Memory Lane
Doug Nolan
September 14 – Financial Times (Martin Arnold and Mary McDougall):
“The European Central Bank has raised interest rates to an all-time high in a bid to cool consumer prices…
The ECB’s knife-edge decision to lift its deposit rate for the 10th consecutive time, by 25 bps to 4%, came as officials cut their growth forecasts for the eurozone economy.
The euro fell to a three-month low against the dollar…
The ECB hinted that eurozone borrowing costs had peaked.
It said that Thursday’s move meant ‘interest rates have reached levels that, maintained for a sufficiently long duration will make a substantial contribution to the timely return of inflation at the [2%] target.’”
Post meeting, markets see a 34% probability of one additional ECB rate hike – 21% for the October 26th meeting and 13% for the meeting on December 14th.
This compares to pre-meeting 18% for October and 23% for December.
Markets dismiss Christine Lagarde’s “we can’t say that now - that we are at peak,” but are all ears for dovish commentary.
ECB Vice President Luis de Guindos:
“We believe that with the latest increase in the level of interest rates, if kept there for some time, may be enough for inflation to converge to the 2% target.”
Estonian central bank Governor Madis Muller: “To the best of our knowledge, no further interest-rate hikes are expected in the coming months.”
The hawks pushed back in a Friday FT article:
“‘I don’t agree that we are definitely done,’ said one of the [hawkish] policymakers.
‘We would need a very negative surprise [on inflation] to hike again in October, but we might in December.’
Another one said a quarter-point rise in December was ‘still possible — I’m not ruling it out’.”
With the ECB downgrading economic forecasts and generally adopting a more dovish posture, bond market reaction must be concerning.
Italian 10-year yields jumped 11 bps this week to 4.46%, closing Friday at the highest yield since (pre-SVB) March 7th.
Greek yields rose 12 bps to a two-month high 4.07%.
Spanish 10-year yields rose 10 bps, closing the week less than two bps from a near decade-high.
Economies throughout Europe have weakened meaningfully of late.
That bond yields continue their rise supports the New Paradigm thesis.
Eurozone CPI (y-o-y) has been sticky, with August’s 5.3% rate unchanged m-o-m.
Headline U.S. CPI rose 0.6% in August, the strongest one-month gain since June 2022.
At 3.7%, y-o-y inflation was the highest since May.
“Core” inflation rose a stronger-than-expected 0.3% for the month (strongest since May), with y-o-y “core” at 4.3%.
August inflation data offered something for doves and hawks alike.
Most analysts focus on what they view as encouraging underlying trends.
I see “sticky.”
“Auto Insurance Year-Over-Year Surge Highest Since 1976.”
“UAW Workers Launch Unprecedented Strike Against All Big Three Automakers.”
“Gasoline Prices Soar to US Seasonal Record on Crude’s Rally.”
September 15 – Reuters (Joseph White and David Shepardson):
“The United Auto Workers union launched simultaneous strikes at three factories owned by General Motors, Ford Motor and Chrysler parent Stellantis NV on Friday, kicking off the most ambitious U.S. industrial labor action in decades.
The walkouts at the Detroit Three will halt production of the Ford Bronco, Jeep Wrangler and Chevrolet Colorado pickup truck, along with other popular models, though the action was smaller than some expected.
‘For the first time in our history we will strike all three of the Big Three,’ UAW President Shawn Fain said, adding that the union will hold off more costly company-wide strikes for now, but all options are open if new contracts are not agreed.”
The WSJ went with, “China May Dodge Deflation, After All.”
Reuters: “China’s Deflation Pressures Ease…”
And Bloomberg: “China’s Consumer Prices Creep Out of Deflation in August.”
At 0.1% y-o-y, China’s consumer inflation data paint a picture of phenomenal price stability.
August Credit data not so much.
The first rule of sound inflation analysis is to diligently study Credit data.
Aggregate Financing (China’s metric of system Credit growth) expanded a stronger-than-expected $428 billion during August, rising strongly from July’s dismal (first month of the quarter) $73 billion.
