

CHINA

How did you go bankrupt? ‘Two ways’, gradually and then suddenly.’ (Hemingway)

We just reached the second stage in this slow-mo disaster. Good luck Mr. Xi! But it will ripple…good luck us all!

Major China Developer Sunac Defaults as Debt Crisis Spreads China’s fourth-largest developer said in a filing to the Hong Kong stock exchange that it didn’t pay a $29.5 million coupon on the note before the end of a grace period Wednesday, and that it doesn’t expect to make payments on other securities.

(…) “Going into the cycle you may have been expecting 20%-30% of developers defaulting, but now we are talking about more than 60% or 70% of the market being priced under 60 cents on the dollar, where the implied default rate is very high.” (…)

(…) The effects of China’s slowdown are showing up everywhere from German factories to Australian tourist spots. Exports are weakening in Asia as China’s neighbors watch their largest market sag. Companies including Apple Inc. and General Electric Co. warned investors about production and delivery problems stemming from China’s troubles, as well as dwindling sales. (…)

That means its weakening economy is bad news for commodity exporters such as Brazil, Chile or Australia that supply China with oil, copper and iron ore. It is bad news for manufacturing powerhouses such as Germany, Taiwan and South Korea that rely on China as a huge market for machinery, cars and semiconductors, as well as a critical link in world-wide supply chains for their companies.

And it is bad news for the U.S., where galloping inflation is squeezing household budgets. (…)

China in 2021 accounted for 18.1% of global gross domestic product, according to International Monetary Fund data, behind the U.S. at 23.9% but ahead of the 27 members of the European Union at 17.8%. It accounts for almost a third of global manufacturing output, according to United Nations data from 2020. (…)

Official data Monday showed Chinese export growth slowed sharply in April, as lockdowns hammered factories and global demand waned, especially in Europe and Japan. After adjusting for inflation, imports of iron ore were 13% lower than a year earlier, imports of copper were down 4% and imports of cars and chassis were down 8%, according to economists at Nomura. (…)

“China’s policy makers have heralded easing to prevent a growth slowdown—but have yet to fully act,” senior economists at BlackRock Investment Institute, the investment analysis division of the world’s largest asset manager, BlackRock Inc., said in a note to clients Monday, in which they downgraded their stance on Chinese assets to neutral. (…)

Taiwan and South Korea’s exports to China in April each fell 3.9% compared with March, according to economists at Goldman Sachs. The slide highlights how some Asian economies are tightly plugged into China’s industrial engine, making them especially vulnerable to a slowdown.

Data from the Organization for Economic Cooperation and Development show that whereas Chinese parts and other inputs account for around 1.4% of the value of U.S. goods exports to the rest of the world, in South Korea they account for 5.2%, in Taiwan, 6.3% and in Vietnam, 14.4%. (…)

Around 900,000 jobs in Germany depend on the Chinese market, he said, while German companies employ close to one million people in China.

Mr. Wuttke said he expects the worst of the Covid-related disruption from the recent lockdowns hasn’t even been felt in Europe yet, as shipments that were supposed to leave China during the last couple of months would only now start to arrive in European ports. (…)

Global growth slows and inflation pressures intensify amid rising economic headwinds
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Bitcoin Falls Below $26,000, Tether Briefly Edges Down From $1 Peg Bitcoin plunged and the world’s largest stablecoin, tether, briefly edged down from its $1 peg, adding to fears of more turbulence in the cryptocurrency market.

FYI, it’s been rumoured that many of the commercial paper assets “backing” Tether are Chinese developers’…

We will shortly know who’s swimming naked. Here’s a candidate:

OSFI says it may tweak mortgage stress test as interest rates climb, housing market cools Since the Office of the Superintendent of Financial Institutions toughened the mortgage stress test last June, the country’s housing market and borrowing conditions have changed significantly

(…) OSFI rules apply to borrowers who do not require mortgage insurance, which occurs when borrowers make a down payment of at least 20 per cent of the property’s purchase price. The regulator requires borrowers to prove they can make their mortgage payments at an interest rate of 5.25 per cent, or 200 basis points above their mortgage contract, whichever is higher.

But now, fixed-mortgage rates are quickly rising as the Bank of Canada embarks on an aggressive round of interest-rate hikes, and could soon top OSFI’s minimum qualifying rate of 5.25 per cent.

Today, the average five-year fixed-rate mortgage has an interest rate of 4.19 per cent, according to mortgage brokers. That is up from January’s average of about 2.69 per cent. That means that a borrower must now prove they can make their mortgage payments with an interest rate of 6.19 per cent if they want a fixed-rate mortgage, which is already above the 5.25-per-cent stress-test floor. And the stress test will become even harder as mortgage rates continue to climb.

That will drive more borrowers to variable-mortgage rates, as well as to non-bank mortgages – which typically have higher interest rates than chartered banks.

Already, borrowers are seeking variable-rate mortgages, which are at about 2.4 per cent today, according to mortgage brokers. (…)

Borrowers are also turning to alternative lenders such as trusts and private mortgage-investment companies, which do not have to comply with federal banking rules. (…)

VALUATIONS CORRECTION

First and foremost, this is a valuation correction, the pricking of the broad valuation bubble. Profits are still rising and apart from a few doomsayers, recessions calls are still not significant (though rising). Fed tightening has just begun. Since 1962, there have been 9 tightening episodes, 7 ending in recessions, starting on average 27 months after the first hike (range 12-41 months).

Since 1961, there have been 7 valuation correction episodes, when the Rule of 20 P/E exceeded 23 and subsequently declined to its median “fair value” of 20. Only 3 were followed by recessions (1968, 1971, 2000).

