Archive for category: #recession
US central bank vice-chair notes cross-border ‘spillover’ risk as monetary policy tightens globally
The European Systemic Risk Board is essentially an offshoot of the European Central Bank. And central banks are normally the last to admit that a crisis is around the corner, if not already here.
In financial markets, the tide is going out when central banks are raising interest rates and growth is slowing. That is to say, right now.
“If there was no intervention today, gilt yields could have gone up to 7-8 per cent from 4.5 per cent this morning and in that situation around 90 per cent of UK pension funds would have run out of collateral… They would have been wiped out.” So says a UK bond trader yesterday.
A liquidity crisis erupted in British bond markets after the announcement by the new right-wing Conservative government that it would spend up to £60bn to maintain and energy price cap for householders for up to two years, subsidise business energy costs AND also cut corporate and income taxes. The total hit from this largesse (mainly to the rich) to the UK public debt level over the next few years has been estimated at over £400bn or nearly 20% of GDP. With UK public debt already at 100% of GDP, that sounded the death knell for the UK bond prices. Yields (interest rate) surged.
UK ten-year govt bond yield (%)
Alongside this, the Bank of England plans to hike interest rates yet further over the next year to ‘control’ inflation. So the cost of borrowing and servicing debt is rocketing. Suddenly, investors holding government bonds were facing serious losses, particularly pension funds that tend to invest on long-term bonds using short-term interest rates to borrow – short-term interest rates up; long-term bond prices down. That’s a mismatch on asset values and a credit liquidity squeeze was on.
In the case of the UK, apparently pension funds and others had been employing yet another piece of financial jiggery-pokery called “liability-driven investment” schemes . This was the practice of buying bonds that are then used as collateral for loans to purchase more bonds – as much as £1.5trn over the last decade since the global financial crash. If the value of the bonds used for collateral drop like a stone, as they have just done, then the ability to borrow vanishes. So the BoE has been forced to loan £65bn to such bond holders to bail them out of their Ponzi scheme.
And it was not just in the UK with its crazy government. Even in the US, with supposedly a ‘sensible’ administration that is not cutting taxes or funding price caps, the credit squeeze is also there. The $24tn US treasury market has been hit with its most severe bout of turbulence since the coronavirus crisis, underscoring how big swings in international bonds and currencies and jitters over US rate rises have spooked investors. “Right now, it is all about market volatility,” said Gennadiy Goldberg, a strategist at TD Securities. “You have investors staying away because of the volatility — and investors staying away increases volatility. It is a volatility vortex.”
The US 10-year treasury yield, a key benchmark for global borrowing costs, has surged to more than 4 per cent from 3.2 per cent at the end of August, leaving it set for the biggest monthly rise since 2003. It is on track for its sharpest ever annual rise. The two-year yield, more sensitive to fluctuations in US monetary policy, has leapt 3.55 percentage points this year, which would also mark an historic increase.
Tightening liquidity (credit) has hit all those wild speculative assets hard. Take so-called NFTs. Trading volumes for the ridiculous non-fungible tokens (NFTs) have tumbled 97% since January, and the blockchain-bound digital art and collectibles market went from $17 billion to just $466 million in September, according to Bloomberg,. Similarly, the fall in the Bitcoin price has wiped out nearly all the gains from cryptocurrencies of the last few years.
As I have argued in previous posts, there are two blades of the scissors that are closing to deliver a slump: falling profitability and rising interest rates; or falling earnings and tightening liquidity, if you like.
Take the first blade. Marx explained the role of credit in capitalist production very clearly in Capital. Credit is essential for capitalist investment and production: “the credit system accelerates the material development of the productive forces and the establishment of the world-market. It is the historical mission of the capitalist system of production to raise these material foundations of the new mode of production to a certain degree of perfection.”
But this beneficial role for capital has a dark side. “The credit system appears as the main lever of over-production and over-speculation in commerce solely because the reproduction process, which is elastic by nature, is here forced to its extreme limits, …. the self-expansion of capital based on the contradictory nature of capitalist production permits an actual free development only up to a certain point, so that in fact it constitutes an immanent fetter and barrier to production, which are continually broken through by the credit system.”
