Turning a soft landing hard

Sigh. I apologise for the ceaseless battery of bearish outlooks this morning but damn, that’s the way the world is going, and I’m not going to “pull a Yardney” and pretend it isn’t so that yours and my hard earned capital goes up in smoke.

This morning we have two excellent pieces on the debt-ceiling debacle in the US from Wesptac and the inevitable and likely swift return of the European crisis, by Delusional Economics.

However, I’m not going to talk about either because beyond both now looms a greater problem, the Western world is sliding towards recession.

Consider the following from Data Sword over the weekend:

After the release of the Chicago Fed National Activity Index earlier in the week we suggested that there was downside risk to the GDP outcome for Q2. While we suggested we could see an annualised rate of around 0.5% for the quarter which would result in the actual annual pace of growth dropping below 2%, the final outcome came in above that expectation at an annualised rate of 1.3%. However a substantial negative revision to the previous quarter which saw the annualised rate of 1.9% revised down to 0.4% means that the annual rate of growth has slowed in line with the pace that the CFNAI suggested. With the US government currently debating how to cut the country’s budget deficit which will ultimately provide a drag on growth and the Fed reluctant to embark on another round of quantitative easing, growth in the US will remain weak for some time.

Now, for perspective on how slow this is, let’s turn to Gavyn Davies:

According to the GDP statistics released on Friday, the US economy has grown at less than 1 per cent annualised in 2011 Q1 and Q2 combined, a rate which is well below its usual stall speed. This is very sharply lower than I expected at the start of the year. Previously, economists were puzzled by the “jobless recovery” in the past few months. Now the mystery has been solved: there was never much of a recovery in the first place. And the solution to the debt ceiling crisis which may emerge in coming days will, in all likelihood, do nothing to help matters.

A budget deal is now rumoured to be within reach in Congress…The most likely deal will see around $1 trillion of government spending reductions starting next year, along with an automatic trigger mechanism to ensure that the scale of tightening is increased in a second round of cuts before very long. Furthermore, these cuts may be legislated in advance to take effect whatever the state of the economy is at the time. This means that if the economy slides back into recession, any emergency fiscal action has been ruled out in advance.

According to JP Morgan, both the House and Senate fiscal packages, from which the compromise is likely to be forged, would involve a tightening in the budgetary stance of some 4 to 5 percentage points of GDP over the next two years. This tightening, however, is only about half of what would be required to ensure that the US attains a position of long term debt sustainability by the latter years of this decade. In other words, the economy seems likely to be hit by a sizeable, early fiscal tightening, while failing to achieve longer term debt sustainability. This seems to be precisely the wrong way round.

Let’s not beat around the bush, that’s ipso facto a US recession.

Over the pond, Europe too is slowing sharply. Also from Gavyn Davies recently, leading indicators are heading south:

Meanwhile, in the eurozone, there have also been some early activity indicators published for July. The flash PMI surveys for the entire eurozone were very weak. In addition, the IFO survey for Germany and the INSEE survey for France have also declined, suggesting that the slowdown has now begun to infect core Europe, which was previously immune from it. This was especially true for the forward-looking parts of the surveys, which are used to calculate the Fulcrum leading indicator shown in the third graph.

The leading indicator implies that the industrial sector of the eurozone economy is now stagnating, compared to the very healthy growth rates recorded earlier in the year. It is probable that the sovereign debt crisis has taken a toll on business confidence throughout the area, including, lately, in Germany and France. This is yet another sign of the economic costs which have followed from the failure of Europe’s leaders to get to grips with the debt crisis.

We can add to that, UK GDP which is also sliding sharply. From Data Sword over the weekend:

Despite monetary policy remaining extremely accommodative with the cash rate at a record low of 0.5% and £200bln in Quantitative Easing completed to date, economic growth in the UK continues to slow. Growth increased by 0.2% over the quarter with the annual pace of growth slowing from an already weak 1.6% to an anemic 0.7% with the economy only growing by 0.2% over the past 9 months. With the UK Government pursuing a rather rigorous austerity program to address the countries ailing public finances growth in the home country is likely to remain weak for some time.

