Most indicators are pointing down, but a couple are rising. The average of the Empire State and Philly Fed indicators is trending up after falling since the beginning of the year (Trump's tariff pagaille). It's true, this only covers the NE United States, so isn't definitive. However, it fits well with the average of the two national surveys by the ISM (Institute of Supply Management) and the PMI (Purchasing managers' index, from S&P Global):
We'll see.
US inflation has started to rise, in consequence of the swingeing jump in tariffs. It took a bit longer than I expected, probably because stocks (inventories) were higher than I thought. But now that businesses have run down their pre-tariff stocks, they have no choice but to pass on their increased costs. No doubt, as inflation gathers momentum, they will also be indulging in a bit of "greedflation", as they did in the post-covid inflation surge.
But it's not just tariffs. The government's campaign against immigrants has meant that food prices are soaring, because immigrants pick and pack the USA's food. (Coffee is rising because of global warming, and because of 50% tariffs on Brazilian coffee imports)
In my judgment, neither of these forces is anywhere near over. Prices will continue to rise until equilibrium is reached, and that will be several months away.
The Fed could "look through" this surge in inflation, on the argument that it will not be a sustained jump in the inflation rate, but a one-off adjustment in price levels. "Cost-push" rather than demand-led inflation. That is what markets (shares, bonds and currencies) think will happen, and the next cut in rates later this month seems baked in.
This rise in inflation will reduce real (inflation-adjusted) incomes, reducing spending, deepening the economic downturn. This might seem to be an argument for further rate cuts, if it happens, but just as the inflation might be transitory, so would the economic downturn caused by that inflation.
Now, it is possible that wages may rise to compensate---which I do not think will happen---but if they do this will heighten Fed fears that higher inflation is becoming embedded in the system, which means they won't cut interest rates any further.
So, the Fed moves depend on data over the next few months. If the economy continues to weaken, and wage inflation doesn't accelerate, the Fed will prolly cut the Fed Funds rate again. If the economy stabilises, then the Fed will have the luxury of waiting for the inflation surge to slow, and it prolly won't cut rates again. If wage inflation starts to pick up, all rate cuts are out of the question.
I'm not at all sure what the inflation rate will peak at, but I wouldn't be surprised if it nears 5% by year-end or early in 2026. This will be a very uncomfortable environment for the Fed to cut rates, as opposed to keeping them stable. It will need to be quite sure that the rise in the inflation rate is transitory. And that its moves are not seen as a response to Trump's pressure, which would destroy its credibility.
I haven't commented before now on the US labour market stats which came out a week ago---I've been kept busy with changing my data sources and rewriting my programs to work with these new formats. Plus other software improvements, as well.
First, non-agricultural employment. Note how employment growth started to pick up in the second half of last year, and has been falling since the beginning of this year. Employment growth is still positive, but only just. Ignoring the Covid Crash, it hasn't been this weak since coming out of the GFC, 15 years ago.
Second, unemployment. This comes from a different survey to the payrolls data. The BLS gets the payrolls data by asking companies how many people they employ. They get estimates for unemployment by asking a random sample of households whether they are employed or unemployed.
If these two different surveys, drawn from different samples populations, show the same thing, we can be more confident about what's happening. And they do.
The unemployment rate is usually regarded as an indicator which lags the cycle, i.e., it turns up or down after the economy does. However, its change over 6 months coincides quite well with the cycle, except it is inversely correlated---it rises when the economy falls. So in the chart below, I have plotted the six-month change inverted. A falling line with this indicator thus indicates a slow-down or a recession.
Observe how unemployment had started falling (shown as a rising line in the chart) in the second half of last year, showing that an economic recovery was getting underway, and how this recovery has reversed since January.
Another data series from the household survey is total employment. Because this comes from the survey of households, not employers, it shows a slightly different picture to the payrolls chart. But not that different. And it also points to a very rapid slowdown in jobs since January---the largest fall since the GFC, if we exclude the Covid Crash. Note that because the household survey draws on a smaller proportion relative to its sample population than the payrolls survey, its random month-to-month fluctuations are larger. So I have used a six-month average change to smooth this.