So credit helps capitalist production to continue even when profitability is falling but only “up to a certain point”, after which “credit accelerates the violent eruptions of this contradiction — crises — and thereby the elements of disintegration of the old mode of production.” In other words, the level of credit now becomes debt that acts as a burden on further expansion and even triggers crises. If the gap between inflated financial prices and profits in the rest of the economy is large enough, a financial collapse can precipitate a full-blown recession. All of a sudden, credit dries up. When credit is needed the most, financial institutions are too frightened to lend it. As Rosa Luxemburg once argued, “after having (as a factor of production) provoked overproduction, credit (as a factor of exchange) destroys, during the crisis, the very productive forces it created.”
But as Guglielmo Carchedi puts it: “the basic point is that financial crises are caused by the shrinking productive base of the economy. A point is reached at which there has to be a sudden and massive deflation in the financial and speculative areas. Even though it looks as if the crisis has been generated in these sectors, the ultimate cause resides in the productive sphere and the attendant falling rate of profit in this sphere”. (Behind the Crisis).
And that brings us to the other blade in the scissors of slump: profits. I have discussed what is happening with profits in a recent post. Corporate profit margins, having reached record highs, are now sliding down as the costs of production rose from the end of the COVID slump and revenue growth slows.
In a report, JP Morgan economists concluded, “relative to its pre-pandemic trend, cumulative global profits since the pandemic are still over 20% depressed.” And now profits growth is disappearing. JP Morgan forecasts that “Combined with rising interest rates, profit margins will fall, dampening overall earnings.”
Even the Federal Reserve has noted this. In a recent paper, a Fed economist noted that “over the past two decades, the corporate profits of stock market listed firms have been substantially boosted by declining interest rate expenses and lower corporate tax rates.” These factors were responsible for a full one-third of all profit growth for S&P 500 nonfinancial firms over the prior two-decade period.
The significant decline in corporate interest rates allowed interest expenses to decline as a share of earnings, even as corporate debt rose.
This was a feature of 21st century capitalism: falling interest rates and plentiful liquidity, even in a period where profitability was not rising. Indeed, the response to falling profitability in the major economies was not to go for liquidation of the weak and unprofitable to clear the decks, but instead for the monetary authorities to save the banking system and prop up ‘zombie’ companies with zero- interest rate policies and ‘quantitative easing’.
But all this has done is to expand the credit-debt mountain to unprecedented highs without restoring profitability in the productive sectors. The bulk of the rise in earnings has been from speculation in the financial sector, property and in a few technology areas. The rest of the productive base of capitalist economies has been struggling – thus we have low investment growth, low productivity growth and ever larger credit liabilities that, as profits now begin to fall, are coming back to bite capital.
Rising inflation has led to rising interest rates as central banks switch from quantitative easing (QE) to quantitative tightening (QT) to try and control inflation. However, that is just exacerbating the slowdown in growth into outright recession – and generating a credit squeeze that threatens to hit not only financial assets but also corporations globally, So it’s back to QE!
In previous posts, I have noted that an inverted bond yield curve is a pretty accurate indicator of a coming slump. An inverted yield curve is when the interest rate on, say, ten-year debt is lower than on 3m or 2yr debt. That only happens when investors are so worried about possible recession that they tend to buy government bonds as a safe haven, driving down their yield, while central banks are hiking short-term rates to levels that threaten to bring down the financial house of cards.
The US yield curve has been inverted now for some time (red line).
One analysis reckons that since 1990, a 1 per cent increase in the Fed Funds rate (the central bank rate) flattens the 2-10 yield curve by 35 basis points on average. So, if the Fed Funds rate hits 4.75 per cent as forecast by the market that could flatten the curve by 1.58 per cent, leading to a curve that is inverted by as much as 1.28 per cent (the 2-10curve started this year at 0.3 per cent) by the end of the year.
Moreover, this credit squeeze is being exported by a strong dollar to the rest of the world’s economies, particularly those with large dollar-denominated debt. The US dollar is super strong against other currencies as it is seen as a ‘safe-haven’ for investors to hold their cash and assets as inflation spirals and the world slips into recession. But a strong dollar and rising interest rates are pushing the world economy into slump. “These recessionary forces emanating from the US and the rising dollar come on top of those created by the big real shocks. In Europe, above all, there is the way in which higher energy prices are simultaneously raising inflation and weakening real demand.” Martin Wolf, FT.
And the recessionary forces are getting stronger to the point that many economies are probably already in a slump. The latest forecasts by the World Bank and by the OECD, as well as the IMF, portend a slump, confirming the indications of the inverted yield curve. In its latest economic forecast, the OECD reckons the world economy is slipping into recession driven by high energy prices, rising interest rates and China’s slowdown. The OECD now forecasts just 2.2% global growth next year and as 4% is needed to keep pace with rising global population, that will mean a fall in per capita growth.