So, we are protected here, right? Sadly, no. Whatever mix of growth you ascribe to the Chinese economy, there is one lesson from 2008 that is worth heeding. Exports to Western markets matter to Chinese growth. From Sean Corrigan via Zero Hedge:

Market participants should not lose sight of the fact that, far beyond the twin, transatlantic farces, a rather darker drama is beginning to play out in terms of world economic activity.

The first warning signs come from the freight industry, where US West Coast container traffic has slowed appreciably. Imports, indeed, have decelerated to an extent only exceeded—and then by the smallest of margins—a handful of times in the past 15 years, sending the growth rate plunging from August 2010’s chart topping 26.4% to a 17 month low of 2.2%.

More broadly, while US intermodal rail traffic is still setting records, its tally now stands a bare 2.5% above the reading recorded at the same juncture in 2010—a sharp deceleration from that earlier period’s 26% YOY increase.

Matching this, across the Pacific, Shenzhen port numbers are also barely in the plus column, as of May/June, while Shanghai has dropped from 18% yoy in the whole of 2010, to a 16 month low over the quarter, touching 7.4% in June itself.

Then we have the IATA air freight numbers, recording their first global decline since the crisis, paced by a singeing 9.8% YOY drop in the crucial Asia Pacific region—a drop only exceeded during the worldwide export slump between Sep08 & Mar09.

Adding to series of cautious statements emanating from the shipping industry, several key machinery makers have also struck a less optimistic note, among them Atlas Copco, Caterpillar, Sandvik, Alstom, Terex, and Siemens. For an Austrian, signs of stress among these higher order goods manufacturers are a clear warning of the chance of stormy weather ahead.

All of these micro trends have again been borne out with the decline seen in various regional PMIs—notably in China and Germany—in the last month, as well as in the slowing of Taiwanese export orders and industrial production.

We have not yet tipped unequivocally into a renewed slump, but it is undeniable that the stimulus fuelled rebound from the slump has more or less run its course.

We can add to this the experience of 2008, which was nicely captured recently in an Australian Treasury Working Paper:

While China’s relatively closed capital markets protected it from the financial fallout from the crisis, trade proved to be a key channel for transmitting the financial crisis to the Chinese economy. The growth rate of exports and imports declined in November 2008 and continued to be negative until November 2009. The USA, the EU, and Japan account for about half of China’s exports. China’s exports to these regions fell substantially as demand in these economies contracted.


Now, I don’t think we’ll see the kind of precipitous fall in trade we had in 2008, unless there is a new financial shock resulting from the policy freeze.

But, there’s is a big danger of a new inventory cycle commencing in Western economies as new waves of austerity shock consumers into further retrenchment and unemployment rises.

I know also that most of the data in this post is backward looking and is affected by both Japan and the oil price. But so what? A new austerity shock is about to pile in on top of already weak economies and there is no prospect of the oil price declining without significant economic weakness first. Fiscal and monetary stimulus is inhibited in Europe, the US and China. And a slowly recovering Japan can’t carry us all.

The array of potential reversals in markets outlined at Data Diary today is a pretty good guide to what’s to come in my view:

So what are the likely trends from here?

As the ‘sell USD’ meme has gone mainstream, the risk/reward probably favours a counter-trend move. Certainly, ‘safe haven’ sentiment is at extremes (here), capital flows are becoming concentrated in fewer stocks (here andhere), and the climbing interest in protecting the downside even as volatility remains subdued (here), all suggest that the weak side is one where the USD rallies hard.

On the assumption then that the market is vulnerable to a USD rally – whether it is the result of a ‘resolution’ or not – what are the trades to consider?

1) Short gold – When I look at the relative underperformance of the gold miners versus the metal, I get the feeling that the ‘alternative money’ is due for a nasty sell-off. Note that the gold miners (HUI – blue line) have failed to make a new high while gold (black line) has pushed on through. This view is number 1 for good reason.

