Weekly Report
Artem Karida
Educator | C-suite advisor | business strategy, innovation, and marketing expert
Weeks 50-51. December 12 - December 25, 2022
INDEX
Macroeconomic indicators
Analytics
Don't miss the next report -?Subscribe
Macroeconomic indicators
Don't miss the next report -?Subscribe
Analytics
The primary cause for the Russian oil embargo?
According to OPEC figures, the oil market quickly swung from a deficit to a surplus, putting pressure on oil prices. The worldwide average daily shortage is expected to be 1.7 million barrels in 2021. This imbalance was made up for by drastically reducing oil reserves in Europe and, especially, the United States.
Commercial oil reserves in the world totalled 3036 million barrels in December 2020, 2651 million barrels by the end of 2021, and 2725 million barrels at the start of Q4 2022.
Strategic oil reserves were 1.541 million barrels in December 2020, 1.484 million a year later, and 1.248 million barrels at the start of Q4 2022, with the United States, contributing the most to the fall in strategic reserves.
As a result, commercial and strategic reserves were 4.577 million barrels in December 2020, 4.135 million barrels a year later, and 3.973 million barrels in October 2022.
Concerning the oil balance. There was an average deficit of 310 thousand barrels per day in Q1 2022, a surplus of 300 thousand barrels in Q2 2022, which was one of the catalysts for the decrease in world prices, and a surplus of 0.9 million barrels per day in Q3 2022.
To compensate for excess oil in the global market, OPEC opted for a substantial drop in production, which was implemented in November, decreasing output from 29.6 mln barrels per day to 28.8 mln barrels per day - the greatest production cut since May 2020.
Saudi Arabia contributed the most to the fall, cutting immediately by 404 thousand barrels, followed by the UAE with a reduction of 149 thousand, Kuwait (minus 121 thousand), and Iraq (minus 117 thousand).
Without the production decrease, the oil excess would be greater than 1 million barrels per day. The oil market is characterized by excessive oversupply; this is still a recession that has not yet expressed itself in full expansion.
OPEC anticipates that even if there is no possibility of a global recession in the first quarter of 2023, OPEC countries will need to cut output by 500-600 thousand barrels in order to balance the market, following a 700 thousand drop in November.
This was most likely one of the main reasons for the fast embargo on Russian oil.
Russia may be completely cut off from the oil market
Russia is currently very important in the global oil market, but the globe is establishing new balances, and there is a real possibility that Russian oil may become "superfluous" over time.
Global oil demand in the first quarter of 2023 might increase by 1.5 million barrels per day compared to the first quarter of 2022, according to OPEC, assuming no global recession (irresponsible optimists :-)). Based on the assumption that the global economy will expand, although at a slower rate than in 2022. So, what about oil, if you're optimistic?
Non-OPEC oil output should climb by 1.1 million barrels per day this year, assuming Russia's production falls by 1.4 million barrels per day, although production is presently just 300,000 barrels per day lower than it was at the start of the year. The embargo component, according to OPEC, will cost the market at least 1 million barrels per day from the October-November 2022 base to the first quarter of 2022.
As a result, non-OPEC output excluding Russia will rise by 2.4 million barrels in Q1 2023 compared to Q1 2022, with OECD countries contributing 2 million and the US contributing 1.5 million barrels.
So, 2.4 million barrels per day more production outside of OPEC, excluding Russia.?But there's also OPEC, which raised output by about 1.5 million barrels in October compared to the first quarter before the emergency production cut in November.
With worldwide demand increasing by 1.5 million barrels by Q1 2023, the possible increase in global output, excluding Russia, is 4 million barrels, which is roughly what Russia delivered to Europe in the best years.
If necessary, OPEC countries can easily inject 1 million barrels into the market in comparison to November 2022 levels (this is the difference between potential production in November and actual production, because according to the plan there was an increase of 300 thousand barrels, but they urgently cut it by 700 thousand barrels to reduce oil surplus in the world market).
All this without taking into account the potential of Iran, which is not considered exclusively by narrow-minded "experts". These are calculations without a recession, while if the world suffers a recession in 2023, demand will definitely collapse, allowing Russia to be easily squeezed out of the market (this, in principle, is already possible at the moment).
The financial system or the actual economy?
For the first time in 15 years, the rate of credit expansion in the United States outpaced the rate of bond debt accumulation.
The entire quantity of debt on loans supplied by the American financial system climbed by $1.24 trillion between March 2022 and September 2022, while the volume of debt on bonds increased by 0.84 trillion.
The proportion was reversed from 2009 to 2021. Bond debt increased by $3.5 for every dollar increase in loan liabilities. Since 2014, when the credit system normalized, the percentage has been less pronounced: two dollars in bonds were issued for every credit dollar.
This is the first quantitative assessment of the dollar system's shift in goals and directions following the onset of the inflationary crisis. We've been discussing the debt issue since March of this year, as it manifests itself in the form of an inability to borrow in bonds due to negative real rates.
The credit market has stabilized the system, owing largely to the collapse of the Fed's transmission mechanism. For the first time in 15 years, demand for loans is high due to the desynchronization of interest rates in the open market and the credit market, which occurs when interest rates on loans grow less rapidly than interest rates on bonds in the debt market.
Furthermore, banks are eager to make loans in an environment of unlimited liquidity and a 15-year period of cheap money, which cannot be said for bond demand, which has virtually vanished.
This is a ridiculous situation.
