Treasuries point to a US bond crisis

US bond yields are soaring.

Bond yields in any country rise for one or more of the following factors:

• Inflation has risen and/or is expected to rise.
• Growth is picking up.
• The government deficit is ballooning
• Default risks are rising.

In the US, inflation is expected by the markets to remain high.  This is because of the soaring oil price as a result of the Iran war, and also because the new Governor of the Fed Kevin Warsh is Trump's creature, and is suspected of being soft on inflation.  It's also because of Trump's penchant for tariffs.

Growth appears to be picking up, for now, which makes it more likely the Fed Funds rate will be raised rather than lowered.  This will push up long bond yields, unless the markets decide it will increase the risk of recession.

The federal deficit is exploding, thanks to Trump's tax cuts as well as the Iran war.  Tariffs, on again then off again then back on again, have not plugged the gap.  The big cuts DOGE was supposed to bring have turned out to be mouse-sized.  The Trump administration is unlikely to take any action to reduce the deficit, and the Iran war is not going away.

Default risks are rising.  The deficit has doubled from $20 trillion in 2017, to $40 trillion.  Paying the interest charges is now the largest single item in the Federal budget.  This makes it harder to repay the debt, because as interest rates rise, the debt and interest burdens increase.  And Trump has repeatedly gone bankrupt in the past, and may think that a US debt default would be as painless as his property companies going to the wall.  Then there was some half-wit in the administration (whose name escapes me) who proposed recalling the debt and issuing new paper for half the value of the old.  Or maybe at half the yield.  Either way, that is, of course, a default.

A further unique factor to this crisis is that foreign central Banks of countries which were once allies of the United States — Canada, Europe, Japan — are big holders of Treasuries, as is China, and could decide to sell for political reasons.  They probably won't because they know the risks better than I do, but I would not be at all surprised if they were quietly allowing their Treasury holdings to run off and replacing them with gold, bought by intermediaries, and not held in the vaults of the New York Fed.   Trust in the US has gone, and that makes everything much harder to navigate, and much riskier.

Bond yields are at 20-year highs, and are still rising.  This creates a doom-loop, where interest rates rise, increasing the deficit as new paper is issued, which increases the interest burden which causes interest rates to rise even further.  It was this dynamic which created the Euro crisis 15 years ago.  

The US bond market is central to the operation of global financial markets.  A default would cause a deep global depression.  One hopes that the grown-ups will act in time to prevent this catastrophe.  But will they?

Emissions have peaked

Two recent graphs, from different articles, have given me hope that we might yet avoid catastrophic global warming.  The first chart come from Carbon Brief, which I referenced here.

Let's dig deeper into the chart.  

It shows the smoothed year-on-year change in electricity demand in China, and the year-on-year change in the supply of electricity, broken down into fossil fuels (mostly coal, but some gas) and clean energy.  Over the last 20 years, there have been 5 times when production of electricity from fossil fuels has fallen: in 2009 (the GFC); in 2012/13 (the Euro crisis); in 2016 (a global mid-cycle correction which was quite severe in China); in 2022 (Covid lock-downs); and this year.

This year is the first time that fossil fuel production has fallen when electricity demand growth is strong.   Notice how the size of the pale blue bars (renewables) has got bigger and bigger, as China has installed exponetially increasing quantities of wind, solar and batteries.  Second, notice how electricity demand has grown, as (a) the economy grew, and (b) EV sales exploded, with each peak tending to be higher than the previous one.

Right now, an annual expansion in clean energy production of +-600 terawatt-hours (TWh) is enough to more than satisfy demand, causing fossil fuel generation to decline.   The 20-year average annual increase in demand is 400 TWh, while over the last 8 years or so, it looks about 500 TWh.  Obviously, if China's growth accelerates back to the heady rates on the early 2000s (10% a year), given how much richer China is now than then, the increase in demand could easily exceed 800 TWh.  However, growth is unlikely to accelerate back to those levels  The recent GDP trend growth rate is about 7%, and, in my judgment, slowing, as China deals with its property crisis.  (Also, China overstates its GDP growth data, so the real growth rate is lower.  The data for growth in electricity demand and supply are better quality.)  

The second chart came from an article by the ABC,  which I  commented on here.

The projected increase in new clean energy generation capacity for the next 2 years is about 600 TWh.  In other words, it's now more than the average rise in electricity demand.  

