Weekly Report
Artem Karida
Educator | C-suite advisor | business strategy, innovation, and marketing expert
Week 09. February 27 -?March 5, 2023
INDEX
Macroeconomic indicators
Analytics
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Macroeconomic indicators
Analytics
The dismantling of the Fed's monetary policy transmission mechanism
These are serious processes, despite the Fed's cautious avoidance of any acknowledgement of the critical divergence of the money and debt markets.
The bottom line is that the rates on deposits in the dollar zone at the country's top commercial banks lag substantially behind the benchmark rate and the debt market (a record gap).
There were instances of local and short-term divergence of the money and debt markets of more than 3 percentage points in the 1970s and 1980s, but not on such a broad scale and for as long as it is currently.
To determine the gap, compare the weighted average deposit rates with the debt market by maturity/circulation, using the Treasury market as the primary comparison.
Under normal conditions, from 2009 to 2021, the difference between US Treasury bills and deposit rates did not surpass 0.5 percentage points, but by February 2023, the spread had expanded to a historical high of 4 percentage points, and the anomaly is consolidating rather than stabilizing. Deposit rates are rising, but with a large lag and lagging behind the Fed's benchmark rate and the debt market.?
What is causing this? Banks' excess liquidity accumulated over the last 15 years, particularly from 2020 to 2021. Because banks are not interested in recruiting funding, they have the option of keeping deposit rates low.
What is the impact? On lending rates, which deviated from both the debt market and the Fed's benchmark rate. A slower rate hike schedule in 2022 contributed to the most intensive loan boom in 15 years.
Customers actively borrowed from banks, fearful of rising interest rates and finding "favourable conditions" with the biggest inflation in 42 years and a record tightening of the Fed's monetary policy. Companies that were cut off from the debt market and had to rely on banks for help were also included.
As a result, rather than lowering lending, the Fed received an increase in loans in 2022, as well as the dangers of rising inflation.
The money M2 supply in the United States
The money supply in the United States is actively dropping (a nominal value decrease of 1.7% year on year and a real value decrease of 7.6% year on year), which greatly exceeds the April 1980 anti-record (minus 6.5% adjusted for inflation).
The contraction of the US money supply was the most significant since 1930-1931, and for the first time in US history, M2 contraction at a record pace occurs on a trajectory of strengthening lending with the greatest intensity over the past 15 years (during the Great Depression, debts were reduced), albeit at a fading pace in 2023.
There are two causes for this: a high base built during the crazy monetary frenzy of 2020-2021, when 6 trillion liquidity was absorbed into the money market compared to the typical of 1-1.4 trillion over two years, resulting in 4.6-5 trillion dollars of over-pumping.
There is currently a natural pitting of surplus money supply.
The second and more essential reason is more fundamental. The fall in the money supply is a result of the search for greater profitability in an environment where deposit rates are still near zero, which has resulted in the establishment of a record disparity between the money and debt markets.
Given the nominal GDP growth rate, the anticipated amount of redistributed liquidity from the M2 aggregate from January 2022 to January 2023 is around $1-$1.2 trillion, i.e. $1-$1.2 trillion each year. If there had been no low interest rate element, the money supply could have naturally expanded by $800 billion over this period, but it actually declined by $400 billion.
There is no answer yet on the allocation of over $1 trillion in cash assets, but at least half of it appears to be parked in the US debt market, which works as support for the debt market in the face of negative real rates.
The market's imbalance has resulted in the desynchronization of several processes. Inflation and consumption should be actively decreased with such a reduction of M2, but this does not occur due to structural distortions in the previously stated processes.
Industry in the United States
Although industry (mining + processing) accounts for no more than 14% of US GDP, a large portion of the service sector is closely tied to and serves the industry.
Construction, electric power and utilities, transportation, communications, wholesale trade and warehouses, finance and insurance, information technology (IT), research and development, marketing, administration, and other commercial services are among them.
Indeed, industry has a tiny proportion of the economy, but the segments of the economy related with industry are quite important, thus the integral contribution of industry is several times more. More precise numbers are required here, but on the lower border, at least 35% of the economy is at stake.
