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Are recession fears overstated?
By Simon White, Macro Strategist, Bloomberg
The market is now considering a recession as its base case. Secured Overnight Financing Rate (SOFR) options, which assume a hard landing to be likely and a Federal Funds Rate of 3% or below by next June, now see a downturn as having a 50% probability. However, that's too pessimistic a view based on the data, which show a low chance of recession over the next three to four months.
Recession risks amid payroll trends and Sahm Rule signals
By: Ashray Ohri, Senior Lead, Macro Research, Fidelity International
The US labour market has moved to the forefront of monetary policy decision-making after being on the dormant side of the debate for over a year. The triggering of the Sahm Rule has prompted market participants to price in recession risks and raised concerns that the labour market is nearing an inflection point, beyond which further weakening could lead to a compounding increase in unemployment. This could create a negative feedback loop of job losses, declining income and reduced spending that further accelerates job losses.
Our view is that we are not at that critical turning point yet. The rise in the unemployment rate and the triggering of the Sahm Rule can partly be attributed to an increase in labour supply, rather than an alarming slowdown in job demand or layoffs.
Accordingly, the chart above illustrates those potential tipping points by examining non-farm private payroll numbers 12 months before and after the start of the last 10 recessions, as identified by the National Bureau of Economic Research (NBER).
On average and/or at the median (orange and yellow lines in the top chart), non-farm private payrolls have typically turned negative at the start of a recession (0 = start of recession) and go on to deteriorate incrementally for another five months before hitting a floor (average peak decline is -195,000). Payrolls then start to recover, although they remain negative for at least 11 months after a recession starts. Clearly, we are not near these levels of contraction.
While these central tendencies may not be the most cautious signals, even the highest non-farm private payrolls at the onset of the last 10 recessions was 76,000 (in the Dec 1973 recession). This suggests that we are still more than 40,000 payrolls away from entering recessionary territory, with current private payrolls at 118,000 in August.
It is important to note that exceeding these thresholds will not necessarily confirm a recession, as circumstances this time may be different. Nevertheless, these serve as simple guideposts to bear in mind as we navigate this volatile cycle.
ECB’s path to easing
By James Bilson, Fixed Income Analyst, Schroders
Even after the recent rally, Eurozone policy rates are priced to go only fractionally below our estimate of neutral in Europe, which is around 2%. If we see growing signs of a weakening outlook in upcoming data, more accommodation will likely be needed from the European Central Bank (ECB) to support the economy.
Given that the ECB’s September 2024 inflation forecast has inflation reaching the 2% target only in 2026, further progress in reducing domestic price pressures will be needed for the central bank to speed up its cautious start to the easing cycle.
Semiconductor sales strong despite SOX slowdown
By Takayuki Miyajima, Senior Economist, Sony Financial Group
The SOX index is a leading indicator of global semiconductor sales. So does the recent decline in the SOX index signal a future slowdown in global semiconductor sales? At this point, I don’t see any significant change in the semiconductor cycle.
The chart compares the SOX index with year-over-year (YoY) growth in WSTS global semiconductor sales. While both the SOX index and YoY growth have slowed in recent months, growth remains strong. Hence, there is a large probability that WSTS global semiconductor sales will continue to maintain double-digit growth for the time being, and there is no reason to be concerned about the cycle peaking just yet.
Loosening financial conditions may delay rate cuts
By Diana Mousina, Deputy Chief Economist, AMP
The Goldman Sachs Financial conditions index is a measure of overall financial conditions using market-based indicators, with different weights across countries depending on the structure of their economies.
An index above 100 indicates that financial conditions are tighter than long-term “normal” for that country, while an index below 100 indicates conditions are looser than “normal.” In the current environment, despite significant tightening in monetary policy across major economies such as the US and Australia, financial conditions have not tightened considerably relative to historical levels. And more recently, conditions have loosened again, driven by lower market volatility, rate cuts priced in by financial markets, and better equity performance.
This recent loosening in financial conditions could argue against significant interest rate cuts from central banks in the near term. But bear in mind that while financial conditions indicators are a good gauge of market conditions, they are less of a guide to actual economic conditions.
Restaurant slump signals rising pressure on US consumer spending
By Enguerrand Artaz, Global allocation fund manager, La Financière de l'Echiquierv (LFDE)
Far from the post-Covid euphoria that saw leisure consumption soar, the US restaurant sector is now in the doldrums. According to the National Restaurant Association index, activity in the sector has fallen sharply since the start of the year. This illustrates a phenomenon seen in other survey data, namely a refocusing of consumer spending on the most essential items.
From a forward-looking point of view, it is interesting to note that restaurant activity has generally correlated with, and even slightly led, trends in retail sales. At a time when the job market is weakening, US household consumption seems to be under increasing pressure.