Growth was also 26% above August 2022.
At $3.457 TN, year-to-date Aggregate Financing growth was 3.8% ahead of comparable 2022 and 15.2% higher than 2021 – while rising $4.519 TN, or 9.6%, over the past year to a record $50.56 TN.
Stronger-than-expected bank lending bolstered credit growth.
Bank Loans gained $186 billion, up from July’s $48 billion and the year ago $172 billion.
This pushed y-t-d growth to $2.510 TN, 17.3% ahead of comparable 2022.
Bank Loans expanded 11.5% over the past year, 23.7% over two years, 38.7% over three, and 76.1% over five years.
Consumer (chiefly mortgages) Loans expanded $54 billion, a reversal from July’s $28 billion contraction, but below August 2022’s $63 billion.
Consumer Loans expanded 6.6% y-o-y, the weakest growth in data back to 2009.
Still, Consumer Loans grew 30% over three years and 73% over five.
There’s some action in business lending.
Corporate Loans expanded $130 billion in August, with y-t-d lending of $1.929 TN running 11.6% ahead of comparable 2022.
Corporate Loans were up $2.540 TN, or 13.9%, over the past year, with two-year growth of 28.5%, three-year 43.1%, and five-year growth of 78.4%.
Government Bonds increased $160 billion (versus July’s $56bn and last August’s $41bn), with y-t-d growth of $680 billion.
Government Bonds expanded $923 billion, or 11.5%, over the past year, with two-year growth of 31.2%, three-year 49.9%, and five-year 77.9%.
The M2 monetary aggregate expanded $209 billion last month, bouncing back strongly from July’s $261 billion contraction.
At $2.812 TN, y-t-d M2 growth has been running 3.4% ahead of comparable 2022.
M2 was up $3.762 TN, or 10.6%, over the past year to a record $39.359 TN.
M2 inflated 24.1% over the past two years, 34.3% over three, and 60.4% over five years.
It’s also worth noting that China’s Bank Assets expanded $1.234 TN during Q2 (to $55.727 TN), putting first-half growth at $3.685 TN, or 14.2% annualized.
Bank Assets expanded $5.291 TN, or 10.5%, over the past year, with two-year growth of 20.9%, three of 31.3%, five of 56.1%, and 10-year growth of 181.6%.
China today offers a rather weird case of “deflation.”
It’s clearly not Credit deflation, with Bank Assets and system Credit still expanding at double-digit rates.
But system stability is certainly at risk from apartment Bubble deflation.
For the most part, there were positive headlines out of China this week.
More aggressive stimulus is supposedly beginning to pay dividends.
“China August Industrial Output, Retail Sales Growth Beat Expectations.”
“China’s Economy Shows Signs of Stabilizing…”
“Recovery Set to Gain Further Momentum.”
“Economic Recovery Reaches Turning Point.”
Beyond the headlines, stronger Credit and M2 data support the recovery thesis.
Beijing controls the necessary levers to achieve its 5% 2023 GDP growth target.
The central government will borrow and spend, the PBOC will print, and, most importantly, its massive state-directed banking system will lend Trillions.
And stimulus has been ramped up over recent weeks.
This week’s bump in industrial production and retail sales should come as no surprise.
But the jury is out on two elemental determinants of a sustainable recovery: housing and China’s currency.
In both cases, Beijing is expending tremendous resources with ominously meager results.
Over the years, markets have become conditioned to dismiss China risks.
After all, the central government controls the strings to a big, thick purse.
A $3.16 TN international reserve position (down from 2014 peak $4.0 TN) provides Beijing enormous firepower to bolster its currency and thwart the type of “hot money” exodus and currency crises that have been fixtures of EM Bubble collapses for three decades.
Tight control over the central bank ensures massive fiscal stimulus as required.
And, of course, a colossal state-directed banking system creates the potential for unprecedented ($10 TN?) targeted lending.
But Beijing is not today in control of China’s deflating apartment Bubble.