The Fed monitors industry in the United States, and 5 of the 12 FRBs (Dallas, Kansas City, New York, Richmond, and Philadelphia) monitor manufacturing activity monthly as a leading indication of the industrial index for the next 1-4 months.
If the main challenge encountered by industrial enterprises in 2020-2021 was logistics and supply chain disruption, which made continuous production difficult, then in 2022, businesses began to complain about difficulties in obtaining qualified and/or working staff, forcing corporations to raise wages.
Logistics is no longer seen as an issue; supply chains are being "unraveled."
Inflationary pressures have a negative impact on both raw materials and intermediate products.
More and more businesses are reporting a reduction in export orders and a rise in warehouse/stock overstocking (an overproduction crisis), which distinguishes the scenario in 2023 from 2021, when there was a shortage of raw materials and components.
Rising funding costs has not yet identified as the fundamental issue. As a result, all of the difficulties remain.
"Fear has a quick ear" - because of this, business is much more negative than usual. According to the aggregate index of industrial activity, the industry should collapse by 3-4%, as it did in 2005, but it has only fallen by 0-1% so far.
The economy is headed for a deep fall, but for the time being, the issue is under control.
Europe's Inflation
In Europe, inflation is shifting structurally. The rate of rise of energy prices in Europe is dramatically slowing - in October 2022, the rate of growth was 42% per annum, and in February, the rates plummeted sharply to 13.7% y / y, and in 3-4 months, Europe will experience energy deflation due to the base effect. The issue of energy "goes off the stage."
Energy was the primary contributor to the total consumer price index decline, which slowed from 10.6% in October to 8.5% in February 2023.
At the same time, inflation, excluding the energy component, has been steadily rising (6.4% in September, then 6.9%, 7%, 7.2%, 7.3%, and ultimately 7.7% in February).
Food costs are rising at an unprecedented rate, reaching highs not seen since the 1970s and 1980s in several countries.
The pan-European food price index is rising by 15% on a monthly basis (prices rose by 4.2% a year ago, and 11.8% in September). The monthly price rise is an unusual 1.6%.
Following a reduction in price increase for services in October-December, there is a price surge at the start of 2023, with price growth of 0.9% m/m and 4.8% y/y, the highest rate for the entire known period of records since 1985.
Non-energy prices are rising by 0.8% month on month and 6.8% year on year (again, the maximum for several decades).
Core inflation in Europe is around 6-6.5%, removing one-time effects and volatile components, which is nearly 5 times the average rate from 2009 to 2021.
What can be said in this case? Because energy costs have begun to spread across industrial linkages, production chains, and trade channels, the difficulties are really significant, and these processes could endure another 12-15 months.
Inflation structurally damages the insecure sectors of the population because energy, electricity, and groceries account for more than 60% of the poor's expenditure structure, and price increases exceed all permissible limitations in this segment.
This is why customer trust is so low. As a result, it is even more intriguing to see what fresh monetary policy decisions the ECB will make.
How does Russia ship its oil?
Prior to the advent of sanctions, 25-27% of Russian crude oil was exported via pipelines, with the remainder via tankers.
The Druzhba pipeline transports European pipeline exports with an average volume of 3.2 million tons per month in 2021, with a peak actual throughput of 3.7-3.8 million tons per month.
Germany intercepts 1.3-1.7 million tons on average, Poland receives 0.70-1.1 million tons, Slovakia receives 0.4-0.6 million tons, Czech Republic approximately 0.3-0.5 million tons, Hungary received 0.2-0.4 million tons prior to sanctions, and Austria is within the accuracy of the count (according to Bruegel).
From March to October 2022, Druzhba exports increased to 3.4-3.6 million tons, primarily due to Poland (+300 thousand tons) and Hungary (+200 thousand tons), but from November 2022, they decreased by nearly 1 million tons to 2.5-2.6 million tons (2-2.5 times reduction in deliveries to Poland, three times reduction in deliveries to Hungary, and a 20% decrease to Germany).
According to plans and trends, Druzhba exports may drop to 2-2.2 million tons by mid-2023 due to a bigger reduction in supply to Germany.