Bond prices remain below their historical averages
By: Kevin Headland and Macan Nia, Co-Chief Investment Strategists, Manulife Investment Management
Over the last month or so, there has been much debate concerning the Federal Reserve’s path for rate cuts. As the market started to price in the first rate cut and then the potential for more than 25 bps per meeting, yields across the Treasury curve fell, resulting in solid performance for fixed-income investors.
That raises the question of whether the window for bonds is now closed. We believe that’s not the case and that there are still attractive opportunities. The fixed-income market is deep and diverse, offering pockets of opportunity for astute active managers, not only from a yield perspective but also from a capital gains perspective. Despite some increases in price, many fixed income asset classes remain below their post-global financial crisis average.
History suggests more aggressive rate cuts ahead
By Jens Nærvig Pedersen, Director and Chief Analyst, FX & Rates Strategy, Danske Bank
The Fed decided to go big this week by starting its rate-cutting cycle with a 50bp cut. Now the market is left wondering what comes next. Will the Fed deliver more big rate cuts and how low will it go? The market expects over 100bp of cuts over the next four meetings, suggesting the possibility of further significant reductions.
At first glance, this may seem aggressive, but history tells another story. In half of the previous six cutting cycles, the Fed ended up cutting rates more than the market initially expected. In the other three instances, the Fed delivered cuts in line with expectations.
Yield has been a good predictor of future returns
By Niklas Nordenfelt, Head of High Yield, Invesco
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A notable feature of the high yield market is that longer-term total returns have closely aligned with the starting yield.
Chart 1 shows rolling 5-year and 10-year total returns alongside the starting yield at the beginning of each period since 2005.
While the fit is not perfect, Chart 2 shows a strong relationship over an even longer period. It plots the starting yield to worst (YTW) on the X-axis and the subsequent 5-year annualized return on the Y-axis, showing a correlation of 0.68 between the 5-year annualized return and the starting yields.
Always be prepared for a return of volatility
By George Vessey, Lead FX & Macro Strategist – UK | Market Insights, Convera
Currency volatility has been in the doldrums since most central banks paused monetary tightening in 2023. But this calm across markets contrasts with elevated macro and political uncertainty.
A big question is how long this low-volatility regime can persist. We’ve witnessed such extended periods of low volatility in GBP/USD only a handful of times over the past two decades, each followed by a shock that reignited volatility. One could argue that the longer the slump, the bigger the eventual jump...
Long-term corporate bonds set to outperform as Fed easing looms
By Brian Nick, Managing Director, Head of Portfolio Strategy, NewEdge Wealth
In light of the approaching Fed easing cycle and recent softening in macro data, I examined the changing relationship between stocks and bonds.
Investors have grown accustomed to viewing duration as a drag on their portfolios, but it's important to highlight that longer-term corporate bonds have significantly outperformed cash and cash-like instruments over the past year. Historical patterns during rate cuts and economic downturns suggest this outperformance is likely to continue.
Balancing act for Bank of England as markets race ahead
By: David Hooker, Senior Portfolio Manager, Insight Investment
With the easing cycle just beginning, the housing market is already starting to show signs of increased activity and firmer prices. Long-term yields have declined in anticipation of future rate cuts, dragging down mortgage rates and easing financial conditions. This underscores the complex challenge the Bank of England faces: preventing markets from running far ahead of what is likely to be a gradual decline in rates.
Against a backdrop of still elevated service inflation and high wage growth, don’t be surprised if the BoE maintains a hawkish tone in its statements as it attempts to temper market enthusiasm.
Chart packs
US financial conditions are easing
Despite the rate increases, US financial stress is easing again.
This chart shows a financial conditions index that we constructed at Macrobond. It applies a principal component analysis to several financial time series, including the policy rate, equity prices and volatility, the exchange rate and credit conditions.
The spike during the crisis of 2008 is obvious, as is the somewhat smaller shock during the early days of the pandemic. (The Federal Reserve’s monetary policy response was much more aggressive.)
The tightening that occurred throughout 2022 was a result of rising interest rates and falling asset prices. But the latter effect has now somewhat reversed, easing the tension.
Tracking the world of central banks and inverted yield curves
The following table shows different nations’ policy rates, their last interest-rate move and the number of months since the last hike or cut. (Japan is notable for not having tightened in more than a decade; this is likely to change as global inflation persists.)
We have also calculated the proportion of yield spreads that are inverted in each nation – a classic warning sign of recession. The US is currently experiencing the most inverted yield curve; all longer-term debt tracked in the chart (2-, 3-, 5-, 7- and 10-year durations) is yielding less than the 1-year government bond.
Markets are thus telling us that the Fed is likely going to cut rates. Most likely, this will coincide with an economic slowdown – or even a recession.
