Doug Noland: Controllable

Michael Bond comments: Popping bubbles “a little bit” is like getting a little bit pregnant. It does not happen a little bit. What happens with popped bubbles is the Fed has to blow the next one, bigger faster to save the system. The fastest one blown so far was the one that started in March of 2020.

As for inflation, what we had prior to 2019 was financial inflation due to financial stimulus that made little way into the real economy. We had fiscal tapping on the brakes for the last 40 years. Flat wages, reduced COLAs, and suppressed interest payments were part of the tapping of brakes.

In 2020 for the first time we saw what happens when we got real fiscal stimulus. It bridged the economy and much more since the stimulus was inefficient and too much too fast. It also led to inflation, but…

…we had pent up wage demand. I am making up the term “wage demand” today to explain that after wages had run flat officially for 40 years for working age males and in the real world the truth was wages were declining because of understated inflation.

Families can not live on their reduced share of the US national income. The investor/donor class squeezed the middle class and working class to the point of breaking. Now I expect to see a bounce back in wages. And that will lead to wage-push inflation. And the Fed is in no position to stop it.

What might stop it is a global recession which may be emanating out of China as I write. If 30% of their economy stalls, then the commodity inflation will reverse next year. If the Fed is forced to raise interest rates on the world, the world’s credit tightening will induce a deeper recession.

The Fed is about to crash our plane into the inflation canyon wall on the right or interest rate induced market crash on the left. Either way, the pain is coming.

Excerpts from Doug’s article:

October 14 – Bloomberg (Sridhar Natarajan): “Morgan Stanley Chief Executive Officer James Gorman is girding for rate hikes, and he says markets are ready for them. ‘You’ve got to prick this bubble a little bit,’ Gorman said… ‘Money is a bit too free and available right now.’ Gorman pointed to wage increases, supply-chain bottlenecks and surging commodity prices driving inflation higher.

“Got to prick this Bubble a little bit.” “Money is a bit too free…” Things have turned so crazy that even Wall Street executives would prefer a little bit of air to come out of the Bubble. The world would prefer to see some come out of respective Bubbles. China clearly wants to see their Bubbles deflate – a bit. But everyone waited much too long to begin withdrawing stimulus. Everyone’s “behind the curve” like never before, making it difficult to envisage “a little bit” being germane to anything going forward.

Policymakers around the globe are coming to the realization that inflation has become a very serious issue, while asset markets remain dangerously speculative. And it’s not at all apparent that today’s extraordinary predicament – surging inflation and runaway asset Bubbles – is Controllable.

And if I were a long-term bond, I’m not sure my anxiety would be Controllable.

No one has even begun to contemplate a return to fiscal sanity.

Meanwhile, central bankers clearly prioritize market-friendly liquidity abundance, ultra-low interest-rates and loose financial conditions. And they are at this point trapped by Acute Bubble Fragility.

I specifically see today’s intense inflationary dynamics as Uncontrollable. Over the past three decades, the monetary management focus shifted to asset prices. Central banks managed rates to ensure ever-rising securities prices and, when they eventually had no further to go with rate cuts, resorted to money-printing and liquidity injections directly into the markets.

Spurred by the pandemic, their reckless monetary inflation and attendant asset Bubbles became Uncontrollable. Moreover, inflationary dynamics jumped from the asset markets to engulf commodities, producer and consumer prices.

Policymakers would like to believe the situation is Controllable; they want to believe the system will return to the way it was. But the genie is out of the bottle, and inflationary dynamics will not be conveniently abandoning the real economy and heading back to the comfortable confines of asset prices.

There are major unknowns, of course. How long can Beijing hold Bubble collapse at bay? How aggressively do the Chinese implement infrastructure investment programs to help offset the deflating real estate sector?

Considering the unfolding inflationary backdrop, bond yields should be (at least) a couple percentage points higher to approach some semblance of reasonable valuation.


Controllable

by Doug Noland

Now that was wild. Let’s start with the Chinese developers. Indicative of the more troubled companies, Kaisa Group bond yields surged to almost 51% in Wednesday trading, up from 36% to begin the week (20% to start the month). Yields closed the week at 44.7%. After beginning the week at 23.3% (October at 16.6%), Yuzhou Group bond yields surged to almost 38% in Thursday trading, before reversing sharply lower to end Friday’s session at 27.7%. China Aoyuan yields began the week at 16.6%, jumped to almost 20% on Thursday, but were back down to 17% by week’s end. Evergrande yields ended the week at 75%. Acute instability for bonds of a sector that, according to Nomura analysts, has accumulated a frightening $5 TN of debt.

