As at 21 March 2019, economic conditions around the globe are steadily getting worse.
In the United States international revenue has spiraled down due to declining exchange rates and the negative effects of the ongoing trade wars. Pundits M (maverick economic watchers) see slowing international macroeconomic conditions and weaker global trade growth trends continue. The year-over-year decline in FedEx Express international revenue and China’s industrial output and retail sales softening with a jump in unemployment are worrying case examples.
Will the US-China trade negotiations put a floor under it? China is likely to avoid quantitative easing and massive deficit spending. Germany cannot hide the daunting external risks. Turkey entered its first recession in a decade. U.S. manufacturing output was down for the second straight month in February. Freight volumes dropped for three months in a row. Class-8 freight trucks were down 58% from a year ago. Residential construction spending plunged for the six month in a row.
The economy pundits point to low prices for corn, soybeans, milk and beef. In the 12-month period ending in June 2018, more than 80 farms filed for bankruptcy – doubling the number over the same period in 2013 and 2014. Now record floods devastating a wide swath of the farm belt across Iowa, Nebraska, South Dakota and some neighboring states. First estimates of lost crops and livestock are approaching $1 billion in Nebraska alone. With their stockpiles of grain gone, the one thing that can stand between them and financial ruin farmers have also lost their livestock as a result of the devastating floods.
Global economic conditions continues to deteriorate and in particular the global financial system is vulnerable as .global debt-to-GDP ratios have risen to 231% compared with 208% in June 2018. The U.S. FedEx bleak outlook for the economic future is a very ominous sign as an economic downturn at this time could ultimately set off a very disturbing chain of events.
Industrial production on a year-over-year basis in Europe has fallen for three months in a row. Pundits C (conforming economic watchers) leading economic indicators also took a dramatic turn south. U.S. stock market valuations (SP500 using fourth quarter 2018 data) warms that over 60% of available term-spreads have inverted – meaning valuations are beginning to get close to sounding the alarm. All measuring of pick-ups and decelerations in economic growth are now in negative territory.
Nonetheless the net worth of the American household grows virtually every single quarter year over year. It typically coincides with economic trouble during rare periods when it doesn’t expan and contraction in net worth has always indicated an economic recession was imminent. A more than a 4% decline in sequential quarters is a warning. It is importance that the U.S. stock market remains above the fourth quarter 2018 low in the near term to avoid risk of entering an overall wealth contraction. The current slowing rate of asset growth to +0.8% require a deeper wealth contraction below zero to have the same meaning as in past recessions.
Let’s note that the main components of net worth are real estate and investments. Contracting individual net worth is due primarily to depreciating home values and or stock market declines. The 2000 to 2001 tech bubble implosion home values continued to climb at a double digit pace registering only a modest overall net worth contraction whereas the stock market fell nearly 50%. The most significant wealth contraction since the Great Depression occurred in 2008 with stock market capitulation but was greatly exacerbated by the rare collapse in real estate of 34%. Only if the U.S. stock market end a quarter in 2019 beneath its nadir of the fourth quarter 2018 will there be a wealth panic coinciding with a contracting U.S. economy. The stock market in March 2019 so far is right back to the highs of 2019 is impressive, as if the market is becoming certain there will be a China trade deal. Any net worth issue for 2019 will not be a headwind and possibly and green shoots for a new global expansion can be heralded.
Only if China fail to offer a sufficient solution that risks triggering a severe escalation of the trade crisis. A policy misstep by Trump and Xi could lead to at least a modest contraction in our GDP and household wealth. Then the topic de jour will be declines in gross exports and Pundits M trajectory of weak global macroeconomic conditions will take hold.
Pundits Y (mainstream orthodox economic watchers) note that the Federal Reserve will remain the top holder of U.S. Treasuries for the foreseeable future after the central bank said it would stop shrinking its $4 trillion balance sheet by the end of September. Its balance sheet was less than a quarter of its current size and consisted almost entirely of Treasury securities before the financial crisis of late 2007. The Fed’s quantitative easing (QE) bought a mix of Treasuries and mortgage-backed securities (MBS) from the end of 2008 to late 2014 (six years) resulting in its balance sheet mushrooming nearly five-fold due fostering an economic recovery.