A soft landing from the Fed could mean a bright outlook for equities
Historically, stocks have reacted quite differently when the Fed ends a hiking cycle.
The following chart tracks the S&P 500’s performance before and after various interest rate peaks. The average increase is more than 12% over the subsequent year. Outliers include 1973 (era of the OPEC oil shock) and 1995 (Alan Greenspan’s “irrational exuberance” comment was made the next year).
We graphed the current cycle by assuming rates peak in May, as the markets predict. And those same markets are already pricing in a pivot to rate cuts next year. That suggests equities might actually do quite well, provided the Fed actually achieves a soft landing.
The Powell spread and yield curves
As the Fed chairman ponders how much to keep tightening, it’s worth examining his preferred recession indicator.
The following chart displays the “Powell spread” between the yield on a three-month Treasury bill and its implied yield in 18 months’ time. We have also overlaid the proportion of yield curves that aren’t inverted (along the lines of our central bank tracker, but using more durations); with more than 80% of the spreads inverted, that’s not good news.
The Powell spread has been one of the most accurate predictors of an economic downturn. Once a substantial share of the yield curve is inverted, a recession becomes much more likely.
France is generating less nuclear power than usual
France is Europe’s biggest producer of nuclear energy. In theory, that made it less exposed to the energy crisis than its neighbours when Russia cut gas shipments. However, many French reactors were shut down this year amid maintenance issues.
The following chart tracks French nuclear electricity output week-by-week in 2022, showing how it was well below the range of production from 2014 to 2021
In recent weeks, output has picked up in time for winter as plants under repair return online.
Reserve assets are melting in Asia
Asian countries continuously accumulated reserves before the pandemic; after the onset of Covid-19, they surged. As nations use reserves to defend their currencies against King Dollar, that trend is over now.
As our chart shows, it’s historically unusual for Asian reserves to decline so much. The Fed’s tightening cycle has led to rising interest rates around the globe, while most currencies have depreciated quite substantially against the dollar.
The Bank of England’s tough recession prediction
The Bank of England’s forecasts suggest the UK’s central bank might engineer a more prolonged recession than necessary.
The following chart shows the BOE’s forecast for nominal gross domestic product: the sum of real GDP and inflation. It suggests one of the longest recessions in UK history, with the economy contracting throughout 2023 and 2024.
The BOE sees inflation well below 2% in 2024 while real output declines, implying below 2% nominal growth. Such a low figure is associated with lower wages and falling asset prices – a tough economic prescription associated with lower wages, falling asset prices and debt deflation.
One is reminded of Japan’s “self-induced paralysis” of the 1990s, as Ben Bernanke put it.
Russian shipments of cheap oil to India and China are rising
As Western nations impose sanctions on Moscow and restrict oil purchases, India and China have been buying much more Russian crude.
It’s cheaper for those nations. The following charts show the change in purchases while demonstrating how the Urals oil price has been trading at a discount to the Brent crude benchmark.
Falling productivity is a recessionary sign
Our final recession indicator considers productivity.
The following chart uses the composite purchasing managers index (PMI) minus employment PMI as a proxy for productivity growth. We calculated it for the G3 economies, weighting the US, eurozone and Japan by their respective GDP series.
Our constructed measure shows a quite severe slowdown in productivity recently. It tracks OECD productivity figures quite closely as well.
Bitcoin and wine are anomalies in our eight year asset class scorecard
The following chart displays the annual performance of different asset classes from 2015 to 2022.
Several things stand out. First, Bitcoin returns have been “binary” over the last few years. For every calendar year in this time frame, it was either the best or worst asset class. The S&P 500 performs quite well most years, whereas emerging market equities and commodities, including gold and oil, are much more volatile.
Wine is another interesting case as it’s one of the few remaining assets measured in GBP. Returns in sterling terms have been decent, but in USD, your cellar would have lost money due to the greenback’s surge.
UK stands out as a weak market in commercial property scenarios
Real estate will be a key sector to watch in 2023 as interest rates rise. And in the office market, the long-term impact of the pandemic-driven shift to work from home is unknown.
The following chart compares commercial real estate values in different countries in 2021 with forecasts for 2023, courtesy of our newly extended partnership with Oxford Economics.
In any scenario, from a strong economic rebound to severe disruptions stemming from a renewed coronavirus outbreak to geopolitical conflict, the UK stands out as a weak market for commercial property.
US CPI inflation would be lower using market rental prices
Lagging indicators in economic data can lead to policy mistakes. With this in mind, it’s interesting that real-time residential rents differ from shelter costs used in the US consumer price index (CPI).
The following chart displays US core CPI, which uses the cost of shelter index calculated by the US Bureau of Labor Statistics (BLS), and a hypothetical alternative that uses market-based rents.
