DATA DIVE - A matter of time

Read Time: 7mins

Given the special circumstances, I have decided to open up today's note to everyone.

Yesterday we had quite a bounce during Powell's speech, so let's start there before moving on to look at some economic data.

Powell was balanced and honest, reaffirming his desire to keep on tightening but at the same time acknowledging the uncertainty regarding the future path of inflation and economic activity. He confirmed that further rate increases should be expected, albeit at a slower pace and that the reductions in the balance sheet will continue at the current pace of -90B per month. He was quite clear that the Fed does not want to start cutting rates any time soon, and instead will aim to keep rates at a higher level for longer.

Nothing new.

It appears the market was expecting a repeat of Jackson Hole, where Powell came out firing on all cylinders, so his more balanced tone became a reason to rally.It's kind of absurd that the market is moving based on the "Tone" of the Fed chairman, and not discounting economic reality, but at least for now, this appears to be the trend.

Let me just say that I do not think Powell is an idiot. If I can spot the economic slowdown, then he and his army of PHDs surely can.

This year the Fed has hiked rates by +75bps 4 times in a row, an unprecedented amount.It is well documented that monetary policy acts with a lag and that rate hikes take at least 6 months to filter through to the economy, so the extent of economic pain this will cause has yet to be seen.The real question is how quickly will economic activity deteriorate from here as these higher rates begins to filter through?

To gauge this it is worth looking at the housing market, one of the most sensitive sectors to interest rates changes, due to the alsmot immediate impact on mortgage rates on home affordability.

US 30 year mortgage rates went from 3% to 7% in less than a year.

The flip side to that is that in 2022 the US has experienced one of the fastest slowdowns in housing activity on record

As can also be seen in pending home sales, another measures of overall contract activity

Surveys of home builders also show sentiment falling off a cliff at an unprecedented rate

United States Nahb Housing Market Index

So the fastest rate hikes cycle in history has led to the fastest decline in housing activity on record.

The question is whether this trend will extend to the broader economy or not.

Before I go and share some thoughts on this, lets take a look at some of the latest global economic data, to get a big picture idea of what the current state of affairs is.

Fresh off the press, Exports from South Korea in NOV contracted -14% YoY, led by semiconductor exports down -29%.

Industrial Production declined more than expected in OCT -3.5% MoM and -1.1% YoY

South Korea’s GDP growth rate slowed to +0.3% QoQ, or +3.1% YoY in Q3, but given the size of the negative data in Oct and Nov, it is quite likely this turns negative QoQ in Q4, and posts a significant slow down on a YoY basis.

The outlook for South Korea remains bearish, and one or two more rate hikes of 25bps are to be expected before the BOK pauses in early 2023.

Another interesting data point is the GDP of Turkey, a major producer nation and thus receiver of global demand.GDP growth rate turned negative QoQ -0.1%, for the first time since the pandemic, led by slowing consumer spending, slower exports, and higher imports (due to the cost of the high dollar)

This is supported by the decline in Turkey's Manufacturing PMI to new lows

No surprise that Turkey is one of the few countries lowering interest rates atm, -150bps to 9% just last week.

In the Euro Area, Industrial Sentiment recently fell to a new low, with new orders falling and stocks of unsold product piling up.

Meanwhile Consumer Confidence has ticked up somewhat, a pattern observed on the individual country level as well, although this should be taken with a pinch of salt as it is coming off all time lows.

If we look at some of the lastest European GDP numbers the slowdown in growth is quite evident.France’s GDP recorded the weakest growth since 2020 at +1% YoY, and +0.2% QoQ in Q3.

Italy’s GDP also slowed the most since post Covid.

Swiss GDP growth rate has ground to a halt at +0.5% YoY

Now remember Europe didn’t start raising interest rates until July of this year, and didn’t get to 1.25% until Sept. So in a sense, the impact of rate increases has not even been a factor yet.

One of the things that has been jumping out at me from Europe is the extent of bad data which is coming from the northern countries, which historically have been some of the strongest performers.

Take Retail Sales in Denmark for example -10.3 YoY, -1.7% MoM

Or Retail Sales in Norway which are down -5% YoY this Oct, and that is coming off an already negative read of -3.3% in Oct 2021.

In Sweden Retail Sales are down -7.7% YoY

Meanwhile back across the pond in the US GDP for Q3 is estimated to have risen 2.9%, a meaningful expansion following the two negative previous quarters.