2) Short ‘safe haven’ currencies – we’ve been positive on the CHF since the start of the year (“Trends you can trust“), but with the most recent move it has got just plain ridiculous. While the Swiss central bank may have given up fighting the trend, the current mood leaves USDCHF particularly vulnerable to a sharp correction.

3) Neutral Risk assets – If we take the defensive posturing of money managers as a guide, the argument could be made that there are willing buyers for risk assets (equities and/or lower grade bonds) on resolution of the debt ceiling. While I’m not a buyer down the risk curve from a longer run valuation perspective, it’s unclear to me as to which way these asset classes can run in the shorter term.

4) Neutral Commodities – On the face of it, a stronger USD should hang heavily on the commodity sector. Still, commodities are more inclined to follow the breezes coming out of China, so the sector may not be as susceptible to movements in the big dollar.

Obviously, I’m less sanguine about commodities.

Houses and Holes
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  1. Australia is different. We are insulated from all this. There is a massive amount of investment in the pipeline. Big skills shortage looming. We are ready for take-off in 2012. 🙂

    • The_Mainlander

      I don’t think there is much of a ‘win’ either way we’re left with Dutch Disease, Rates up or down someone will hurt.

      I think also regardless of a rate hold, rise that property is in trouble, we are past Peak Debt and disleveraging is well under way… there is no ‘boosting’ left in the local/regional/federal governemnts Big Wooden Spoon (BWS) for stirring the economy.

      2011 has been bloody interesting so far 2012 will be the main show, don’t forget your popcorn!


    • Being the least sick patient in a ward full of suffering cancer sufferers is small consolation.

      And I don’t think we will be better than most, because as you have convinced me, our Dutch Disease has caused massive malinvestment, productivity has fallen off the political radar and we have some of the most regulated markets in the world, so they will struggle to adapt to the change that is needed.

      We also have a Government that is economically clueless….

      AND as is common knowledge, we are now just a quarry for China and will probably suffer worse than any other country if (WHEN!) China’s fixed investment farce blows up with bad debts.

      • To clarify – our malinvestment has occured in housing…pouring tons of $ into an unproductive industry at the expense of profitable businesses

        • The_Mainlander


          I agree houses only produce when the values go up and given how expensive housing is today you can forget about the notion of yield making money out of housing – why else would we need negative gearing!

          Australia needs a get back to basics programme and actually make uselful stuff and sell it… I think this was known as manufacturing?

          Speculation in housing has become readily condfused with investing.


          “Investment has different meanings in finance and economics. In Finance investment is putting money into something with the expectation of gain, that upon thorough analysis, has a high degree of security of principle, as well as security of return, within an expected period of time.[1] In contrast putting money into something with an expectation of gain without thorough analysis, without security of principal, and without security of return is speculation or gambling.”

          God bless wikipedia!


  2. But the bullhawks are all obsessed with “surging inflation” – this is eerily similar to the commentary and loose analysis going into 2007, where inflation was indeed growing higher, before it collapsed.

    Disleveraging (and outright deflation via debt defaults/writedowns) has so far outweighed every single monetary and fiscal stimulus thrown at the GFC.

    Why they can’t understand that and inflation is only a temporary problem (and by the way, you want wages to rise so people can pay off debt – and boost your precious house prices…..unbelievable) is why there is likely to be a “shock” coming….

    • Price, isnt it possible we will have deflation of asset prices and inflation of consumer goods?

      Stimulus and easy monetary policy will try to prop up asset prices (mistake!) and only feed through to consumer inflation, as people use the easy money to drive up the price of commodities.

      • Sorry Prince…and also, this is honestluy a question…I dont know the answer to it, but it seems strange we talk of inflation and deflation as economy wide concepts. My understanding of how inflation works depends on the amount of $’s chasing partiular goods. I dont see how this is always going to be consistent across the economy

        • I believe asset deflation and CPI inflation is well established now.

