Weekly Report
Week 43. October 24 - October 30, 2022

Weekly Report

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Week 43. October 24 - October 30, 2022

INDEX

Macroeconomic indicators

Analytics

  • Seismic shifts in US energy policy
  • The US real estate market
  • The tensions between China and the USA
  • Creating the framework for a new global order
  • Helicopter money
  • Stocks vs Bonds
  • Japan's crisis is worsening
  • Reactions to China's elections
  • Western countries are entering a crisis
  • The state of American corporations
  • Is there a crisis in the United States?
  • Gas supply to Europe
  • ECB problems are rising
  • US GDP
  • Forex market
  • US Monetary policy
  • Europe is in the grip of a massive crisis
  • The US households' savings


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Macroeconomic indicators?

September Chinese data is mixed. GDP, investments, and industrial production have all increased; nevertheless, retail sales have slowed, unemployment has risen, and new home values have dropped at the fastest rate in seven years. As a result, we are anticipating unfavourable processes, but it is difficult to predict how they will unfold in reality.

Given the exceedingly intricate relationship between Chinese economic statistics and reality, only relative changes may be discussed. We see that the Chinese authorities are being compelled to acknowledge some bad phenomena, which is significant in and of itself. A very serious "bomb" lurks beneath the Chinese economy in the shape of domestic subsidies equal to around 25% of GDP (by the way, the picture is absolutely similar in the USA).

  • Orders for durable goods in the United States have not increased for the second month in a row, excluding the transportation sector.
  • Manufacturing sales in Canada have fallen for the fifth month in a row (-0.5% m/m).
  • For the third month in a row, the balance of industrial orders in the United Kingdom has been negative.
  • Leading indicators of the business cycle in South Africa have fallen for the second month in a row.
  • Leading Indicators of the Business Cycle Switzerland has been below long-term norms for six months in a row.
  • The Eurozone Manufacturing PMI (professional index of the state of the industry; a number less than 50 indicates stagnation or recession) has dropped the most in 2.5 years (46.6).
  • The European Union's Service PMI has dropped the most in 20 months (48.2).
  • UK Manufacturing PMI 45.8
  • UK Services PMI 47.5
  • The US Manufacturing PMI fell into recession for the first time in 28 months (49.9)
  • The US Services PMI fell further (46.6)

In this regard, preliminary US GDP statistics for the third quarter of this year (+2.6%) appear to be debatable. Why should GDP expand when the economy is clearly not improving? This is covered in the Analytics section.

  • Eurozone economic sentiment is at its lowest in two years.
  • Apart from the covid failure of 2020, the IFO business climate index in Germany has been at rock bottom since 2009, as well as in the United Kingdom and Sweden.
  • Since January 2021, business sentiment in Italy has been at an all-time low; in Canada since 2009.
  • South Korean business confidence is at its lowest in two years.
  • The Richmond Fed industrial activity index is the weakest in 2.5 years, failing to rise for 6 months in a row. For the fifth month in a row, the service sector index in the same region has been negative. The Kansas Fed sees a similar picture: the bottom in 2.5 years, with similar figures in 2009.
  • New building sales in the United States are down -10.9% month on month.
  • Pending sales of existing homes in the United States are down -10.2% per month, the tenth decrease in the last 11 months. And -31% per year - nearly a record drop; sales at all-time lows in 2010 and 2020.
  • Mortgage applications in the United States fell another 1.7% last week, marking the fifth consecutive weekly decline and the tenth in the last 11 weeks, updated the 25-year low in the context of the highest loan rate since 2001 (7.16% for 30-year loans)
  • According to S&P/Case-Shiller, single-family home prices in the United States have fallen by 1.6% per month since the 2009 low.
  • Italy's PPI +41.8% per year, a record in the 31 years of data gathering.
  • Italy's CPI +11.9% per year - a 38-year high; and +3.5% per month - historically unparalleled growth.
  • Australia's PPI is up 1.9% year on year, a 25-year high, and up 6.4% year on year.
  • Australia's CPI is +7.3% per year, the highest since 1990.
  • French CPI is +6.2% per year, the highest since 1985.
  • German CPI is +10.4% per year - the highest level since 1951.
  • Tokyo Prefectural CPI in Japan is +3.5% year on year, the highest rate since 1991.
  • Sweden's annual lending growth (+5.1%) is approaching a 25-year low.
  • Retail sales in Sweden fell -0.4% month on month, marking the fifth consecutive loss, and -5.9% year on year, marking the fifth consecutive loss and the largest decrease since 1993.
  • Customer sentiment in Germany remained around all-time lows, as well as in Sweden.
  • The ECB hiked interest rates by 0.75% to 2.00% and intends to tighten the policy further.
  • The Bank of Canada hiked the interest rate by 0.50% to 3.75%, which was less than the +0.75% predicted.
  • In the face of rapidly decelerating inflation, the Central Bank of Brazil made no changes.
  • The Bank of Japan has maintained interest rates at -0.1% and will continue to purchase limitless amounts of government bonds.

