Both the US Federal government and California’s government are facing a fiscal inferno. Thanks to a softening economy and inane fiscal policies.
At the macro level, we see that The Federal government has gone wild spending money and borrowing it. Much more than businesses and households. Biden’s wild spending reduces the degrees of freedom that Treasury has if the US slips into another recession or depression.
First, let’s begin with banks to illustrate the worsening condition of the economy. Emergency loans from The Fed’s Bank Term Funding Program (BTFP) is on the rise, signaling perceived trouble in the economy.
Small banks are suffering more than big banks.
Consumer sentiment is below 70 (100 baseline) under Biden and Bidenomics.
And then we have Gavin “Gruesome” Newsom and California. California is now facing a $68 billion deficit. It has also defaulted on a $20 billion loan from the federal government. The situation is so dire the state is telling agencies not to replace broken printers or re-stock office supplies. Workers are being stripped of benefits and could face furloughs. This is all happening as the state has spent billions funding High-Speed Rail and expanding Medi-Cal to all undocumented immigrants, while losing billions in tax revenue from people leaving the state.
$68 billion is over twice this forecast deficit of $24 billion.
But never fear. “Billions Biden” will make sure California is okay, ar least until the 2024 Presidential election.
Traders and investors must spend precious time deciphering them. For those who wouldn’t mind a break from this parlor game, there are some markets that don’t march to the beat of the global policy cycle, and offer diversification benefits for portfolios.
The game was in full flow at Wednesday’s Federal Reserve meeting, as the central bank patiently unpicked the higher-for-longer stitching it had spent many months carefully inculcating in the market.
Anyone who had listened to it on financial conditions, keeping rates restrictive for an extended period, or who thought Powell meant it when he implied he was a Paul Volcker and not an Arthur Burns, is now left trying to figure out if the Fed’s reaction function has indeed changed.
Adding confusion to the game are the dots. They reinforced the dovish message, with the median dot implying three cuts next year versus two back in September.
But with one dot implying six cuts, two implying none and the rest all spread in between, this isn’t exactly sure-footed clarity.
It’ll be repeated again today with the ECB, BOE, the SNB and the Norges Bank all meeting to set rates (the SNB held rates steady and the Norges unexpectedly hiked). For those who can trade only G7 markets, there is not much choice but to play the game.
However, for those looking for markets less reliant on the Delphic utterances of central bankers, there are other options.
The problem is that most bond markets tend to be quite alike over the medium-to-longer term.
Interest rate cycles are typically quite synchronized (with the US the most influential), and capital can flow freely around most of the world.
To show the broad uniformity of bond markets we use a statistical tool called principal component analysis.
PCA is a way of making sense of large data sets. For instance, a retailer may have reams of data on how users use its website: how long they spend on it, which pages they visit, where they hover their mouse, etc. PCA will tell you which input – or combination of inputs – has the greatest explanatory power in determining the total time users spend on the website (something they would want to maximize).
Using PCA on yields from 40 countries, we can show that over half of global bond market moves are described by just one factor.
This not a trivial result. It means we could replace our data on 40 bond markets by this one component and it would capture more than half of the variance of the individual yields.
A bond market that was similar to this component would therefore be a good proxy for the global bond market. However, as the mathematician Carl Jacobi advised, we should always invert. A more interesting question is: which bond markets look least like this factor?
The chart below shows how each of the 40 bond markets are correlated to the first PCA factor. Most have a high correlation – more than 75% – but what stands out is the handful of markets with a low or negative correlation.
Japan and Turkey are among those with a negative correlation, while China’s correlation is close to zero.
This is intuitive.
Japan has been running a deliberately counter-cyclical monetary policy, while Turkey until recently was running a through-the-looking-glass one, cutting rates in the face of rampant inflation. And China’s economy is in deflation, at odds with every other major DM and EM country.
The above analysis provides analytical backing for the intuition that Japan et al have provided diversification for global bond portfolios in recent years, while most other markets, e.g. Europe, the US, Australia, New Zealand, etc are low-resolution facsimiles of each other and therefore have delivered few diversification benefits.
Of course, there will be other things to consider before adding a country’s bond index to a portfolio, such as how overbought or oversold it is, how liquid it is, the expected stance of the central bank, and so on.
But if the correlations persist, such a market should produce a more resilient and lower-volatility bond portfolio.
We can extend this analysis to look at stocks.
Global equity markets are even more similar to one another than bond markets, with the first component explaining 60% of the total move. Nonetheless, applying PCA offers up some portfolio diversification candidates (using as our data set MSCI country indices in USD).