Like the ISM surveys, all three charts show that a recovery in the economy had begun, and this recovery was aborted by Trump's tariff imbroglio.
I see no reason for this to change direction over the next 6 months, because we will now be seeing the inflation effect of the huge jump in tariffs. This will reduce real incomes, and therefore expenditures.
Will the Fed cut rates to save the day? No. Not until it's sure that the rise in inflation from tariffs is transitory. And even if it does, interest rate changes take many months to increase economic activity.
There will be random month-to-month zigs and zags, but I expect US economic data to worsen inexorably for the next few months.
The ISM for services came out last night. It "surprised the markets" by falling instead of rising.
The chart below shows the ISM for services and the ISM for manufacturing, both extreme-adjusted.
Note how there have been a few times in the past when one was going up and the other down. However, over the last few months, since January this year, and Trump's trade wars, both have been falling.
In the past, when this average has fallen below these levels, there has been a recession: 1989-1991, 2001, 2009. The trend is clearly down, and there is no reason to assume it will change. The rise in tariffs is a significant fiscal shock, since, contrary to Trump's beliefs, it is American residents who will pay the tariffs, which are the equivalent of a rise in taxes. In addition, there is the huge uncertainty imposed by his shilly-shallying. One day the tariff is 10%, the next 35%. Then it is postponed for 90 days. Then because the leader of the other country doesn't suck up to Trump enough, it jumps to 50%. Only to be postponed for a month. People who invest in plant and equipment, and consumers who spend on consumption goods, close their wallets. When cash is king, economies go into a recession.
This will be the first recession in my long involvement with financial markets, which has been entirely caused by rank stupidity. And Trump's response? He sacks the people who produce the stats.
The Fed isn't going to save the situation. It will be reluctant to cut rates until it is sure that the inflationary impulse caused by the jump in tariffs has passed. And when it does cut the Fed Funds rate, it will take 9 to 15 months for the economy to respond.
The sales of heavy trucks in the USA provide a clear leading indicator of recession. They have led every recession over the last 58 years. They are falling fast now.
What about false signals? 1986/87 was a slowdown, not technically a recession, and in fact heavy truck sales didn't fall that much. In 1996, growth slipped to 1.2% QoQ, annualised. In 2011, growth was negative in Q1 and again in Q3, but that doesn't count, technically, as a recession. In 2016, growth slumped to 0.7% QoQ annualised. In these cases, the slide in heavy truck sales portended a slowdown not a recession.
And, you can't rely on just one indicator. There are differences between every recession and every recovery. Random fluctuations can affect how soon and also by how much indicators turn down or up. But we're getting enough slumping economic time series to suggest a recession is on the cards.
And the longer the tariff pagaille continues, the worse it will be. Trump likes tariffs. He loves the attention he gets every time he changes policy, and he keeps on changing it. This uncertainty is very bad for consumer spending and business investment, and that's before the effect of price increases caused by tariffs on real income. I'm not optimistic that the US will avoid recession, and in my opinion, the likelihood of deep recession is high, because under the US system, there's no way to get rid of an incompetent and dangerous leader. The Republican Congress is too scared of MAGA, the Dems are too feeble (mostly), and Trump will likely go on making pronunciamentos on social media about tariffs until the end of his term, or at least to the mid-term elections (assuming they happen), throwing everything into chaos until then.
Will the Fed save us? Printing money (cutting interest rates) doesn't lead to real growth if the environment is too chaotic. It just leads to inflation. And anyway, the economy only responds with a lag. So, no.
Normally, at this stage of the cycle, bond yields would be falling, and they aren't. Why? For two reasons. One, Trump's tariffs and his deportation of migrants will drive up inflation in the USA, which will inhibit the Fed from cutting the fed funds rate in the short term. And maybe longer term too. The second is also Trump's fault. The bond market is very wary of his tax cuts for billionaires. This will cause the US deficit to balloon. The Republicans plan to increase the debt ceiling by an incredible 4 TRILLION dollars.