On the one hand, the disintegration of the Fed's transmission mechanism kills a direct effect on the financial system's exterior contour. The Fed is unable to contain inflation and dump excess demand for the first time in its existence.
On the other hand, this enables saving the financial system from annihilation. Due to a lack of finance on the open market, businesses turned to lend to fill liquidity gaps.
Saving the financial system is, of course, more vital in the Fed's hierarchy of priorities, but this is a short-term remedy. And what if inflation persists (which is almost certain)? That is when the crisis processes will fully express themselves. Is anyone considering this option??
Bonds versus loans
A dramatic halt in US bond issuance and rapid lending expansion (at a record pace in history). Why is it significant?
The non-financial sector's market debt in the United States is $46 trillion. This is a substantial debt that must be serviced and refinanced. This $46 trillion includes $200 billion in non-financial corporate notes, $23.6 trillion in treasuries, $11.4 trillion in mortgage-backed securities and agency paper, and $6.7 trillion in non-financial corporate bonds.
Bonds are unbeatable when compared to $30.8 trillion in credit.
The entire non-financial sector debt portfolio (not just commercial banks, but all structures that can issue loans) is distributed in the form of corporate loans of $7 trillion, consumer loans of $4.7 trillion, mortgage loans of $19.1 trillion, retail mortgage loans of $13.2 trillion, cooperative mortgages of $2 trillion. As a result, loans to enterprises total $10.8 trillion, while loans to the general public total $17.9 trillion.
The $46 trillion of bond debt must be refinanced at a rate of around $10 trillion each year. The position is now such that only government debt and investment-grade corporate debt are being refinanced, while junk bonds are being avoided. From March 2022 to September 2022, the overall rise in non-financial debt was $839 billion, with treasuries, MBS and agency papers. That is, at the moment, the power to accumulate debt is limited to state and quasi-state organizations, the acquisitions of which are regulated by the Fed.
This is an example of a debt crisis that is halted by credit expansion caused by a distortion in the money market when the financial system is able to issue loans in conditions of abundant liquidity.
This will continue until the imbalance is corrected, or until someone falls victim to the increase in delinquencies and write-offs. The situation is extremely volatile and explosive.
Fed interest rate
What happens next after the rate was raised by 0.5% to 4.5%?
Powell stated that the Fed has not yet taken a "sufficiently restrictive stance," and that the rate hike will continue. Rate increases should be maintained. The Federal Reserve will attempt to tighten financial conditions.
Powell, on the other hand, emphasized that the Fed has been steadily raising its benchmark rate for the past 1.5 years, and there is no universal prediction instrument to fix some credible picture of the future. There is no guarantee that the peak level (5%) will not be exceeded.
All subsequent moves and actions will be determined by future data, financial market and economic situations. The high value of 5-5.2% is based on the data that is available and the related patterns. If financial or macroeconomic conditions change, so will the estimation of peak rates.
If the inflation data continues to deteriorate, the Fed's prediction for the rate will be affected, and vice versa. Powell's main message is that there is no certainty.
The Fed's movement into 2022 was in line with the inflationary concern and the magnitude of price increases. According to the Fed, 4.5% is considered a tight area, but there is still room for improvement.
The rate will remain at its "restrictive level" until the Fed is satisfied that it has made headway in controlling inflation.
The labour market mismatch remains severe, and it will take a long time to remedy it. Inflation in the service sector has the potential to be more steady and long-lasting than inflation in the commodities sector.
As a result, sounds like the Fed intends to keep interest rates high until pricing imbalances normalize.
Don't be misled by Fed statements
Powell emphasized that a rate drop in 2023 is out of the question, at least based on the facts and risk considerations that are now available. "The Fed will not decrease rates until it is satisfied that inflation is under control and approaching the 2% target."
In fact, the Fed is deceiving by claiming that it is conceivable to securely proceed down this path while averting the collapse of financial infrastructure. All of their swagger and confidence about combating inflation will evaporate the moment someone in the too-big-to-fail group begins to burst at the seams.
As a result, all of their intentions to keep raising interest rates and tightening financial conditions will be thrown out the window as soon as someone large falls downhill, which actualizes the issue of quick monetary policy relaxation.
The Fed speaks as if it exists in an isolated world where there is an inflation problem and nothing else can disrupt a coherent plan to counteract the inflationary momentum.?
In 2020-2021, the Fed pretended that nothing was happening, ignoring common sense, a sense of proportion, and balance, as inflation accelerated from mid-2021 and asset market bubbles were actively inflated. Too late reaction to monetary, fiscal, and financial imbalances has resulted in the current difficulties.
According to the Fed, combating inflation is more important than maintaining positive GDP growth. If inflation and inflationary expectations are not controlled, a high degree of inflation may take hold, causing incomparably greater damage in the long run, both in the labour market and in terms of income and general economic activity. The Fed is also attempting to impact the labour market indirectly by lessening the supply-demand imbalance (to force people to enter the labour market and reduce the number of open vacancies). This can be accomplished through the collapse of income and savings, as well as the decline of the stock market.
However, the Fed does not state the primary goal of its policies. This is not even a war against inflation as an objective in itself, but rather an endeavour to restore trust in the Fed, which in turn restores confidence in the dollar, the monetary system, and, with them, the debt markets.
As a result, it stabilizes the overall debt structure as well as the financial system. For the Fed, the process of battling inflation is more essential than the ultimate result, because the process allows the Fed to build confidence in the markets and the economy that the issue is under control.