Core CPI would have been significantly higher last year using market-based rents, easily exceeding 10% throughout 2021. Now, however, the situation has completely reversed.
Consequently, the hypothetical core CPI would be close to the Fed’s 2% target. The actual core CPI series is still above 5%.
If you use the BLS numbers, the Fed should stay hawkish. But market rents are suggesting that tighter policy has already had a significant impact on at least one segment of the economy.
Recession risk is creeping higher with US industrial production in focus
The following chart tracks US industrial production against a backdrop of recession risk – based on a model estimated by the New York Fed using the yield curve, which historically has been a good indicator of future economic downturns. Darker shaded areas mean higher risk.
As one can see, we are currently edging toward higher recession risk; the US yield curve has been inverted for quite some time. The Energy Information Administration is forecasting a decline for industrial production by the start of next year.
There is a broad consensus that even if a recession is avoided in 2023, the US economy will slow significantly as a result of tighter monetary policy.
Stocks tend to follow a trend before and after inflation peaks
As one of our previous charts showed, high-inflation environments can hamper stock-market performance. Tighter monetary policy brought in to tame that inflation can have a knock-on effect on equities, as can looser policy once inflation eases.
The following chart displays the S&P 500’s performance 250 days before and after inflation touched a peak.
The market’s median performance is extremely strong after inflation peaks. But there are severe outliers – especially 1957 and 2008 – when equities suffered substantially.
Applying the Taylor Rule to Germany
The European Central Bank must set policy for the whole eurozone, but it has been arguably too loose for the continent’s largest economy.
John Taylor gave his name to an equation used as a rough guideline for the Federal Reserve’s response to inflation.
Typical formulations of his rule include the concept of a “natural” rate of interest. In the chart below, applying the Taylor Rule to Germany, we used two assumptions: In the first, we assume the natural rate r* = 2, and in the second we assume that r*=0.
Even the more dovish version would have called for tighter policy for Germany than what was actually in place from 2014 to 2020. This looseness likely contributed to the real estate boom the country experienced, even pre-pandemic, after decades of stagnating prices.
With inflation at a record high and the economy arguably running near its potential, the Taylor rule prescribes an interest rate of more than 5% for the German economy right now. The ECB’s policy rate is only 2%.
China Covid cases and retail sales
Unsurprisingly, Covid-19 outbreaks result in tough business conditions for retailers.
The following chart tracks retail trade figures and coronavirus cases in China. There is quite a tight correlation between the two due to China’s zero-Covid strategy, which has seen entire metropolitan areas locked down.
Cases are now rising rapidly as we move into winter, and we could have a repeat of the retail downturn we saw during the start of the summer.
European producer price inflation is mostly easing
Inflation – as measured by the price companies pay for their inputs – is easing in Europe. And this should pass through into consumer prices going forward. But the continent isn’t a monolith.
The following chart focuses on producer price index (PPI) readings across Europe, measuring how much they have fallen from their 2022 peak in percentage terms. This year was notable for soaring energy prices and global supply chain disruptions.
About half of Europe is seeing significant drawdowns, including Germany and Italy. France is the biggest economy to have experienced little relief by this metric.
When tech stocks tumble job cuts are around the corner
When the Nasdaq swoons, job cuts at tech firms are coming within the year.
That’s the pattern indicated by our chart. There is a high correlation between the US technology stock benchmark’s performance and job reduction in the tech sector (as measured by Challenger, Gray & Christmas) eight months later.
Massive job cuts at Meta, Twitter and Amazon have been in the news. But based on the continued downward trajectory of the Nasdaq, there may well be more pain to come.
The seeming permanence of the US twin deficit
The “twin deficit” is the sum of a country’s government budget deficit and its trade deficit.
As our chart shows, the US has been recording a twin deficit since the early 1970s, with the exception of a very brief period of budget surpluses in the 1990s.
Many economists argue that the twin deficit is related to the status of the US dollar as the global, primary reserve currency. The world craves US dollar assets, which is why the world’s biggest economy can borrow money relatively cheaply in international capital markets.
US homebuilding boom is likely to crash back to earth
It seems simple enough: when people are buying newly built homes, construction companies make more of them.
As our chart shows, this is usually a tight correlation, but due to the pandemic and its aftermath, we’ve seen a certain divergence over the past year.
Homebuilding surged throughout 2021 and early 2022 as the US economy recovered quickly. But the Federal Reserve’s rapid tightening cycle has resulted in mortgage rates that are now significantly higher than any time post-2008.
Consequently, the real estate sector seems to be turning quickly, and the number of houses sold has been plunging. It’s probably only a matter of time until that pain feeds through to new construction.
