The Global Race to Hike Rates Tilts Economies Toward Recession The Fed looks willing to tip the US into a slump if that’s what’s needed to beat inflation. Other central banks are ready to make the same gamble
(…) About 90 central banks have raised interest rates this year, and half of them have hiked by at least 75 basis points in one shot. Many did so more than once (…).
The result is the broadest tightening of monetary policy for 15 years — a decisive departure from the cheap-money era ushered in by the 2008 financial crisis, which many economists and investors had come to view as the new normal. The current quarter will see the biggest rate hikes by major central banks since 1980, according to JPMorgan Chase & Co., and it won’t stop there. (…)
As they slam on the brakes, policymakers are starting to lace their language with gloom in a public acknowledgement that the higher they raise rates to quell inflation, the bigger the risk they harm growth and employment. (…)
Analysts at BlackRock Inc. reckon that bringing inflation back to the Fed’s 2% goal would mean a deep recession and 3 million more unemployed, and hitting the ECB’s target would require an even bigger contraction. (…)
But their overriding focus now is to avoid repeating the mistake of the 1970s, when their predecessors prematurely loosened credit in response to slowing economies without first getting inflation under control. (…)
Dartmouth College professor David Blanchflower, a former BOE policymaker, accuses US central bankers of “groupthink” and charges that they’re on a path to hammer a weakening economy to combat inflation that’s already dissipating. (…)
Central banks all over the world are pushing in the same direction, and that heightens the danger, says Maurice Obstfeld, a former chief economist at the International Monetary Fund.
“They risk reinforcing each other’s policy impacts,” says Obstfeld, who’s now a senior fellow at the Peterson Institute for International Economics. They’re also effectively engaging in competitive appreciation of their currencies and, in the process, exporting inflation abroad, he says. (…)
Adam Tooze piles on and also explains the global race:
The tightening of monetary policy is compounded by a similar shift in fiscal policy. This attracts far less headline space than interest rates, but it too is unprecedented. The share of countries that are tightening their fiscal stance is greater today than it was during the global austerity drive after 2010, or in the heyday of the Washington consensus in the 1990s. (…)
Source: World Bank
The dramatic surge in interest rates around the world is mutually conditioning. Notionally, in a world of relatively flexible exchange rates, countries ought to have a degree of freedom in relation to US policy. But this underestimates the force of the global dollar cycle. Once the Fed starts hiking, others have little option but to follow suit or face severe currency devaluation, which, by raising import prices, will stoke further inflation. And though we think of the world economy as being one of flexible exchange rates, in fact, many currencies, from the Bahamas to Hong Kong, are pegged more or less explicitly to the dollar. As Shang-Jin Wei, former chief economist at the Asian Development Bank points out:
For the 66 smaller economies that peg their currencies to the US dollar – especially those without significant capital controls, like Hong Kong, Panama, and Saudi Arabia – local interest rates tend to rise automatically whenever the US raises its interest rate, even when higher rates are harmful to their economic prospects.
Though there is interdependence of central bank decision-making, what we have not seen so far is any effort at explicit coordination. The lack of coordination is a problem because if interest rate decisions are taken in isolation from each other this may well lead to an excessive tightening. As Shang-Jin Wei explains:
an interest-rate hike by any major central bank has the effect of exporting inflation to other countries, forcing other central banks to raise interest rates more than they otherwise would have done. For example, when the Fed raises its interest rate, if the BOE and the ECB do not respond, the pound and the euro would depreciate against the US dollar, leading to higher import prices and adding to the already high inflation. If the BOE and ECB respond by further raising their interest rates, they export a bit of extra inflation back to the United States and to other economies. The result is an interest-rate spiral that is more damaging to world output and employment than these countries may wish to see collectively.
As former IMF chief economist Maurice Obstfeld explains in a post for the Peterson Institute once we allow for interaction between economies, the effect ought to be to moderate interest rate increases rather than to amplify them. Obstfeld’s arguments runs by way of slack in goods markets and not exchange rates. A central bank that raises interest rates hopes to slow its economy down and raise the level of slack. In a globalized world that has effects not just at home.
The proliferation of global value chains and global trade integration, reflecting a big increase in the share of international trade due to intermediate products, makes it plausible that foreign slack could lower import prices with knock-on effects for inflation. If so, inflation could depend more on foreign and less on domestic slack, attenuating the Phillips relationship between domestic inflation and purely domestic slack. If we accept the hypothesis that global slack matters for domestic inflation, then in current circumstances, it suggests that each central bank should be less rather than more zealous in raising interest rates. The reason is that central banks abroad, through their own inflation-fighting efforts, are also helping to dampen inflation at home. If central banks do not take into account that spillover in calibrating their own needs for higher interest rates, they will each overdo monetary tightening.