Of course, there is an economic cycle, with demand rising at 800 TWh in boom years, and reducing to 200 to 400 TWh in slower years.  So we may have a pattern of  falling emissions during low-growth years, followed by modest rises when the economy is stronger.  Yet this doesn't take into account the exponential growth in new wind and solar output over the last 7 years.   It's risen from 200 TWh to 600 TWh in just five years.  And although the forecast for the next two years is for only limited growth, the costs of solar and batteries contimue to decline rapidly.  The exponential growth will continue.  By 2028, new clean energy output will be increasing by 800 TWh a year, or more, so that even in high growth years, Chinese emissions from electricity generation will be falling.  

China is by far the world's largest emitter of CO2, causing over 25% of global emissions, compared with the US at 18%, and the EU at 17%.   Europe's and the USA's emissions peaked years ago:

Source: Our World in Data

What this means is this: if China's emissions have peaked, global emissions have probably peaked too.

It's true that the Trump administration has embarked on an utterly demented attempt to return the USA to the 1950s,  but cheap Chinese solar panels, batteries and EVs, are persuading the rest of the world (for example, Pakistan)---the other 80% of emissions---to switch to clean energy.  Plus, Trump's high-handed trashing of tariff and trade agreements means that the USA's opposition to carbon border taxes will not be effective.  If the USA can arbitrarily raise tariffs, then so can the rest of the world.  And they will.  Moreover, renewables are much cheaper than fossil fuels.  As electricity prices soar in the USA, cooler heads might prevail.

The peak in global emissions doesn't mean global temperatures will stop rising.  Emissions will have to fall by 90% for that to happen.  But what these devlopments do mean is that emissions are now in secular decline.  And the sustained fall in the costs of clean energy means that the decline will accelerate as renewables and EVs get ever cheaper.  As the impacts of catastrophic global heating worsen, the world will take stronger and stronger measures to slash emissions.

Temperatures will go on rising, but for the first time, it looks as if, by the 2040s, the decade-by-decade increases will start falling.

A slow world recovery

The chart shows the GDP-weighted averages for manufacturing (blue-dotted line) and services (red-dotted line) PMIs, as well as their average  (green line).   The big 8 are: the US, the Euro zone, China, Japan, India, Russia, Brazil and the UK, and together they make up roughly 70% of world GDP.

It is typical that after a deep recession, economies rebound sharply, but after a "soft landing", where growth doesn't actually go negative, economies take more time to get going.  Look for example at the pattern during the Euro crisis, and compare that to the rebounds after the GFC and the Covid crash.  This seems to the pattern now.

We avoided a deep recession thanks to US deficit spending stimulus with the IRA act, and because of revenge spending on services (experiences like eating out, travel, holidays and shows) after covid lock-ups were ended.   But precisely because we avoided a deep downturn, the economy is unlikely to bounce strongly from its lows.  Eventually, falling interest rates will engender a stronger recovery, but the lags between changes in interest rates and the economy are long.  

So:-  no recession, but for now, a slow recovery.   I expect 2025 to be a year where growth picks up, but not rapidly, as it did in 2013/14.  After that, Trump's tariffs will play havoc with the world economy.

Big 8 PMI average ticks up a little

 As usual, the services and manufacturing PMIs are PPP-GDP-weighted averages of extreme-adjusted country PMIs.  The average of the two (the green line) then gives us the "Big 8" total PMI.  The Big 8 economies are the USA, the Euro Zone, the UK, India, China, Russia, Brazil, and Japan.   They make up roughly 70% of the world economy.

As you can see, the "revenge spending" on services after covid lockdowns ended is fizzling, while the manufacturing sector may be bottoming.   Of these economies, the Euro Zone and the UK remain by far the weakest, while the US seems to be rebounding, despite the swingeing rise in the Fed Funds rate, because of the fiscal sugar hit caused by the so-called Inflation Reduction Act.  The varying response of Europe and the US to the combination of fiscal stimulus and monetary stringency demonstrates the effectiveness of big deficit spending:  big stimulus in the US stops the downturn, no stimulus in Europe lets the European economy slide deep into recession. 

I'm sorry I didn't comment on this earlier in the month.  I've been dealing with some personal issues.

