Decoding the Half-Year Macro Trends of 2023

Inflation trends 2021, from war MMT to Pandemic MMT

A functional view of Deficits in time of Corona, impacts on Rates, Inflation and Growth

Libor Term Stucture in Time of Corona

Fed impacts, context and inflationary pressures

The Fed’s response to the current health crisis is unprecedented in scale. In two weeks, the Fed has slashed interest rates to zero, implemented a shock and awe Quantitative Easing program, buying one trillion bonds (the previous largest QE2 program 800bn…had taken 2years to achieve!), the Fed also launched many programs to boost market liquidity and help fund large and small companies.

Below I highlight some of these programs to show the massive scale:

•           Unlimited QE: Treasuries, MBS and CMBS
•           Primary and Secondary Credit facilities
•           TALF, for ABS (Asset Backed Securities)
•           TALF II, for Auto, Student…loans
•           TALF III, for riskier ABS
•           MMLF, to back up Muni debt as States deficits are ballooning and risk bankruptcies
•           A Commercial Paper (CP) program for banks to finance themselves short term
•           A Primary Dealers financing window
•           Central banks $ swap lines to make dollar liquidity available to foreign entities
•           A Central banks repo facility to avoid a fire sale of treasuries by foreign entities, after the latter sold 100bn in a week
•           A lending facility for small businesses thru the Paycheck Protection Program…

The Fed is also doing everything in its powers to facilitate the transmission mechanism of its various programs. In the past it had relied solely on banks for that, but it seems that it is learning from its mistakes. Following the 2008 crisis, despite large amounts of liquidity injected in the system, banks remained reluctant to lend. At the time, it was a financial crisis and new regulations forced bank to deleverage, watch their capital ratio and weighted assets. So instead of lending, they kept on hand billions of dollars that they conveniently placed at the Fed’s IOER window (Interest on excess reserves) for a small carry arb. That phenomenon killed the velocity of money and contributed to tepid growth.

Recent measures from the Fed to lower the burden on banks, relaxing their SLR (Supplemental Leverage Ratios) are powerful measures and will probably help inject another 1.6tr of liquidity in the system, allowing more leverage thru repo books, facilitate Prime Brokers channels…

These types of measures are surely different than the ones implemented in 2008 that penalized intensive balance sheet businesses (Gross notionals and risk insensitive).  The new measures will probably contribute to higher velocity of money this time around. Higher velocity of money was the missing ingredient for higher inflation.

 All in all, the fed has already injected 2 trillion dollars of liquidity, the government will also inject 2 trillion thru its fiscal response, while banks are in a position to release an extra 1.6 trillion of liquidity, totaling 6 trillion or 25% of the US GDP!

You probably understand where I am heading with my comparisons.  

It seems to me that if very short term the crisis is deflationary, prices across the globe are tumbling: oil, copper, Hotel rooms, food away from home…

Medium term, I wouldn’t be surprised to see inflation pressure building up fast:

•         Much of the stimulus is going straight to companies and employees which will reinject directly in the economy, classic Keynesian behavior
•           Most countries are learning their lessons of ultra-reliance on cheap goods from China. I believe many developed countries will rebuild their own manufacturing businesses, at least in the health care and primary needs sectors
•           Globalization was already being questioned pre-virus, the break up of supply chains will just accentuate from here
•           At the zero bound, fiscal policies become even more relevant taking over monetary , we are moving from the liquidity trap to the liquidity boon
•           Corporate issuance has already exploded (some days more than 30bn, with mega deals like the 19bn T-Mobile offering), I am hopeful that this time around that money will not go to buybacks but back to support investments in capex and employees…unless of course they pay down debt with new debt
•           Velocity of money tend to be correlated to the level of rates and at current levels no room to go lower (the Fed contrary to European Central Banks, is reluctant to allow negative yields) so that should put a floor to the velocity of money from here
•           All central banks and governments are following the Fed initiatives so inflation pressures will be a global phenomenon
•           Crisis of this nature tend to have a V shape recovery
•           Lower commodity prices are already priced in with many commodities in contango and many trading below their production costs (See graphs below),
•           Similarly, inflation expectations have priced outright depression two weeks ago as fears and deleveraging hit markets hard. Back then, I sent a note showing 5 year Break-Evens were pricing -8bps, so an average deflation for 5 years! Even in 2008 the realized inflation floored at 100bps. Since, Break-evens and Real Yields have rallied 50 to 75bps as the markets are digesting the massive stimulus put in place to fight the negative impacts of the pandemic. 

All in all, the massive scale and speed of the stimulus put in place by the monetary and fiscal authorities should this time be more inflationary than not. The Fed paying special attention to the transmission mechanisms is a major difference compared to the 2008 policies. Trade supply chain disruptions and a manufacturing boost in developed countries should also be inflationary. I am not saying we are going back to the 1950s, services will remain a larger part of GDP growth with all the deflationary pressures from technology advancements and all, but at the margin the inflationary forces should be higher than they were over the last 25yrs of globalization. New trends towards European models of the welfare state when it comes to health care and the treatment of employees could also add to inflationary pressures.

Now, lower interest rates are probably here to stay which could hurt the velocity of money, but even that is questionable as the world is entering a new MMT (Modern Monetary Theory) experiment with unlimited supply of government bonds and deficits.

The risk remains that we are just fueling yet another bubble (lessons in greed and fear are hardly learnt), applying the same medicine to any problem we face, as an MIT professor said:  "This crisis has taught us one thing, that if the Martians attack Earth, our first response would be to lower interest rates." 

Appendix:

If the Velocity of money has headed one way, down…

…I prefer to watch a different indicator : [Velocity * M2 yoy growth] which started grinding higher since 2019, M2 is clearly on the rise after this month Fed’s shock and awe and I expect Velocity to pick up as well as the Fed pays special attention to the transmission mechanisms

Oil, Copper and Bloomberg Commodity index are already very depressed

Source Bloomberg

Buybacks, the shareholders decade 

Source Larry McDonald

Trad’em well

Hicham Hajhamou

The unintended consequences of protectionism

As trade disputes between the Trump administration and China intensify, I thought would be useful to review some of the experiences with protectionism
Click on link 
Trade and Protectionism