“The world economy is paying a high price for Russia’s unprovoked, unjustifiable and illegal war of aggression against Ukraine. With the impacts of the COVID-19 pandemic still lingering, the war is dragging down growth and putting additional upward pressure on prices, above all for food and energy. Global GDP stagnated in the second quarter of 2022 and output declined in the G20 economies. High inflation is persisting for longer than expected. In many economies, inflation in the first half of 2022 was at its highest since the 1980s. With recent indicators taking a turn for the worse, the global economic outlook has darkened.”
The OECD wants to blame the impending recession on the Russian invasion of Ukraine and Putin, but the world economy was already heading into a slump just before the COVID pandemic broke and the recovery after the COVID slump was already petering out in 2021 before the Russian invasion.
The World Bank is more accurate: “To cut global inflation to a rate consistent with their targets, central banks may need to raise interest rates by an additional 2 percentage points, according to the report’s model. If this were accompanied by financial-market stress (which has now started – MR), global GDP growth would slow to 0.5 percent in 2023—a 0.4 percent contraction in per–capita terms that would meet the technical definition of a global recession.”
One of the features of the 21st century in the major economies has been low unemployment, at least in the official figures. But much of this employment has been in low-paid services sectors, part-time or temporary. Now even here, there are signs of cracks. In the US, full-time jobs are falling, to be replaced by part-time employment. And in another sign of a weakening labour market, weekly working hours are down over the last six months to the lowest reading since the COVID slump in April 2020.
The other feature of the last decade and post-pandemic period in both the US, Europe and the UK has been the huge rise in property prices. That too is now showing signs of fading. This month home prices in the US fell outright for the first time since 2012. Mortgage rates have doubled, making it increasingly impossible for many to buy homes.
So falling profits; rising interest rates; slowing economies and a credit crisis. “What can be done?”, asks FT columnist Martin Wolf –“Not that much.”, he replies to himself. The impending world slump cannot be avoided. “What is known is that the central banks’ ability to support the markets and economy are for a while gone. …Even previously credible G7 governments, such as the UK’s, are learning this truth. The financial tide is going out: only now do we notice who has been swimming naked.”
Or are they already drowning?
Win McNamee/Getty Images
- A “market riot” won’t stop until the Fed reverses course on its aggressive tightening strategy, Societe Generale global strategist Albert Edwards said.
- UK gilts “have crashed horribly,” forcing the Bank of England to temporarily halt its quantitative tightening by buying long-dated bonds, he said Thursday.
- The “markets are still in charge and they just won’t tolerate QT,” in Edwards’ assessment.
A sell-off in financial markets won’t end until the Federal Reserve reverses course on its aggressive tightening strategy, according to Societe Generale global strategist Albert Edwards.
In a note published Thursday, he focused on the recent battering of UK bonds, or gilts, that has sent prices plunging and yields soaring in recent sessions. The UK 30-year gilt yield this week shot past 5% for the first time since 2010, and the 5-year yield moved above 4.5% for the first time since 2008, with markets seeing more risk in 5-year bonds than those for eurozone members carrying the heaviest debt loads.
He noted while blame for the selloff has been placed on the UK’s mini-budget — which includes billions of pounds in tax cuts — gilts began selling off last Thursday when the Bank of England’s Monetary Policy Committee said it will reduce its purchases of UK bonds by £80 billion ($88.4 billion) over the next 12 twelve months, to a total of £758 billion.
It also raised the benchmark interest rate by 50 basis points, a less aggressive move than the Fed’s latest rate hike of 75 basis points to fight inflation.
“While most press attention is on sterling’s weakness, it is UK Gilts that have crashed horribly. But the markets have proved that, as in 2018, QT is not ‘boring like watching paint dry’ and they have forced the BoE into an ignominious Powell-like pivot. What comes next? ‘Not-QE’ comes next,” Edwards wrote.
In 2019, Federal Reserve Chairman Jerome Powell said the central bank would restart buying Treasury securities to avoid market turmoil but said “in no sense is this QE,” according to Bloomberg. QT, or quantitative tightening, is the reduction of a central bank’s balance sheet, or its assets and liabilities. The process is a reversal of quantitative easing, or QE, when more funds are pushed into financial systems via bond purchases.
The so-called BoE pivot came this week when it intervened in the bond market, saying it would temporarily purchase £65 billion in long-dated UK government bonds. Bond buying is aimed at pulling yields down and lowering borrowing costs for the government and companies.