US equity returns as tracked by growth and inflation regimes
The following chart compares how stock markets (as measured by the S&P 500 in this case) perform in different macroeconomic environments going back to 1970.
We split the data using the 33rd and 66th percentiles to delineate whether inflation or growth in a given time period was high, “normal” or low. That results in nine different inflation/growth regimes.
Unsurprisingly, equity returns have historically been highest in a high growth-low inflation environment. Equally unsurprisingly, low growth and high inflation is bad news.
Korean electronic part shipments and the Nasdaq tend to move in lockstep
South Korean and Taiwanese exports are often considered leading indicators for global trade.
For this chart, we chose a more narrow focus -- South Korean electronic component shipments –and tracked the year-on year change against 12-month returns for the Nasdaq.
As the chart illustrates, there is a strong correlation between the two variables. The recent slump in shipments, a drop of about 18% year-on-year, was accompanied by a tumbling Nasdaq index.
German producer inflation should ease as supply chain stress recedes
Germany’s producer price index (PPI) went ballistic over the last year. Input cost increases for German companies topped 40% as the global commodity price shock combined with interruptions to supply chains.
The following chart shows the tight correlation between this measure of inflation and the New York Fed’s global supply chain pressure index (which has been pushed forward by 9 months).
As supply chain pressures eased in the second half of this year, German PPI is finally reversing and bound to come down further.
Advanced economies have almost matched emerging market inflation rates
For the first time in many decades, inflation across emerging markets is not significantly higher than it is in advanced economies.
In the following chart, we track not only inflation rates but their volatility, showing the 12-month range of inflation for each country.
Among advanced economies, the UK ‘s large increase stands out. Among the emerging markets, inflation is extremely pronounced in Russia – an obvious consequence of the war in Ukraine and the Western sanctions that resulted.
Chinese moviegoers are staying home again amid Covid concerns
If China relaxes its Covid zero strategy, cinema owners will be among those businesses sighing with relief. They experienced a false dawn earlier this year.
The following chart examines Chinese moviegoing over the course of different years, as expressed by the daily box-office return smoothed as a 1-week moving average. It compares the average trend in the 2017-2019 period, the peak pandemic years of 2021-22, and the current year.
Box office revenue has been significantly lower over the past 100 days than at any time during the past two years. That compares to the spike at the start of 2022, when revenue soared past the pre-pandemic mean. Film-hungry audiences took advantage of a lull in coronavirus cases that coincided with the consumption-boosting Chinese New Year.
Our recent Covid monitor chart detailed outbreaks by region. Moviegoers are an important gauge of consumer activity, given box office figures are a contributor to domestic retail consumption figures.
California is almost richer than Germany
California’s population is only half that of Germany, but as measured by gross domestic product, the home of Silicon Valley has almost surpassed Europe’s biggest economy.
The following chart shows that shrinking GDP gap, as expressed in dollars. (Obviously, the very strong greenback helps America’s most populous state in this comparison.)
While the tech sector is retrenching after a great expansion, this chart reflects the enormous amount of wealth and productivity it has brought to the West Coast. Compared to other advanced economies, the Golden State truly stands out and could easily overtake Germany in the years to come.
Cryptocurrencies look like other bubbles deflated by the Fed
Cryptocurrencies are suffering across the board after the FTX debacle. As the Federal Reserve and other central banks tighten monetary policy, the sector resembles other deflated asset classes.
Bitcoin is now well below USD 20,000, down from more than USD 60,000 about a year ago. As our table shows, most other cryptocurrencies have seen similar drawdowns. Total crypto market value is now well below USD 1 trillion, less than half its level a year earlier.
FTX and the echoes of Lehman and Enron
The crypto world has seen a high-profile collapse that will enter the history books with other financial downfalls. The following chart plots the price of the FTX token versus shares of Lehman Brothers and Enron, tracking their glory days and subsequent collapse.
As the FTX story unfolds, the bankrupt crypto exchange resembles Enron more than it does Lehman. Indeed, FTX’s new CEO, lawyer John Ray, led Enron through the energy trader’s own bankruptcy almost two decades ago. Enron, like FTX, had weak internal controls; FTX has been accused of fraud in Bahamian court filings.
Lehman, by contrast, was brought down by falling asset prices and investors withdrawing funds, a dynamic similar to a bank run.
Fewer and fewer up days for stocks
The past 12 months have seen more red than green for the key US stock benchmark.
The following chart plots the number of positive trading days that the S&P 500 had over the previous year. The current bear market has pushed that figure to a two-decade trough, much lower than any moment during the 2008-09 global financial crisis.
Somewhat surprisingly, a period in 2015-16, the Fed’s first tightening cycle since the GFC, also stands out as an era that saw more down days than up for equities.