As a result, everything that is happening, as well as the Fed's deliberate aggression and steadfastness, is the product of an incredibly huge gap between destructive processes and the Fed's reaction to these processes, at which point the Fed truly began to lose control of the financial system.
What's interesting here is that when the key rate and deposit/lending rates were decoupled, the Fed effectively lost control of the financial system's outward contour. For obvious reasons, the Fed does not express it and will never do so.
The red line for the Fed: March 2023
The Fed's less aggressive and fiery tone at the December 14 conference resulted in a considerable fall in market expectations for the rate for the February 1, 2022, Fed meeting.
So a 25 basis point hike to 4.75% is predicted at 76% at the February 1, 2023 meeting, compared to 35% a day earlier, a 50 basis point increase has a probability of 24% versus 51% a day earlier, and a 75 basis point increase has no bets (before there was a probability of 14%).
Interestingly, at the March meeting (March 22, 2023), more financial market participants are betting on the rate remaining unchanged and the conclusion of the tightening cycle - 28% versus 9% earlier - and a rate increase to 5% is now the most likely - 57% versus 39% the day before.
1.5 months later, our November expectations remain similar to 4.75% as the cap. However, both the market and the Fed believe that an increase to at least 5% in 2023 is appropriate, if not slightly higher. Simultaneously, for the first time in a long time, the market puts integrally a little lower than the Fed - 5% versus the Fed's 5.1-5.2%. Actually, this is the upper border's edge.
We continue to believe that the February meeting may be the last time action to tighten financial conditions is taken. Average rates at the upper end of the Fed's target range were 0.29% in Q1 2022, 0.93% in Q2 2022, 2.36% in Q3 2022, 3.83% in Q4 2022, and closer to 4.65% in Q1 2023.
That is why we do not see the effect because rates were below 2.5% in the third quarter, and the margin of safety was sufficient to compensate for the catastrophic effects of growing funding costs and limited demand for debt instruments.
As you can see, average rates are rapidly rising, and the margin of safety is dwindling, so the first unpleasant news from financial reports in the US and Europe may arrive in early 2023. This will be obvious to the naked eye in March-April 2023, so by the Fed meeting on March 22, the conditions will be entirely different, and tightening will be officially finished.
The Fed (and the ECB as well) will soon be in a difficult position when inflation exceeds the target level and the financial system begins to unravel.
Global financial system stress test
The global financial system is increasingly being stressed. The rate of inflation is at its highest in 40 years, but the debt burden is vastly larger.
Over the course of 15 years, Western countries' financial systems and economies have adapted to extraordinarily shaky financial conditions (zero rates, endless liquidity on demand). This is changing now.
The absence of evident implications at the moment is the result of monetary policy transfer/transmission to the economy being delayed / lagged.
Debts have increased dramatically during the last 15 years:
Only 6-7 months ago, the average monthly rate for the leading banks was less than 1%, implying that the main destructive impact on the financial system and economy will begin in 2023, on the trajectory of reducing the margin of safety/depletion of the buffer for compensating for negative consequences.
The effect will be felt, but only afterwards.
Concerning bluff and idiocy (Fed forecasts)
Can the Fed's forecasts be relied on? Exactly a year ago, at the Fed's December meeting, in a setting where inflation was out of control (6.8% y/y in November 2021), the Fed published a prediction, according to which 2.6% inflation was predicted in 2022%, economic growth of 4%, and the rate at the end of the year 0.9%.
It's worth noting that the Fed said a year ago that they weren't going to tighten policy at all, that until March 2022 they were hitting quantitative easing in both directions, and that the first upward movement in the rate was only 0.25% since March 17, 2022.
The time lag between the accumulation of imbalances and the Fed's first significant reaction to difficulties (in May 2022, when the rate was hiked by 0.5 percentage points to 1%) was at least 12-14 months, implying that action was required in March-May 2021 rather than 2022.
The aim of comparing the two meetings is to demonstrate the Fed's zero predictive ability - they are unable to construct realistic development trajectories not only for several years ahead but even for 6-12 months.
As a result, the value of the Fed's forecasts is close to nil in terms of content. It is impossible to develop investment plans based on their initiatives because the error rate is extremely high and the delays are prohibitive.
Powell stated recently that the Fed will maintain the restrictive policy for as long as it takes to bring inflation under control, and that there will be no rate cuts in 2023.
However, this is a bluff and idiocy. The system will begin to sway to borderline levels in the spring of 2023, indicating that the refusal to tighten financial conditions will be rapid - we should not bet on the Fed's desire to tighten monetary policy.
Another point. Do you know the Fed forecasts 0.5% US GDP growth in 2023, and no recession??
Industrial production in the United States
In the United States, industrial production virtually remained the same from April 2022 to November 2022 - the total growth was only 0.2%, although the industry was rising at a rate of 5-6% each year until April 2022.
Because of the accumulated base from December 2021 to March 2022, annual growth in 2022 is still positive - 2.5%, which does not enable us to speak of the start of stagflation, but there are symptoms of a slowdown.
The post-COVID period has a total growth rate of 2.8%, although the dynamics are complex. The military-industrial complex makes the largest contribution to the structure of American industry growth, with a considerable portion of its value sitting in aerospace and transportation equipment, where growth is an astonishing 26.4%.
The military-industrial complex in the United States is fully untwisted. Commercial, industrial, and military machinery (Machinery) is rising rapidly, with a 7.5% increase from February 2020, and manufacturing of heavy military equipment appears to be increasing.
