No Money, No Honey

 Sometimes, all it takes is one or two charts.  Without further ado, see below 

1. What has happened to disposable income for Americans (basically, gross income after all taxes) and the price of everything (inflation).  I'm showing only the last 4 months because COVID cash handouts muddle the picture.  Inflation is soaring, income is not.

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Annual Change In Disposable Income (blue) And Inflation (red)

2. Surely, you may think, Americans still have plenty of money left over from the Biden/Powell shower of free cash during 2020-21.  But no, they most definitely do not.  Savings balances are the lowest in 8 years in absolute dollar terms ($945 billion as of 2Q22) and the lowest in 12 years as a percentage of current GDP (3.88%).

Personal Savings As A Percentage Of GDP

With prices soaring for essentials, incomes rising at a much slower paces and not much money in the bank, it's pretty easy to predict a consumer-driven recession in the immediate future, after the current spate of "revenge" spending post-COVID (eg travel) is over.

It isn't rocket science...

Slay The Sacred Cows

 The Gang That Couldn’t  Shoot Straight To Save Their Lives, aka the EU, has proclaimed upcoming “measures” to deal with sky-high energy prices. The announcement contained zero specifics, in keeping with TGTCSSTSTL standards. Oh, wait.. they announced a summit meeting on a specific date. Good night, and good luck.

What could they do? Here’s a list of sacred cows that they could (but won’t) slay:

1. Abolish the TARGET model for pricing.

2. Suspend and quickly abolish all energy trading on exchanges (they are OBVIOUSLY being manipulated).

3. Abolish all energy wholesalers, permit only one energy provider per country/region who must also be a sole producer and heavily regulate prices/ROEs.

4. Use a Public Utility Commission model for pricing once a quarter, or even less frequently.

5. Use eminent domain and state of emergency statutes to impose the above.

This should do for now…. 

Powell To The People

 Fed Chairman Jerome Powell did the right thing and poured cold water all over markets, affirming a tight US monetary policy until inflation goes back to around 2%.  Kudos, and good for the average working American who is seeing his/her disposable income evaporate under the highest inflation in 40 years.

Back in Europe, Mrs. Lagarde is immobile like a deer caught in the headlights of a truck.  Only, the truck (soaring inflation) has already hit her, so it’s  probably better to remove her and replace her with a real central banker of acknowledged status.

Super Mario (Draghi) is once again available 😄

American Luddites

 US Republicans are seeking to ban Environmental, Social and Governance (ESG) investment criteria. Florida governor DeSantis banned them from state pension funds (PS he wants to run for President) and Texas banned investments that are “hostile” to the fossil fuel industry.

During 1811-16 bands of English workers attacked cotton mills, destroying machinery that would, supposedly, put them out of work. They were called Luddites, after their purported original instigator. It didn’t work then and, hopefully, it won’t work now. But, one has to wonder: Luddites were uneducated, poor workers. Today’s naysayers are educated, rich political leaders who hold major positions of power.

What does this say for the American Empire’s future?

How About, It Madame Lagarde?

 Yesterday I said “don’t fight the Fed”.  How about the ECB, how is it doing in its fight against record inflation? In a word, it’s doing nothing.  

The real (inflation adjusted) main refi rate, the ECBs main policy rate, is currently at minus 9%, a record negative reading that - if anything - promotes inflation instead of fighting it.  

Yes, it’s true that the ECB faces serious troubles: Italy, Greece, Portugal, even France, are highly indebted and a jump in interest rates will pose a serious threat of bankruptcy.  And unlike Greece in 2010, this time such an event will be the end of the euro as we know it.  So, Mrs. Lagarde is choosing inflation, what she thinks is the lesser of two evils.  

She is making an enormous mistake, being completely deaf to people’s cries of despair over the enormous price increases in basic necessities: energy, food, transportation and housing.  

Social unrest is rising: Italy is almost certain to swing hard right in next month’s elections, its population totally disgusted with “politics as usual”.  Labor strikes are becoming more common after decades of inaction. Governments in the EU are providing stopgap subsidies for electricity and fuel, but they are nowhere near enough and no one is getting fooled. Germany provided near free train travel until the end of August, Greece has devised "Fuel" and "Power" passes that subsidize gasoline and electricity to the tune of 40-80 euro per user, etc.  But those amounts pale by comparison to utility, food, transport and housing bills, which are only going to get much steeper when the heating season begins in a month or two. Even the UK is facing a “heat or eat” winter.

Mrs. Lagarde has to move, and she has to do so fast.  

PS The only thing that will work in bringing down soaring prices, especially in energy, is a firm realization by "the free market (laugh!)" that ECB is willing to do "whatever it takes" to kill inflation. OK, forget raising rates by too much. How about a very sharp eurozone QT? It will certainly work.  Because things cannot continue like this... (see below).

Natural Gas Prices Have Exploded 1000% In One Year

Don’t Fight The Fed

 I just read in Bloomberg that investors don’t seem bothered about the Fed. They don’t believe that the Fed has the “spine” to keep tightening until inflation drops to its target, around 2%.  Maybe they’re right, maybe Mr. Powell will revert to last year’s stance of thinking that inflation is “temporary”.  But, having made that mistake last year it seems highly unlikely to me that he will repeat it.

One of the oldest dictums in Wall Street is “don’t fight the Fed”, ie don’t bet against its ability to set monetary policy goals and to achieve them.  I think lots, maybe most, investors have been lulled into complacency after decades of a docile, nearly somnolent Fed.

But make no mistake: the Fed is the biggest dragon of them all and once it awakes….

A Nice Article On The Fed’s QT

 While most look at interest rates to gauge the Fed’s monetary policy, this time around it’s Quantitative Tightening (QT) that’s more important, in my opinion.  This article from Vanguard Advisors provides a very nice analysis.