Indeed, it can be shown that the first PCA component of equity markets is highly correlated to the US’s manufacturing ISM, elegantly demonstrating that in large part global stocks are driven by macro.
Indonesia, UAE and Chile’s stock markets are all negatively correlated to the global equity move, and therefore the global macro cycle, while European markets move almost in lockstep with it. As the chart below shows, Indonesia’s market (white line) remained supported in late 2022/23, as its market bottomed in July 2022 and rallied through, while other markets went on to make a new low in October of that year.
Indonesia et al also have had among the lowest returns of all global equity markets this year. It is relatively common for the markets that are among the worst performers one year to be the among the top the following year.
We can complete the analysis by looking at commodities.
The first PCA component here explains about half the move of all commodities, a similar proportion to global bond markets. PCA shows that precious metals, such as gold, silver and platinum are the most negatively correlated to commodities.
As almost all commodities are traded in dollars, the first component is quite similar to the DXY.
So to some extent we are asking which commodities are most negatively correlated to the dollar. Precious metals typically exhibit a more negative dollar correlation than most other commodities. Further, in the current environment they should offer some protection against inflation.
The lack of variation among macro-driven markets makes portfolio investment challenging as it is easier to add risk rather than uncorrelated factors.
The above PCA analysis shows that Japanese bonds, Indonesian equities and platinum are examples of assets that may confer some diversification advantages for global portfolios.
At the very least, you may not have to pay as much attention to central bankers.
… it was the dot plot, where the median 2024 dot plot now forecasts 3 rate cuts up from 2, that shocked traders: in a very rare admission by the Fed, the central bank confirmed that the pre-meeting market pricing of multiple cuts in 2024 were correct in interpreting the Fed’s intentions. It also confirmed – yet again – that the market was right and every single FOMC member was wrong. In retrospect, none of this should have been a shock.
Commenting on the dot plot, TS Lombard’s Steven Blitz said that “for a group that prizes the pricing of its policy intentions in the forward markets as being more important to shifting market conditions than the spot rate, they h d to know that moving the median forecast for Fed funds at the end of 2024 back to June levels would be a bullish signal.“
Or maybe concerns about the market’s reaction were of secondary importance to a Fed which had gotten the tap on the shoulder by the Biden admin and its Democratic cronies on the Hill, terrified about their re-election chances now that the snake of Identity Politics is finally eating its poisonous tail. Indeed, almost as if having seen the collapse in the recent approval polls, Biden’s handlers made some very persuasive phone calls to the Fed. After all, only something as ridiculous – and serious – as steady political pressure can explain the unprecedented U-Turn by the Fed chair, one which even shocked Powell’s own mouthpiece, Nikileaks, who commented on the “Powell pivot” saying “what a difference two weeks can make.”
But markets are behaving as if The Fed will begin cutting rates. Look at the US 2-year Treasury yield on Wednesday AFTER the Fed minutes were released.
Bear in mind that mortgage rates are up 149% under Biden. And mortgage payments up 88%. Yikes!
President Gerald For (R-MI) might be best known for his silly attempt at “whip inflation NOW” by having “Music Man” Meredith Wilson write a song: “Whip Inflation Now!” But the second line has been forgotten: “Eat crow instead of cow.” That second line is appropriate for Bidenomics which has left America’s middle class eating crow in the housing market.
The Wall Street Journal had an interesting piece showing the rise of 30-year fixed rate mortgage payments under Biden where the average monthly new mortgage payment is now $3,222, up from $1,787, up 86%!
The 86% rise in mortgage payments is two fold. First, home prices are up 33.2% under Biden and the 30-year mortgage rate is up 181%.
Yes, Americans are eating crow under the utter failure known as Bidenomics: top down government mandates for massive green energy and other nonsense.
We are on a Highway To Hell! Massive Federal Budget deficits and staggering payments to Treasury from The Fed (losses on balance sheet) and $212 TRILLION in unfunded promises to the non-elites.
Under Modern Monetary Theory (or print money without consequences), we are seeing trillion dollars budget deficits with no end in sight. Nothing has been the same since the financial crisis of 2008 with The Fed’s massive intervention.
Then we have The Fed paying an ever growing amount to US Treasury for losses on their huge balance sheet.
Since April 2021, money supply growth has slowed quickly, and since November, we’ve been seeing the money supply repeatedly contract year over year. The last time the year-over-year (YOY) change in the money supply slipped into negative territory was in November 1994. At that time, negative growth continued for fifteen months, finally turning positive again in January 1996.