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Analytics

Seismic shifts in US energy policy

Strategic oil reserves in the United States are actively declining. The United States sold 50 million barrels of strategic oil reserves between May 2021 and February 2022 (8 months), while From February 2022 to October 2022 (8 months), the US sold 170 million barrels, representing a 3.5-fold rise.

Strategic reserves have fallen below commercial oil reserves for the first time since 1983, and the overall amount has been at its lowest since June 1984. Oil from strategic reserves is now sold at a pace of 70 million barrels every 12 weeks.

With imports stagnant for the previous six months, the US export of oil and petroleum products is at an all-time high - more than 10.4 million barrels per day on average over the last four weeks.

This has led to the United States' net exports of oil and petroleum products reaching a record 2 million barrels per day. In contrast, net imports averaged 13 million barrels per day 15 years ago.?

Since 2008, there has been a steady decline in imports (from 14 million to 8 million barrels per day), while exports have increased from 1 million to 10.5 million barrels per day.

The energy paradigm has fundamentally altered, and the United States has shifted its energy balance from being the world's largest oil importer to the world's largest exporter. This is mirrored in geopolitics, both in the Middle East and in Europe.

Previously, friendly relations with Saudi Arabia and the key OPEC countries ensured US energy security, but now the Americans can easily set fire to the "wick of war" without considering the ability to ensure the stability of the energy balance, especially since most imports are closed to Mexico and Canada.

Furthermore, the United States is now a dominant player in the European energy market, even at the expense of depleting its own strategic supplies. From February through October 2022, US strategic oil reserve rates are in line with net exports.


The US real estate market

The real estate market in the United States is yet another explosive structure.

The mortgage market in the United States is now worth $12.7 trillion, a $2 trillion rise since January 2020. This is nearly equivalent to the mortgage bubble pace of 2005-2008 (a $2.5 trillion rise over the corresponding time). In comparison, the growth in mortgage loans from January 2016 to December 2019 (four years) was only $1 trillion.

All of this occurred against the backdrop of a historic spike in home prices - a 40% increase in value in two years. This market has heated up due to high demand and record pricing.

At the height of the hype in 2021, existing sales were 6.6-6.8 million houses, near to the all-time high of 7.1 million recorded in 2007.?Existing sales are already down 30% to 10-year lows, equal to a frozen market between March & May 2020 (lockdowns).

The amount of new house building has some inertia, but there are first noticeable negative swings - from the peak construction rate in 2021 to August-September 2022, the volume of construction declined by 20%, returning to 2015-2016 levels.

Long-term mortgage rates above 7% range are the highest since 2002, and given the value of the real estate and current income, the cost of mortgage charges has more than doubled since 2020, putting an all-time high strain on income.

As a result, the United States From 2020 to 2021, the Home Mortgage Application Index halved, breaking past the lows of 2013, when the market was most depressed. The refinancing index for new loans has nearly wiped out, reaching a 20-year low.

Real estate is critical to the economic and financial system of the United States. Real estate has the biggest multiplier impact in all countries, and the US has the most developed component.

Construction services, material costs, real estate agents, financial intermediaries, transportation, utilities, energy and social infrastructure, furniture expenses, household and digital appliances, home improvement, and so on are all examples of real estate. This category accounts for around 30% of the US economy, either directly or indirectly.?

Real estate was the cause and catalyst for the 2007-2009 crisis processes. The situation has improved slightly since then. Mortgage loan penetration is lower than it was in Q4 2006 when the first signs of an imminent crisis arose. Mortgage loans accounted for 36% of the value of real estate 16 years ago, and this ratio continued to rise until 2011 on the back of declining property values, and it is presently 27.4%.

However, the ratio of real estate value to disposable income is rising, hitting a previously unheard-of 253%, up from 275% at the pinnacle of the 2006 mortgage bubble. A somewhat safe level of 180-200%, implies that real estate is 30% overpriced.

The bubble is about to burst. Demand has already dropped by about 30% and will continue to fall until prices return to normal. This will be reflected in the 30% of the US economy that is linked to real estate, either directly or indirectly. The banks will face new challenges in the form of rising delinquencies and write-offs.


The tensions between China and the USA

The political tensions between China and the United States over Taiwan in early August had little effect on China's commitment to bond investments.