“The bottom line is, after decades of central bank stimulus inflating bubbles and financial leverage to grotesque heights, the markets are still in charge and they just won’t tolerate QT,” Edwards said.
US bond yields also spiked during this week’s panic in bond markets. The 10-year Treasury yield rose to 4% for the first time since 2010.
The Federal Reserve this month ramped up its own quantitative tightening program to $95 billion a month. Fed officials are allowing a monthly run-off of $60 billion of Treasuries and $35 billion of mortgage-backed securities. Its balance sheet shot up to about $9 trillion under QE from under $1 trillion before the 2008 global financial crisis.
Hinting at another possible pivot, Edwards referred to a quote by former heavyweight champion boxer Mike Tyson: “Everyone has a plan till they get punched in the mouth”.
“Which reminds me, isn’t the Fed in the process of doubling its QT to $96 bn a month? Good luck with that!” wrote Edwards.
AP Photo/Michel Euler
- Former Treasury Secretary Larry Summers sees today’s market risks as similar to those seen right before the 2008 Great Financial Crisis.
- A series of inflation, interest rate, and currency shocks have led to increased market volatility around the world.
- “In the same way that people became anxious in August of 2007, I think this is a moment when there should be increased anxiety,” Summers told Bloomberg.
Former US Treasury Secretary Lawrence Summers thinks today’s market risks are looking eerily similar to those that surfaced just before the Great Financial Crisis.
“We’re living through a period of elevated risk,” Summers told Bloomberg Television on Thursday, later adding, “In the same way that people became anxious in August of 2007, I think this is a moment when there should be increased anxiety.”
The summer of 2007 is when red flags became apparent regarding the stability of the global financial system, as big hedge fund wipeouts and mounting subprime mortgage losses became more and more apparent. That led to a complete freeze of the interbank foreign exchange market in August of that year.
Today, various shocks in inflation, interest rates, and currencies over the past few weeks have rocked both stock and bond markets, leading to a surge in volatility. The most recent shock occurred Wednesday morning when the Bank of England launched an emergency purchase program of long-dated bonds to prevent a UK pension crisis.
Days before that, the British pound plunged to record lows against the US dollar following Prime Minister Liz Truss’ plan to cut tax rates at a time when inflation is at multi-decade highs. She doubled down on her plan and resisted calls for scaling back the new fiscal policy in an interview with the BBC on Thursday.
“This is a global financial situation. Currencies are under pressure around the world,” Truss said, arguing that her tax plan is not to blame for the recent volatility.
Summers called the ongoing situation in the UK “very complex and uncharted territory,” and said the Bank of England’s emergency bond purchasing program is unsustainable.
While he admitted there aren’t many signs that other markets around the world are acting “disorderly,” that can change in the blink of an eye given ongoing geopolitical tensions with Russia and a reduced outlook for global economic growth.
“We know that when you have extreme volatility, that’s when these situations are more likely to arise,” Summers said. “When a country as major as Britain is going through something like this, that is something that can have consequences that go beyond.”
Heidi Gutman/CNBC/NBCU Photo Bank/NBCUniversal via Getty Images
- The US will go into recession — it’s just a question of when and how hard, Citadel’s Ken Griffin warned.
- He urged the Fed to keep to its rate hikes so that high inflation doesn’t drive a wage-price spiral.
- US stocks are holding up for now, but job losses could drive a sell-off, the billionaire investor told CNBC.
Hedge fund billionaire Ken Griffin has warned the US will go into recession — the only question is when and how painful it will be.
In a CNBC interview, the Citadel founder also acknowledged the Federal Reserve faces a tough job in tackling inflation, as interest rates are a “very blunt tool”. But he urged policymakers to keep hiking rates aggressively to make sure high prices don’t become accepted as the norm.
Griffin said Wednesday that economic downturn now looks inevitable for the US — particularly in a “hard landing” scenario, where the Fed’s efforts to curb soaring prices lead to higher unemployment and a slowdown in growth.
“Everybody likes to forecast recessions, and there will be one,” he said at CNBC’s ‘Delivering Alpha‘ conference. “It’s just a question of when, and frankly, how hard.”
“Is it possible [that at the end] of ’23 we have a hard landing? Absolutely,” he added.
The US central bank has raised interest rates by 75 basis points at three meetings in a row to curb inflation, which is running close to 40-year highs. Rate hikes tend to make a recession more likely because they make borrowing money more expensive, leading to falls in spending and growth.
