By Michael Every of Rabobank
Things we should and shouldn't say
Yesterday saw another of our back-to-back daily mini-cycles of market denial, anger, bargaining, depression, acceptance,…and then new denial. Because stocks went down and bond yields up on Monday, it was obviously time for stocks to go up and yields to come down on Tuesday.
Yet, again, nobody paid enough attention to commodities, where oil went up again – Brent is now nearly $121 despite all that is happening, and not happening in China. More on that later.
Nobody paid any attention to Chad either, Africa’s fifth-largest country, whose government just declared a “food and nutrition emergency” after a poor harvest and unaffordable grain imports. That’s 14m people discovering what well-fed participants in Western markets mean when they euphemistically say “demand destruction”: indeed, the phrase is arguably placing itself up there with certain others as something one oughtn’t to be either saying or allowing to happen.
As a report from the ground (not from a well-fed Western journalist working from home) puts it, “In the village of Falke, some 665km (413 miles) from the capital Niamey, Tassiou Adamou, a farmer, told DW that this year's harvest will likely be poor because producers cannot afford to buy enough fertilizer. "Groundnuts, which are our main cash crop, need fertilizer," Adamou pointed out. "Until last season, a bag of fertilizer cost 17,000 CFA francs. This year, it has reached 30,000," he said, adding that it is impossible to produce much for those in the countryside. "If you used to use three bags of fertilizer for your field, today, you can only have one bag with the same amount. Where you used to harvest 50 bunches of millet, you can barely produce 30 bunches without fertilizer."” Much of Africa is in the same boat – and it is rapidly sinking.
US Treasury Secretary Yellen told to Congress, and social media, “We now are entering a period of transition from one of historic recovery to one that can be marked by stable and steady growth. Making this shift is a central piece of the president’s plan to get inflation under control without sacrificing the economic gains we’ve made.” That is as Friday may see an upside surprise to US CPI, and the Atlanta Fed downgraded its estimate of Q2 GDP growth to just 0.9%: and we still have three weeks left for revisions to imply the US is already in a technical recession.
Moreover, Philip Marey, with exquisite timing, just published ‘The inevitable recession’. As he puts it, the negative supply shocks from Covid and the Russian invasion of Ukraine are causing headwinds, *and* a wage-price spiral has now started that will be difficult to stop without the Fed hiking the economy into recession next year. Even if the US is able to absorb the exogenous shocks, the Fed response to the wage-price spiral will cause a recession from within anyway.
That is echoed from the logistical coal-face. FreightWaves argues ‘US import demand is dropping off a cliff: Inbound container volumes to the US are reverting to pre-pandemic levels’. As the industry, and 2021’s ‘In Deep Ship’ made clear, we could always take away supply-chain pressures with a consumer recession. That’s “demand destruction” again, implying an awful increase in unemployment, homelessness, and bankruptcies.
The World Bank also slashed its 2022 global GDP growth forecast to 2.9% from 3.2%, warning of stagflation and several years of above-average inflation ahead. President Malpass said, “The downside risk is that it could be a global recession. One of the key variables is whether supply comes back online in order to add growth and slow down the inflation rate. But this is the sharpest slowdown in 80 years.”
As Malpass says, and Yellen recently said she got wrong, it is all about SUPPLY as well as demand. If one only looks at demand, the signal is for a Fed pivot, lower bond yields, and (perversely) higher stocks. It is also for an unspoken risk of socio-economic unrest, because overall prices won’t come down, just the rate of inflation will. People who already can’t pay their bills will find they don’t have a job either. In which case, the level of rates is largely irrelevant.
FreightWaves has important things to say on that supply side, which economists should have been listening to in 2021 to see that inflation was not going to be transitory:
“If bookings continue to soften through June, we expect to see spot rates on this trade lane decline further, but ocean carriers may go to greater lengths than ever before to try and protect their record-setting earnings. They have already been cutting capacity on major trade routes through measures such as blank sailings and reassigning vessels to other services, but if the decline in volumes accelerates in the weeks ahead, we may see the alliances test their strength and discipline like never before. If rates start dropping quickly, it is reasonable to suspect that the ocean carriers that have not locked in a majority of their allocations in longer-term contracts may begin aggressively undercutting one another as they compete in the spot market.”