The sharp reaction in oil prices already suggests the power of this effect. As energy markets digest the growing probability of a global recession and oil prices plunge, that will have an immediate effect on imported inflation in many economies around the world. With falling global energy prices, central banks have less need to take radical action to stop the inflation. (…)
It is encouraging against this backdrop that there are notable exceptions to the contractionary tend. The Bank of Japan is holding the line on yield curve control and allowing the yen to depreciate against the dollar. In light of Japan’s decades long struggle with deflation, the BoJ is happy to accept the inflationary pressure that the devaluation generates.
The Peoples Bank of China is also bucking the trend. Indeed, last week it actually cut rates. But that just goes to show how serious are the worries about China’s economy. It faces not only a dramatic slowdown in growth. The PBoC is also deeply concerned about financial stability. The deliberate bursting of the property bubble threatens to bring the whole house down.
In 2015 the last time the Chinese economy was in serious trouble, the Fed deferred the interest rate hike planned for September 2015 until 2016. Even if talk of a deal between the Fed and the PBoC – the so-called “Shanghai Accord” – exaggerates the degree of cooperation, the Fed was quite explicit in arguing that it did not need to tighten in September 2015 because the deterioration in global financial market conditions triggered by the crisis in China was doing the work of tightening for it.
What are the options today? As MauriIn Obstfeld remarks:
In principle, central banks could avoid excessive monetary tightening without explicit coordination simply by accurate forecasting of each other’s policy moves and their global effects (The 2015 scenario, AT). Just stating this computational problem, however, illustrates how difficult it might be compared with proactive direct consultation, which at the very least would provide more transparent guidance. Moreover, joint action by central banks coupled with clear public communication could usefully moderate inflationary expectations globally. Central banks have coordinated to good effect during financial crises that raised deflationary threats, but the current inflationary conjuncture equally merits such an approach. … Now is the time for monetary policymakers to put their heads up and look around. They should take into account how the forceful actions of other central banks are likely to reduce the global inflationary forces they jointly face. … If central banks collectively pursue a gentler tightening path, however, at the same time communicating their coordinated intentions clearly to the public, they will avoid excessive sacrifices of output and employment beyond what is needed to bring inflation down.
After all the speculative talk about possible alternatives to the US currency with which 2022 began, we now face a serious test of how the actually existing dollar system works. Explicit coordination in interest rate setting is perhaps a tall order. But, if an uncoordinated surge in interest rates, driven by the Fed’s determination to control US inflation leads to a global recession, it will raise real questions about the system’s functionality. (…)
The fact of the matter is that this inflation spike is unlike others which were mainly demand driven. This one is mainly supply driven, requiring a larger decline in demand than before, which may require much more tightening than before. We are in “unknown unknowns” territory.
FREIGHT DEFLATION
Cass Inferred Freight Rates fell 4.4% m/m (-3.2% SA) in August. Lower fuel prices were a factor in the decline, but with looser truckload market conditions, further deceleration is very likely. With the tight supply/demand balance in U.S. trucking markets easing considerably this year, industry rates are topping out and set to slow sharply in the months to come. While shippers aren’t seeing any real savings yet, such relief is now highly probable for 2023, which is welcome news for the broader inflation picture.
During the active hurricane seasons of both 2020 and 2021 (June 1- November 30), the ACT Research composite of DAT spot rates, ex-fuel, rose 8% and 4%, respectively, into Labor Day. This year, spot rates fell about 6%, ex-fuel, amid the calmest hurricane season since 2013. (…) The shipment rebound is, so far, not enough to outweigh the 4%-5% growth rates in the driver and Class 8 tractor populations presently.
Moreover, the looser market balance we see in U.S. freight markets is consistent with the easing happening in global ocean spot markets, where rates were 56% below year-ago levels in early September.
U.S. Return-to-Office Rates Hit a Pandemic High Office use on average was 47.5% of early 2020 levels for workers in the office recently over five business days in 10 major metro areas.
Tycoon Running a Quarter of China’s Copper Trade Is on the Ropes He Jinbi’s empire is suffering a liquidity crisis, and the ripple effects may go global.
(…) the company handles a million tons a year — a quarter of China’s refined copper imports — making it the largest player in the most important global trade route for the metal, and a major trader on the London Metal Exchange.