Euro zone as weak as during the euro crisis in 2012

The economies of "small 8" (Switzerland, Sweden, SA, NZ, Israel, Canada, Belgium, Australia, making up ~6% of the world economy) are driven by what happens to the Big 8.   Whatever politicians in smaller economies promise, it's hard to evade the consequences of the global business cycle.

Why these countries?  They were the countries I could construct 20 years plus of data for.  I wanted to see the relationship over several business cycles.  I have recently found data for Denmark and Norway back to the late 1990s, so I will be adding them to the small 8, making it the small 10.  More of that in a later post.

Big 4 PMI slides again in November

 S&P Global (who took over IHS Markit, and now produces the PMI surveys) releases "flash" (provisional) PMIs for just 4 of the big economies: The USA, UK, Euro Zone, and Japan.  But the correlation of the "Big 4" with the "Big 8" is (no surprise) close.  

Both series are calculated from the extreme-adjusted series for each country, weighted by PPP GDP.  The "Big 8" PMI crossed the 50% "recession line" in October, and so will likely have retreated further in November.  Note that extreme-adjustment sharply attenuates the downward spike in GDP during the Covid Crash in early 2020.  These indices are now lower than they were during the Euro crisis in 2012.

Debt and deficits after coronavirus

A fascinating chart from Getup!

See how Federal deficits in Australia surged during both world wars, as did the ratio of outstanding debt to GDP.  For example, the (Federal) deficit to GDP ratio peaked in 1944 at 20%.  The debt to GDP ratio peaked at over 100% two years later.  The debt to GDP ratio didn't fall because the Federal government ran a surplus (though there was a small one in 1949) but because the denominator in the equation rose.  Debt to GDP  was high in all post-war belligerent economies, not just Australia.  But they understood the thesis that Keynes had made, which was that raising taxes and cutting expenditure to repay debt was counter-productive, because these actions reduced economic activity, so although the deficits naturally reduced as war ended, they didn't attempt to create fiscal surpluses as had been done after WW1.   The truth of Keynes's theory was conclusively demonstrated during the Euro crisis of 2011, when forced deficit reduction led to a "double-dip" recession.

Once again, governments are running large fiscal deficits, to keep economies afloat during the covid crash.  And it will be interesting to see whether "austerity", which has been discredited again and again, will be introduced after the recession is over to pay back sharply higher debt levels, or whether they'll do as most economies did after the war, and allow the ratio of debt to GDP to fall as a result of economic growth.

There is in any case a difference between debt incurred to fund the construction of capital goods (railways, roads, schools, housing, factories) and debt incurred to fund current expenditure (wages and salaries, running costs, etc.)  It makes sense to fund, say, a railway with bonds, repayable over 25 or 30 years.  However, only in the rarest circumstances, borrowing to fund current expenditures is unwise.  This is one of those rare circumstances.

US dips into recession

We now have both the ISM and the PMI surveys for August.  As usual, I have extreme adjusted both and added them together.  That's the green line in the chart below.  This average is now lower than it's been at any time since the GFC (Global Financial Crisis) in 2009.

The ISM commentary is bleak:

Comments from the panel reflect a notable decrease in business confidence. August saw the end of the PMI® expansion that spanned 35 months, with steady expansion softening over the last four months. Demand contracted, with the New Orders Index contracting, the Customers' Inventories Index recovering slightly from prior months and the Backlog of Orders Index contracting for the fourth straight month. The New Export Orders Index contracted strongly and experienced the biggest loss among the subindexes. Consumption (measured by the Production and Employment Indexes) contracted at higher levels, contributing the strongest negative numbers (a combined 5.6-percentage point decrease) to the PMI®, driven by a lack of demand. Inputs — expressed as supplier deliveries, inventories and imports — were again lower in August, due to inventory tightening for the third straight month and continued slower supplier deliveries. This resulted in a combined 1.5-percentage point decline in the Supplier Deliveries and Inventories indexes. Imports and new export orders contracted to new lows.

Respondents expressed slightly more concern about U.S.-China trade turbulence, but trade remains the most significant issue, indicated by the strong contraction in new export orders. Respondents continued to note supply chain adjustments as a result of moving manufacturing from China. Overall, sentiment this month declined and reached its lowest level in 2019.