According to statistics issued in the US Treasury's TIC report, China's percentage of bond investment climbed marginally (from 14.6% to 14.7%) in August in the total amount of bonds on non-residents' balance sheets.

China sold bonds from March through July 2022, but they were halted in August. In this sense, the argument that the bigger the political tension between the US and China, the faster the sale does not apply.

Then, in August, after the public humiliation of China (Pelosi's travel to Taiwan), it appeared to many that China would reply with a large-scale bond sale. There is no real-time reply, at least not yet.

China has reduced its share of investments (nearly by half) during the last decade. Still, the phases of sale and accumulation are not directly coordinated with the vector of political relationships. From the standpoint of Western reaction logic, China stands out for its unusually feeble replies to US sanctions and provocations (synchronous retaliation strike).

China has not replied to the arrest of a Huawei CFO, the devastation of Huawei's smartphone and processor business, the imposition of arbitrary technology penalties, or the US political provocations. China has its own response logic based on slight resistance with exterior peace-loving and even friendly replies.

They might masquerade as partners while secretly exploiting advantages to achieve their long-term objectives. What good is the concealed advantage? Trade relationships worth hundreds of billions of dollars (China's primary commercial partners are the United States and Europe), as well as the adoption of Western technologies, in parallel, to continually establishing financial technical & economic autonomy.

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Creating the framework for a new global order

The United States is converting key friends to its own dollar ecosystem, steadily boosting its influence in the structure of the major holders of US bonds.

During the last 10-15 years, two basic tendencies have emerged that are fundamentally altering the present architecture of the international order.

The first is a major decline in the structure of OPEC nations' imports of oil and petroleum products into the United States. As a result, the security architecture that the United States has been developing since the late 1970s is becoming obsolete. After the 1970s energy crisis, control over trade flows and major oil exporters became a subject of national and energy security for the United States.

The United States was on track to become a net exporter of oil and petroleum products by the end of 2021, and it did so in 2022, exporting more than 2 million barrels of oil per day (net exports). As a result, any local or global war in the Middle East, Africa, or Europe that disrupts oil supply would no longer have the same impact on the US energy balance as it had in 2005-2007.

Second, the United States no longer views developing markets as the primary source of finance for its economy. Following the fall of the USSR, the US tried to create external control in satellite countries among the formerly neutral countries as part of the vision of a post-war global order. But making neutral nations benefactors to the American economy did not work well enough to address the massive current account and government budget deficits.

Over the last decade, there has been a reversal trend, with the US strategic allies gaining significance as the US's primary political, scientific, economic, and financial partners and contributors. The significance of US strategic partners in funding the US public debt is significantly growing. The involvement of the United Kingdom, Australia, and Canada is rapidly increasing, but so is that of Europe.


Helicopter money

The US Treasury postponed the publishing of the report on the budget deficit by ten days and they did so for a cause.

In the United States, an unprecedented amount of helicopter money has been launched. Normally, the US enjoys a fiscal surplus in September. However, what was revealed in September 2022 went above and above. A $430 billion deficit in one month, compared to a $65 billion deficit in 2021 and a $125 billion deficit in a wild 2020.

The third quarter of the present proved disastrous for the budget - a deficit of $861 billion, which is out of the ordinary when compared to previous times. (budget deficit of $537 billion in 2021 and $387 billion in 2020 (Covid)

From March 2021 to July 2022, the yearly deficit shrank to $962 billion before skyrocketing to over $1.4 trillion by September.

The United States learns "living within our means," but it does not work out. Following the fall of the financial markets, they decided to return to the prior paradigm of "helicopter money".

Three-month revenues dramatically decelerate to 7% y/y at par, after growing by 30-35% y/y in the middle of the year, while expenditure, on the other hand, began to expand by 26% y/y in terms of three months, after decreasing by 30% y/y. This is why there is such a deficit.

The cause for the frenzy this time is the Department of Education's overspending on $400 billion in student loan subsidies under the Biden program, where around 22 million people can earn a $10,000 to $20,000 deduction depending on circumstances and income.

For fiscal 2022, helicopter money on direct earmarked revenue subsidies was cut in half, from $1.65 trillion to $0.87 trillion, subsidized loans were reduced from $307 billion to $20 billion, and total spending was reduced from $6.82 trillion to $6.27 trillion.

Revenues increased by 20%, rising from $4.04 trillion to $4.49 trillion.


Stocks vs Bonds

Over the next few months, there will be a significant shift in priorities for long-term and conservative investment decisions.

Bonds rates are now higher than the whole yield of the S&P 500 for the first time in 20 years (dividend yield plus funds earmarked for buybacks).