(…) He admitted publicly last month that Maike had asked for help to resolve liquidity issues. (…) Some Chinese domestic traders have suspended new deals, while one of the company’s longest-standing lenders, ICBC Standard Bank Plc, was concerned enough that it moved some copper out of China that had been backing its lending to Maike. (…)
In recent weeks, Maike began experiencing difficulties paying for its copper purchases, and several international companies — including BHP Group and Chile’s Codelco — paused sales to Maike and diverted cargoes. (…)
But its trading activity has largely ground to a halt as other traders grow increasingly nervous about dealing with the company. And, in the wake of Maike’s troubles, some of the biggest banks in the sector are pulling back from financing metals in China more generally. (…)
China’s weak property market is more and more contagious…
China Steps Up Robotics Efforts as Workforce Shrinks China installed almost as many robots in its factories last year as the rest of the world, accelerating a rush to automate and consolidate its manufacturing dominance.
Shipments of industrial robots to China in 2021 rose 45% compared with the previous year to more than 243,000, according to new data viewed by The Wall Street Journal from the International Federation of Robotics, a robotics industry trade group.
China accounted for just under half of all installations of heavy-duty industrial robots last year, reinforcing the nation’s status as the No. 1 market for robot manufacturers worldwide. The IFR data shows China installed nearly twice as many new robots as did factories throughout the Americas and Europe. (…)
The world’s second-largest economy lags behind the U.S. and manufacturing powerhouses such as Japan, Germany and South Korea in the prevalence of robots on production lines. (…)
China is still the world’s factory floor, accounting for 29% of global manufacturing, according to U.N. data. (…)
The IFR data shows industrial-robot installations worldwide rose 27% in 2021 from 2020, to 486,800. Growth in shipments in 2020 was little changed compared with the previous year, as the pandemic dented investment.
The U.S. and other parts of the Americas added 49,400 robots in 2021, up 27% for the year, and installations in Europe rebounded 15% to 78,000. (…)
EARNINGS WATCH
Factset tells us that
In terms of estimate revisions for companies in the S&P 500, analysts have lowered earnings estimates for Q3 2022 by a larger margin compared to recent quarters and the 5-year average. On a per-share basis, estimated earnings for the third quarter have decreased by 5.5% since June 30. This is the largest decline in the quarterly EPS estimate for a quarter since Q2 2020. This decrease is also larger than the 5-year average of -2.3%.
That was before FedEx pre-announced and cancelled guidance last Thursday afternoon. FedEX CEO was as clear as Mr. Powell was at Jackson Hole:
The chief executive also said that the loss in volume is wide-reaching, and that the company has seen weekly declines since around its investor day in June.
“We’re seeing that volume decline in every segment around the world, and so you know, we’ve just started our second quarter,” he said. “The weekly numbers are not looking so good, so we just assume at this point that the economic conditions are not really good.”
“We are a reflection of everybody else’s business, especially the high-value economy in the world,” he later added.
Some pundits said FedEx is the canary in the coal mine. It is rather the elephant in the china shop (next charts done with Morningstar/CPMS data and software):
- The S&P 500 is primarily a “goods” index and FedEx delivers goods from and to everybody, everywhere. If the past relationship endures, we can expect S&P 500 EPS to decline below $190 (the red dot is Friday’s EPS consensus for FDX). Trailing EPS are now $220.45 and the 12-month forecast is $232.35. A typical recession sets EPS back ~15% ($187).
- Ned Davis’ global recession indicator is at a never-missed extreme level:
(Ned Davis via CMG Wealth)
- FDX P/E looked washed out last week at 7.8x trailing. But the denominator was too high. P/E has bounced to 10.3x after the 21% drubbing on Friday but the EPS consensus has yet to completely adjust. Same with the S&P 500 P/E, based on history.
- Price to Book: there are similarities with 1999-2000, no?
- Never look at P/Bk without also looking at ROE (return on book). Can S&P ROE stay up there while FDX’s drops ~7%?
Another question is can S&P 500 companies maintain such a high (insane) 22% ROE? The largest jumps in ROE since 2019 were in IT, Consumer Discretionary and Energy. Clearly pandemic and war related. Stein’s law: “If something cannot go on forever, it will stop.”
The current S&P 500 index book value is $986. Between 15% and 18% ROE = $150 – $177 EPS. A 7% decline in ROE = 15%. 
Some S&P 500 data at Friday’s close FYI:
- median P/E: 18.7 x trailing EPS
- the 6 largest stocks by weight (21.4% of the index) have an average P/E of 50.2
- those 6 companies are expected to report EPS up 10.0% on average in Q3. Ex TSLA: -1.2%
- 37% of the companies have a P/E below 15.0
- 16% are below 10x
- 28% of companies had declining EPS YoY in Q2. 39% currently expected in Q3.