As a result, Russia's losses are anticipated to be 1 million tons per month in 2021 and 1.5 million tons in March-October 2022. In barrels, this equates to around 250 and 370 thousand barrels per day, respectively.
East Siberian oil is also supplied to China via the ESPO Pipeline, with monthly exports remaining consistent at 2.5 MT (peak deliveries 2.7 MT).
Current pipeline deliveries to China vary between 2.4 and 2.6 million tons per month, with an average of 2.5 million tons (610-615 thousand bpd), which is consistent with average monthly deliveries in 2021.
In 2021, cumulative pipeline exports were 3.2 million tons to Europe and 2.5 million tons to China, i.e. 5.7 million tons per month or 1.4 million bbl/d; by mid-2022, shipments had increased to 6.2 million tons per month or more than 1.5 million bbl/d.
Pipeline shipments to Europe and China were approximately 5 million tons per month (1.2 million bbl/d) at the beginning of 2023; but, by mid-2023, exports may have decreased to 4.4-4.7 million tons per month, or approximately 1.05-1.1 million bbl/d.
Consequently, prospective losses on crude oil pipeline exports are expected to be no more than 400,000 barrels per day.
It's difficult to analyse what's going on with oil tanker transportation right now. The market has almost fully shifted into the gray zone; all activities are carried out by particular (and well-known) western operators, the actions of which are largely ignored (it's astonishing how this works ??).
The United States budget deficit
According to preliminary figures (based on US Treasury data), the US budget deficit was $297 billion in February, putting 2023 in second place after February 2021 ($310 billion).
Taking inflation into account, the February deficit in 2023 equates to the 2009-2012 crisis. More telling is the $420 billion accumulated deficit from December to February, which is much bigger than last year's $120 billion.
The budget gap over the last three months is only second to the period of COVID frenzy and frenzied printing press 2020-2021, when $617 billion was issued for the stated period. The present three-month run-up is more than double the corresponding period's average deficit from 2013 through 2020.
In March, the deficit was typically $140 billion; but, with inflation and growing social needs, military spending, and debt interest payments, the deficit could fall below $200 billion in 2023.
Then, in April, which has an average surplus of $170 billion (last year's surplus was $300 billion), we estimate a surplus of $160-$200 billion this year, implying that March-April will work to zero, and the gap will widen in May.
From May through July, a $500 billion deficit is possible, which would be a very excellent situation. What exactly does this mean?
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The present operational balance of cash in Treasury accounts with the Fed is $355 billion, with a lower limit projected at $50-$70 billion, implying that another $300 billion might be spent.
Under a best-case scenario, they will approach the red line by April, then the April surplus, and finally deplete all reserves by June-July.
There are also emergency processes of the Ministry of Finance and manipulations with domestic debt that can give $ 250 billion, but in general - July is a "Dday".
As a result, it will be necessary to enter the debt market, which is intriguing. Inflation is raging, consumption is not slowing, and lending is not slowing as a result of the disturbance in the Fed's transmission mechanism.
What will be the situation of the debt market by the time the rate rises in the middle of the year? It is an excellent question.
Business expectations in the United States
For the first time in eight months, U.S. service business forecasts for volume and the year ahead are the highest since May 2022, as the country emerges from an unbroken era of apocalypse and output cut plans.
In order to enhance output within the present employment and service sector structure, service providers have grown employment at the quickest rate since September 2022, despite dwindling free reserves.
New order dynamics returned to October 2022, breaking the three-month contraction of November 2022 - January 2023.
Production costs have been reduced significantly as a result of dropping commodity prices and the stabilization of intermediate product pricing. Following the creation of a peak in June-July 2022, the purchase price index declined to levels seen two years previously (spring 2021).
Simultaneously, the company is rising selling prices in order to equalize margins and pay for losses incurred in 2022, when the company compensated for price disparities with profits while retaining employment and output.
Wage growth has decreased but remains at historically high levels (twice as high as in 2010-2020). Internal costs are high enough to maintain high selling prices.
The service industry is facing uncertainty as a result of decreased export orders, strong inflationary pressures, and the possibility of demand diminishing due to high interest rates.
What should be noted here? The service sector accounts for two-thirds of American consumer expenditure and more than 60% of the US economy, making it an essential component.