As I've said before, my US longer-leading index (18 months to two years' lead) suggests a turn sometime in 2020, and that timing is more or less consistent with my shorter leading index (9 months to one year).  That's a good six months away, and it ignores any stupid actions from Trump.

And I am concerned that there are few tools to reverse this slide.  Yes, the Fed can cut rates.  But they are already very low.  And QE (Quantitative Easing, i.e., buying long dated bonds to drive down the yield)?  They are already at 75 year lows.  Fiscal stimulus?  We've had our fiscal sugar hit.  And though Republicans voted for a tax cut for the rich and for companies, somehow I doubt they'll vote for any more fiscal stimulus.  The deficit is already substantial.  A tax cut at the economic peak is always stupid.  So it proved this time too.

And remember, in a world where trade flows between countries are significant, weakness in one can be transmitted around the world, especially if politics doesn't provide a circuit breaker.  Look how the U economy turned down in 2012 in response to the Euro crisis.  And right now politics is actually reducing confidence, worsening trade, affecting demand and investment.  We have cretins in charge in the US, the UK, Brazil, and Oz.  And in Europe, the German passion for budget surpluses is constraining Europe's ability to spend its way out of its recession, while the ECB already has a interest rate of zero.

Big 3 PMI index ticks up

The (unweighted) average of the PMIs for Japan, Europe and the USA (purchasing managers indices—an excellent early guide to the overall state of economies where IHS Markit does their surveys) ticked up a little in April.  These are the provisional ("flash") estimates based on a partial sample, and are often revised slightly when the full sample is available.   Markit no longer does a "flash" estimate for China, so this chart shows just the average for the US, Europe and Japan which together make up about half the world's economy.

Although it ticked up in April, I don't think it's a sign that the world's economy has stopped slowing.  The sugar hit of the Trump tax cuts is fading, and the Fed has raised interest rates steadily since December 2015.  Even if it's stopped raising rates, the lags between changed monetary policy and the real economy are long—18 months to 30 months.  I could be wrong, of course.  I notice that a lot of investment banks are forecasting a modest recovery.  Since, on the whole, they didn't forecast the slowdown .....

Note that the index is below 50, suggesting that the world economy has gone into recession. The previous flirtation with the 50% line in 2016 turned around when Europe began a recovery which was then put into overdrive by the Trump tax cuts which took effect from January 2018.  US fiscal policy this year will be actually be slightly negative—as higher incomes and spending increases the Federal tax take.  The combined effects of tighter (less loose) fiscal policy and the lagged effects of tighter monetary policy in the US will slow the US economy to a crawl or worse.  The other big economy, Europe, already has a discount rate below zero, and will take too long to move to fiscal stimulus because of tighter rules imposed during the Euro crisis in 2011/12.  But the authorities in China have their feet firmly on the accelerator, and this may be enough to give the world economy a bit of a pick up.  As long as we don't have further trade wars.

Europe continues to slow

I mentioned the close correlation between Austria's economy and the economy of the whole of Europe before.  The latest PMI survey data for September show another fall for Austria after the "flash" (preliminary) estimate for Europe also fell.  Though both surveys are still above 50%, i.e., are still growing, the gap between them and 50% has narrowed, showing the growth is lower.

In 2012, when the European economy experienced a "double-dip" recession as a result of the debt crisis, these indices fell below zero.  The ECB (European Central Bank) and the European government don't seem to  be managing this very well, frankly.  Growth for the last 6 years has for the most part been sluggish.  If the current cycle is to end soon, that is not good news.

PMIs show world econ picking up

This is the GDP-weighted average for the PMIs ("purchasing manager indices") for Europe, the US and Japan. The latest observation is based on preliminary not final data. (Markit no longer releases prelim figures for China.) This the first real synchronised pick-up in major world economies/regions since the euro crisis.  For the first time since then we're seeing a recovery in Europe as well as a pick up in the US and Japan.  And this acceleration is before the surge which will come from the Trump spending and tax cuts.

European GDP

The volume of GDP ("real" GDP) in Europe still hasn't passed its previous peak (the chart shows the level of GDP, not its rate of change).  A triumph, really, a stunning triumph of bad and doctrinaire policy.

Marshlands

Europe starting to look a bit soggy. ECB rate cut just in time. Via.

Welcome back to the Eurozone Crisis

A telling piece from the FT.

(You have to sign up to read the story, but that's no big deal.  It's still free!)