An index of Chinese dollar developer bonds began the week with yields of 17.5%, up from 14.4% to begin the month and 10% back in July. Yields closed Thursday trading at a record 20%, before ending the week at 19.3%.

Ample volatility as well in the cost of insuring against default for the major Chinese banks. China Development Bank CDS surged 10 Monday to 77 bps, up from 43 bps points at the beginning of September to the highest level since the pandemic crisis. China Development Bank CDS then reversed sharply lower, ending the week down at 62 bps. Industrial and Commercial Bank of China CDS traded to 78 bps (high since April ’20), up from 48 on September 17, before closing out the week at 76 bps. China Construction Bank traded to a post-pandemic high 75 bps (ended week at 74), after beginning the year at 36 bps.

It’s been a wild ride for China’s sovereign CDS. After beginning October at 47, China CDS closed last week (10/8) at 52.5 bps. Prices spiked to above 60 early in the week (high since April ‘20), before reversing lower to close Friday at about 50. Indonesia CDS traded to an almost one-year high 96 bps Tuesday, before reversing sharply lower to end the week at 86. Malaysia CDS rose to a 15-month high 66 bps on Tuesday, before ending the week at 60 bps. India CDS jumped six to a six-month high 88.5 bps. Turkish bond yields surged almost 100 bps to 18.85%.

Global markets in the first half of the week traded with a problematic dynamic of high correlations, rising sovereign yields, widening Credit spreads, increasing CDS prices and sinking stock markets. Miraculously, yields, spreads and CDS prices reversed sharply lower, as stocks surged higher.

Italian yields traded to a five-month high 0.93% in early-Thursday trading, only to reverse abruptly with yields down to 0.83% by the afternoon (before closing the week at 0.87%). European “crossover” (high-yield) CDS jumped to a seven-month high 277 bps in Tuesday trading, only to reverse lower to end the week at 257 bps. After trading down to about 15,000 early Tuesday, Germany’s DAX equities index rallied almost 4% to close the week at 15,587.

The S&P500 rallied 3.3% off Wednesday’s trading lows to end the week with a gain of 1.8%. U.S. high-yield CDS prices jumped to a seven-month high 315 bps in Wednesday trading, only to reverse sharply lower to close the week at 300 bps. A similar story for investment-grade CDS, with a seven-month high 55 bps reduced to 52 bps by Friday. The VIX index traded to about 21 Tuesday, but was back below 16 on Friday.

Acute Chinese Credit stress and U.S. options expiration week made for a combustible mix. And once again, those hedging or attempting to time a market swoon were hammered by an abrupt reversal and rally into expiration. Equities again prove unable to adjust to a deteriorating backdrop – in true speculative Bubble form.

October 12 – Wall Street Journal (Stella Yifan Xie, Elaine Yu and Anniek Bao): “Home sales in China are seizing up as curbs on lending and worries about developers’ financial health deter house buyers, casting a pall over an industry that is central to the Chinese economy. In recent days, numerous big developers have reported lower sales figures for September, with many showing year-over-year declines of more than 20% or 30%… If sustained, the sharp downturn could have serious economic consequences. Real estate has played an outsize role in China’s economy in recent years, compared with its importance in many other countries, and Chinese families have much of their wealth tied up in homes and in investment properties. Slower sales could spill over into investment and construction, potentially hurting growth, employment and local government finances. Discounting to spur sales could hurt home prices and hit household wealth.”

October 13 – Reuters (Andrew Galbraith and Marc Jones): “The rumbling crisis at China Evergrande Group and other major homebuilders drove debt market risk premiums on weaker Chinese firms to a record high on Wednesday and triggered a fresh round of credit rating downgrades… The $5 trillion property sector accounts for around a quarter of the Chinese economy by some metrics. In the clearest sign yet that global investors’ worries are growing, the spread – or risk premium – on investment grade Chinese firms… jumped to its widest in more than two months. The spread on the equivalent high-yield or ‘junk’-rated index… surged to a new all-time high of 2,337 bps. That drove the yield… to an eyewatering 24%. ‘We see a risk that a disorderly correction in the property market could cause sharp price declines, hitting the personal wealth of homeowners,’ Kim Eng Tan, a credit analyst at S&P Ratings, said… ‘Such an event could also contribute to large-scale losses by investors in wealth management products, and the contractors and service firms that support the developers.’”