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The valuations corrections lasted between 3 months (1987) and 28 months (2000-03) with an average of 13 months (median 9 months) and brought the S&P 500 index down 17.5% on average before the index reached “fair value”. (In 1992, valuations corrected but equities nonetheless rose 12.5% as profits exploded 40% during the period.) Excluding this episode, valuations corrections brought the S&P 500 down 18.3% on average and lasted 11 months on average.

During the current episode, the S&P 500 has declined 18% so far over 4.5 months but the Rule of 20 P/E, at 24.5, remains 18% above its 20 fair value.

There are 2 ways to reduce the R20 P/E: rising earnings and/or declining inflation. If the current consensus is right, trailing EPS will near $221 after the Q2 earnings season in early August. To get a R20 P/E of 20, we would thus need inflation at 2.4% at the current 3900 level.

Assuming inflation of 4%, an index level of 3550 would be fair value. Understand that undershooting is the norm.

Because after the valuations correction might come the recession correction which would take earnings down.

The Great Dollar Squeeze of 2022 is causing global havoc The rocketing US dollar is draining global liquidity and tightening conditions violently for large parts of the international financial system, and for the interlinked nexus of credit contracts and derivatives.

(…) Something was bound to snap, and snap it has over the last three trading sessions. Almost every asset has gone down in unison: equities, credit, Bitcoin, gold, commodities, and ‘high beta’ currencies. Technical support lines have been breached across the board. (…)

The twin-effect a rising dollar and rising US rates is slow torture for the $12 trillion offshore dollar lending market. Borrowers in emerging markets have $3.7 trillion of outstanding loans and bonds denominated in dollars (BIS data), and a substantial chunk is on maturities of one-year or less, and must therefore be rolled over at much higher cost.
Some $9 trillion of global financial contracts are priced off dollar credit rates (formerly Libor). The Financial Stability Board in Basel estimates that world markets have $200 trillion of notional exposure to dollar-linked derivatives. As US Treasury secretary John Connally said pithily in 1971: “the dollar is our currency, but your problem”. (…)

Episodes of extreme currency misalignment have powerful consequences and usually end badly. This one feels like a mix of the Asian financial crisis in 1998 and Europe’s ERM crisis in 1992, both caused by the relentless rise of an anchor currency that was causing havoc for everybody else on the periphery. (…)

The BoJ has briefly achieved the Holy Grail of 2pc inflation but it is the wrong kind of inflation, causing people to tighten their belts rather than generating a virtuous circle of rising wages and rising demand. Governor Haruhiko Kuroda thinks the headline rate will slither back down. It is “very, very hard” to create lasting inflation, he said.
The weak yen has in turn destabilised China’s exchange rate policy, made worse by Xi Jinping’s war on “disorderly capital”, by which he means overmighty technology tycoons who dare to defy the Communist Party. It is made worse yet by his refusal to ditch zero-Covid in the face of Omicron, a policy now enforced with a Maoist hunt for “doubters, distorters, and deniers”.

Beiijing has given up trying to defend yuan in the face of capital flight and the competitive trade threat of the cheap yen, all too aware that currency intervention has the unwanted side-effect of tightening internal credit conditions within China. This would compound what is already a de facto recession.
Beijing has let the yuan plummet against the dollar over the last month, though we are not yet back to the Chinese currency crisis of 2015. (…)

The consensus among the big banks is that the Fed will blink once Wall Street drops by another 5pc or so. Or put differently, the strike price of the ‘Fed Put’ is around 3,800 on the S&P 500 index. We are getting close. And remember, bear market rallies can be torrid.
There again, the consensus may be wrong, and we have yet to find out what ugly feedback loops have already been set in motion by the Great Dollar Squeeze of 2022. The weak link is never where you expect it to be.

Finland Says It Will Apply to Join NATO in Response to Russia’s Ukraine Invasion Membership of the alliance would be a major break from decades of nonaligned defense policy and deal a blow to Russian President Vladimir Putin’s ambition to divide and weaken the Western alliance.
Rare Russia Criticism Within China Shows Simmering Policy Debate

Russian setbacks in Ukraine have begun to prompt more explicit warnings in China about Moscow’s value as a diplomatic partner, in a sign of growing unease over President Xi Jinping’s strategic embrace of Vladimir Putin.

Russia was headed for defeat and being “significantly weakened” by the conflict, a former Chinese ambassador to Ukraine told a recent Chinese Academy of Social Sciences-backed seminar in remarks widely circulated online. The comments, which Bloomberg News was unable to verify, were attributed to retired diplomat Gao Yusheng, who served as China’s top envoy in Kyiv from late 2005 to early 2007. (…)

“The so-called revival or revitalization of Russia under the leadership of Putin is a false proposition that does not exist at all,” Gao said. “The failure of the Russian blitzkrieg, the failure to achieve a quick outcome, indicates that Russia is beginning to fail.” (…)

Besides Gao’s comments, one of the country’s most prominent international relations scholars said this week that the war meant “nothing good” for China because it accelerated a shift from globalization.

“The war makes it almost impossible for Russia to have any global influence,” Yan Xuetong, dean of Tsinghua University’s Institute of International Relations, said in an interview Tuesday with Phoenix TV. The conflict brings “only losses and damages to China, but no benefits whatsoever,” Yan said. (…)

Gao, the former ambassador to Ukraine, went further to say that Russia was “duplicitous” and had reneged on promises. (…)

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Confused smile FYI: Are NFTs really art? Collectible and cartoonish, these digital multiples, traded in cryptocurrency, confer membership of an exclusive club – sometimes literally. But do they have any aesthetic value? A critic weighs in. (The Guardian)