The market's nearly 25% loss and near-record buybacks sent the S&P 500 yield up to 4.85%, roughly in line with short-term bonds bets. The market's dividend yield has increased from 1.1% to 1.83% since last year. The rates for one-year bonds are 4.56%, three-year are 4.52%, ten-year bonds are 4.2%, and thirty-year bonds are 4.32%.?

Up until 2022, the stock market dominated even among conservative institutions because its cash flow (regardless of assets) outpaced the yield on bonds. However, since then, everything has changed. As a result, bond owners will consistently receive a higher guaranteed return than the stock market.

The Fed is more concerned with debt - in the face of a lack of demand for instruments, the difference in yield should support bond demand while decreasing demand on stocks. This is in theory; how it will play out in practice remains to be seen, but the last two months have seen a regrouping of large equity from stocks into bonds.


Japan's crisis is worsening

Japan's Minister of Economic Recovery resigns. Despite the fact that little information about Japan is available in the media, Japan has the potentially most explosive situation of any major developed country.

The Bank of Japan made two unsuccessful attempts to intervene in the foreign exchange market on Friday (October 21) and Monday (October 24).

The exact amount is unknown; this information can be obtained indirectly in 2-3 weeks as part of the Bank of Japan's assessment of reserves and balance sheet, but preliminary estimates suggest that at least $50 billion was spent from two interventions.

And these volleys were a complete failure. Breaking through the defence level of 145 caused the JPY/USD to rise to 150 and higher. The market sensed the Bank of Japan's weakness and will exploit it, including through international speculators.

Any weakness of the Central Bank is always exploited to exacerbate the situation. It has been with the Bank of England and the UK debt market, and it is now happening in Japan. The Central Banks' panic is becoming more pronounced.

A weak yen wreaks havoc on the trade balance, with imports growing much faster than exports. Japan's trade deficit has already reached an all-time high.

In turn, a weak yen causes capital outflows from Japan, and with a trade deficit, Japan's current account is reset to zero, because an investment income of 180-200 billion dollars is insufficient.

The current account deficit will necessitate the attraction of foreign capital or the repatriation of Japanese assets to Japan (the sale of foreign assets that are owned by residents of Japan). This endangers the global financial system, as Japan is the world's second-largest supplier of capital after the United States.

Why is the Bank of Japan failing? The reckless monetary policy pursued over the years. There are too many cheap yen in the financial market, and the difference in rates between Japan's money and debt markets and the dollar and eurozone is too large, causing capital to be redistributed from Japan to foreign markets.

The problem is almost certainly irreversible. The interest rate differential must begin to narrow in order to stabilize Japan's foreign exchange market and financial system. Either Japan will start raising rates, or the US and the Eurozone will lower. But Japan will be unable to raise rates because the debt market, which has a record load, will collapse.

There were disruptions at almost every level in less than a month. The European industrial sector, the debt markets, the Bank of England panic, the UK political crisis, interest rates in the dollar zone in space, and Japan's currency crisis.?

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Reactions to China's elections

Deglobalization and the separation of the two development poles Foreign investors' reactions to Xi Jinping's re-election are instructive.

Non-residents sold shares on Monday, totalling $17.5 billion. With the exception of October 24, there were only three occasions when more than $15 billion was sold. Twice in July 2020, when SEC attacks on Chinese stocks occurred, and once in early 2022, during the period of Covid lockdowns, another escalation of US-China relations, and problems with money liquidity. Sales were less than $15 billion in 2020, even with covid lockdowns.?

The collapse of the Hong Kong HK50 index was 8.4%, the highest since the spring of 2009 at par and the lowest since 1990 when the money supply was taken into account. The largest drop since March 12, 2020, but if the index rose 7.4% on March 13, there was virtually no recovery.

Xi Jinping is re-elected for a third term. The main point is that Xi cleared the political space somewhat less than completely, ruthlessly burning out almost any opposition at the highest level (with tacit approval, the intelligence service violently removed Hu Jintao from the hall). There was most likely a political signal.

It is obvious that Xi's main emphasis will be on retaining power at the expense of economic development. Isolation from the collective West and the construction of an autonomous international order architecture might be the major vector of China. In any case, data and statistics of China become more and more closed.?

Meanwhile, the risk of a political and military confrontation between China and the West as a whole is growing.?

The US will almost certainly insist that the EU impose export restrictions on China. The Biden administration will seek to capitalize on its previous experience with anti-Russian sanctions activated by the EU in line with American suggestions. The United States needs export controls to slow China's progress in the global technology race.

Earlier this month, EU leaders already held several discussions on China, and a consensus was reached on reducing reliance on Beijing. Some European countries were wary of imposing restrictive measures against China. At the same time, the United States does not intend to extend Russian export control practices to China, at least not yet.