          Also, once we all well and truly abandon the “homes as wealth makers” mindset we will
          see the mess we are standing in.

      • “Price, isnt it possible we will have deflation of asset prices and inflation of consumer goods?”

        I suppose anything is possible but I’m not aware of that ever happening previously. Stagflation is when we get inflation and stagnant growth. The 1970s were a time of stagflation in Australia. House prices tripled and even rose in real terms during that 1970s stagflation. Combined with the rent (imputed or received) the return was above well above inflation.
        The UK had even more severe stagflation in the 1970s yet house prices rose 5 fold.

        • Thanks Suzi…but historically, have we have ever had a run up in private debt like what has occured in the past 20 years…? No, so we are in uncharted territory when it comes to asset deflation – as never have we had a period of such inflation of asset prices.

          Further – in terms of inflation of consumer items – have we have ever had a period where Governments have been so willing to debase their currencies?

          I cant think of a period where the money supply has increases the way it has in recent years – simple to prop up deflating asset prices.

          So it is not just possible, it is highly probable and as Peter said, it is already occuring in Oz (house prices down, cost of food, electricity up)…

          • IMHO, current times have no precedent.

            The globe has never been almost entirely debt-ponzied/peak-debt before….the entire world….crikeys….

            My 2c

    • The_Mainlander

      God Prince, you are right (as usual) and they did go nuts lifting rates until the Great Rcession hit and then it was how fast can you cut!

      Thanks, always enjoy your insight and encyclopedia like financial memory…

      Oh no… I just realised that with the advent of Google that the ‘encyclopedia’ dates me badly… does anyone use these texts anymore?

      Assuming The Prince knows what an encylcopedia is and is not of the Google Instant generation! 😉

      (sorry off topic)

    • Stavros, yes the meme of “deflation in all that you own (owe?) and inflation in all that you want” is highly probable, but considered unlikely by the consensus crowd.

      Inflation is really a political/behavioural phenomenon, not economic and no it’s not consistent (e.g manufacturing is experiencing deflation (at the cash register) and inflation (at the supply door) whilst mining has inflation everywhere (labour, supplies, fuel, plus additional taxes)

      And no, its not Google, I remember all the chest beating inflation hawks in my office during 2007, who then did nothing when the markets turned down and screamed for lower interest rates to boost their asset prices (and their client portfolios) thereafter.

      Even though I work from home now, its not hard to find the chesty bullhawks flying about doing the same two-step dance….

  3. H&H the “ceaseless battery of bearish outlooks” is more like “realistic assessment” IMO. Something that we get little of from the government, and MSM.

    The global economy is quaking with debt, slow growth (in developed economies), and long running budget deficits; some correction is going to happen IMO.

    My macro alarm bells are ringing loud.

    Keep up the good work.

    • In this country cash means “residential mortgages” in June 80% of the increase in deposits went into funding the increase in the balance of resi mortgages.

      • So if you say “them banks are doing dodgy things with your cash, even last month”
        then where to put the cash remains an important question.

  4. Sandgroper Sceptic

    Yeah cash is best until you look at real rate of return. Inflation is much higher than the horrible CPI that came out last week, I look at my own budgetary expenses which are up over 13% YoY an example – gas increase 10% YoY, electricity increase 5%, council rates 6%, food and groceries 20%, water 10%, petrol 25%, health insurance 5%, school related 7%, taxes up etc. Cash in a term deposit at best after taxes and inflation is probably 0, possibly negative. Cash is trash too!

    • Which makes Adama Carrs call for a rate hike seem reasonable does it not? The simple fact is, that by manipulating CPI numbers, savers are punished to protect the indebted. If you take out all the discretionary crap like appliances and cars (yes, we need them, but not 5 TV’s and 2 cars per person!), CPI is quite a bit higher than the official numbers

      • Virtually none of the things that Sandgroper mentioned fall into the realm of discretionary consumer spending though – why would we expect interest rate hikes to have any great effect on them?