October 15 – Bloomberg: “China’s central bank broke its silence on the debt crisis at China Evergrande Group, saying risks to the financial system stemming from the developer’s struggles are ‘controllable’ and unlikely to spread. Authorities and local governments are resolving the situation based on ‘market-oriented and rule-of-law principles,’ People’s Bank of China official Zou Lan said… The central bank has asked lenders to keep credit to the real estate sector ‘stable and orderly,’ said Zou…”

Well, risks have been spreading – and rather briskly at that. The jury is out on “Controllable.” With developers discounting apartment units to generate precious liquidity, and millions of nervous apartment buyers fretting significant delays in the completion of their units, it would appear Beijing faces challenges convincing would-be purchasers that apartments remain a risk-free avenue to wealth accumulation.

October 15 – Bloomberg: “China’s inflation risks are ‘controllable’ and while rising costs may hurt small businesses, authorities have increased support for those types of firms, central bank officials said. Sun Guofeng, head of the monetary policy department, said… producer price inflation will remain elevated in the short term before falling toward the end of the year, though imported inflation and the impact of the global commodity boom is controllable.”

China’s inflation risks are “Controllable,” but at this point there’s a bit of a “in theory” caveat. At least in the near term, the Chinese economy faces potential multiple shocks – acute energy shortages, factory shutdowns and supply-chain bottlenecks, along with a spike in coal, energy and wholesale prices more generally.

October 13 – Bloomberg: “China’s factory-gate prices grew at the fastest pace in almost 26 years in September, potentially adding to global inflation pressure if local businesses start passing on higher costs to consumers. The producer price index climbed 10.7% from a year earlier, beating forecasts and reaching the highest since November 1995, as coal prices and other commodity costs soared… As the world’s largest exporter, Chinese prices are another risk factor for the global inflation outlook.”

October 13 – Reuters (Colin Qian): “China’s export growth unexpectedly accelerated in September, as still solid global demand offset some of the pressures on factories from power shortages, supply bottlenecks and a resurgence of domestic COVID-19 cases. The world’s second-largest economy has staged an impressive rebound from the pandemic but there are signs the recovery is losing steam. Resilient exports could provide a buffer against growing headwinds including weakening factory activity, persistently soft consumption and a slowing property sector. Outbound shipments in September jumped 28.1% from a year earlier, up from a 25.6% gain in August.”

Could China’s Bubble Economy possibly be more unbalanced? The export sector is on fire.  Manufacturers are struggling to keep up with orders, as supply-chain and transportation bottlenecks significantly push out delivery times. Meanwhile, the developers are losing access to new finance; apartment transactions have slowed markedly; and everything points to a major leak in China’s historic apartment Bubble.

Inflation is Controllable, so long as Beijing tightens liquidity and Credit growth. Risks to the financial system from a collapsing real estate Bubble would be in the near-term Controllable if Beijing floods the system with liquidity and directs the banking system to lend aggressively to the sector (with dire longer-term consequences). Of course, Beijing will attempt to thread the needle, ensuring ample liquidity and Credit expansion, while employing various measures to dampen inflationary effects.

The complexity of China’s economic system has grown exponentially over recent years. From ensuring local energy supplies to logistics to speculative impulses to household confidence – a control-focused Beijing has never faced such a litany of intricate challenges.

China’s Aggregate Financing (system Credit) increased $450 billion during September, about 5% below estimates. Six-month growth in Aggregate Financing was down 22% compared to 2020, with the y-t-d expansion 16% below last year. While slowing markedly, Chinese Credit growth remains formidable – certainly sufficient to fan inflationary fires. During the first nine months of 2021, Chinese Credit expanded $3.84 TN. Year-over-year growth slowed to 10%, the weakest reading in data back to 2017.

New Bank Loans were reported at $258 billion, about 8% below forecast. At $2.60 TN, y-t-d loan growth is at a record pace – running 2.8% ahead of comparable 2020 and almost 23% ahead of 2019. But New Loan growth over the past three months was 5% below comparable 2020 (flat with 2019).