Treasuries now account for 55% of the assets on the Fed’s balance sheet. MBS is about 40%. Other assets include gold. Some securities range in maturity from 1-month bills to 30-year bonds. Before the financial crisis the Fed’s preference was for short-term securities such as T-bills, which mature in a year or less. In addition notes maturing between five and 10 years accounted for just 7% of the Fed’s Treasury holdings. The longest-term securities which matured in 10 years or more were around 10% of its portfolio.
By early 2013 the five-to-10 year sector shot up to as much as 52% as the Fed was making a concerted effort to lengthen its maturity profile to pressure long-term bond yields lower and boost the housing market. The longest-dated bonds grew to account for 25% and its holding of T-bills dropped to near zero. Today the Fed’s five-to-10 year paper is about 11% and its holdings of long-dated bonds has risen to nearly 30%.
It’s a piped dream that overall balance sheet can shrink a bit more relative to the U.S. economy. It was roughly 25% of annual U.S. economic output at its peak compared with around 6% before the crisis. As a percentage of nominal gross domestic output, the balance sheet today is just 20% of the $21 trillion U.S. economy. The Fed’s goal is about 17% and then growing the portfolio at a pace to maintain that balance sheet-to-GDP ratio over the long term. All of this is happening at a time when the US economy is close to full employment and the Fed has a 2% inflation goal.
Bond prices rose sharply on 20.3.19 after the Fed forecast slower economic growth. The policy to stop shrinking its bond portfolio in September should hold down long-term interest rates. Bond yields touched the lowest level in more than a year. The Nasdaq edged up 5 points ( 0.1%) to 7,728 but the S&P 500 fell 8 points (0.3%) to 2,824. The Dow Jones Industrial Average lost 141 points (0.5%) to 25,745. As the outlook for higher rates dimmed prices of banks fell. Incidentally the Dow was weighted by Boeing shares which for instance on 11.3.19 wiped nearly $16 billion off Boeing’s market value, marking an abrupt reversal for a stock that had been the runaway top performer of 2019.
Bottom-line outcome was a rainbow fire as the yield on the 10-year Treasury note dropped to 2.53%. This was comparatively positive as the US 10-year Treasury notes on 12.3.19 was 2.65% and two-year yield was at 2.49%.
Now the Fed’s target range currently was 2.25% to 2.50% whereas the “effective” federal funds rate on 20.3.19 was 2.41% which was above the 2.40% interest rate (IOER) the U.S. central bank currently pays on the excess reserves that banks leave with it.
To understand what was troubling we understand that the rise in the average cost for U.S. banks to borrow excess reserves from each other overnight (known as federal funds) or “effective” federal funds rate could be due to the plan to halt the shrinkage of the U.S. central bank’s bond holdings. If the effective rate increases further there would alarm about the central bank’s effectiveness in controlling short-term rates.
In 2018, the Fed adjusted the IOER twice in an effort to keep the effective fed funds rate in the middle of its target range. Pundits Y recalled that in 2018 yields on 10-year Treasury paper held at 3.24% at one stage, near a seven-year top.
Rising treasury yields tend to dampen stocks and threaten the economic outlook, thus putting pressure on the Federal Reserve to go slow on policy tightening. Although tailwind from increased trade friction did not lead to any morphing into a recession the Dow dropped 92 points on 17.9.18 when the 10-year U.S. Treasury note was above 3%. The alarm bells were not sounded although it reached 3.05% because the then strong dollar kept inflation in check.
At end of November 2018 the U.S. Federal Reserve Chair Jerome Powell turned dovish albeit without political reference. Treasuries rallied hard to down 10-year yields at 2.99%. It appeared that the Fed’s perception of strong economy might not be as solid. The gap in interest rates between 2-year and 10-year Treasury securities dipped to 0.15% point. The spread between the 3-year and 5-year notes dropped to negative 0.01 percentage point on 3.12.18, the first time that had happened since 2007. For gauging recession risk and weighing investor doubt about the future, an inversion of the yield curve is significant because it has preceded past recessions.
If underlying economies were linked with stocks the spillover effect of deflated wealth was enormous because only the U.S. and Japan were clearly in positive territory in respect of stocks performance. In any scenario there was a need to see continued rise in business investment otherwise even the boom of U.S. companies current earnings would subside.