In the United States, inflationary pressures stay on the path of cost transfer from the external to the domestic expenditure structure, as raw material costs are replaced by domestic ones. The desire for employment persists, as does the possibility of output stabilization or even expansion, implying that it is premature to discuss the crisis.
The Fed monetary policy transmission is still limited. The rise in interest rates has been noted by business, but it is not yet a priority.
The lags between the influence of negative factors and the margin of safety were longer than planned.
The debt market
The open market, which provides finance through the issue of corporate bonds, is one of the most important funding sources for American businesses.
The entire outstanding volume of corporate bonds issued in the dollar zone in US jurisdiction is around $10.2-$10.3 trillion. At the same time, the annual volume of redemptions ranges between $1.3 and $1.7 trillion.
Last year, the volume of corporate bonds issued was $1.4 trillion, with nearly nil change in the balance of obligations at the end of the year, i.e., everything that was repaid, plus or minus with a minor lag, was refinanced through the placement of new issues at higher rates.
What happens in the start of 2023? According to Refinitiv / Sifma data processing, there has been an improvement. In January-February, each received $170 billion, which, according to preliminary calculations, is greater than the volume of repayments, indicating that the volume of corporate debt began to expand for the first time in about 14-15 months.
Why? The difference between predicted inflation and corporate bond rates has been narrowed. Imagine, in March-April 2022, when the Fed was just beginning to raise rates from zero and inflation was shattering records, real rates on medium-term bonds were negative to minus 5-6 percentage points.
Real rates are now close to zero, which is beneficial in several cases. High-quality bonds are quoted at rates ranging from 4.2% to 6%, which corresponds to predicted inflation.
The second factor is the redistribution of a massive flow of liquidity from the money market, where interest rates lag substantially behind the Fed's benchmark rate for the reasons indicated previously.
The intricacy of the debt market's work in 2023 is that there is a steady demand solely for high-quality bonds, while junk bonds are not in demand - debt reduction and replacement with bank credit continues.
Because of the funds acquired during the previous 15 years, the acute period of the gap survived.
Debts vs stocks
Why is the debt refinancing mechanism in the United States functioning properly? Excess liquidity has accumulated, limiting the rise in interest rates on bank deposits and keeping inflationary expectations in check.
Deposit rates are rising, but at a slower pace than the Fed's main rate, treasuries, and corporate bonds, causing liquidity to flow out of the money market and into alternative products (in search of higher returns).
This is reflected in the money supply contracting and the rise of demand for corporate bonds.
The money supply in the United States is declining for the first time in modern history (at least since the founding of the Fed), despite record loan growth - this is folly in monetary theory, and it destroys most monetary structures and algorithms.
But, this is the reality of 2022-2023, which deforms the Fed's regular transmission channels, limiting the point adjustment of monetary aggregates, credit activity, and inflationary pressure.
On the other hand, it prevents the American debt market from collapsing.
Either weaken demand, investment activity, and inflationary pressures, or leave things alone and save the debt market. The preservation of the debt market is obviously a priority.
One of the most significant concerns in 2022 was the demise of the debt refinancing mechanism in the face of negative interest rates. There were numerous reasons behind this. A circumstance in which a company or the government needs to repay bonds but cannot refinance them due to a lack of demand or insufficient demand. This is what the Fed feared in the first place, forcing Powell to abandon his dove rhetoric and become a radical hawk, changing shoes in flight.
The Fed is concerned with inflation expectations and confidence in monetary policy, which keep the entire architecture of the currency system running smoothly.
The essential point is the debt refinancing process, which is central to the financial system's operation.
Investors base their investment decisions on weighted risks (the current composition of risk variables), the profitability of a financial instrument, and expected inflation.
If an investor purchases a three-year bond with a fixed yield of 4% per year, the investor must consider what the accumulated inflation over the next three years will be (past inflation does not matter), whether there is an adequate alternative, and whether the issuer will be able to redeem the face value of the bond.
As a result, even in the face of strong current inflation, it is critical to reset inflationary expectations, allowing bond demand to normalize.
