SNIPPETS OF MACRO, MARKETS, & CRYPTO
Weekly Market Review N°11
12/06/2022
by Alessandro Gherzi
Bed news typically don’t come in isolation but well accompanied by other bad news, and this week there was a rapid fire of dire news in quick succession. The negative news were varied in nature and had a depth and breadth to rival the Mariana Trench, some might inelegantly say that we are indeed in deep … Profanities aside it was downright concerning that no matter what the data release or the economic news, they were either bad or extremely bad, more often than not the latter. The first half of the week was muted and markets remained range bound as the heavyweight releases were slated for the back end of the week. Nonetheless what we did get although not headlines were hints, piling up at an accelerating rate and fast becoming certainties, suggesting that global economic growth is slowing and that recessionary alarm bells are now ringing loud and clear. Economic data has been difficult to decipher however as good detectives we are getting overwhelming evidence that is starting to point in one direction, the most dreaded one, and we need to take stock that the path seems to be set towards stagflation. The World Bank on Tuesday slashed its global growth forecast and warned that many countries could fall into recession as the economy slips into a period of stagflation reminiscent of the 1970s.
Economic data has been difficult to decipher however as good detectives we are getting overwhelming evidence that is starting to point in one direction, the most dreaded one, and we need to take stock that the path seems to be set towards stagflation.
Global economic expansion is expected to drop to 2.9% this year from 5.7% in 2021, 1.2% lower than the 4.1% predicted in January, the World Bank said in its latest Global Economic Prospects report. Growth is expected to then hover around that level through 2023 to 2024 while inflation remains above target in most economies pointing to stagflation risks. The World Bank’s June report offers what it calls the “first systematic” comparison between the situation now and that of 50 years ago, when in the 1970’s Paul Volcker rug pulled markets by opting for an uber aggressive monetary policy and went on a rate hiking spree that resulted in having the base interest rate above the rate of inflation. The present high-inflation, weak growth environment has indeed drawn parallels with the 1970s, that ultimately experienced a string of financial crises in emerging market and developing economies. Will history repeat itself? Difficult to say as things are different this time around; from the strength of the dollar, overall solid corporate balance sheets, generally lower commodity prices, technological advances that are deflationary in nature, however it is difficult to disagree with World Bank President David Malpass that stated: “For many countries, recession will be hard to avoid.” We would go a step further and claim that recession is impossible to avoid as we are, de facto, in a recessionary environment already, we are just waiting for a confirmatory nod from the number crunchers. Merely a formal exercise of box ticking, but we are there already.
Central banks can be as aggressive as they want with rate hikes and quantitative tightening, however they are very much powerless in terms of constraining supply side shocks.
On Wednesday, another reputable international institution the Organization for Economic Cooperation and Development (OECD) cut its prediction for global growth this year, estimating that global GDP will hit 3% in 2022, a 1.5 percentage point downgrade from a projection done in December, numbers not too dissimilar to those published by the World Bank a day earlier. It is interesting that they cite the invasion of Ukraine, along with shutdowns in major cities and ports in China due to the zero-COVID policy, as major culprits of global economic slowdown and it is precisely these supply side shocks that put policymakers in a particularly difficult spot. Central banks can be as aggressive as they want with rate hikes and quantitative tightening, however they are very much powerless in terms of constraining supply side shocks. This is perhaps the only silver lining, and beacon of hope, that the Fed and ECB will recognize their limited ability to decelerate inflation and that slamming the breaks too hard can bring their economies into a tailspin. Further not all malaise will be equal as growth is set to be considerably weaker than expected in some economies, especially in Europe, where an embargo on oil and coal imports from Russia is incorporated in OECD’s projections for 2023. The bloc has been heavily dependent on Russian fossil fuels and cutting some of these supplies overnight will have a significant economic impact, with perhaps inflation being the most out of control metric that the EU now has to deal with.
The ECB does seem to have smelled the coffee even later than the Fed and have woken up very late in the fight against inflation
To this effect it was widely expected that the European Central Bank would confirm plans to begin hiking interest rates in July. Indeed they did and following its latest monetary policy meeting on Thursday, the Governing Council announced that it intends to raise its key interest rate by 25 basis points at its July meeting, and expects a further hike in September, while if these announced rate increases weren’t bad enough, they further downgraded their growth forecasts and raised inflation projections. The ECB does seem to have smelled the coffee even later than the Fed and have woken up very late in the fight against inflation, after all rates are still at negative 0.5% and we expect to reach neutrality only after the summer, and that with inflation well in excess of 8%! Remember Paul Volcker? If it was for him rates in Europe would be pushing 10%, let alone still being firmly in negative territory. The dilemma however is, as we’ve alluded to before, the nature of this inflation and it’s stickiness. In Europe the primary issue is that the bulk of the rise in inflation relates to energy and food prices, little the ECB can do about. The one saving grace perhaps is that the EU labour market is not overheating, and wage growth is robust but moderate, which perhaps does justify caution with ECBs rate hiking plans going forward. Although it was inevitable that the ECB would join the hike-parade, we do not expect that it would adopt a more aggressive tightening stance than its counterpart on the other side of the Atlantic. Consumer sentiment in much more brittle in Europe, the geopolitical conflict in Ukraine is much closer to home, food and energy prices spiraling out of control is something beyond ECBs control, hence it will be interesting to see how daring will the European Central Bank be in it’s monetary policy. It is likely that the Fed will be bolder and should that be the case it will be interesting to see how long will the Euro-USD hold above parity, it might not be too long before we will be getting short changed for our Euro.