Since February 2020, the chemical industry has risen steadily at a rate of 6.6%, with computers and electronics growing at a rate of 5.7%.
Thus, in the post-COVID period, American industry has turned its focus to the military-industrial complex and high-value-added science-intensive industries, with a strong increase observed from April to November, particularly in the Aerospace and transportation equipment area.
The situation does not appear to be disastrous, but government defence orders and the reorientation/relocation of the electronics industry from Asia are currently shutting down a substantial portion of US business.
American demand
Demand in the US economy remains robust, making it difficult to rectify supply-demand imbalances. Nominal retail sales climbed by 31% between February 2020 and November 2022, and by 14% when adjusted for inflation.
This unusual gap was formerly maintained by helicopter money and unrestricted Fed issuance, but today it is supported by depleted savings and the highest lending rate in 15 years.
Inflation is a universal strategy for adjusting for system flaws because it utilizes excess financial savings, bringing the labour market and the market for goods/services into balance.
It is not required to dig into the finer points of the monthly dynamics (a 0.6% drop), but rather to examine the issue holistically.
Now, the difference between actual and potential demand is at least 10%, implying a labour shortage of at least 6 million people (according to the Fed, about 4 million) or the need to increase overall economic labour productivity by 4-5% in the context of current industry demand.
In actuality, this is impossible, and as a result, there is an unavoidable long road of demand normalization in line with the economy's available potential, labour market structure, and productivity.
The decline in demand should be at least 8-10% in order to reduce the major inflationary impetus; otherwise, the inflationary situation cannot be stabilized. Prices will continue to rise faster than wages until the level of available income, savings, and supply of goods and services reach equilibrium.
The gap between retail demand and industrial production reaches up to 30%, despite the fact that they moved simultaneously with a high level of connection until 2016.
However, everything can get worse due to the desynchronization and imbalance of intersectoral linkages in the setting of extended inflation and labour market degradation. The longer steady inflation persists, the more difficult it is to restore everything to its previous state.
Plan for US Treasury Borrowing
The US Treasury's plan for $550 billion in "grand" borrowings in Q4 2022 failed as expected.
Borrowings totalled $31 billion in October and $185 billion in November 2022, with net repayments totalling $85 billion from December 1 to December 14, resulting in net placements of just $131 billion and a $419 billion deficit with the target. Clearly, this will not be completed before the end of the year.
The US Treasury's cash position was predicted to be $700 billion at the end of 2022. Another flop. The current balance sheet cash amount is $342 billion, having declined by $190 billion between December 1 and December 14, 2022.
The debt ceiling cushion has grown to $166 billion as a result of debt reduction. Even if we assume that $166 billion will be released by the end of the year, it will not be enough to meet the announced borrowing and cash balance sheet targets.
The Fed has also been struggling during the last two weeks. The Fed announced its strategy to decrease the balance sheet in October-November, and there have been no sales since December (neither treasuries nor MBS).
Typically, the FRS sells in "favourable conditions," such as October-November, when the markets, both equities and bonds, increased (decrease in yields). Since December, financial markets have been tense, and the Fed has applied the brakes, as it did in June and July.
As a result, the deficit between planned and actual securities sales increased to $172 billion, up from $130 billion two weeks earlier. Financial conditions have not yet begun to worsen, and markets are in quite a good shape.
The Fed's lack of selling and the infusion of roughly $200 billion into the system kept the economy running, but this can't last forever. The US Treasury's reserves are low, and it will need to borrow again shortly.
What does it all mean? Do not trust the Fed's or any other Central Bank's forecasts, and do not rely on the plans of any regulatory bodies.?
EU countries record trade deficit
Exorbitant energy costs have contributed significantly to the construction of a record deficit in the EU's trade balance with the rest of the globe. The EU-outside trade balance is negative 395.3 billion euros from January to October 2022, down from a surplus of 86 billion euros last year.
Surprisingly, the two countries most vulnerable to Western foreign policy pressure were the largest contributors to the EU's trade imbalance.
China contributed 336.7 billion euros to the trade deficit of European countries, compared to a deficit of 189 billion in 2021, and Russia - 134.7 billion (previously there was a deficit of 53 billion), implying that excluding China and Russia, the EU countries could have a surplus of 76 billion euros.
Who else contributes negatively to the EU members' trade balance from January to October??
From January to October 2022, the EU countries' trade surplus with the following countries:?
As can be seen, the EU has a surplus with AUKUS (Australia, the United States, Canada, the United Kingdom and all other 'connected' states) and a record deficit with countries at the forefront of political conflict (China and Russia).
Not everything is as horrible as Bloomberg made it out to be
Bloomberg's story "Europe's $1 Trillion Energy Cost Only Marks the Beginning of the Crisis" on Europe's $1 trillion energy bill in 2022. The article's storyline is highly unusual for the mainstream business press in the United States and Europe, which is controlled by financial and political establishments.
To begin with, the big headline of $1 trillion in energy losses is methodologically incorrect. When average prices and consumption are taken into account, excess expenditure is rough twice as great (500 billion) as it was in 2021.
In the end, energy spending in 2022 is simply the beginning of a long energy crisis that could linger until 2026.
High energy prices necessitate compensation from European governments, but this option is constrained by the debt market's marginal capacity.
Due to the depletion of the safety buffer, somewhat successful compensating for the energy crisis in 2022 will be challenging in 2023.