The billionaire investor said the Fed’s task was made harder by an unprecedented labor market and a “tremendous” amount of government spending.
“So the Fed’s had a really difficult job to try to use a very blunt tool — interest rates — to address an overheating economy where Washington keeps making moves on the chess board that turned the oven hotter. So it’s a tough job,” he said.
Griffin called on the Fed to continue with its aggressive rate hikes to make sure it keeps a lid on what is seen as a normal rate of inflation. If not, persistently high levels could lead to higher wage demands, which feed into a wage-price spiral where repeated pay rises spur prices higher.
“We should continue on the path that we’re on to ensure that we reanchor inflation expectations,” Griffin said.
“There’s a psychological component to inflation that we need, to make sure that our country doesn’t start to assume that we should expect 5 or 6 or 7% inflation.
“Because once you expect it broadly enough, it becomes reality. It becomes the table stakes in wage negotiations, for example.”
Uncertainty over the Fed’s monetary tightening and the risks of recession has weighed on US stocks in 2022. The benchmark S&P 500 index has tumbled 22.2% this year so far, as equity markets suffered a broad selloff.
But the losses have fallen short of the 50% selloff predicted by market gurus like Jeremy Grantham and Michael Burry earlier in the year.
Griffin said the US stock market is showing some resilience, even in the face of high inflation, central bank interventions. It’s also facing off the threat of Russia launching a nuclear war over Ukraine.
But the Citadel boss said he expects stocks to fall further, if a Fed-induced recession leads to higher unemployment. That would lead individual investors to start pulling their money out of equities and pivot to less risky assets such as bonds.
“The market is — of course, it’s down, I don’t want to sugarcoat that. But it’s not down as much as you probably would have thought if you looked at the news headlines,” he told CNBC.
“That, again, reflects [that] people have job security, they feel safe in their jobs. Because they’re safe in their jobs, they’re willing to put money at risk in the stock market.
“If people started to hear their neighbors losing their jobs, we’d see a rotation out of equities and into fixed income.”
Mark Makela/Getty Images
- Investors should avoid most stocks with recession risks rising, according to BlackRock.
- The Fed and other central banks have underestimated the severity of the recession that their rate hikes could trigger, the asset manager said.
- “This all implies a clear sequence: overtighten policy first, significant economic damage second and then signs of inflation easing only many months later.”
Investors should look to avoid most stocks with recession risks rising, according to BlackRock.
The $10 trillion asset manager has warned that the Federal Reserve and other central banks have underestimated the severity of the recession that their rate hikes could trigger.
“Many central banks aren’t acknowledging the extent of recession needed to rapidly reduce inflation,” a team led by BlackRock Investment Institute head Jean Boivin said in a recent research note. “Markets haven’t priced that so we shun most stocks.”
The Fed hiked interest rates by 75 basis points for the third time in a row last week. Its tightening campaign has weighed significantly on stocks, with the benchmark S&P 500 falling 7% since August’s hotter-than-expected inflation data suggested the Fed would have to carry on hiking to bring soaring prices under control.
The US central bank also indicated last week that it will raise interest rates as high as 4.6% by the end of next year, while Chairman Jerome Powell acknowledged that there’s a “very high likelihood” the US faces a period of below-trend growth.
But Boivin’s team said that the Fed’s cheerful economic projections overestimate the likelihood of a soft landing. In that scenario, the Fed successfully cools inflation with interest rate hikes while avoiding a severe downturn.
“The Fed still sees positive growth this year and sees it picking up next year,” the BlackRock strategists said. “But it also wants to see evidence core inflation is on a decisive 2% trajectory beyond 2023 before it stops hiking.”
“This soft landing doesn’t add up to us,” Boivin’s team said.
The Fed wasn’t the only central bank to raise interest rates last week, with the Bank of England implementing a 50-basis-point hike and Sweden’s Riksbank announcing a supersized 100-basis-point hike.
The global “rate-hike blitz” suggests that other central bankers share the Fed’s optimistic outlook, according to Boivin’s team. BlackRock warned that aggressive overtightening could trigger a downturn before inflation has cooled sufficiently, leaving central banks torn between raising and slashing rates.
“Many central banks, like the Fed, are still solely focused on pressure to quickly get core inflation back to 2% without fully acknowledging how much economic pain it will take in a world shaped by production constraints,” Boivin’s team said. “Case in point: last week’s rate-hike blitz.”
“This all implies a clear sequence: overtighten policy first, significant economic damage second and then signs of inflation easing only many months later,” the strategists added.