Western countries are entering a crisis

According to S&P Global's PMI index, Western countries are entering their worst crisis since 2008.

The worst situation in Germany. According to data for September 2022, German business activity is declining for the fourth month in a row, with a rapid rate of decline since August, falling from 45.7 to 44.1 points. This is the lowest indicator since COVID (the 2008 crisis level).

High energy price expectations reflect concerns about record inflationary pressures, rising interest rates, the possibility of a recession, and skyrocketing energy prices. The deterioration was widespread across all sectors, with the greatest mass in the context of Germany's limited economy and a rapid decline in the manufacturing industry, where the rate of decline is the highest. Businesses report a decline in demand, which has intensified since July and remained the same trend for at least half a year.

The suppressed activity of the citizens, combined with the extreme uncertainty of business regarding the trajectory of supply/cost of production and rates, constrain investment activity, which will be reflected in the escalation of crisis processes next year.

The main neutralizers of enterprise margins are wage fund increases and energy. To maintain output, employment, and capacity utilization, businesses balance end prices with natural profits, but the space to exploit costs through immediate profits has been exhausted.

Business records warehouse occupancy (in 2020-2021, on the contrary, insufficient warehouse occupancy), a sharp drop in new orders to a covid minimum.

The trend applies to all Western countries, BUT to a lesser extent to the United States.


The state of American corporations

The outcomes are deteriorating. Revenue growth peaked in the second quarter of 2021 (+24.4% yoy) as a result of a low base in 2020 after covid restrictions. In the third quarter of 2021 - 16.4% yoy, and then slowed continuously every quarter (15.8% y/y in Q4 2021, 13.6% y/y in 1Q 2022, 13.5% y/y in 2Q 2022, and 10.1% y/y in 3Q 2022)

However, the energy sector (oil and gas) contributed exactly 5 percentage points to growth for all S&P 500 companies (annual revenue growth of 41%), excluding oil and gas, a symbolic growth of 5.1% for all companies is below inflation.

For the first time since the COVID-19 Q2 2020, a drop in real terms of annual revenue is recorded in Q3 2022. The main question is whether IT firms will be profitable. Currently, there is a symbolic increase in revenue of 0.2% y/y, but for metallurgists and chemists, it is very bad - plus 0.8% y/y at par. Telecoms are down 9.4%, the financial sector is up 6%, medicine is up 7.7%, nondurable consumer goods are up 8%, and long-term is up 31% due to the automotive industry. Plus 14% for industrial companies.

The trajectory of net profit is similar. The peak in Q2 2021 - growth of 115% y/y on a low base in Q2 2020 (minus 35%), in Q3 2021 - 44% y/y, in Q4 2021 - 29%, in Q1 2022 - 12.9%, in Q2 2022 - 10.6% y/y, and the result for Q3 2022 only +4% y/y (but more than 10 p.p. contributed by oil&gas segment). As a result, a drop in profits began in the third quarter of 2022.

Revenue growth and falling profit mean that the margin is shrinking, and the company has used up all of its cost-cutting options. Those that were previously the main contributors to profit growth (IT and the financial sector) are now declining by 8% and 9%, respectively, year on year. Profit at oil and gas companies is up 172% year on year due to the implementation of outstanding orders in the aftermath of the consumer and investment boom in 2021.

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Is there a crisis in the United States?

The momentum for revenue and earnings growth is actively declining, and all signs point to a significant risk of a full-fledged crisis beginning in Q3 2022.

When the expected earnings trajectory of S&P 500 companies is compared to twelve macroeconomic indicators, it is clear that the growth momentum has been completely absorbed.

In May-June 2021, the Fed and the US Treasury recorded an active post-COVID recovery on steroids, when unlimited subsidies were hit in all directions indiscriminately. Due to the base effect of April-June 2020, where the main blow from covid restrictions fell, the spike was sharp and quite strong in terms of the ejection format.

Since July 2021, a continuous process of deterioration in the operational performance of US corporations has been underway.

If comparing this to macroeconomic indicators, we can conclude that the correlation exists unambiguously.

The trend is strictly downward - down the set of macroeconomic indicators. The identification of a crisis in the United States is somewhat premature. Very high inertia, a margin of safety, and residual effect from unprecedented incentives that, in fact, ended at the start of 2022.

However, it is the residual effect that keeps the industry in the United States, which has been operating for two years in conditions of a supply and demand gap, when there are too many orders and no ability to close orders. They are now fulfilling the accumulated obligations, so the industry is still profitable and performing better than other sectors.

The labour market is still strong, but has slowed; capital expenditures are lowering growth rates, but remain positive. The dollar's effective exchange rate is very interesting; the stronger the dollar is against the currency basket, the lower the profit. Furthermore, when the US economy entered a slump, the CRB Commodity Index never rose.