Note that the 25-year downtrend in yields, which underpinned advances in the stock market and property, has been decisively broken.
Despite some contra movements (for example, Brazil is raising its Central Bank rate), world interest rates have broadly peaked. The ECB has just cut the discount rate for the Euro Area (the countries which have the Euro as their currency), which has been followed by other European countries. The Fed Funds rate (the US's equivalent of the discount rate or bank rate) will prob'ly not be cut again in the near term because of the inflationary impact of Trump's tariff and immigration policies. However, other countries will prob'ly cut their interest rates even faster to reduce the impact on growth of Trump's trade wars.
In the chart shows the GDP-weighted average discount rate for 83% of the world. The other shows the unweighted median interest rate, including many additional countries in the analysis (e.g, Angola, Kenya, Ukraine, Argentina, and others.)
We now have most of the manufacturing PMIs for the world for July. (Services PMIs out next week).
There has been a worrying decline in July, almost all of it in the USA, echoed by July's labour force data. China has also been weak, which I talked about here.
Economic time series do not always move in straight lines. For example, in 2013, as the world was recovering from the Euro crisis, there was a 4-month period when the Big 8 manufacturing PMI fell. At the peak in 2010, the Big 8 PMI apparently peaked in 2010, before going on to achieve an even higher reading in 2011. So blips in an up or down trend do happen.
What causes recessions is major monetary and credit imbalances. Slowdowns are different. Economies don't grow in a straight line. There are small waves within the big ones.
So the key question is whether this is just a small wave in the USA, or the start of something much bigger.
The Fed's tightening has been extreme. Biden's IRA provided a massive fiscal stimulus, but that is fading (I'll explain how fiscal stimulus works one of these days). The fiscal stimulus, and the "revenge spending" in services, helped mask the negative effects of the Fed's tightening and the swingeing cuts in liquidity they imposed. So is the very recent weakening due to the delayed impact of the Fed's tightening of monetary policy? Because it can't be anything else: inflation is trending lower; there's no credit crisis; there's no collapse in consumer confidence. (I will update my US indicators shortly.)
I think the sudden tumble is just a blip. But I may be wrong; I have been before. Again, though, I reiterate: this global economic recovery will not be vigorous.
The Fed will start cutting rates in September. It may regret not doing it sooner.
To disentangle the signal from the noise, I have first extreme-adjusted the individual time series (the ISM and the PMI survey data time series) and then I have averaged them. Extreme-adjustment is an algorithm which removes or reduces the impact of extreme events. In particular, over this period, it reduces the impact of the Covid Crash in early 2020. In addition, averaging two statistically independent series reduces the random fluctuation (error term) in the resulting index. Both these techniques reduce the "spikiness" of the time series, making the chart easier to read.
Right now, the PMI is giving a more robust picture of the US economy, and the ISM survey a slightly weaker view. This pattern has been the other way around in the past, for example in 2017/18. But the line to watch remains the thick green one. It points to a renewed upturn, as the economy shakes off the impact of the Fed's policy tightening, as government spending and private investment on the back of IRA tax incentives push the economy forward.
Good news for Biden's re-election. But it also means that the Fed will be reluctant to cut rates, until it gets evidence that inflation is continuing to decline.
The extreme-adjusted GDP-weighted average of the provisional ("flash") PMI for the "big 4" (US, Euro zone, UK & Japan) for December was down slightly on November's number. In the chart below it is compared to OECD GDP, and not world GDP, because the big 4 PMI calculation does not include Russia, China, India and Brazil, for which "flash" estimates are not released. The estimates were released unusually early because of the Christmas holidays.
The chart suggests that the QoQ (quarter-on-quarter) percentage change for OECD GDP will remain low for Q3 and Q4 of this year. (Q3 and Q4 data have not yet been released)
GDP in the US is picking up, despite the Fed's increase in the fed funds rate over the last year, because of Federal deficit spending in response to the "IRA". In Europe, interest rates have also gone up dramatically, but there has been no big jump in deficit spending by governments, so growth has been much weaker. Moreover, while the Fed has signalled that it will cut rates in 2024, the ECB (European Central Bank) and the BoE (Bank of England) have strongly hinted that they will not. An interesting divergence.