        Unless the RBA hike(s) were enough to scorch the economy or even push it into recession. Then, large numbers of people would find that inflation in the cost of living was even higher since the dole doesn’t pay nearly as much as a job.

        • True, but given that interest rates are pretty much all the RBA has to work with, and in the context of their brief, technically Adam Carr is correct. I think they will hold, but what if (and it’s a mighty big if) inflation does start to gallop off? Apart from rate hikes, is there any other way to respond? I fear that we have painted ourselves into a corner out of which there is no painless route

          • A friend described the RBA as a car driving into a T-junction and only having the foot pedals to change direction because someone forgot to install a steering wheel.

          • Then perhaps the time has come to question whether or not monetary policy should – or any longer can – be used the the main stabalisation tool.

            By a handfull of unelected officials who are (supposedly) not subject to “political interference” – read: not subject to the democratic process.

    • The return on cash may well be negative when inflation is removed, but if other asset classes are deflating, then it could be the best of a bad lot.

  5. There will not be real recovery unless a large chunk of debt is repaid or written off and western countries reinvent their manufacturing. The most likely scenario is that we will have alternating recessions and shallow recoveries for another decade.

    • For countries that have a solvency crisis then a partial default ought to occur IMO. So the various PIIGS should leave the EMU and come to an arrangement with their creditors.

      I’ve seen some stuff floating around the interweb, don’t have it handy, that shows countries that have defaulted and move on do pretty well afterwards.

      Getting manufacturing going is a longer term thing.

    • Foreign holders of US debt take a haircut by virtue of a weaker US dollar. So this has and is already happening. Foreign ownership of debt is still the minority at the moment in any case.

      • good point precious. but at some point the inevitable will dawn on these holders and then its not just money printing that undermines their portfolios. by the way your handle is worse than mine. rank.

        • the US doesn’t have a solvency problem though energywonk. so what you are describing is moot.

          Also what is inevitable is that while the US run current account deficits foreign countries will accumulate dollars and use them to purchase treasuries. end of story.

          • liabilities are about to exceed GDP this is a solvency issue no? and secondly the increasing bilateral trades in currencies other than USD would indicate a move away from USD as a reserve currency. witness fortescues yuan deal in our own country. am i missing something here. i dont think i agree with you PBF.

  6. The US could always default on the treasuries which were purchased by the Fed.
    It is my understanding that the US banks borrowed money from the Fed at close to 0% and then bought up the treasury bonds with their 3% yields. Money for jam for the US banks.
    Maybe they should be the ones to take the haircut and the Fed writes off their debt.

  7. all of the money is loaned into existance and all bears interest payable to “the masters of universe”.
    While it was paid from new credit- the wheels were turning, but when it starts biting into “principal” (“balanced budget, austerity”)- the system stops- no more permanent inflation.

    Because for inflation to be sustained little bogan has to get either a pay rise (which comes from new credit issued to the very same bogans tricling down the pipe) or goverment handout (balanced budget, anyone?)

    it all boils down to the same question:
    Who will take a new credit to cover interest payments on outstanding loan balances?

    With credit machine broke you can’t sustain inflation. Simple as that.

    Increases in gas, electricity, taxes, other monopolies simply will mean “we are permanently reducing shelf prices”, “clearance” and so on.
    Ben is damn right saying that it is “transitory” 🙂

    But interest due and “eating into principal” will have social consequences too.
    And the only way to mitigate this is to unwinde what got us here in the first place, meaning to reverse cash flows from bankers to bogans.
    By the way, it probably wouldn’t be a payrise (in this broken economy), but handout.

    It is not about politics at all- just a simple debt math 🙂
    handout to bogan dilluting bankers “assets”.
    “Go early, go households” except that going should be real (grant and tax cut are not the same) and long term.

    what a funny conclusion!

    but the alternative would be to hear bogan screaming loud when squeezed too much.

    “converting debt to income” has gone way too long…