The typical German household's spending on gas and electricity has increased from 2.5 to 6.8 thousand euros per year, undermining the purchasing power of household income and the industrial capacity of European countries, causing them to lose competitiveness with the United States and China.
We will add that it was the reimbursement of energy costs by European governments that allowed the economy to avoid collapse and even the 1970s recession.?
The costs were simply shifted by the state through governmental subsidies.
Who buys US Treasuries?
The share of foreign holders of treasuries held by China and Japan is actively declining, while the Eurozone countries serve as the primary support group for US government debt.
China currently holds 14.4% of all Treasuries on non-US balance sheets, far less than the average of 17% between January 2020 and May 2021, before China initiated another wave of Treasury flight.
China is responding in waves but in a consistent manner. During the first stage of the intense US-China geopolitical, commercial, and economic dispute, the most powerful and longest Treasury exodus cycle occurred from June 2018 to February 2020.
Then there was a vast barrage of so-called US technology penalties aimed at slowing China's technical progress. Surprisingly, China's proportion of treasuries has nearly halved since 2011.
The decline in Japan's share of foreign holders of treasuries occurs for other reasons, including capital outflows, trade deficits, and the need for foreign exchange interventions. However, Japan's share of US public debt is at its lowest level in decades.
At the same time, for the first time in history, the Eurozone became the greatest supplier of capital to US government debt, surpassing China in February 2022 and Japan in September 2022.
The most active buyers are the United States first-circle strategic allies (Eurozone, Great Britain, Canada, Australia and controlled offshores).
There is a nuance here that must be considered. The US Treasury considers nominal holdings, although real holders are nearly hard to follow in operational measurement. Same China can invest in treasuries through European funds and trusts based in or outside of Europe.
Japan's difficulties persist
After the Bank of England, the Bank of Japan is the second central bank to blatantly succumb while professing to have everything under control. Simultaneously, the Bank of Japan demonstrated its strategy: "in any incomprehensible circumstance, start hammering QE in all directions."
Actually, this was anticipated and has been discussed over the past ten months. All of their planned stubbornness in the face of an unwinnable battle against inflation is a bluff, a momentary clouding. That is, until the first breakdown, as they say. All toughening measures will be tossed out the window as soon as someone huge staggers, and he surely staggers.
However, Japan is more challenging. Debt is excessively concentrated among inhabitants; risks cannot be distributed across the economy in a thin layer as the United States does. On the one hand, this is positive because the system is more centralized and controlled, but on the other hand, it is a disadvantage because funding sources are scarce.
A distributed financial system, such as the one used in the United States, enables you to dump excess stress and entropy outside. This allowed the US to run smoothly for decades since surplus emissions, like inflation, were distributed globally. Tension is focused on Japan.
In truth, there is no market in Japan for public debt. The Bank of Japan controls a market in which commercial Japanese banks and pension funds trade. The issue is that only the Central Bank has the necessary funds.
When the money ran out in the banking system, the Bank of Japan began to buy up debts, accelerating to the point where it purchased more than half of the total public debt. This has been bad not only for asset prices but also for the structure of a market that has degenerated and become overly reliant on ultra-low interest rates.
Any increase in rates above the weighted average of the small band around zero is an unprecedented shock to the system.
That is precisely why the Bank of Japan has not raised the rate until now, because doing so destabilizes the financial system, which has lost its ability to digest imbalances autonomously.
Japan's quantitative easing
If the BOJ's intentions to buy back 9 trillion yen per month come to fruition, it will be the fastest rate of buybacks in history, equal to the peak of the monetary frenzy in mid-2015. The yearly pace of purchasing Japanese government bonds by the Bank of Japan at the time was 90 trillion yen. In annual terms, the current fuse is worth more than 108 trillion yen.
These, however, are only plans. Between 2017 and 2022, the Bank of Japan had buyout plans that never materialized due to a variety of factors, each of which is distinct and acted at a specific time. Market conditions, Ministry of Finance of Japan placement volumes, monetary policy phases, and many other factors.
Formally, 9 trillion is a very powerful fuse, but how it is used in practice remains to be seen. The present annual buyback rate is 32 trillion yen, with half of it purchased in October-November 2022, implying that the real pace of repurchase is around 8 trillion yen, which is close to the new target border.
As a result, the Bank of Japan has been printing money since September 2022 in order to stabilize markets that are more volatile than ever.
Since January, the rate of monetary doping should have reached a new plateau, indicating the start of the next phase of quantitative easing. It didn't last very long. The fall in the Bank of Japan's integral balance is due to the return of about 60 trillion yen in "emergency COVID loans" from August to November 2022, granted mostly to the Japanese banking system between May 2020 and June 2021.
The entire amount of loans provided was more than 100 trillion yen, implying that roughly 60% of the money received was returned. The resulting liquidity shortfall prompted the resumption of QE. The financial system enjoys taking but dislikes giving.
So far, the New Year's rally has turned into a "New Year's drain," notwithstanding a minor movement of Central Banks during the last week. In a single week, markets have wiped off about half of the cumulative stock market pump from October to mid-December, and IT companies have fallen to new lows.
Russia continues to deliver record amounts of LNG to Europe
LNG imports are breaking records, despite a record fall in pipeline gas supplies from Russia to Europe. According to Bruegel, Europe imported 1.85 billion cubic meters of LNG from Russia in November 2022, 55% more than in November 2021, about 1.9 times more than in November 2020, and close to the historical high established in March 2022 (1.96 billion cubic meters).