The chart below shows the Euro-zone (i.e., the countries which use the Euro) PMIs for manufacturing and services, both extreme-adjusted, and their average.
Manufacturing (dotted black line) is now as bad as it was during the covid crash (extreme-adjusted), and heading towards the GFC (2009) lows. Services (i.e., retailing, restaurants, travel, hotels, etc.) --- the dotted blue line --- were much worse affected by the lockdowns. Pent-up demand led to the early-2023 services "revenge spending" bounce, which lifted the economy, but which is currently fizzling out.
Why so much weaker than the USA, despite equally stringent monetary tightening? The misnamed "Inflation Reduction Act" has stimulated the US economy, but no similar program has been enacted in Europe. Proof positive (if you needed it) that fiscal stimulus works. Biden is returning us to the 1945-1984 Keynesian consensus, where the Federal Government was intimately involved in mitigating deep recessions. The long-term implications are interesting, politically and economically. For example, the divergence between the US and Europe suggests that Europe's interest rates may have peaked and may start falling soon, while, even if you believe that the Fed has stopped raising rates, the Fed Funds rate is unlikely to fall soon.
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| As usual, you should be able to get a clearer image by clicking on it |
Despite my forecasts that the US economy would slow sharply after the fastest rise in interest rates and the steepest fall in money supply in 40 years, it hasn't happened. Growth appears to be accelerating. (However, my forecast for a European recession, where, unlike the US, there has been no massive fiscal stimulus, is being fulfilled)
It appears that the federal fiscal stimulus is enough to offset the Fed's deep tightening. So far, at any rate. US GDP growth is the highest in the G20 GDP growth table from Trading Economics (though some data are only available till June). Remarkable. So much for neo-liberalism. Joe Biden has returned us to the 1945-1984 situation where big government works, where fiscal stimulus and deficit spending is used to reduce the severity of economic downturns.
The chart shows the average of the extreme-adjusted PMI and ISM manufacturing surveys for the USA (the service sector surveys for October won't be available for a few days, yet). An average of two statistically independent time series will have lower random month-to-month variability than either on its own. In addition, each series is adjusted for extremes independently before the average is calculated. This average is shown by the green line in the chart below. It shows a rebound over the last few months, with a small dip in October.
I talked before about how a surge in commodity prices can lead to a subsequent recession here. The current decline in commodity prices points to an ultimate recovery in the world economy sometime in 2024.
There are several reasons for this relationship. When commodity prices surge, they make commodity exporters richer, and commodity users poorer. But the increased incomes of commodity exporters aren't spent immediately, while commodity users have to find the money to pay for higher commodity prices by spending less. At the same time, rising commodity prices push up inflation and central banks tighten monetary policy. This all plays out with a lag, but in essence it causes the world economy to slow.
When commodity prices fall, commodity exporters lose out, and they have to reduce spending. Often their economies struggle. But there are fewer of them --- think of the small number of oil exporters vs the large number of oil consumers. Meanwhile, the more numerous consuming countries are better off, because their real incomes improve. Central Banks stop raising interest rates, confidence increases, and economies start to recover.
The complication comes from the fact that too fast economic growth leads to excessive commodity price increases, which in turn leads 18 months to two years later to the economic downturn. Economic policy should be directed at stable growth, because of this feedback process. But commodity price shocks can also occur because of politics. The two oil embargoes in 1973 and 1979 caused the deep 1974 and 1980–1983 recessions. But the embargoes only worked so well because the world economy was strong. And of course, the deep 1980–1983 recession eventually caused the oil price to fall.