I expected a more pronounced September Credit slowdown, in Household borrowings in particular. At $122 billion, Household (chiefly mortgages) Loan growth was the strongest since June (September is a seasonally strong month for lending). Boosted by a booming Q1, y-t-d Household Loan growth is running 3% above record 2020 levels. Over the past three months, however, growth is 31% below comparable 2020 (8% and 15% below comparable 2019 and 2018). Year-over-year growth slowed to 13.2%, down from March’s 16.3%, to the weakest reading since 2009. With apartment sales having slowed dramatically over recent weeks, expect much weaker consumer borrowing over the coming months.

Corporate Bank Loan growth remains robust. At $153 billion, growth was the strongest since June, and up 4% from September 2020. Y-t-d growth of $1.046 TN was 2.5% above comparable 2020 and 40% ahead of comparable 2019. Moreover, three-month growth was 18% ahead of Q3 2020. Corporate Loans expanded 11.3% over the past year, 25% over two, 39% over three and 67% over five years. Elsewhere, Corporate Bond issuance jumped to $67 billion in September, the strongest performance since pandemic crisis April 2020.

Government Bond issuance was also robust. At $152 billion, Government Bond growth was the strongest since September 2020. While y-t-d growth is running 34% below comparable 2020, it is 11% above a more “normal” 2019.

We have a generation of central bankers who are defining themselves by their wokeness. They’re defining themselves by how socially concerned they are. They’re defining themselves by how concerned they are about the environment. They’re defining themselves by how concerned they are about financial excess and business ethics. And they’ve grown up and had their whole experience shaped by a period when inflation was below target. And, so, it’s very hard to lose old habits… We’re in more danger than we’ve been during my career of losing control of inflation in the US… We’ve gone even further towards losing it in Britain and I think we’re at some risk in Europe.” Former Treasury Secretary Larry Summers, October 13, 2021.

Yet another noteworthy week in raging commodities markets. WTI crude jumped another 3.7% to $82.28, an eighth straight week of gains to a new seven-year high (up 70% y-t-d). Gasoline’s 5.1% rise pushed 2021 gains to 76%. Copper surged 10.6%, increasing y-t-d gains to 34%. Zinc prices rose 20.4%, with Aluminum up 6.9%, lead 5.3%, Nickel 4.2%, and Tin 2.9%. The London Metal Exchange benchmark index rose to an all-time high. Chinese thermal coal (Zhengzhou Commodity Exchange) prices surged 34% this week. Overall, the Bloomberg Commodities Index gained another 2.1%, increasing y-t-d gains to 34.2%.

Up 5.4% y-o-y in September, Consumer Price Inflation has not been stronger since 2008. The 5.9% Social Security cost of living adjustment is the largest since 1982. September Producer Prices inflated 8.6% y-o-y. Import Prices were up 9.2% y-o-y in September, with Export Prices surging 16.3%.

The five-year Treasury “breakeven inflation rate” jumped seven bps this week to 2.75%, nearing the high since 2005. University of Michigan’s consumer survey had One-year Inflation Expectations rising to 4.8%, the high since the 2008 crude-induced inflation spike. Ignoring May, June and July 2008, consumer inflation expectations have not been higher since 1982. It’s worth noting that 10-year Treasury yields traded up to 4.25% in the summer of 2008, were above 4.6% in November 2005, and sat at 14% in June 1982.

It’s never good for credibility when a central bank’s inflation view becomes a joke (even within the bank’s own organization!).

October 12 – Bloomberg (Steve Matthews): “Federal Reserve Bank of Atlanta President Raphael Bostic said this year’s inflation surge is lasting longer than policymakers expected, so it’s not appropriate to refer to such price increases as transitory. ‘Transitory is a dirty word,’ Bostic said… He spoke with a glass jar labeled ‘transitory’ at his side, depositing $1 each time he used the ‘swear word,’ as it’s become known to him and his staff over the past few months. ‘It is becoming increasingly clear that the feature of this episode that has animated price pressures — mainly the intense and widespread supply-chain disruptions — will not be brief,’ Bostic said. ‘By this definition, then, the forces are not transitory.’”

The Fed has made a mockery of its overarching responsibility for ensuring monetary stability. And even the heads of the Wall Street firms have begun prodding the Fed to reduce accommodation, increasingly concerned by the inflationary backdrop.