Money-supply growth has now been negative for twelve months in a row. During October 2023, the downturn continued as YOY growth in the money supply was at –9.33 percent. That’s up slightly from September’s rate decline which was of –10.49 percent, and was far below October 2022’s rate of 2.14 percent. With negative growth now falling near or below –10 percent for the eighth month in a row, money-supply contraction is the largest we’ve seen since the Great Depression. Prior to this year, at no other point for at least sixty years has the money supply fallen by more than 6 percent (YoY) in any month.
The money supply metric used here—the “true,” or Rothbard-Salerno, money supply measure (TMS)—is the metric developed by Murray Rothbard and Joseph Salerno, and is designed to provide a better measure of money supply fluctuations than M2. (The Mises Institute now offers regular updates on this metric and its growth.)
In recent months, M2 growth rates have followed a similar course to TMS growth rates, although TMS has fallen faster than M2. In October 2023, the M2 growth rate was –3.35 percent. That’s down from September’s growth rate of –3.35 percent. October 2023’s growth rate was also well down from October 2022’s rate of 1.42 percent.
Money supply growth can often be a helpful measure of economic activity and an indicator of coming recessions. During periods of economic boom, money supply tends to grow quickly as commercial banks make more loans. Recessions, on the other hand, tend to be preceded by slowing rates of money supply growth.
It should be noted that the money supply does not need to actually contract to signal a recession and the boom-bust cycle. As shown by Ludwig von Mises, recessions are often preceded by a mere slowing in money supply growth. But the drop into negative territory we’ve seen in recent months does help illustrate just how far and how rapidly money supply growth has fallen. That is generally a red flag for economic growth and employment.
The fact that the money supply is shrinking at all is remarkable because the money supply in modern times almost never gets smaller. The money supply has now fallen by $2.8 trillion (or 13.1 percent) since the peak in April 2022. Proportionally, the drop in money supply since 2022 is the largest fall we’ve seen since the Depression. (Rothbard estimates that in the lead-up to the Great Depression, the money supply fell by 12 percent from its peak of $73 billion in mid-1929 to $64 billion at the end of 1932.)
In spite of this recent drop in total money supply, the trend in money-supply remains well above what existed during the twenty-year period from 1989 to 2009. To return to this trend, the money supply would have to drop at least another $3 trillion or so—or 15 percent—down to a total below $15 trillion. Moreover, as of October, total money supply was still up 32 percent (or $4.6 trillion) since January 2020.
Since 2009, the TMS money supply is now up by nearly 186 percent. (M2 has grown by 141 percent in that period.) Out of the current money supply of $18.9 trillion, $4.6 trillion—or 24 percent—of that has been created since January 2020. Since 2009, $12.2 trillion of the current money supply has been created. In other words, nearly two-thirds of the total existing money supply have been created just in the past thirteen years.
With these kinds of totals, a ten-percent drop only puts a small dent in the huge edifice of newly created money. The US economy still faces a very large monetary overhang from the past several years, and this is partly why after eighteen months of slowing money-supply growth, we are only now starting to see a slowdown in the labor market. (For example, job openings have fallen 22 percent over the past year, but have not yet returned to pre-covid levels.) The inflationary boom has not yet ended.
Nonetheless, the monetary slowdown has been sufficient to considerably weaken the economy. The Philadelphia Fed’s manufacturing index is in recession territory. The Leading Indicators index keeps looking worse. The yield curve points to recession. Temp jobs were down, year-over-year, which often indicates approaching recession. Default rates are rising.
Money Supply and Rising Interest Rates
An inflationary boom begins to turn to bust once new injections of money subside, and we are seeing this now. Not surprisingly, the current signs of malaise come after the Federal Reserve finally pulled its foot slightly off the money-creation accelerator after more than a decade of quantitative easing, financial repression, and a general devotion to easy money. As of early December, the Fed has allowed the federal funds rate to rise to 5.50 percent, the highest since 2001. This has meant short-term interest rates overall have risen as well. In October, for example, the yield on 3-month Treasurys reached 5.6 percent, the highest level measured since December 2000.
Without ongoing access to easy money at near-zero rates, banks are less enthusiastic about making loans, and many marginal companies will no longer be able to stave off financial trouble by refinancing or taking out new loans. Commercial bankruptcy filings increased sizably during 2023, and continue to surge into the last quarter of the year. As reported by Monitor Daily:
The bankruptcy filing by WeWork in November propelled November commercial Chapter 11 filings to 842, an increase of 141% compared with the 349 filings registered in November 2022, according to data provided by Epiq Bankruptcy.
