Nicholas Glinsman | January 20th, 2022
· Fed Needs to Regain Control of Policy Narrative
· Some interesting market questions posed, with thoughts offered in response
· Ocean freight rates likely staying tight throughout 2022, according to Flexport
· New job postings are still rising
· Credit and debit card spending, aggregate demand and inflation
· Will Putin cut off the gas to Europe?
Fed Needs to Regain Control of Policy Narrative
All we see at present is an increasing number of talking heads and analysts discussing the Fed’s next steps. Such chatter underscores the urgent need for the US central bank to regain control of its policy narrative. This can only happen if officials explain why they appear to have underestimated the pace of price growth and quickly follow up with a credible response.
Meanwhile, S&P Global provide us with an interesting chart on the ability of companies to pass on their increasing costs. About two-thirds of sector analysts say that the companies they cover can easily, or somewhat easily, pass on their cost increases to end customers. Have a look:
Some interesting market questions posed, with thoughts offered in response
· How do policymakers respond to stubborn inflation if it coincides with slower growth?
This is very likely to be a policy dilemma if not by late 2022 then in 2023. After a monetary shock, the inflation slowdown tends to lag softer growth by 12 months, so there is considerable danger in this cycle that the side that is demand-led inflation, looks stubborn even as growth slows. At least while GDP growth is at or close to trend (probably just shy of 2%), there are good reasons to give precedence to inflation. If growth slips below trend and this is seen as likely to persist, the inclination will be to hit the policy tightening pause button.
· What are the chances of a 50bp incremental Fed move?
When policymakers can see far ahead and see that multiple rate hikes as very likely, there is a strong argument that they should lift rates more quickly and potentially by larger increments, including at the start of the cycle. But in the likes of the 1994 and 2000 cycle, it was later in the cycle that policymakers were frustrated and tightened by larger increments to finally gain traction. This time the Fed is playing catch-up and is far behind the inflation curve, so the case for a larger incremental moves early in the cycle is more persuasive than ever, even if it is tantamount to admitting a policy mistake. Watch for any Fed considerations of larger incremental moves, but so far comments strongly favor gradually tightening the monetary screws in 25bp increments until it gains traction. What could change that? A still robust economy with inflation proving much more stubborn than expected in H2.
· What are the preconditions for a stronger USD surge?
Ideally there are four elements at hand:
a) short-term nominal and real interest rates linked to expected Fed policy continue to surprise to the top side. The cost of hedging USD assets goes up and favours unhedged capital inflows.
b) the back-end of the curve starts to prove more resilient i.e. the curve flattens, and attracts fixed income inflows;
c) risk negativity draws capital away from the high beta currencies; and perhaps
d) an emerging USD cross border shortage shows up in metrics like basis swaps.
Of these factors a) and b) are very likely, c) should be there in some lukewarm form; d) is unlikely in the next year or more, given current excess liquidity. There is still enough here to keep the USD bid.
· Is Gold telling us anything?
While there are said to be ETF rebalancing flows, the geopolitcal concern as they relate to the Ukraine, are creating an underlying bid. If the geopolitical concerns dissipate, gold should start to respond to higher US real rates, much like other currencies. That real rates are still so negative, possibly is acting as an additional cushion for XAU. Gold is going to be a good measure of Fed credibility. In the gradual hiking on 2004-6, gold still went up, which was a sign policy was too easy even as it tightened!!
Ocean freight rates likely staying tight throughout 2022, according to Flexport
Extremely strong US import demand has been the key driver behind the ocean freight boom. This US import boom has placed extreme strain on the entire logistics network causing congestion across ports, inland rail, warehouses and equipment. Flexport’s Ocean Timelines Indicator shows a more than doubling in shipping time from Asia to US at more than 100 days.
Flexport sees supply/demand fundamentals staying tight until 2023. New vessel deliveries will be low in 2022, while there is a high likelihood that the US import boom persists given a strong US consumer and ongoing inventory build (inventories still low, could see structurally higher inventory buffer post COVID). US port congestion has showed no real signs of improvement, and US west coast port labour negotiations from mid-2022 could also drive additional disruption with a quick agreement unlikely.