The Bull versus Bear spread correlates with equity performance
This has been a punishing bear market, but at least one indicator suggests it might be over soon.
The following chart plots the American Association of Individual Investors (AAII) Bull-Bear spread – based on a survey of whether respondents feel optimistic or pessimistic about equities – versus a smoothed series for the number of stocks in the S&P 500 that are above their 12-month moving average. (A negative number means more people are bearish.)
The two series are tightly correlated, with the sentiment series tending to lead by more than a year. Our analysis shows the highest correlation is at 0.55, with the AAII series leading by about 15 days. The Bull-Bear spread can thus be used as a leading indicator. After touching a record low in 2022, the spread has returned to more neutral territory, potentially indicating the bear market may be running its course.
Equity market trends historically reflect the presidential cycle
The stock market tends to underperform prior to midterm elections and usually rallies in the aftermath.
The following chart graphs the performance of the S&P 500 during President Biden’s current term against the historic trend for four-year presidential terms after World War II.
We shall see whether this cycle follows a similar pattern.
Democrats and Republicans preside equally over economic misery
The “misery index” was initially created by economist Arthur Okun as a simple sum of the inflation and unemployment rates. (Subsequent variations have put a greater weighting on unemployment and included different variables.)
The following chart tracks Okun’s original misery index alongside the party occupying the US presidency at the time. Republican terms have been slightly more “miserable” than Democratic presidencies, but the difference is marginal and probably not statistically significant.
The 1970s stagflation is prominent on this chart, as is the massive increase during the pandemic. That reflects the impact of the inflation spike during a time of historically low unemployment.
Emerging market growth and the outlook for equity outperformance
Emerging-market stocks have the potential to start outperforming their developed-market peers again.
The following chart uses IMF data to calculate when emerging markets are posting quicker economic growth than developed markets. Unsurprisingly, that differential is correlated with outsized equity performance (after a time lag of almost three years) – as measured by the ratio between price returns for MSCI’s emerging market and global equity benchmarks.
Emerging markets did particularly well from the mid-2000s after developed economies stagnated due to the financial crisis.
IMF forecasts project EM economic growth is expected to stabilize at a level somewhat above that of developed markets. That could indicate a rebound for that stock ratio, which is trailing its usual performance.
Chinese coronavirus cases flare up again
Speculation is rampant that China might soon revise its zero-Covid strategy, which has seen rolling lockdowns of large cities at a substantial economic cost.
The following chart shows how Covid cases are on the rise in the nation’s major provinces again. A more fine-tuned zero-Covid strategy might influence the economic outcome that results.
Chinese PPI is not passing through to CPI
When it comes to inflation in China, consumer prices aren’t reflecting the pressure that producers are experiencing from input costs.
The following chart displays China’s CPI and PPI inflation rates, followed by the correlation between the two indices. Throughout 2022, PPI surged to a record high, reflecting the global increase in commodity prices. But CPI inflation remained moderate, probably as result of the country’s domestically driven economic slowdown.
As the pass-through from producer prices to consumer prices did not occur, the correlation between the two series turned negative during the pandemic.
Global current account imbalances feel like 2008 again
Current account imbalances are on the rise, renewing interest in one of the hottest topics in macroeconomics.
Economists like Maurice Obstfeld and Kenneth Rogoff argue that rising imbalances were a major factor in the crisis of 2008. More specifically, the global role of the dollar as the reserve currency inflated the value of US assets as capital from Asia and oil-exporting nations flowed in.
There was only a short period of normalization post-2008. The imbalances resumed their rise, especially during the first year of the pandemic.
As our chart shows, the US continues to be the main current-account deficit country; the rest of the world records surpluses. This doesn’t reflect any particular US trade weakness. As Ben Bernanke explained, the trade deficit is the tail of the dog, adjusting to a variety of variables: interest rates, the currency exchange rate, global financial flows, etc.
Ultimately, the rest of the world still craves US dollar assets and exports capital to the US economy.
German consumers are more pessimistic than businesses
German consumer confidence is even lower than it was during the depths of the pandemic. Inflation at 10 percent and the likelihood of recession are probably the factors to blame.
The following chart plots the progression of measures of consumer and business confidence in Europe’s largest economy, with the pre-pandemic business cycle in blue and everything since in green.
Business confidence is also very low – but it has yet to plunge past the troughs of the global financial crisis and the spring 2020 Covid-19 shock.
Slowing momentum for Japanese industry
Japan is one of the world’s leading exporters, so when its industrial companies lose momentum, that’s a signal that the global economy is slowing.
The following chart displays Japanese industrial production as measured by its yearly and monthly growth rates. Compared to a year earlier, Japan’s industrial production is up more than 9 percent. But the month-on-month growth rate is now slightly negative.