What echoed in the corridors of power in Europe reverberated louder and clearer in the deepest corners of the US economy, with a double whammy on Friday that left markets reeling.
European markets led its US counterparts lower on Thursday, perhaps in anticipation of grimmer things to come. What echoed in the corridors of power in Europe reverberated louder and clearer in the deepest corners of the US economy, with a double whammy on Friday that left markets reeling. Most stock indexes in the US were markably lower on Thursday, perhaps as mentioned, it was in sympathy with a sharp sell-off in European bourses or perhaps more probably it was due to the negativity surrounding the upcoming inflation and consumer sentiment data. Oddly, most analysts and pundits expected to see a reversal in inflation, with May’s data starting a downtrend in inflation and inflationary expectations. It didn’t happen. Actually the opposite was reported on Friday. The May consumer price index report came in at its highest level since 1981, putting enormous pressure on the stock market. The report showed prices rising 8.6% year over year, and 6% when excluding food and energy prices. Economists surveyed by Dow Jones were expecting year-over-year increases of 8.3% for the main index and 5.9% for the core index. So much so for a trend reversal in inflation. The pain however didn’t stop there, not only CPI showed a faster-than-expected rise in prices, but to add insult to injury consumer sentiment was beyond disappointing. The preliminary June reading for the University of Michigan consumer sentiment index came in well below expectations, hitting a record low. CPI is no doubt starting to have an impact on consumer psyche and subsequently confidence and spending. The consumer sentiment number was shockingly bad as the widely-followed gauge of optimism registered a paltry 50.2, the lowest in survey data going back to 1978. That’s lower than the depths of the Covid outbreak, lower than the financial crisis, lower even than the last inflation peak back in 1981. The deadly combo of high CPI and low Consumer Confidence paints an increasingly dark economic picture, a Picassoesque painting of entangled spaghetti where a confused theme of something sinister is starting to emerge. The word has already been used in this report, and it’s the one that characterises an intermingling of low growth, low confidence and high inflation…stagflation. How long it will take to get to an official recession, and a very probably stagflation, is a matter of debate that only time will resolve. However recent data and news flow suggest the moment of reckoning may be closer than many economists are willing to concede.
The pain however didn’t stop there, not only CPI showed a faster-than-expected rise in prices, but to add insult to injury consumer sentiment was beyond disappointing.
Whilst the debate of whether we will enter a recession or narrowly avoid one is still raging, what was beyond doubt is the lackluster reaction of markets that on Friday alone retreated by nearly 3% as far as the the Dow Jones and S&P 500 are concerned, with the Nasdaq shredding over 3.5%. The sell-off was broad, with nearly every member of the 30-stock Dow in the red, with declining stocks on the NYSE outpacing advancing ones by more than 5 to 1. Friday’s declines means Wall Street suffered its worst week in months. The Dow fell 4.58% for its 10th down week in the past 11, The S&P 500 and Nasdaq lost 5.05% and 5.60%, respectively, for their ninth losing week in 10 and the worst week since January. Should any doubts remain that matters are pretty dire and that perhaps markets are over reacting, we will point to a random set of stats and numbers that should put the “everything is unicorns and rainbows” argument to bed. In no particular order, other data that was released this week forecasting darker clouds ahead includes: a) savings rates have dipped to its lowest level since September 2008, b) household debt rose 8.3%, the biggest annualized gain since 2006, c) May’s nonfarm payrolls tally, represented the smallest gain since April 2021 d) Target has been serving as a canary in Wall Street’s coal mine, offering up two recent readjustments on its outlook to reflect a weakening shopper, burgeoning inventories and thus declining pricing power, e) mortgage demand hit its lowest level in 22 years f) according to a LendingClub report, as of April, 61% of consumers said they are now living paycheck to paycheck, g) overall credit card balances rose year over year, reaching $841 billion in the first three months of 2022, at this rate, balances could soon reach record levels. Things are far from rosy and only time will tell if policymakers will essentially fall into a damaging policy mistake by flexing their muscle way too excessively in the months to come causing a severe recession. They are skating on very thin ice with the odds of unceremoniously falling into freezing waters increasing by the minute.
Friday’s declines means Wall Street suffered its worst week in months.
As for crypto, it is a shame that market dynamics overshadowed what happened early in the week, when two U.S. senators introduced a bipartisan bill that, if passed, could clear the way for increased crypto adoption and growth. The Responsible Financial Innovation Act, proposed by Democrat Kirsten Gillibrand and Republican Cynthia Lummis, aims to take a light regulatory touch that will foster innovation while putting up just enough consumer guardrails in the crypto sphere. Most quite rightly believe, that the bill’s chances of passage before the midterm elections are extremely slim, however it is crypto’s first inroads into mainstream politics and a very significant stepping stone in its wider adoption. The bill is far reaching and all encompassing; dealing with matters that create an oversight framework for stablecoins, assessing crypto’s impact on the environment and its potential inclusion in retirement accounts, and addressing the debate of whether a crypto should be classified and regulated as a security or a commodity. The bill marks the very early innings of what will eventually become the regulatory framework in the US and most probably beyond, and although it is likely to undergo endless alterations and will not be recognizable it in it’s current form, it is nonetheless an important landmark for the industry. Cryptos seem to be stuck in purgatory if not hell of late, and all that can we can ask for, is for the industry and its good actors to plug along and to keep on building on its fundamentals with patience and rigor.
Things are far from rosy and only time will tell if policymakers will essentially fall into a damaging policy mistake by flexing their muscle way too excessively in the months to come causing a severe recession.
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Alessandro Gherzi | CFO STIMA
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