October 14 – Bloomberg (Sridhar Natarajan): “Morgan Stanley Chief Executive Officer James Gorman is girding for rate hikes, and he says markets are ready for them. ‘You’ve got to prick this bubble a little bit,’ Gorman said… ‘Money is a bit too free and available right now.’ Gorman pointed to wage increases, supply-chain bottlenecks and surging commodity prices driving inflation higher. Not all of that is a temporary phenomenon, forcing the Federal Reserve to move a little more aggressively than policy makers are predicting right now, according to Gorman.”

“Got to prick this Bubble a little bit.” “Money is a bit too free…” Things have turned so crazy that even Wall Street executives would prefer a little bit of air to come out of the Bubble. The world would prefer to see some come out of respective Bubbles. China clearly wants to see their Bubbles deflate – a bit. But everyone waited much too long to begin withdrawing stimulus. Everyone’s “behind the curve” like never before, making it difficult to envisage “a little bit” being germane to anything going forward.

Policymakers around the globe are coming to the realization that inflation has become a very serious issue, while asset markets remain dangerously speculative. And it’s not at all apparent that today’s extraordinary predicament – surging inflation and runaway asset Bubbles – is Controllable. And if I were a long-term bond, I’m not sure my anxiety would be Controllable. No one has even begun to contemplate a return to fiscal sanity. Meanwhile, central bankers clearly prioritize market-friendly liquidity abundance, ultra-low interest-rates and loose financial conditions. And they are at this point trapped by Acute Bubble Fragility.

Bullish equities pundits are fond of invoking “trillions of cash on the sidelines” as a key factor ensuring the historic equities price inflation will continue uninterrupted. But, at the same time, unprecedented cash balances and securities market wealth provide inflationary firepower throughout the real economy. The Fed somehow locked itself into a market-pleasing process, where months of elevated inflation have been allowed to take root before so much as commencing a reduction of its monthly $120 billion money-printing operation. The Fed is likely nine months away from its first little baby-step rate increase. And the way things look today, it would be years before our central bank reaches what would traditionally have been viewed as restrictive policies.

I specifically see today’s intense inflationary dynamics as Uncontrollable. Over the past three decades, the monetary management focus shifted to asset prices. Central banks managed rates to ensure ever-rising securities prices and, when they eventually had no further to go with rate cuts, resorted to money-printing and liquidity injections directly into the markets. Spurred by the pandemic, their reckless monetary inflation and attendant asset Bubbles became Uncontrollable. Moreover, inflationary dynamics jumped from the asset markets to engulf commodities, producer and consumer prices.

Policymakers would like to believe the situation is Controllable; they want to believe the system will return to the way it was. But the genie is out of the bottle, and inflationary dynamics will not be conveniently abandoning the real economy and heading back to the comfortable confines of asset prices.

There are major unknowns, of course. How long can Beijing hold Bubble collapse at bay? How aggressively do the Chinese implement infrastructure investment programs to help offset the deflating real estate sector? How cold will the northern hemisphere winter be, and how quickly can supplies of crude, natural gas, and coal be built and transported? Will additional weather disasters further complicate global shortages, supply-chain stress and transportation delays?

Maybe the world gets lucky. But inflationary risks have not been this elevated for decades. Meanwhile, global bond markets are priced for ongoing ultra-loose monetary policies – the policy backdrop required to hold the ugly downside of historic Credit, speculative and economic cycles at bay. Considering the unfolding inflationary backdrop, bond yields should be (at least) a couple percentage points higher to approach some semblance of reasonable valuation.

October 14 – Fox Business (Breck Dumas): “Deere & Co. and union representatives for as many as 10,000 of the company’s employees represented by the United Auto Workers are on strike as of Thursday… The agricultural equipment manufacturer based out of Moline, Illinois, hasn’t seen a workers’ strike for 35 years. But with labor shortages across the country and Deere raking in record profits, workers feel now is the time to hold their ground and ask for more. ‘The whole nation’s going to be watching us,’ Deere employee Chris Laursen told the newspaper. ‘If we take a stand here for ourselves, our families, for basic human prosperity, it’s going to make a difference for the whole manufacturing industry. Let’s do it. Let’s not be intimidated.’”

Original Post 15 October 2021


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