Cash is king for more stock investors
Investors’ desire to hold cash increases sharply during times of economic stress and falling asset prices. This is one of those times, and it’s probably a bearish signal for the business cycle.
The following chart tracks equity drawdowns by the S&P 500 over the years as well as the average percentage of individual portfolios held in cash, based on a survey by the American Association of Individual Investors. Periods where the US was officially in recession are highlighted in gray. (In 2022, we’re not there yet.)
Cash balances are at spring 2020 levels, the survey shows.
Tracking German export dependency on the Chinese market
China is a key market for other exporting nations, especially Germany. The following chart tracks the relative importance of exports to China for Germany, the rest of the EU and the United States.
US exposure to China is modest here: exports account for about 0.7 percent of GDP. For the EU excluding Germany, that figure is roughly twice as high: almost 1.5 percent.
Germany has by far the greatest dependence, with exports to China accounting for about 2.7 percent of GDP.
Chancellor Olaf Scholz said he doesn’t want to decouple Germany from China as he visited the world’s no. 2 economy earlier this month – a trip that was controversial domestically and internationally.
A dramatic shift in the trade balance for China and Germany
Sometimes, international trade data doesn’t add up. According to Chinese data (which we have chosen to use for the following chart), the country recently snapped a negative trade balance with Germany that lasted for nearly a decade.
The German data contradicts this to some extent. (This article explains the discrepancies in detail; measurement error is sometimes to blame, as is whether cost, insurance and freight are included in the figures.)
However, regardless of which nation’s statistics are used, recent data shows a dramatic shift. While Chinese exports are still going strong, imports from Germany have recently declined. The most obvious explanation is that the economic slowdown in China is weighing heavily on domestic consumption.
Commodity prices are stabilising as a volatile 2022 winds down
The S&P GSCI is a benchmark tracking a basket of 24 different commodities.
As our chart shows, that basket is now evenly split: half of the commodities posted a positive monthly return for October, and half were in negative territory. The green line tracks that percentage. At different points this year, almost all the commodities in the basket were rising or falling in tandem.
The GSCI index’s monthly return (in blue) has been edging back into positive territory.
A breakdown of commodities shows fuel and coffee getting cheaper
The following chart shows the monthly return for commodities by category.
Fuel prices are declining again. And while several food-related commodities are more expensive, there is good news for coffee drinkers: after surging earlier this year, prices are coming down.
Plunging US oil inventories and surging production
The stock of petroleum in the US has plunged by an unprecedented amount this year, as our chart shows.
It’s now at the lowest level since the late 1980s. Part of the decline can be attributed to the government’s decision to release part of the strategic petroleum reserve to curb domestic fuel inflation.
Meanwhile, US crude oil production is exceeding 12 million barrels per day once again -- which should alleviate price pressures, at least on the margin.
Lacklustre US labour productivity
The Bureau of Labor Statistics recently released productivity estimates for the US economy. Unfortunately, they are anything but stellar.
The chart below graphs productivity for the years following the start of several US recessions. The current situation, as graphed by the thicker line, is not following those past trends.
During the Covid-19 shock, labour productivity initially surged rapidly, potentially due to the rise of remote work. However, for more than a year now, productivity has stagnated – and even declined.
It’s not clear whether this is a fluke or a real trend. One plausible theory focuses on the very high number of job-switchers. The pandemic led to some significant shifts between industries, and a record number of US workers resigned from their jobs in 2021/2022.
A domestic tourism boom in Japan
Until quite recently, international travel to Japan was completely restricted due to the pandemic. So far, only a trickle of travelers are taking advantage of Japan’s reopened borders.
However, hotel accommodation is surprisingly healthy given the lack of foreign visitors. As the first chart shows, occupancy has recovered quickly, and is close to its pre-pandemic average.
Domestic travelers are reportedly spending almost twice as much as they did last year. The significant depreciation of the yen might also be having an effect; by increasing the price of foreign travel, it makes “staycations” within Japan’s borders more attractive.
Emissions grow unevenly over the business cycle
Economic growth has lifted living standards for billions of people. But that growth has coincided with rapid expansion in carbon emissions, at least during the early stages of industrialisation and economic development.
Conversely, one of the few silver linings of economic contractions is slower growth in emissions.
The following chart tracks global business cycles going back to the 1850s and graphs their estimated CO2 emissions. During a typical expansion (which lasts an average of 3.5 years in this period), emissions increased more than 12%. During a typical recession (about 1.5 years long on average since 1854), emissions increased by about 2.3% -- a much slower pace even when adjusted for the shorter time frame.
Per capita emissions show which nations are using cleaner energy
The following chart tracks energy use and emissions per capita for major economies over recent decades.