The case filed by WeWork on Nov. 6 included 517 related filings, according to analysis from the American Bankruptcy Institute, representing the third-most related filings in a case since the U.S. Bankruptcy Code became effective in 1979.
Overall commercial filings increased 21% to 2,252 in November, up from the 1,864 commercial filings registered in November 2022. Small business filings, captured as Subchapter V elections within Chapter 11, increased 79% to 181 in November, up from 101 in November 2022.
There were 37,860 total bankruptcy filings in November, a 21% increase from the November 2022 total of 31,187. Individual bankruptcy filings also registered a 21% year-over-year increase, as the 35,608 in November represented an increase over the 29,323 filings in November 2022. There were 20,250 individual Chapter 7 filings in November, a 23% increase compared with the 16,421 filings recorded in November 2022, and there were 15,280 individual Chapter 13 filings in November, a 19% increase compared with the 12,862 filings last November.
Lending for private consumption is getting more expensive also. In October, the average 30-year mortgage rate rose to 7.62 percent, the highest point reached since November 2000.
These factors all point toward a bubble that is in the process of popping. The situation is unsustainable, yet the Fed cannot change course without reigniting a new surge in price inflation. Although some professional economists insist that price inflation has all but disappeared, the sentiment on the ground is clearly one in which most workers believe their wages are not keeping up with rising prices. Any surge in prices would be especially problematic given the rising cost of living. Ordinary Americans face a similar problem with home prices. According to the Atlanta Fed, the housing affordability index is now the worst it’s been since 2006, in the midst of the Housing Bubble.
If the Fed reverses course now, and embraces a new flood of new money, prices will only spiral upward. It didn’t have to be this way, but ordinary people are now paying the price for a decade of easy money cheered by Wall Street and the profligates in Washington. The only way to put the economy on a more stable long-term path is for the Fed to stop pumping new money into the economy. That means a falling money supply and popping economic bubbles.
But it also lays the groundwork for a real economy – i.e., an economy not built on endless bubbles – built by saving and investment rather than spending made possible by artificially low interest rates and easy money.
Then we have US consumers, attempting to cope with Biden’s inflation, by paying all-time highs on credit cards while trying to service ever-growing credit card balances.
After ADP has printed lower than BLS for the last two months…
Source: Bloomberg
…expectations were for a small tick higher in November (from 113k to +130k), despite the ugly JOLTS print. However, ADP reported just 103k jobs added (and October revised down to 106k)…
Source: Bloomberg
Manufacturing saw the biggest job losses but Leisure and Hospitality lost jobs for the first time since Feb 2021…
ADP’s Chief Economist Nela Richardson notes that:
“Restaurants and hotels were the biggest job creators during the post-pandemic recovery. But that boost is behind us, and the return to trend in leisure and hospitality suggests the economy as a whole will see more moderate hiring and wage growth in 2024.”
Bidenomics…
Job-stayers saw a 5.6 percent pay increase in November, the slowest pace of gains since September 2021. Job-changers, too, saw slowing pay growth, posting pay gains of 8.3 percent, the smallest year-over-year increase since June 2021. The premium for switching jobs is at its smallest in three years of data.
Is this the recessionary signals the STIRs market is banking on for 125bps of rate-cuts next year? Because stocks sure aren’t thinking recession.
And as US Treasury 30Y yield drop, so do crude oil prices.
While the exciting headline is “Mortgage Purchase Demand rises 35%!” bear in mind that the level of mortgage purchase demand is still relatively low. This is volatility in mortgage applications.
Mortgage applications increased 2.8 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending December 1, 2023. Last week’s results include an adjustment for the observance of the Thanksgiving holiday.
The Market Composite Index, a measure of mortgage loan application volume, increased 2.8 percent on a seasonally adjusted basis from one week earlier. On an unadjusted basis, the Index increased 43 percent compared with the previous week. The seasonally adjusted Purchase Index decreased 0.3 percent from one week earlier. The unadjusted Purchase Index increased 35 percent compared with the previous week and was 17 percent lower than the same week one year ago.
The Refinance Index increased 14 percent from the previous week and was 10 percent higher than the same week one year ago. Mortgage rates declined last week, with the 30-year fixed-rate mortgage falling to 7.17 percent – the lowest level since August 2023.
And with 5 rate cuts priced in, we should see mortgage demand increasing in 2024.
On the hotness front, here are the 10 smokin’ housing markets. Strange that the hotness score is highest for generally depressed economic cities like Manchester NH, Rochester NY and Rockford IL. Hey, at least Columbus Ohio made the top 10 on the hotness list!
Confounded Interest - Anthony B. Sanders 
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