And the most recent strength in the world economy indirectly contributed to the war in Ukraine, which caused commodity prices to soar. Why do I say this? Because Russia is a major oil and gas exporter, and those prices rose as the world economy boomed post-covid, making the Russian government very confident that the war could be paid for and that the West couldn't respond with a boycott because it would cause commodity prices to soar, leading to recession and political crises. They have been wrong so far.
Commodity prices now point to a late 24 or early 25 recovery. But before that happens, we'll have a recession. Looking just at this indicator, and there are obviously others, it looks as if it could be as deep as the GFC, but that was worsened by the Fed letting Lehman's go, which froze the banking system and caused a deep plunge in activity. They have presumably learnt from past mistakes. We'll see.
Here, I showed a chart of real (= inflation-adjusted) US M1. The unadjusted version is as interesting.
As you can see, nominal (i.e., not adjusted for inflation) M1 is falling as fast as it did during the Great Depression (1929-1933). It fell then because banks failed, and when that happened, their deposits were written off, causing money supply to fall. It's happening now because The Fed is allowing its book of government bonds bought during the Covid Crash to run off without replacing them. When that happens, the money it receives is extinguished (central banking is complicated to explain!) and so the money supply is reduced.
The huge surge in money supply during Covid led to an economic boom (though fiscal stimulus exacerbated the boom) and a jump in inflation to 40-year highs. Of course, there's never just one factor---inflation was worsened by the invasion of Ukraine, by a surge in commodity prices, and by supply chain hiccoughs. However, there is no doubt in my mind that massive monetary stimulus in the form of zero interest rates plus quantitative easing helped overstimulate the economy and worsened inflation.
Now the situation is reversed. Interest rates have risen the fastest in 40 years, and money supply is falling as fast as it did in the Great Depression. It is of course possible that neither of these two factors will lead to recession. But, alas, it seems very unlikely.
We must be alert to the possibility that the Fed's redefinition of money supply to include liquid interest-bearing deposits has changed its behaviour, but you would have expected the effect to be the other way, as precautionary motives and rising interest rates led to an increase in interest-bearing liquid assets. But M2, which includes money market funds, is also falling faster than at any time in the last 60 years, though not as fast as M1.
US real M1, i.e., M1 deflated by the CPI, is falling faster than at any time in the last 100 years. The post WW2 decline in the inflation-adjusted time series was because war-time price controls were lifted and published inflation jumped to 20%, before falling back. In fact, it went negative---businesses had in fact raised prices too enthusiastically, which I suspect is happening again.
The Fed instituted a policy of "quantitative easing" during the Covid crash, which caused a big jump in money supply. Since it became concerned about inflation, it has reversed this policy, and this has reduced money supply. There was also a change in definition of money supply, but I have adjusted my data to reflect this.
If you argue that quantitative easing expanded the economy, leading to low unemployment, high growth and surging inflation, you must accept that "quantitative tightening" will lead to the reverse outcomes. There is no sign that real M1 has started to rise. If anything, its absolute decline is accelerating.
I think this is a major blunder on the part of the Fed, and will lead to a sharp decline in economic activity. The lags are long, but we should be starting to feel the effects of this singular plunge in real money supply from now on.
The chart below shows the year-on-year increase in the core PCE (personal consumption expenditure) deflator. This is one of the Fed's key inflation indicators.
Though down from Q4/22 levels, it's no longer falling. This points towards further rate rises by the Fed.
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| click on chart to see clearer image |
The twin crashes in US commercial real estate and the US bond market have collided with $US9 trillion ($13.5 trillion) uninsured deposits in the American banking system. Such deposits can vanish in an afternoon in the cyber age.
The second- and third-biggest bank failures in US history have followed in quick succession. The US Treasury and the Federal Reserve would like us to believe that they are “idiosyncratic”. That is a dangerous evasion.
Almost half of America’s 4800 banks have already burnt through their capital buffers and are running on negative equity. They may not have to mark all losses to market under US accounting rules, but that does not make them solvent. Somebody will take those losses.
“It’s spooky. Thousands of banks are underwater,” said Professor Amit Seru, a banking expert at Stanford University. “Let’s not pretend that this is just about Silicon Valley Bank and First Republic. A lot of the US banking system is potentially insolvent.”