But how much gas is 1.8-2 billion cubic meters per month? From January to November 2022, Europe imported approximately 17.8 billion cubic meters of LNG from Russia, although regular pipeline gas deliveries used to be 150-170 billion cubic meters per year.
This year, pipeline gas deliveries from Russia to Europe declined by 55% from January 2022 to December 16, 2022, or minus 80 billion cubic meters; losses will provide 84-85 billion cubic meters at the end of the year.
LNG is the primary source of gas deliveries to Europe. By November 2022, LNG imports had nearly doubled to about 12 billion cubic meters per month, matching the highs of April 2022, which were nearly twice as high as in 2021. LNG exports greatly outstripped pipeline gas supply from Russia for the first time in the history of gas trading with Europe.
At the same time, LNG supplies from the United States have topped Gazprom's gas deliveries since June. Gas balances are shifting dramatically, there is a shift to LNG, adequate infrastructure is being constructed, and logistics are being streamlined.
Despite the sanctions, Russia's share of LNG shipments to the EU exceeds 15% (third biggest supplier) and is expected to stay constant in 2022, while pipeline gas is rapidly declining.
Gas price cap
The European gas price cap is not directly tied to Russia and is conceptually distinct from the Russian oil price restriction.
The EU agreed on a gas price ceiling of 180 euros per MWh (1930 euros per thousand cubic meters) on December 19, which will take effect on February 15, 2023.
Restrictions apply to the derivatives market (futures with delivery dates of one month, three months, and one year), but not to over-the-counter trades or spots. All gas hubs under EU authority are covered.
When market prices exceed the threshold for three days and the difference between LNG prices is 35 euros per MWh, the limits are modified.
The agreement is written in such a way that a reversal is possible if "anything goes wrong" and system breakdowns and energy supply issues arise.
Because of the close proximity of transactions in the gas market, it is impossible to assess what volumes of final transactions for the physical supply of gas are carried out under exchange contracts and which are carried out under contractual long-term contracts. There is a lot of contradicting information on the distribution of spot market and futures prices among exchange contracts.
The initiative's major goal is to prevent the speculative practice of Pump and Dump, in which news reports about gas are promoted through controlled media and coordinated pricing pressure raises prices to an exorbitant level, followed by a crash.
So, in order to eliminate market inefficiency, distorted information can induce market participants to take incorrect actions, causing prices to deviate from the "fundamentally justified level," including through the mechanism of direct manipulation of backbone players in the gas and financial markets.
What are the possible outcomes?
Because of the market pricing concept, Europe was able to fill gas storage even in the face of a drop in Russian imports. This resulted in disproportionate global pricing, with European costs being the highest, driving suppliers in Asia and the United States to transport LNG to Europe. Yes, it was pricey, but it worked.
The existing limits in the context of the shock may result in a shift of LNG flows to Asia, causing an imbalance in supply and demand and compromising Europe's energy security.
There was also a purely market mechanism in place to compensate for excess prices when the weak links in the chain in Europe went bankrupt and/or exited the stage, reducing overall demand for gas and balancing the supply-demand balance. In principle, the gas limit might break the delicate equilibrium that was struck in 2022.
What are the implications for Russia? Nothing.
Nothing will likely change because average monthly gas prices in 2023 will be much lower than in 2022, even if they do not reach the cap.
Shock does not occur repeatedly in the same situation. Negative oil prices occur only once every century. Extremely unlikely unusual occurrences must occur at the same time and in the same area.
The second shock is less evident if such a large-scale gas supplier, which occupied more than half of the European market, left already (Gazprom).
There may be a shock if LNG supplies become unstable, but they are scattered and diverse. If demand rises dramatically, there may be a shock, but the EU strictly controls it. Those prices we've seen in 2022 are already history.
Who precisely purchases US Treasuries?
Who buys treasuries while non-residents and the Fed, the primary holder, are selling? Households, both directly (as persons through the exchange) and indirectly (through intermediaries in the face of mutual funds).
Structure of Treasury Holders:
In all, banks, investment funds, brokers, and dealers held 17.6% in Q4 2021, and currently 16.3%.
As a result, the majority of support was centred among the population.
The people transferred financial resources from deposits and shares as the yield on treasuries increased. The idea here is that the worse things are in the stock market, the better the position in the debt market, thus the strategic guarantees for holding the debt market are the stock market's weakness. They are in the opposite phase.
The US stock market
The American stock market has not yet completely capitulated, moreover the position is being built.
Individuals (U.S. residents) purchased $268 billion in securities directly and through intermediaries from January to September 2022, compared to $1.04 trillion in purchases from January to September 2021. Cash flow has decreased twice but remains positive.
They did, however, hold out until the third quarter before succumbing. There were $115 billion in net sales by American individuals in the third quarter of 2022, the most in four years, but this is nearly three times lower than the flight from the stock market during the 2008-2009 crisis.
Given the scale of expansion in the money supply and capitalization, the current $115 billion represents a 6-8 times less intensive withdrawal of money than occurred during the 2008-2009 crisis, which lasted two years (sales began in 2007) and totalled $1.4 trillion.
To put things in perspective, since 2009, $4.4 trillion has been invested in the stock market by households (directly or indirectly) through the third quarter of 2022.
The primary capital flows were distributed for a total of $4.3 trillion from 2013 to Q2 2022, with the most intensive from Q2 2020 to Q2 2022 being $1.9 trillion in net inflows, which was the most intensive entry into the stock market in the whole history of the US financial system.