September 11 – Reuters (Liangping Gao, Ziyi Tang and Marius Zaharia):
“New home sales in Beijing jumped last week, keeping property showrooms open late into the night to meet demand, in a sign government efforts to revive the sector are yielding some results in the Chinese capital if not elsewhere in the country.
A survey by real estate research firm China Index Academy showed on Monday new homes transactions in Beijing rose 16.9% by area sold in the week of Sept. 4-10 from the previous week even as they fell 20% on average across the country.”
The above article ran under the positive headline, “China’s Easing of Property Market Curbs Gives Beijing Home Sales a Boost.”
It included a bleak zinger:
“Another report, by Haitong Securities, showed sales by area in China’s four largest cities were still down 45% in the first week of September from the same period last year.”
Still down 45% in the first week of September” compared to weak year ago sales – despite lower mortgage rates and down payment requirements, along with a laundry list of stimulus measures?
And the major housing markets are apparently holding up much better than the lower-tier cities.
At this point, it appears confidence and speculative zeal have been irreparably damaged.
I would now expect accelerating apartment price deflation to spur millions of unoccupied units to the market, raising the specter of panic selling.
With unsold apartment inventory surging, investment demand is disappearing.
This Bubble collapse has all the makings of a debacle.
It was a big week.
The U.S. CPI report and an ECB rate increase, along with a $4 TN quarterly option expiration.
But the most market-impacting global development garnered little attention outside currency circles.
“We will not hesitate on taking actions when necessary to firmly correct the one-sided and pro-cyclical market moves, to resolutely address the actions which disturb market order, and to unswervingly avoid the overshooting risks in the exchange rate.
Financial regulators have the ability, confidence and conditions to keep the yuan’s exchange rate basically stable.”
Bloomberg ran two headlines:
“PBOC: Says Resolutely Put an End to Speculation in FX Market” and “PBOC: Resolutely Prevent ‘Over-adjustment’ Risk in FX Market.”
My take on Monday’s People’s Bank of China statement: For starters, it confirmed the seriousness of the previous week’s heightened currency market instability.
Markets interpreted the PBOC’s strong language as Beijing establishing a currency red line that it was prepared to vigorously defend.
Not coincidently, Bank of Japan Governor Kazuo Ueda over the weekend was quoted as saying the BOJ will likely have enough information by year-end to judge if wages will continue to rise – code words for signaling a possible move to policy normalization in a few months.
The Japanese yen (and offshore renminbi) rallied 0.85% versus the dollar Monday, with China’s renminbi gaining 0.75%.
These moves triggered a general dollar reversal and an immediate easing of global “risk off” dynamics.
For the week, the Mexican peso rallied 3.0%, the Colombian peso 2.5%, the Brazilian real 2.5%, the Chilean peso 1.3%, and the Russian ruble 1.3%.
Major stock indices gained 3% in Brazil, 2.8% in Japan, 2.3% in Chile, 2.1% in Taiwan and South Korea, and 1.9% in India.
Stocks were up 2.3% in Italy, 2.0% in Spain, 1.9% in France, 1.7% in Australia, and 1.0% in Germany.
Global risk indicators, including Credit spreads and CDS prices, leaned risk embracement.
The backdrop, however, did no favors for vulnerable bond markets.
While markets assume Beijing (and to a lesser extent Tokyo) will for now guarantee that a disorderly Chinese currency doesn’t spark global de-risking/deleveraging, that it was even forced to issue such a statement signals an important new phase in Crisis Dynamics.
Beijing is now throwing everything at currency support (see “Currency Watch”).
It’s burning through international reserves, while the Chinese banking system is surely accumulating huge dollar short positions in cash and derivatives markets.
This ensures that if panicky markets cross Beijing’s red line and things turn disorderly, instability could quickly spiral out of control.
How fitting that Friday marked the 15-year anniversary of something that simply couldn’t ever happen actually happening: The spectacular Lehman Brothers collapse.
And while we’re traversing down Memory Lane, the 25-year anniversary of the Long-Term Capital Management implosion is about a week away.
That time of the year.
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