The full shock of monetary tightening by the Fed has yet to hit. A great edifice of debt faces a refinancing cliff-edge over the next six quarters. Only then will we learn whether the US financial system can safely deflate the excess leverage induced by extreme monetary stimulus during the pandemic.
A Hoover Institution report by Professor Seru and a group of banking experts calculates that more than 2315 US banks are currently sitting on assets worth less than their liabilities. The market value of their loan portfolios is $US2 trillion lower than the stated book value.
These lenders include big beasts. One of the 10 most vulnerable banks is a globally systemic entity with assets of over $US1 trillion. Three others are large banks. “It is not just a problem for banks under $US250 billion that didn’t have to pass stress tests,” he said.
The US Treasury and the Federal Deposit Insurance Corporation (FDIC) thought they had stemmed the crisis by bailing out uninsured depositors of Silicon Valley Bank and Signature Bank with a “systemic risk exemption” after these lenders collapsed in March.
The White House baulked at a blanket guarantee for all deposits because that would look like social welfare for the rich. Besides, the FDIC has only $US127 billion of assets (and less very soon) and may ultimately require its own bailout.
The authorities preferred to leave the matter vague, hoping that depositors would discern an implicit guarantee. The gamble failed. Depositors fled First Republic Bank at a fast and furious pace last week despite an earlier infusion of $US30 billion from a group of big banks.
White knights probing a possible takeover of First Republic recoiled once they examined the books and discovered the scale of real estate damage. The FDIC had to seize the bank, wiping out both shareholders and bondholders. It took a $US13 billion subsidy along with $US50 billion of loans to entice JP Morgan to pick up the pieces.
“No buyer would take First Republic without a public subsidy,” said Krishna Guha from Evercore ISI. He warns that hundreds of small and mid-sized banks will batten down the hatches and curb lending to avoid the same fate. This is how a credit crunch begins.
The share price of PacWest, the next on the sick list, fell as much as 60 per cent in after-hours trading on Wednesday. That will be the bellwether of what happens next.
The US authorities can contain the immediate liquidity crisis by guaranteeing all deposits temporarily. But that does not address the greater solvency crisis.
The Treasury and the FDIC are still in the denial phase. They blame the failures on reckless lending, bad management, and over-reliance on footloose uninsured depositors by a handful of banks. This has a familiar ring. “They said the same thing when Bear Stearns went down in 2008. Everything was going to be all right,” said Seru.
First Republic lends to technology start-ups, but it chiefly came unstuck on commercial real estate. It will not be the last on that score. Office blocks and industrial property are in the early stage of a deep slump.
“Where we stand today is a nearly perfect storm,” said Jeff Fine, real estate guru at Goldman Sachs.
“Rates have gone up 400 to 500 basis points in a year, and financing markets have almost completely shut down. We estimate there’s four to five trillion [US] dollars of debt in the commercial (property) sectors, of which about a trillion is maturing in the next 12 to 18 months,” he said.
Packages of commercial property loans (CMBS) are typically on short maturities and have to be refinanced every two to three years. Borrowing exploded during the pandemic when the Fed flooded the system with liquidity. That debt comes due in late 2023 and 2024.
Could the losses be as bad as the subprime crisis? Probably not. Capital Economics says the investment bubble in US residential property peaked at 6.5 per cent of GDP in 2007. The comparable figure for commercial property today is 2.6 per cent.
But the threat is not trivial either. US commercial property prices have so far fallen by just 4 per cento 5 per cent. Capital Economics expects a peak to trough decline of 22 per cent. This will wreak further havoc on the loan portfolios of the regional banks that account for 70 per cent of all commercial property financing.
“In a worst-case scenario, it could create a ‘doom loop’ which accelerates a real estate downturn that then feeds back into the banking system,” said Neil Shearing, the group’s chief economist.