Individuals added $382 billion for the entire first half of 2022.
Non-residents are the second greatest source of liquidity for US stocks.
Non-residents' biggest purchases of US stocks were in 2020 - $670 billion per year - and if we compare the first three quarters of 2021 to 2022, net purchases increased from $108 billion to $154 billion.
Insurance and pension funds sell shares, and have done so regularly over the last ten years - more than $ 2 trillion, owing mostly to the demographic issue and the increase in the number of pensioners in the United States.
Net purchases from US residents (all entities) reached $126 billion in the first three quarters of 2022, compared to $667 billion in 2021.
No buybacks, no debts
Since January 2009, the major buyers of American corporations' shares have become... American companies themselves via buybacks. Through Q3 2022, the cumulative cash flow delivered from US corporations to the market, excluding placements (IPO+SPO), was $4.7 trillion.
Following the sale of $115 billion in shares by US individuals in the third quarter, corporations took a commanding lead in accumulated cash flows to the stock market.
During COVID, there was a rotation - companies dramatically slowed the pace of buybacks, while the population on helicopter money began to buy back shares at the fastest rate in market history (almost $ 2 trillion in two years).
As a result, the population's accumulated purchases reached company buybacks at the end of 2021, but the business is already regaining the lead.
Over a 13-year period, non-residents purchased less than $1 trillion in US company stock, with the largest changes occurring in 2020.
From January 2009 to September 2022, all other structures (pension and insurance funds, commercial banks, state funds, and others) are net sellers of $2.8 trillion in shares, and the pace of sales has accelerated sharply (compared to 2009-2015) and remains roughly constant at over $200 billion per year.
What is significant here is the buyback funding. From 2009 to 2012, net borrowing in bonds and loans was equal to the volume of share repurchases. In other words, the debts are used to fund the buybacks.
From 2009 to Q1 2022, corporations borrowed $1 for every dollar of buyback, and from Q2 2020 to Q3 2022, the debt climbs by $1.4, indicating an integral fall in marginality in the context of the inflationary crisis and a lack of finance for investment projects.
It's worth noting that if there were no buybacks, there would be no debts. Businesses are borrowing from banks as of Q2 2021, while the bond market is frozen due to a lack of demand caused by record negative real rates.
Rate of US household savings
The three-month US household savings rate is 2.3%, a new historical low (previous of 2.4% from July to August 2005). The average savings rate from 2010 to 2021 was 8.5%, and before helicopter money, it was 7.6% from 2015 to 2019.
As a result, the populace distributes 5-6% of its income on a monthly basis, compared to the 2010-2021 standard. The lowest savings rate on record, combined with record loan rates, contributes to a large base of spending on goods and services.
In actual terms, spending on goods and services climbed by 4% in comparison to February 2020 (the final "quiet" pre-Covid month). In comparison to the previous year a symbolic gain of 0.2%.
US families' real per capita disposable incomes are 3.6% lower than in February 2020 and 4.2% lower than last year, implying that the spending base is the depletion of the savings rate and the growth of the debt burden through consumer lending.
The state's fiscal policies have become more stringent. The net withdrawal rate in 2022 is minus 5.6% on average, compared to minus 3.5% and plus 2.9% from April 2020 to December 2021.
The net withdrawal rate from the state is the sum of all payments, benefits, and subsidies distributed by the state to the people (excluding salaries) less all fees for all forms of taxes collected by the state. A negative sign indicates that it withdraws more than it distributes.
They are now removed at a rate that is 2-2.2 percentage points higher than in 2015-2019 and 8.5-9% higher than from April 2020 to December 2021. That is why the people begin to depletion of their savings to compensate for the reduction in their salaries and the state's tighter fiscal policy.
There is no crisis yet, and spending is at its all-time high, but at what cost? Experience has shown that this approach of compensating for revenue deficiencies does not continue for more than 1.5-2 years. This began at the end of 2021, thus there will be a conclusion in 2023.
The worst year for global equity markets
Global equity markets will have their worst year since 2008. In the third quarter of 2022, the total capitalization of publicly traded US corporations with a US address was $44.2 trillion. These are losses of more than $15 trillion in comparison to December 2021.
Capitalization reached roughly 47 trillion dollars (+ 7%) by December 20th, 2022, with losses of 21-22% at the end of the year.
The capitalization of national issuers relative to GDP is around 180%, compared to 245% at the high in January 2022. Even with the recent market fall, capitalisation is still excessively high in relation to the economy.
For example, at the height of the dot-com boom in Q1 of 2000, capitalization to GDP was 170%. If we omit periods of crises and anomalies, such as 2020-2021, then this coefficient was on average 137% from 2010 to 2019, and 120% from 2004 to 2007.
During the inflationary crisis of 1970-1982, capitalization to GDP averaged 53%, briefly falling to 36%. But, as far as one can conceive, the structure of companies and the financial system were radically different back then. As a result, if the inflationary crisis lasts, one should not expect the market to fall below 40-50% of GDP capitalization.
There were no information and biotechnology companies 40-50 years ago, which now have considerable weight in the indices and the highest multiples.
The financial system was significantly different back then; there were no investment funds, a vast range of financial products, instruments, or a large financial market.
What factors should be considered here?
As a result, the likelihood of a further drop in 2023 is very & very considerable.
The US housing market
The real estate market in the United States is drastically sinking. This is no longer a random fluctuation, but rather a consistent pattern.
The real estate market in the United States is facing its greatest crisis since 2007.