The existence of bond demand might partially mitigate the risks of the issuer's default, however if the debt refinancing mechanism is breached, the chances of default multiply several times over.
In a possible crisis, the search for other sources of investment is constrained, and the area for investment decisions is narrowing down to a minor group of products - treasuries, high-yield bonds, which is what is happening now.
In this view, a medium-term or even longer-term advance in the stock market and stable demand in the bond market are incompatible.
So, to summarize what has been said. Current market conditions and the inflation vector indicate that keeping the debt refinancing mechanism operational is the highest priority. This is possible only in a "depressive" stock market.
Persistent medium-term bond demand could be on a path of sustainable inflation expectations that are at or below bond rates, causing the Fed to "twist" and the stock market to fall.
Europe's retail sales
Despite enormous price hikes and plummeting real incomes, retail sales in Europe are quite resilient. A 2.2% year-on-year decrease, with food and beverages down 4.7% and non-food products down 1%.
Two large-scale blows (COVID crisis 2020-2021 and inflationary crisis 2022) failed to break Europe's consumer potential, which is 3% higher in January 2023 than in January 2020. (the last pre-Covid month in Europe).
Three percent above pre-Covid levels is important for Europe. For example, the consumer maximum formed during the 2008-2010 crisis was only exceeded in 2015, and the three-percentage-point threshold was closed in May 2017, taking 9 years. They completed it in three years this time.
In general, the vector is negative. The dynamics inside Europe are extremely multidirectional. In Germany, consumption is down 6.8% year on year and down 0.7% by January 2020, while in France, consumption is down 2.9% year on year and up 7.3% by January 2020.
There is no live data for January in Spain or Italy, but previous data show that Spain is stagnant, plus or minus, and Italy is cutting consumption to a multi-year low.
Extremely solid positions in Eastern Europe, particularly in Poland (+2.4% year on year), Romania (+5.8% year on year), Bulgaria (+5.6% year on year), and Slovenia (+18% year on year), where there is no or a consumer crisis with the ongoing construction of new consumption peaks. One of the reasons is the Ukrainian refugee crisis, which has had a significant impact on the population in Eastern Europe.
The intra-regional structure is changing, the commodity structure of consumption is changing, internal reserves are discovered (depletion of savings and expansion in loans), but when viewed holistically, the crisis is localized, fairly fragmented, not overly severe, and controllable. It was more painful and took longer in 2009.
Income pressures will persist, and depleted savings and rising lending rates will make maintaining high consumption levels difficult. Europe is on the verge of a full-fledged fall.
European Stocks
The European stock market is soaring to new highs in the continent's main countries. Because, from March 7 to March 12, 2022, world markets created a local minimum against the backdrop of a geopolitical shock after the NWO, a mounting inflationary crisis, and the prospects for tightening monetary policy, growth is over 30% for half a year and roughly the same for a year (23-30%).
There have been four periods with comparable or stronger recovery momentum in 100 trading days over the last 20 years: July 2009, April 2015, August 2020, and April 2021. Indexes not only achieve historical highs, but do so with amazing speed - one of the fastest in contemporary history.
Typically, this occurred in the context of big monetary or macroeconomic developments. Such expansion has always been associated with macroeconomic recovery/recovery, increased investment activity, and, in general, large-scale monetary injections.
Is it any different now? The monetary policy cycle is in the midst of the most severe tightening in 42 years, and there is still no relief; inflation is serious and becoming structural; intersectoral imbalances are enormous; and the economy in developed countries is headed for recession.
There are numerous signs and charts that can confirm the spurt's abnormality and medium-term instability. One of the indications is investor activity and demand for IPOs and SPOs, which has remained stable despite being at a historical low.
Normally, such stock market expansion is followed by an increase in risk appetite, as evidenced by higher demand for junk bonds, toxic assets, and increasing interest in stock offerings, but not this time!
Surplus liquidity, flight from deposits, and emotional swings in the mode of intensified manic-depressive psychosis from the expectation of collapse to the anticipation of the next super cycle are all symptoms of the next super cycle.
We live in a world full of incredible anomalies and stories.
THE END OF THE REPORT
Stay tuned.?
Regards, Negorbis.
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