Silicon Valley Bank’s travails were different. Its sin was to park excess deposits in what is supposed to be the safest financial asset in the world: US treasuries. It was encouraged to do so under the risk-weighting rules of the Basel regulators.
Some of these debt securities have lost 20 per cent on long maturities – a theoretical paper loss only until you have to sell them to cover deposit flight.
The US authorities say the bank should have hedged this Treasury debt with interest rate derivatives. But as the Hoover paper makes clear, hedging merely transfers losses from one bank to another bank. The counterparty that underwrites the hedge contract takes the hit instead.
The root cause of this bond and banking crisis lies in the erratic behaviour and perverse incentives created by the Fed and the US Treasury over many years, culminating in the violent lurch from ultra-easy money to ultra-tight money now under way. They first created “interest rate risk” on a galactic scale: now they are detonating the delayed timebomb of their own creation.
Chris Whalen from Institutional Risk Analyst said we should be wary of a false narrative that pins all blame on miscreant banks. “The Fed’s excessive open market intervention from 2019 through 2022 was the primary cause of the failure of First Republic as well as Silicon Valley Bank,” he said.
Mr Whalen said US banks and bond investors (ie pension funds and insurance companies) are “holding the bag” on $US5 trillion of implicit losses left by the final blow-off phase of the Fed’s QE experiment.
“Since US banks only have about $US2 trillion in tangible equity capital, we have a problem,” he said.
He predicts that the banking crisis will keep moving up the food chain from the original outliers to mainstream banks until the Fed backs off and slashes rates by 100 basis points.
The Fed has no intention of backing off. [It raised rates further this week to the highest level in 16 years, and chair Jerome Powell warned not to expect any rate cuts this year]. It continues to shrink the US money supply at a record pace, with $US9 billion of quantitative tightening each month.
The horrible truth is that the world’s superpower central bank has made such a mess of affairs that it has to pick between two poisons: either it capitulates on inflation, or it lets a banking crisis reach systemic proportions. It has chosen a banking crisis.
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| The rise in the US discount rate from 1% in 2004 to 5.3% in 2006 led to the GFC. The rise this cycle has been even larger. |
First tentative signs that my longer-leading index for the US is bottoming. Given the typical --- though variable! --- lag of 24 months, that suggests a low point in the US cycle of end 2024. This may be brought forward if the Fed cuts rates aggressively, but it prolly won't because inflation is still a problem.
Remember: the lags are long. As we used to say in South Africa: the economy doesn't turn on a tickey. It takes time for monetary policy to take effect, in either direction. The reaction of the economy to the sharp rise in the Fed Funds rate over the last year is already built in to the next year. And a banking crisis will only make matters worse, although (good news!) that will discourage the Fed from raising rates any more.
But at least the index is bottoming.
The 'flash' (preliminary) estimate of S&P Global's purchasing manager survey rose a little in January. Does this mean that recovery is in sight? Prolly not. Rising interest rates take a while to affect the economy, and the full impact of the Fed's increase in the discount rate from 0 to 4.3% hasn't yet hit the economy. The lag between changes in interest rates and economic activity is long, but variable. The shortest is 12 months; the average is ±18 months. (I'll give you the chart in my next post)
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| 50% manufacturing, 50% non-manufacturing |
My US QCI (a monthly GDP proxy; QCI stands for "Quick Coinciding Index". Yeah, I know --- as if there isn't already enough jargon in economics!) has started to fall. As you can see, in the chart below, it is very well correlated with GDP, though it is more volatile. Data through December for the QCI; through QIII for GDP.
Remember, economies are like tankers; even if you turn off the engines it takes a tanker 8 kilometres and 20 minutes to come to a stop. Economies respond with a long, and variable, lag to rising interest rates. This time a year ago, the Fed Funds rate was zero. Now it's 4.3%. Expect further declines in the US economy. In March last year, the QCI was rising at an annualised rate of 13% per month; now it's falling by an annualised rate of 1%, which appears to be accelerating. What's the bet that by June, the Fed will have stopped raising rates? But they'll prolly wait too long to cut rates. Alas.