As it states, the Fed hasn’t done anything like this before, not in this scale, anyway.  I think markets are still blind to the negative effects of constantly draining such large amounts of liquidity from the system. According to Vanguard, the Fed is looking to drain around $4-5 trillion over the next 3 years. That’s truly unprecedented.

Should The Fed Stop Tightening? Hell No!

The "market" is already discounting a Fed that will stop tightening soon.  Is  "the market" right? And, more importantly, should the Fed stop tightening?  You be the judge - take a look at the chart below.

It shows the real Fed Funds rate, ie Fed Funds minus CPI inflation. It is at the most negative since at least 60 years ago...

Fed Funds Minus CPI Inflation

How high can/should interest rates go?  Let's do a "back of the envelope" calculation:  last time inflation was this high was in the early 1980s and Fed Funds were as high as 500-1,000 basis points over inflation.  By this measure today's rates should be 13-18% !!

But, let's not be so extreme: let's assume that inflation will ease back to "just" 5% and that Fed Funds should "only" be 250 basis points over that. This gives a reading of 7.50% for Fed Funds versus 2.50% today and expectations that it will go up to, say, 3.50%

What do you think?

What I think is this: there are very few of us dinosaurs left active in markets who remember and understand what high inflation really means for the economy and its ultimate impact in markets. Instead, we have millions of younger people who have never experienced a bear market and thus firmly believe that a bull market by rights a foregone conclusion and buy the dips, plus hundreds of thousands of meme chasers.

In sum, the social anthropology of markets is problematic: myopic, emotional,  uneducated in history. 

Unit Labor Costs Rising Fastest In 40 Years

 Unit labor costs are now rising at the fastest pace in 40 years, and are even outpacing headline inflation - see chart below.  This reading is caused by lower productivity (-4.6%) as well as higher wages (+5.7%) - a one-two punch that is really bad news for inflation prospects.

Once again: whoever thinks the Fed can afford to slow down its tightening is simply whistling past the graveyard.

The Fed’s Path Towards QT

 Warning to markets: things are about to get a lot tighter, money wise.  

The Fed has been tightening money supply very slowly for the last two months, but after August QT is set to double to $95 billion per month - see chart below.

These amounts have already been announced as official FOMC policy - I wonder how many non-professional investors have bothered to look (perhaps even some professionals?). Yes, these are caps, ie maximum QT amounts, but after yesterday’s very strong employment report I don’t see the Fed doing anything less until the economy takes a serious dive.

I believe the Fed, if anything, will err on the side of too tight, to make up for thinking inflation was “transitory”. The market, I am certain, is now expecting/hoping that the Fed will raise its foot off the brake. It is wrong.

More Recession Warnings

 America's economy is cooling fast.  The mighty American middle class consumer has apparently gone on a strike, shunning everything except going on vacation and dining out, the two activities he/she missed during pandemic closures.  Real retail sales (adjusted for inflation) are now flat or slightly negative, after whipsawing violently down/up in the pandemic - chart below.

Imports of everything from plasma TVs to t-shirts are languishing on store shelves and retailers are discounting heavily to move the merch.  Walmart, Target, Amazon, et al are issuing one sales/earnings warning after the other. 

Accordingly, container shipping rates are coming down fast, albeit from nosebleed levels - chart below.

Because the merchandise isn't selling, it has to sit in warehouses.  California's enormous Inland Empire warehouse area is now filled to the max, with vacancies at record lows - chart below.

Consumer sentiment is ambivalent - they feel that current conditions are ok, but their expectations for the future are quite grim, lowest in 10 years - chart below.

No question, consumers still have lots of money sloshing around and jobs are plentiful.  This explains the present situation reading and why the economy hasn't fallen off a cliff.  But, they also see prices for basic necessities soaring, which explains their views for the future.

And what is the Fed doing? Basically, net really very much.  Yes, they have raised short term rates to pre-pandemic levels, but they haven't  drained any money from the system, the one action that would truly make a difference in fighting inflation - see chart below.

 Fed Balance Sheet

PS I am really curious why Mr. Powell claims in Congressional testimony that the Fed has already taken steps to shrink its balance sheet.  It isn't showing in the data..

Geopolitics vs American Markets: A Fallacious Premium

Update: US Speaker Nancy Pelosi just landed in Taiwan, the first time such a high level official visited the island since 1997. China reacted strongly back then, but it was mostly hot air. I think it will be different this time.  In 1997 China’s GDP was 10% of America’s - today it approaches 80% and I think it will react accordingly. 

The US stockmarket has always been "optimistic".  It always managed to quickly discount geopolitical crises and move on to new highs.  For example, in the last 10 years S&P 500 is up 190% while Germany's DAX is up a mere 85% - see chart below.

The obvious reason has been the status of the US as the world's premier economy and undisputed geopolitical power. But, this is no longer the case as China and Russia are clearly nipping at America's heels. The fact that Pelosi's visit to Taiwan has to be kept a secret speaks volumes.

How long can US stockmarkets trade at a fallacious premium?  IMHO, until China decides to truly flex its muscle and challenge the US in a one-on-one confrontation. Pelosi's trip may very well be one such situation, there will certainly be more.  (Russia is already challenging the US/EU with impunity, sanctions are a joke).

The American general public has always been isolated from and indifferent to international affairs, taking their country's power for granted.  Sad to say, but my experience shows that the same holds with American financial professionals. 

I think a rude awakening is fast approaching and the premium will melt away.

PS There are more signs that America's pre-eminence is weakening: India is siding with Russia and China, Turkey's Erdogan is flouting US power, Saudi Arabia is going its own way.  This is not "normal", it's not business as usual.