As a result, for the time being, we are preparing for the onset of a crisis in the USA in 2023.


Gas supply to Europe

The nearly complete withdrawal of Gazprom from the European gas market had no effect on the total gas supply (import) to Europe.

The current situation is as follows: from January 1 to October 21, 2022, gas imports to Europe from all sources and directions decreased by a symbolic 0.3%, or 1.1 billion cubic meters of gas, compared to the same period in 2021. Gas imports increased by 4.7%, or 15.3 billion cubic meters, between 2020 and 2022.

Gazprom reduced supplies by half in 2022, resulting in a reduction of 63 billion cubic meters of gas through October 21, inclusive.

Who compensated for Gazprom's missing supplies:

  • LNG imports increased by a record 70% or 51.4 billion cubic meters;
  • imports from Norway increased by 10.7% or 10.8 billion cubic meters;
  • deliveries from Algeria decreased by 9.4% or 2.8 billion cubic meters;
  • deliveries from other countries increased by 25.5% or 2.3 billion cubic meters.

Thus, LNG accounts for more than 80% of Gazprom's missing supplies.

However, there is an important distinction to be made here. In early 2022, when Nord Stream and Yamal-Europe were operational, the ability to offset Gazprom's supplies was at a high base. Deliveries through these pipes are now zero.

Gas supplies to Europe have been reduced by Gazprom to 530-500 million cubic meters per week, which is 5 times less than in 2021 and 7 times less than the norm for 2019-2020.

When compared to Q2 & Q3, November deliveries to Europe typically increase by 20-25%. Over the 8-week period when Gazprom finally turned off the Nord Stream, total supplies to Europe fell by 5 billion cubic meters or 8.3%. As a result, a more representative indicator of an 8-9% decrease in supplies for a period of limited supplies. With current supplies from Gazprom and the throughput of other suppliers, the winter gas supply shortage is estimated to be 15%.

Currently, Europe can import 7.1 billion cubic meters of gas per week; last year, imports averaged 8.4 billion cubic meters per week from November to February. This is relevant for consumption in the absence of regulations, but if Europe reduces demand by 15%, current supplies will be sufficient to balance reserves and cover the gas shortage.


ECB problems are rising

The ECB raised rates by 0.75 percentage points, bringing deposit rates to 1.5% (Deposit facility), the highest level since December 2008, and lending rates to the Eurozone banking system to 2%. (Main refinancing operations). Lending rates were last at 2% in March 2009.

The ECB's problem is the same as the Fed's: a record gap between inflation and money and debt market rates, which makes debt refinancing difficult. In Europe, the situation is much worse, with a nearly 8% inflationary advantage versus 4% in the US.

In practice, this results in a separation of borrowers based on quality and solvency. In times of excess liquidity, the money went to everyone at low-interest rates. When there is a lack of liquidity, the best among the worst are selected and excluded.

The further you go, the fewer the borrowers who can attract financial resources in a toxic environment of record negative real rates. This undermines the stability of vulnerable borrowers with low credit ratings, and because everything in the financial system is interconnected, negative processes spread to borrowers with higher credit ratings along the chain of mutual cooperation.

What is the reasoning? For example, a group of low-quality borrowers is denied financing, eventually goes bankrupt, or puts investment projects on hold. Investment is the demand for goods and services from counterparties with higher credit ratings, which reduces their income and undermines financial stability.

To correct this situation, real interest rates must be equalized; however, raising rates results in a significant increase in the cost of debt servicing. Given the business's high over-crediting and low margins (everything went to compensate for energy costs), this further undermines the economy's stability.

The United States is winning the battle for monetary capital, while?Europe is in a more complicated and vulnerable position and problems will become very acute here.

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US GDP

US GDP increased by 2.57% year on year, aided by foreign trade. Thus, net exports contributed to GDP at a rate of 2.77 per cent, a decrease of 0.2% excluding the trade balance.

Fixed capital investments are declining for the second quarter in a row (physical assets such as vehicles, factories, real estate, land, industrial plants, technology, etc). In Q2 2022, the negative contribution to GDP was 0.92 per cent, and in Q3 2022, it was minus 0.89 per cent, indicating that businesses have negative expectations about economic prospects. Changes in inventories also contribute negatively, minus 1.9 percentage points in Q2 2022 and minus 0.7 percentage points in Q3 2022. Fixed capital investments are a leading indicator, followed by consumer spending with a 6-month lag (70% in the GDP structure).