But you have to look below the hood, and once again net exports played an outsized role, remove the export/import component and GDP would have been flat. Imports declined -7.3%, which is massive if you think that the US is the consumer of the world!

The formula for GDP has Exports - Imports, so if imports are down and exports are up (which is due to the strong dollar) then you have a positive contribution to GDP. In this case the contribution was of +2.9%.

Meanwhile other leading indicators remain in negative territory such as the Dallas Fed Services Index

Or the Chicago PMI, which measures performance of the manufacturing and non manufacturing sector in the region, and contracted for the third month in a row to 37 (remember with PMIs or Purchasing Managers Indexes, any number below 50 = a contraction).

The slowdown on a global scale is obvious, and everyone is talking about it.

This may be the most widely telegraphed and predicted recession in history.The slowdown so far has been mostly a product of the war in Ukraine, the lockdowns in China, rising food and energy prices, and the impacts of inflation on consumers budgets.

I do wonder however, if people are starting to think that this is it. Housing has slowed, consumer spending has declined, industrial production has contracted, crypto has crashed and global trade has shrunk, how much worse can it get?

Well to answer that lets go back to the point I raised at the start, the impact of interest rates has only now started to filter through to the real economy, so except for in housing, it has hardly been felt yet.

In my opinion we can hardly call 2022 a recession year, we have slowed, no doubt, but after all we were comparing against 2021, one of the strongest years of growth in modern history. I discussed this earlier this year, that the 2 consecutive negative GDP reads in Q1 & Q2 in the US were mostly functions of accounting practices, and far from what we would consider a traditional recession. Are we really going to try and claim that the US was in a recession while Europe was not?

What’s more the labour market has remained historically strong, while in a traditional recession unemployment should rise.It seems to me 2022 was the warm up year.

The focus was War, then inflation, then rates.As we enter 2023 I expect the focus will shift to the economy.

There is only so much the economy can take, and we are approaching the moment where cracks start to show.

Lets take the latest US employment data.Private businesses in the US crates +127K jobs in Nov, the slowest pace in two years.But 127K jobs is still a positive you might be thinking?Lets look under the hood:

• Manufacturing sector -100K jobs

• construction -2K

• professional/business services -77K

• financial activities -34k

• Kinformation -25K

• Goods sector -86K jobs

• Leisure/hospitality +224K

• Trade/transportation/utilities +62K

• Education/health +55K

• Mining and resources +16K

What you see when you look at the details is a lot of job losses in higher paying sectors and large additions in lower paying jobs.

An interesting comment in the report is that “The data suggest that Fed tightening is having an impact on job creation and pay gains”.This is the first jobs report to explicitly point to the impacts of Fed policy.

Something to consider in terms of direct impact to equities of employment is the flow of capital. So far with employment having stayed stable, despite the bear market, money has been flowing into funds, ETFs and indices.Should people start to get fired and have to dip into their savings and retirement funds, as opposed to adding them, that may add a lot of pressure to the market.

The widely telegraphed Fed hiking has mean a lot of professional investors and traders turned bearish and sold, but retail is by en large still long.

There is another place where higher interest rates will now start to have an impact, inflation.

Inflation in the US peaked a few months ago, and it increasingly looks like that might now be the case for Europe as well.

Remember inflation slowing is currently a function of demand destruction both in the West, and in China with their Zero Covid policy and lockdowns. Should China come back online that may add some pressure to inflation again, but otherwise we should expect it to decline from here.The pace of that decline will depend on the rate of economic contraction. Inflation is a lagging indicator, just like jobs, in a slow down they are the last turn.The current narrative is that lower inflation means the Fed will pivot. But as opposed to listening to mainstream media and their narratives ask yourselves whether you think pausing at the highest interest rates in almost 2 decades is pivoting?

At the end of the day it is not a matter of opinion, if you ask me they have already done too much and if they want to avoid a major economic downturn they need to stop now.But the Fed sees it otherwise and we have to deal with that.

The other thing to bear in mind is that when they are eventually forced to ease, which will happen, if they only cut by only 25 or 50bps lots, you know how long it is going to take for the benefit of that to show up into the real economy?

You guessed, at least 6 months, so we are talking 2024 folks.

So keep calm, take it easy, and don’t chase.

The reflexive part of the cycle has begun.

Thank you for reading,

Antonio

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