In other words, we may soon find out if the industry acts in oligopolistic fashion or not – ironically just after a US investigation concluded ‘not’. If the supply of vessels falls to match lower demand then spot freight rates will stay elevated, if off recent peaks, and long-term rates were just signed at record high levels. That will make the politics and geopolitics of the industry ‘interesting’. At the same time, and leaning back to Philip’s argument, US ports are likely to see contract-related strike action ahead, which could bung the whole industry up again.
FreightWaves also underlines ‘How new EU sanctions on Russia will shake up global energy trade’. Once the new insurance ban kicks in, the industry will be “dramatically” impacted. Experts Poten & Partners say Russia would need 20 Aframaxes, 51 Suezmaxes, and 43-48 VLCCs (the biggest ships) prepared to break such sanctions, as they do with Iranian and Venezuelan oil, and “Finding these vessels and arranging insurance could be very challenging.” In short, there is a reason projections for energy prices keep marching higher, taking other commodities with them.
Moreover, lower rates won’t grow more food right now: in fact they will grow less if energy prices spike higher as a result.
While it is true that higher rates are not an appropriate policy response to a painful supply-side shock, that only applies if the shock is brief and a one-off, not a structural attack; not one where wage-price spirals are in place; and not one where the government is trying to help fiscally.
On the latter, ahead of the ECB tomorrow, and its plan to also stop peripheral bond yield spreads blowing out, @RobinBrooksIIF notes that for years, all of Italy’s net government bond issuance has been bought by the ECB. It’s almost as if this were war-time monetary financing – it only didn’t produce any inflation until now because there was no fiscal stimulus, or growth, which was the deliberate structure of the ‘new normal’ paradigm. Yet that changes once you start giving people money to prop up demand, as now vs. energy and food price spikes.
Brooks adds, “What does ECB "spread control" mean? Let's take the most extreme scenario for sake of illustration – say the ECB announces a hard cap on spreads, i.e. Italy's 10-year spread over Bunds is no longer allowed to go over – say – 150 bps. What would this imply for the ECB?
Such a cap commits the ECB to potentially unlimited purchases of Italian debt if there's a speculative attack, if Italian growth falls or if deficits widen. This is incompatible with the "no monetary financing" rule that governs the ECB. An outright cap is therefore NOT possible.
When ECB QE started in 2015, purchases could not deviate from the capital key, so it was in principle not possible to do spread control. PEPP moved in the direction of spread control, since it allowed deviations from the capital key, but PEPP was a one-time program… So – if the ECB really wants to go down this path – the trick will be to design a permanent program that does not run afoul of the "no monetary financing" rule. That is far from trivial and may be subject to legal challenges based on past experience…”
As someone replied to him, “Too bad that what we are experiencing and will live is a war economy. The alternative, I’m afraid, will be food ration books.”
Both of the arguments above are true.
With JPY past 133 and falling, also note the Bloomberg story today, that ‘Tumbleweeds Blow Through Japan’s Bond Market on BOJ Dominance’, where “Japan’s benchmark 10-year government bond didn’t change hands once on the open market Tuesday in a fresh sign of the country’s dysfunctional debt market. It was the first time since Dec. 27 that there was no trading volume in the notes, with the only activity coming from the Bank of Japan’s debt purchase plan.” Coming soon to a market near you, it seems.
To repeat, it is true we people say higher rates are not an appropriate policy response to a painful supply-side shock. Yet it also true when others say this shock is not a brief one-off but a structural attack, with wage-price spirals in place, and a government helping fiscally.
The key issue is being willing to say both together as a new, difficult truth: the global rich, who set rates, have to decide if they will sacrifice their asset prices to help the global poor eat. If we won’t say that, can we at least say that we have a choice between putting calories in rich people's cars or in poor people's mouths?
To conclude, markets say “demand destruction”, but won’t say it can mean “mass starvation”.
Some are now able to say “stagflation”, but many in markets weren’t allowed to until recently.
Some can say “recession”, but many in markets and politics still aren’t allowed to.
Yet nobody wants to say “depression” because there is *still* the assumption that, bad as things are, somehow a ‘hockey-stick’ bounce lies on the other side. Not sticks, stones, burning torches, and pitchforks.
Should we say that? Many will say no, we shouldn’t. Yet when the tail risks are so big, and the need for correct action to avoid them are so urgent, the question actually is, why shouldn’t we say it?