In terms of consumer spending, the picture is less clear. Exorbitant fiscal incentives from the federal government provided the impetus for growth in 2020-2021, reaching up to 18% of income (net state support in household income as a percentage of disposable income) against the norm of minus 3%. (the government took more from the population than it distributed).

The recovery was also aided by pent-up demand following the shock collapse due to COVID restrictions. Federal targeted support began to be sharply reduced (by roughly half) beginning in the first quarter of 2022, but the accumulated savings were enormous. As a result, over the last six months, the population's consumption has been supported by savings, lowering the savings rate to 3% from 7-10% in the second half of 2021.

As a result, we find that total population expenditures made a positive contribution of 0.97 per cent, with goods minus 0.28 per cent (goods absorbed all of the population's excess demand in 2021), and services plus 1.24 per cent (they are difficult to scale).

Government consumption also contributed 0.23 percentage points, as the government began spending at the highest rate in history in Q3 2022.

At the moment, the impact of the deterioration of financial balances, the rise in debt servicing costs under conditions of maximum rates for 15 years, and the critical deficit in demand for debt instruments, which complicates the borrowing and refinancing process, has not manifested itself.

All of this is directly reflected in investment prospects, which have been noticeable since Q2 2022, when investments reversed and began a rapid decline, corresponding to crisis processes. Investments are only 3.9% higher in Q3 2022 than they were in Q3 2019.

In three years of unprecedented monetary and fiscal expansion, less than 4% growth? Such an accomplishment, and given the trend, there is no doubt that the investment contraction will continue as planned among the largest corporations from the S&P500, which provided reports for Q3 2022.

Fixed capital investments will continue to fall as a result of rising interest rates, tighter financial conditions, and a deterioration in debt markets, with businesses and governments cut off from the open market and unable to borrow effectively due to low consumer expectations and depleted savings.

Because investment is the future demand in the economy, jobs, and income prospects, the investment trajectory with a six-month lag determines the consumer spending trajectory. Spending in the home will be reduced.

There are no resources to meet demand because businesses must reduce staff and wages in order to survive.

Given the lack of QE and difficulties in raising capital, financing the deficit will be difficult, so relying on government incentives in the medium term makes no sense. The trade balance is stabilizing as a result of lower imports as the country's solvency declines.

As a result, stagflation in the United States is unavoidable, and it will worsen. The crisis is only getting started.


Forex market

According to the latest BIS study, which is conducted every three years in assessing the structure and trend of the FOREX market, the average daily net turnover of the global foreign exchange market in April 2022 is $7.5 trillion.

The net turnover in dollars is 3.3 trillion per day (6.6 trillion gross turnover) - this is 44.2% of the global foreign exchange market, followed by the euro - 2.3 trillion or 15.3%, the yen - 1.25 trillion or 8.3% of the foreign exchange market, the pound - 968 billion or 6.5% of the market, the yuan - 526 billion (3.5% share), the Australian dollar - 479 billion (3.2%), the Canadian dollar - 465 billion (3.1%), the Swiss franc - 389 billion (2.6%).

Over the last decade, the yuan has outperformed the Swiss franc, Canadian dollar, and Australian dollar, but it still has a long way to go in the top three. Foreign exchange swaps account for $3.8 trillion of the $7.5 trillion turnover in the foreign exchange market, while spot market trading accounts for $2.1 trillion.

In April 2022,?the dollar had complete dominance of the global foreign exchange market, accounting for 42.9% of the foreign exchange market, the euro has 14.6%, and the yen has 10.4%.

The most popular currency pair in the FOREX market is USD/EUR (22.7% of turnover), followed by USD/JPY (13.5% share), USD/GBP (9.5%), and the yuan - USD/CNY (6.6%), which has outpaced the Canadian and Australian dollars in three years.

In general, the yuan has made the most progress in relative terms over the last three years.?

The following countries dominate global currency trading: the United Kingdom, the United States, Singapore, Hong Kong, and Japan, accounting for nearly 80% of global trade, with the United Kingdom accounting for 38% of the global foreign exchange market.


US Monetary policy

For the past ten years, the United States has followed a tried-and-true strategy: any liquidity crisis or lack of foreign capital inflows is met with tighter monetary policy, resulting in a sustainable interest rate differential in favour of the dollar.

This was the case in 2017-2019, during the first tightening cycle of the "new normal," when dollar rates reached their highest level among all developed countries in April 2018. This will be the case in early November 2022, when dollar rates will be 4%, exceeding Canadian rates.

The US not only creates a positive rate differential in favour of the dollar, but it also creates a large overlap, effectively depriving global capital of an alternative.

Inflation problems - in general, structural economic and financial imbalances in developed countries are nearly identical. Furthermore, monetary policy is vector-like, with one exception - scale and speed.

