We are getting to the point where the debt is so high we won’t be able to service it. If we use the CBO’s 3.80% interest cost estimate on our debt, which we believe is optimistic, by 2027, the interest expense alone on the government debt eats all health care spending. By 2047, it eats all discretionary spending, and by 2049 it eats all Social Security spending. The interest costs on the debt are so high that they cripple our ability to service the next generation, and we are not even sure about the ability to support the current generation.

 

The US Dollar

 

The US dollar has become what Louis Gave calls a “wrecking ball” to the global economy. Momentum will eventually bring it back in our direction. One final note on the UK. The long-term policy of Truss’s that would make a huge difference? If the UK actually becomes energy independent and once again an exporter. That is possible, given their reserves. Now that would be an economic game changer and create much-needed high-paying jobs. We will see. “Every Choice Is Bad” The pound sterling’s meltdown isn’t happening in a vacuum. The Japanese yen also deteriorated in recent weeks for similar reasons, though Japan has its own issues too. The dollar’s sharp rise is affecting everything this year.

 

 

Worse, this is a problem no one can easily solve. It’s not an unintended consequence of someone’s policy. It’s the post-WW2 global monetary system doing exactly what it evolved to do.

With the Fed on a path to get us to a 5% fed funds rate (my “prediction”), the other central banks need to recognize this. Powell is not responsible for fixing the chaos that passes for monetary policy in Europe. The value of the euro or the pound is not his remit. (As an aside, technically the value of the dollar is the Treasury’s responsibility. Treasury Secretary John Connally quipped to French authorities who complained about Nixon shutting the gold window, “The dollar is our currency, but it’s your problem.”)

 

Source: chartr

 

A significant number of people believe the Fed should stop raising rates because the rest of the world is having problems. Really? First off, the Fed is not responsible for Europe, Japan, or emerging markets. Its mandates are US price stability and US employment. There has long been speculation about which mandate is more important. At least for the time being, it seems that inflation trumps employment.

Other major central banks have been raising rates too, though less aggressively than the Fed. This partially explains the currency differential. There are multiple reasons for currency rate fluctuation but interest rates are quite important. Complaining the dollar is too strong while holding your own rates below 2% makes little sense.

Just for the record, the BOE’s policy rate is still at 2.25%, the ECB is 0.75%, China is at 3.65%, and Japan is still at negative rates of (minus) -0.1%. Christine Lagarde is telegraphing another 0.75%, which Germany has basically signed off on as inflation is 10% there as it is in much of Europe. Again, just for the record, I recognize that Europe and the United Kingdom have far worse problems with inflation and their economies than the US.

The dollar’s problems will come home, too. They are simply taking time to develop. GMO’s Ben Inker has a fascinating study of currency valuations vs. equity market changes. He goes through a lot of detail but basically, undervalued currencies help local stocks while overvalued currencies hurt. And guess whose currency is most overvalued? Ben adds, “Today’s strong USD looks, in the end, to be our currency and our problem.”

 

Yield Curve

 

Here’s what the yield curve across the spectrum of U.S. Treasurys looked like back [in January]. It’s considered “normal” – meaning the longer-maturity end of the curve offers higher yields.

 

 

Here’s what the same data looks like now.

Today, the rates on these short-term U.S. Treasurys are higher than longer-term bonds. That’s where the term “inverted” yield curve comes from. Take a look…

 

 

As you can see, the six-month U.S. Treasury bill’s yield now exceeds the 30-year U.S. Treasury bond’s yield. That’s nuts!

 

Wealth to GDP

 

Over long periods household wealth is remarkably stable relative to GDP. Yet it rose considerably higher since the mid-1990s and particularly since 2020. Niels Jensen explains how this imblance developed and how it may end.

Key Points:

  • Math says wealth can’t grow faster than GDP in the long run, yet it has been doing so. This suggests a reversion to the mean lies ahead.
  • Either US household wealth will have to drop some 30%, or GDP will have to rise while wealth stays flat, or some combination of the two.
  • Ominously, real estate currently accounts for almost 40% of total wealth in the US.
  • The wealth-to-GDP ratio is a measure of capital efficiency, i.e. how much capital is needed to generate each dollar of output.
  • This indicates US capital isn’t working as efficiently as in the past.
  • Europe faces a similar situation but less extreme than in the US.