EU Energy Crisis
With the exception of Turkey and Ukraine, Europe supplied 155-175 billion cubic meters of gas from Russia prior to the crisis (approximately 151 billion in 2021). Pumping will fall to 68 billion cubic meters in 2022, and import amounts over the last three months are equivalent to 30 billion per year (this level is likely to remain in 2023).
As a result, pipeline gas imports from Russia are expected to fall by 120-140 billion cubic meters in 2023, compared to the pre-crisis average of 2017-2021.
In terms of energy supplier diversification. By the end of 2022, Europe's LNG imports had climbed by 63-65 billion cubic meters, with another 11-12 billion coming from other sources. In sum, the maximum limit replacement potential amounted to 77 billion, or nearly complete replacement of Russian gas in 2022.
In comparison to 2023, the replacement will be around 60%, based on the degree of diversification in 2022. In 2022, Europe employed nearly all available resources to deliver gas from all sources throughout the world, thus a comparable breakthrough in diversification is unlikely in 2023.
We are discussing replacing 70% of Russian pipeline gas. 30%, or around 40 billion cubic meters, remain. These 40 billion must be offset by lower consumption and/or stock balance.
Improving energy efficiency and depending on renewable energy sources is a long-term initiative with a total capacity of 12-14 billion cubic meters per year, or 2.2-2.4% of European consumption. (Provided it continues, although there are already behind-the-scenes discussions regarding a gradual cessation at the highest levels in many European countries).
As a result, a short-term but more drastic method exists - a forced reduction in consumption through direct economic loss.
Everything is dependent on European countries. According to the energy balance and production structure, Germany will suffer the most harm among the large countries, both relative and absolute, and Spain the least.
Europe is faring better than previously assumed. Gas usage will fall by 12% since 2014, reducing the demand for net gas imports by 90 billion cubic meters.
The core scenario (for the current European configuration) is as follows: the European energy market is permanently closed to Russia, mostly for ideological and political reasons on the European side, when the economic expediency of trade ties is put on the back burner.
Foreign trade flows, new counterparties, the energy doctrine, intersectoral interactions, and the pan-European energy strategy are all changing.?
As a result, every effort will be made, both in domestic energy policy and in foreign trade ties, to reduce Russia's footprint as much as possible. Without making any concessions. The strategic direction has been established and will not alter. Europe will be moving in four major directions:
It must be realized that the major thing that Europe is presently is a sales market, but this advantage will progressively fade as the major development paths mentioned above lead to a drastic fall in people's standard of living, and hence a collapse in demand for goods and services.?
If there are not 100% of the necessary primary resources for the entire range (which were purchased in Russia), then Europe lacks a foundation for development. However, as stated earlier, this is a scenario for Europe's current configuration.
The extreme growth of rates in the money and debt markets
Extreme growth rates in wealthy countries' money and debt markets (USA, UK, Eurozone) create a twofold challenge for developing countries.
This applies to countries with a heavy debt load, which is dispersed as external debt in the form of loans in foreign currency. This is also true for countries with chronically substantial current account deficits.
The problem has not yet been "highlighted" in official publications of the IMF, World Bank, OECD, and prominent investment banks because the focus is currently on the inflationary crisis in developed countries, but it is critical to consider all risk factors. There is a trend of financial, industrial, and trade deglobalization, with the formation of two "ecosystems":
As a result, isolation from financial sources in first-world countries does not guarantee the search for investors in second-world countries.
So, what's the issue? Many developing countries have large current account deficits that will establish new highs in 2022. India, Brazil, Turkey, Thailand, Argentina, Colombia, the Philippines, Pakistan, Chile, Bangladesh, Egypt, and many other countries are among them.
A deficit necessitates an influx of foreign investment/money in the financial account or the use of gold reserves to close the gap. Although gold reserves in many countries are exhausted and do not cover the shortfall, there is still an influx of foreign wealth.
However, given the track of financial deglobalization, rising rates, and crises in rich countries, this will provide challenges. There isn't enough for everyone. In the aforementioned countries, a currency and debt crisis are quite likely.
Another win in the fight against global warming
The EU countries struck an agreement to expand their own carbon market, which authorized the majority of the Green Deal agenda. Emissions trading will now include heating systems, road transportation, and shipping.
The new rules also allow for the imposition of a price on pollution caused by the importation of specific goods into Europe, thereby shielding domestic companies from cheaper competitors from countries with less severe environmental standards.
Carbon costs have already reached a record €99.22 per metric tonne this year, thanks to expectations of stricter regulations. Carbon futures sold in Amsterdam finished for roughly €84 on Friday, more than ten times higher than five years ago.
Isn't it a cool mechanism? Something was agreed upon there, and the price of a ton of CO2 increased - another success in the fight against climate change. And these more expensive tons will have to be purchased by importers, which benefits European producers. But don't expect self-interest here; without carbon futures, the earth will perish, heh.
On a given example, what is a structural crisis?
A strange story of how a scarcity of semiconductors might affect gummy bear supplies. Grupo Bimbo, Mexico's largest confectionary producer, is experiencing a gelatin shortage caused by a decline in pig slaughter, which was caused by a decrease in demand for pork skin from car makers, which was caused by a decrease in automobile production owing to a lack of chips from Taiwan.
THE END OF THE REPORT
Merry Christmas. Stay tuned.?
Regards, Negorbis.
Don't miss the next report -?Subscribe
We don't make recommendations; instead, we highlight critical patterns that will help you fail less.