When the first signs emerged that the Fed would begin to tighten policy more aggressively than anyone else, the dollar surged to a record high. The pattern is now repeating itself, with a similar record strengthening and updating highs for several decades.

In the presence of the first systemic problems, however, the response pattern shifts and the Fed pursues a reverse policy of unlimited liquidity pumping, as it did in 2009 and 2020.

As long as systemically important structures do not fall, the Fed creates competitive conditions in favour of the dollar for foreign capital inflows, thereby forming a margin of safety. However, once it begins to fall, the Fed replaces foreign investors with its own buyout program. Foreign capital is unconcerned in these circumstances because the printing press is operating at full capacity.

There has never ever been a more aggressive cycle of monetary policy tightening in modern history. Previously, an unlimited volley of liquidity was in the context of a deflationary trend, but now there is record inflation for 40 years, which constrains Central Bank operations. It'll be both interesting and painful.

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Europe is in the grip of a massive crisis

Europe is in the grip of a massive crisis. The latest data from the European Commission as part of the calculations for business and consumer activity indicate continued continuous deterioration on all fronts.

Consumer trust in EU countries has been completely destroyed - it has never been so low. The consumer confidence indicator has dropped to minus 30 and has been there for three months, far worse than the 2009 crisis (minus 21), the COVID crisis (minus 24.7), and the early 1990s crisis (minus 18.9).

Except for COVID lockdowns, which lasted two months, there are no comparables in terms of the speed of the index's collapse, and there are no prospects for improvement this time.

The reasons are well known: the energy and food crises have dispersed food, utility, and fuel prices for the population, which has been exacerbated by the euro's fall.

Consumer inflation is at an all-time high (in Germany, the maximum since the 20s). The downward trend is clear.

  • First, interest rates are rising, increasing the burden on household budgets and making debt refinancing difficult.
  • Second, the tendency in Europe to reduce staff and salaries is becoming more pronounced - yet another source of instability.

In Europe, there are no prospects because, as inflationary pressures ease in 2023, destabilizing factors will shift to debt burden and labour market. One problem inevitably leads to another.

Since March 2022, the industrial sector, services, and construction have been steadily deteriorating (the turning point in February 2022).?

Construction and services are slightly better off as a result of unfulfilled demand following the protracted anti-COVID restrictions.

European economy Integrated index will undoubtedly contract by at least 2% over the next six months, according to the Economic Sentiment Indicator, a composite measure that has dropped to 90 points, but the destabilization process has only just begun.


The US households' savings

The US household savings rate has reached an all-time low of 3%. Such a savings rate last occurred in 2008, before the financial crisis.

The normal savings rate was 7% on average between 2013 and 2018, rose to 9% in 2019, and with the financial and economic crisis of 2020–2021, reached 33.8% in April 2020 and 26.3% in March 2021 (an annual average of 19%, the highest in history).

The cause of the growth in savings in 2021 is revealed by the population's net state support, which is calculated as the sum of all payments distributed by the state to the population less all fees and taxes collected from the population. 2021 saw record-high savings, while 2022 saw record-low savings.

In 2015-2019, the state withdrew an average of 3% of income per year; by mid-2021, it was plus 6% (the highest net subsidy in US history); thus, the state formed up to 9% of income per year. Now, 5-6% is being withdrawn, implying that fiscal policy is the tightest since 2007.

To offset the rigidity of fiscal policy and support consumption, the population actively borrows and reduces savings to near zero. The issue is that real per capita income is about the same as it was in mid-2018, while spending is 6% higher - the gap is closing through lending and savings.

Since March 2021, spending on goods has been frozen, with spending on services rising slightly and spending on goods falling, while revenue has been steadily declining.

What might result from consumption that doesn't match income? Unsecured consumption inevitably leads to a buildup of imbalances, debt burdens, and crises. The gap will have to be filled but at a higher cost.

Consumption should be reduced by at least 6-8% to normalize the balance sheets and reduce the inflationary impulse. However, these are political risks.?

The most pressing concern is whether we have national elites and politicians who have a clear vision of the future and are willing to fulfil their promises and accept personal accountability for their actions.

THE END OF THE REPORT

Stay tuned.?

Regards, Negorbis.


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The following themes and more will be covered in the upcoming report:

  • Looking forward to the Fed meeting on Nov. 2nd
  • Inflation in Europe
  • European GDP in the Q3
  • The structure of demand for goods and services
  • The Fed's balance sheet gap
  • Monetary policy (update)
  • Renewable energy sources in Europe
  • State assistance in the Eurozone
  • Investment policy structural changes in the US
  • US debt market
  • The stock market's future

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We don't make recommendations; instead, we highlight critical patterns that will help you fail less.

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