The US and the EU both saw an increase in per capita energy use and emissions until the 1990s, but since then, both economies have reduced per capita emissions steadily through a transition to cleaner energy. (The US has always emitted far more per capita than the Europeans, but both have made relative progress on that front: current per capita emissions are about half their peak.) Meanwhile, per capita energy use has slipped, but not as dramatically.
Russia’s emissions and energy use (and economy) collapsed after the fall of the Soviet Union. Both have recently picked up again.
China has been on a completely different trajectory, with energy use and emissions per capita rising steadily as the country industrialises.
Fed funds futures suggest pivot talk is premature
The Federal Reserve just raised its key interest rate by 75 basis points to a 14-year high of 4 percent. Is it still too early to talk about a “Fed pivot” to a more dovish stance?
Recent labour market data shows the economy is still going strong: unemployment is at a record low, and job vacancies are at a record high. Moreover, third-quarter growth surpassed expectations, with gross domestic product rising 2.6 percent, showing that the recession scare earlier this year was just that.
While the housing market has started to cool significantly, this has yet to materially affect the larger economy. That’s why it’s probably too early to talk of a Fed pivot, and futures are telling us as much. Traders are effectively betting that rates will peak above 5 percent next spring, as our table shows.
The Powell spread is almost negative
One of the key charts to watch when looking for a potential Fed pivot might be Chairman Jerome Powell’s preferred gauge of the bond market: the spread between the three-month Treasury yield and the expected yield on those bills in 18 months’ time.
As our graph shows, this “Powell spread” has decreased significantly as the Fed hiked aggressively. It’s now very close to inverting. And yield curve inversions are a classic harbinger of recessions.
US stock benchmark dragged down by tech pain
The chart below tracks the S&P 500’s 20 percent slide this year and breaks it down by sector. Almost every industry group has experienced negative returns -- with energy being the notable exception.
Big Tech shares have been crushed in recent weeks, and the US benchmark’s information technology sector reflects that. It has by far the biggest weighting in the S&P 500: close to 30 percent.
Consumer discretionary and communications stocks, two sectors with weightings above 10 percent in the benchmark, have also contributed quite substantially to the recent equity market drawdown.
Unemployment is oddly low for a bear market
One of the more peculiar macro correlations is the one between US equity markets and the nation’s labour market.
Historically, large declines in asset prices are correlated with a higher unemployment rate. (This is precisely why the economist Roger Farmer has advocated that central banks should directly target asset prices to manage economic fluctuations and unemployment.)
However, while equity prices have plunged this year, unemployment has continued to fall. The current situation is an extreme outlier, as the following chart shows: the biggest equity drawdown that has ever occurred with joblessness below 4 percent.
Macro hedge funds win and fixed income funds suffer
This is an update of a chart that we posted recently, tracking the performance of various hedge fund strategies versus the S&P 500. That broad equity benchmark is now doing worse than all strategies.
One of the interesting things about the current environment is how macro-driven it is: after a series of large macroeconomic shocks, central banks are the most important actors as they rapidly tighten rates to combat inflation.
Macro funds have navigated this tricky environment the best so far, posting positive returns of several percentage points.
Unsurprisingly, fixed income hedge funds have suffered. They’re down more than 10 percent year-to-date after rate hikes slaughtered global bond markets.
Chinese pork prices are rising again
China is the world’s biggest consumer of pork, and it’s heavily weighted in the national consumer price index. The nation even has a strategic frozen pork reserve to shield farmers and consumers from price swings.
As our chart shows, pork prices have surged more than 50 percent this year, with reports citing the high cost of feed and the impact of reduced breeding stocks a year ago, when prices were falling. Authorities are releasing stocks from the pork reserve to stabilise prices.
In recent years, only 2019 saw a steeper increase. Prices more than doubled that year after an outbreak of African swine fever.
EU carbon trading shows it will get more expensive to pollute
The following chart displays forward prices for the right to emit CO2 in the European Union, with the positions on the X axis reflecting the number of months out from the present moment.
While the curve for the near future is relatively flat, emission prices more than a year from now are approaching EUR 100 per metric ton. The entire pricing curve is three times as expensive as it was three years ago, though it has been mostly stable over the past year.
These rising expenses are bad news for polluters but definitely good news for the climate.
Shipping rates are plunging back to normal
The explosion in shipping costs is over, and the next graph shows just how unusual 2021-22 was.
Due to a combination of strong demand and supply-chain disruptions, shipping rates through much of 2022 were five to eight times higher (and sometimes more) than their pre-pandemic norm. That unprecedented surge was a big contributor to the global spike in inflation.
In recent months, shipping rates have been normalising rapidly as global trade stagnates. As our second chart shows, world container trade is slightly lower than a year ago as the world’s central banks tighten monetary policy.