The most interesting part of this data is how much of the rising “wealth” comes from the assumed value of illiquid assets like real estate and small businesses. No one really knows what it is worth until they try to sell it. That implies wealth totals could drop hard in a weak economy… and with central banks trying to generate one, it could happen fast.

 

Inflation

 

Jerome Powell said last week that he wanted to see positive real rates across the entire yield curve. That means every maturity would be above the inflation rate. He later said by “inflation” he meant core Personal Consumption Expenditures (PCE). This chart shows Treasury yields are nowhere near doing what Powell wants. The black line below is core PCE inflation. The colored lines are Treasury yields ranging from three months to 30 years.

 

 

For Powell to get what he wants, all the colored lines (yields) must rise above the black line (inflation). That will happen only if yields keep rising and/or core PCE inflation keeps falling. In other words, the Fed chair is setting a very high bar to stop tightening. That may be what it takes to control inflation… but it also means a lot more pain ahead

 

US Economy

 

  • US consumer spending continues to climb. The Fed’s efforts to slow demand have not had the desired effect thus far.
  • Consumer spending on services and lower imports boosted the Atlanta Fed’s GDPNow estimate of economic growth in Q3.

 

 

  • Personal saving remains well below pre-COVID levels.
  • As we know from the CPI report, inflation accelerated in August. The PCE inflation measure was above estimates, with gains driven by services.

 

 

  • The MNI Chicago PMI surprised to the downside, pointing to a manufacturing contraction in the Midwest region in September.
  • The report suggests that manufacturing activity contracted at the national level (ISM PMI) as well.
  • New orders are shrinking.

 

 

  • Hiring has stopped.
  • The backlog of orders is not growing.
  • Customer inventories are rebounding.
  • Input price gains keep slowing, which points to moderating inflation.
  • The combination of faster supplier deliveries and shrinking order backlogs points to tighter corporate margins and lower PPI.

 

  • Job postings on Indeed continue to drift lower, but this rate of decline is not fast enough for the Fed. The goal is to get job openings to pre-COVID levels.

 

 

  • The August job openings report surprised to the downside, an indication that the labor market is finally starting to ease. From the Fed’s perspective, this is good news.

 

 

  • The monthly decline was substantial.

 

 

  • However, there is still a long way to go to bring the labor market balance to pre-COVID levels. Here is the number of openings per unemployed American.

 

 

  • Surprisingly, construction saw an increase in labor demand, which is unlikely to persist

 

 

  • The September ADP private payrolls report showed solid job gains.

 

 

  • Mortgage applications are crashing…

 

 

  • … now down almost 40% from a year ago.

 

 

  • Home sales are dropping…

 

Source: Redfin

 

  • … and there are further declines ahead.

 

 

  • The probability of a recession in the next six months climbed above 50%, according to the Capital Economics model.

 

Source: Capital Economics

 

  • The market increasingly sees a 75 bps rate hike in November.

 

Market Data

 

  • Earnings estimates for the next couple of years look aggressive.

 

Source: J.P. Morgan Asset Management

 

  • PMI indicators point to weaker profits ahead.

 

 

  • It appears that equities have not fully priced in tighter financial conditions and deteriorating liquidity (2 charts).

 

Source: Variant Perception

 

Source: Morgan Stanley Research

 

  • The 2008 analog is holding.

 

 

  • Largest US tech stocks:

 

 

  • Treasury yields are moving lower.

 

 

  • The S&P 500 held support at the 200-week moving average.

 

 

  • The percent of stocks above their 200-day moving average in the NYSE Composite reached the lowest level since the 2020 pandemic crash last week.

 

 

  • The S&P 500 2023 earnings estimates continue to decline.

 

 

  • In previous recessions, the low in equities occurred alongside a peak in the dollar.

 

 

  • On consecutive sessions, buyers overwhelmed sellers in NYSE-listed securities. More than five times as many securities advanced as declined last Monday and Tuesday, and more than ten times as much volume flowed into those securities. Similar thrusts always preceded a positive one-year return in stocks.

 

Quote of the Week

 

“No man has a good enough memory to be a successful liar.”

– Abraham Lincoln

 

Picture of the Week

 

 

 

All content is the opinion of Brian J. Decker