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High levels of debt globally (government, individuals, corporations – totaling over $350 trillion) only increase global economic fragility and reduce the ability to tolerate higher interest rates.
By: Les Nemethy, CEO, Euro-Phoenix Financial Advisors Ltd., former banker at the World Bank
Last month, I traveled to North America and Western Europe, where I met quite a few people, including bankers, and in general, I was surprised by the “business as usual” feeling.
There is no sense that a slowdown or recession is coming. Some of the reasons for this are:
– the strength of the US labor market;
– high levels of aggregate savings and bank deposits of American consumers.
– the US federal deficit has decreased to $1.1 trillion in May 2022, from a peak of $4.3 trillion in March 2021 (measured on a 12-month basis).
Why do I think this belief is wrong?
-Michigan’s consumer confidence index is at its lowest level since 1980.
– The distribution of these savings is unequal. 60% of Americans have little or no savings.
– The reporting of jobs is carried out late and the number of unemployed has already started to increase.
– Nominal growth in the first quarter in the USA was -1.5%.
-The S&P has fallen 18.2% in the first 111 trading days of 2022, the fourth-worst performance since 1932, denting consumer and investor confidence.
-Inflation continues to rise in most countries of the world, making it possible for further increases in interest rates, economic slowdown and the decline of stock market indices.
-Bond yields are generally rising rapidly around the world (e.g. in Germany, they went from negative a year ago to over 1.5% on June 10), while yields on the periphery of the EU- are growing even faster (eg a year ago Italian 10-year bond yields were about 1% higher than German ones, today they are over 2% higher).
The yield on 10-year Italian bonds has risen from 1% at the start of 2022 to 3.86% on June 1, despite massive bond purchases by the European Central Bank (ECB). While most believe the ECB will do “whatever it takes to save the euro” (as Mario Draghi declared in 2012, turning the tide of the then-euro crisis), the size and speed of the bond rate movement Italian, is cause for concern.
As the US Federal Reserve raises interest rates, negative real interest rates of -7% indicate that monetary policy is still loose.
The European Central Bank is not giving signals about quantitative tightening either; it has limited room to raise interest rates, due to the effects this would cause in the EU’s peripheral countries, and moreover, European monetary policy is even looser:
After declaring that inflation was not a threat, and then calling it “transient,” Treasury Secretary Yellen admitted that she was wrong in her assessment of inflation (a welcome step), but added: “I don’t expect that inflation remains high, although I hope it will decrease now”. Since when did hope become a strategy?
Expectations
As I explained in a previous article, I predict that the Federal Reserve will continue to be tight until something is damaged (eg a major market decline or the credit markets stalling, etc.) and then after, it will begin its fifth Quantitative Easing program.
As Peter Schiff said: “The biggest mistake that investors (and I would add, Central Banks) are making is thinking that a recession will solve the problem of inflation. In fact, he will only make it worse. When the Federal Reserve reverses course and begins its fifth round of quantitative easing to stimulate the economy, the dollar will fall, accelerating consumer price increases.
As macro strategist Lyn Alden recently stated, there are two main supply-side factors redefining the world economy today:
1.For at least the last decade, there has been a massive underinvestment in energy. Hydrocarbon drilling has declined. The Keystone Pipeline was canceled. Uranium programs have been closed (eg in Germany); no new uranium mining capacity has been developed since Fukushima. Meanwhile, the insufficient supply of minerals necessary for the development of alternative energies (nickel, lithium, copper, etc.) limits the capacity.
2.For decades, the global value chain was optimized for efficiency. Since the war in Ukraine, priorities have changed and suddenly security of supply became a priority. Manufacturing closer to the country, holding more inventory, etc., requires massive investment and contributes to significant price increases.
Central banks have no control over the above factors. They also have no control over Covid-19 and the war in Ukraine, which have further worsened supply chains and pressure on prices.
Although higher interest rates may dampen demand, as long as interest rates are negative in real terms, the dampening of demand will not be enough to quell inflation, especially if the aforementioned pressures on supply chains continue or even will be highlighted.
High levels of debt globally (government, individuals, corporations – totaling over $350 trillion) only increase global economic fragility and reduce the ability to tolerate higher interest rates.
What is happening
For decades, the global value chain was optimized for efficiency. Since the war in Ukraine, priorities have changed and suddenly security of supply became a priority. Manufacturing closer to the country, holding more inventory, etc., requires massive investment and contributes to significant price increases. Central banks have no control over the above factors./ Monitor
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