- 18% of companies saw EPS drop more than 10% in Q2. 24% currently expected in Q3.
@GameofTrades
We might be set for big surprises:
(Goldman via The Market Ear)
Ed Yardeni has this chart on forward P/E by caps. Gravity is not size-dependent…
- And this one showing relative P/Es:
- Staring at these next 3 charts is quite interesting. Could prove rewarding, too. (Trendlines are mine). Note the log charts; so relative slopes = relative growth.
- Now go back to the relative P/E chart. Here’s one of the Russell 2000 index which, it’s important to know, includes several losing companies’ stocks, unlike the S&P 600. The R2000 is thus higher than it seems.
Not recommendations. Only FYI.
Xi and Modi ‘not standing with Putin’ over war in Ukraine, analysts say Modi told Putin that “today’s era is not an era of war”. The Russian leader told his counterpart: “We will do our best to stop this as soon as possible,” citing “concerns that you constantly express”. That came after Putin acknowledged Xi’s “concerns” about the war in public remarks at the event.
On “60 Minutes last night:
- Pelley: “[W]ould U.S. forces defend the island?”
- Biden: “Yes, if in fact there was an unprecedented attack.”
- Pelley: “So unlike Ukraine — to be clear, sir — U.S. forces, U.S. men and women would defend Taiwan in the event of a Chinese invasion?”
- Biden: “Yes.”
Ukraine War Shows the US Military Isn’t Ready for War With China Providing Kyiv with weapons has depleted the Pentagon’s munitions alarmingly, and defending Taiwan would be far more costly.
(…) The number of major US military contractors has fallen dramatically since the end of the Cold War, making it far harder for the Pentagon to scale up production quickly in a crisis.
There isn’t much spare capacity in this system, or in US manufacturing more broadly: America lacks even the basic building blocks, such as adequate machine tools and a trained labor force, that it would need for wartime mobilization. As Mark Cancian of the Center for Strategic and International Studies writes: “America’s defense industrial base is designed for peacetime efficiency, not mass wartime production, because maintaining unused capacity for mobilization is expensive.”
As a result, the US could find itself in a terrible position after just a few months — even just a few weeks — of fighting. It might struggle to replace the precision-guided, long-range munitions that would be crucial to striking Chinese ships in the waters around Taiwan without having to venture into the teeth of China’s anti-ship missiles and air-defense systems. The loss of large numbers of ships or planes might make it difficult to win a protracted war in the Western Pacific; even if Washington did prevail, those losses might leave the military crippled for years. (…)
Expanding production capacity is not a simple matter, especially when supply chains are snarled and key components are in short supply, in part because of the Covid pandemic. Yet at some level, the issue is ultimately one of money. (…)
Although Congress, for its part, has been willing to bump those budgets, inflation is eating away at the Defense Department’s buying power. And because the Biden administration has emphasized R&D and future capabilities in its early budgets, the loser has typically been procurement — buying capabilities that exist today. If the US waits any longer to get serious about rearming for a conflict that its own officials warn is coming, it will have waited far too long. (…)
- Pentagon Pushes Defense Companies to Limit Use of Chinese Supplies Finding China-made alloys in F-35 jets put U.S. officials on alert as they seek to limit vulnerabilities.
(…) The Pentagon has identified China’s rapidly expanding military as its main threat driving policy and, by extension, the Pentagon’s own spending. China’s defense budget has climbed 72% between 2012 and 2021, according to the Stockholm International Peace Research Institute.
That growth is helping to drive increased U.S. spending on high-end weaponry including long-range missiles and nuclear submarines, and Defense Department leaders have said the U.S. is losing its long-held technological advantage in key areas such as satellites and missiles. U.S. defense companies also expect additional military spending in the coming years, in part because of the arms shipped from Western countries to help Ukraine fight Russia’s invasion.
Relying on China for circuit boards or Russia for titanium makes no sense if sanctions or conflict cut off supplies, Pentagon leaders have said. The recent heightening of tensions over Taiwan has added to the unease. (…)
Pentagon officials said the Covid-19 pandemic exposed how fragile supply chains have become, even for high-end weapons, and the extent to which China remains the source for materials and components, including computer chips and rare-earth minerals used to make magnets and the chemicals used in explosives. (…)
Domestic U.S. production of many materials has declined, undercut by cheaper production overseas. The number of Chinese companies in the Pentagon’s supplier base rose more than fivefold to 655 between 2012 and 2019, according to a survey by consultant Govini, a unit of Poplicus Inc. (…)