Pre Chinese New Year forward bookings generally robust, but a little freight rate softness has emerged in recent days. Post Chinese New Year is likely to see a minor dip that could last a little longer than usual as newer players are reluctant to cut capacity. But spot rates likely to broadly hold around these levels through most of 2022. And while spot rates will eventually crack, freight rates are unlikely to fall to pre COVID levels in the coming years given higher cost structures particularly around vessel charters.
Finally, 2022 annual contracts look on track to increase by 2-3x 2021 levels across all key trade lanes including backhaul. Liners are allocating less capacity to contract versus spot given expectations of another capacity constrained year. Some liners are signing multi-year contracts (no more than 5-7% of market) with contracts now better structured to ensure compliance. Tight market is also allowing liners to reduce benefits such as free time allowance and surcharge discounts.
New job postings are still rising
New job postings on Indeed have risen this year, breaking out of sideways range that began in the autumn 2021:
Credit and debit card spending, aggregate demand and inflation
Total spending was up $1.34 trillion (+18%) from 2020 to 2021, far more than prior years.
Total spending varies greatly by Equifax Risk Score (ERS), a proxy for socio-economic status.* ERS quintiles 1, 2, & 3 grew from 2019 to 2020 by 9%, 4%, & 2% respectively, while quintiles 4 and 5 declined by -1% and -6%. For 2021 spending was up substantially from 2020 for all quintiles (up by 18% to 19%).
The next two charts compare spending relative to 2018. Thus, 2019 can be seen as a “normal” reference point.
Lower ERS quintiles in 2021 had a larger percentage increase in spending compared to 2018.
All ERS quintiles had large total dollar spending increases from 2020 to 2021, ranging from $240 billion (Quintile 1) to $292 billion (Quintile 3).
Exiting 2021, total inflation-adjusted spending for Quintiles 1 and 5 are both running well above earlier levels (bold dots). This will help fuel aggregate demand and keep inflation at unacceptably high levels.
In part, we can attribute the current bout of inflation to the $0.8 trillion (+13%) increase in inflation-adjusted spending that has occurred from 2020 to 2021. This is a significant addition to personal consumption expenditures (PCE), as total spending accounts for about 45% of all PCE.
This was due to the effects of 3 different federal punch bowls, with differing impacts on the various quintiles:
(i) Monetary Punch Bowl — low interest rates and quantitative easing getting capitalized into higher house and stock market prices and creating trillions in new wealth (Quintiles 3, 4, and 5),
(ii) (ii) Housing Leverage Punchbowl — policies by Fannie Mae, Freddie Mac, and the FHA — (Quintiles 3 and 4), and
(iii) (iii) Pandemic Social Assistance Punch Bowl — trillions in various pandemic relief acts (Quintiles 1, 2, and 3).
The CARES Act (March 2020) was the first relief act, which allowed ERS Quintiles 1, 2, and 3 to quickly recover and then exceed pre-COVID spending levels on an inflation-adjusted basis (orange line). Other relief acts followed.
ERS Quintiles 4 and 5 took longer to recover (blue line). However, by early 2021 spending was growing rapidly due to the wealth effect. The stock market has gained $15 trillion and home equity has gained about $7 trillion since the end of 2019. Research indicates that annual spending increases by about 3 cents for each dollar of increased wealth.
Note: For simplicity, quintiles 2-4 are not shown in the below chart.
Will Putin cut off the gas to Europe?
We are reaching a dramatic climax in the standoff between Russia and Ukraine. Russia is now in a position where it is militarily and politically ready. Vladimir Putin has got the troops where he needs them to be: in Belarus to the north, and in Russia along the border with Ukraine. He has got the backup logistics in place. And, more importantly perhaps, he is ready to take any hit on international sanctions. He has first-rate intelligence about what the Europeans are likely to do, or more likely what they are not going to do. A smaller but agile power can prevail in conflicts with a larger but disunited opponent. Putin thinks he can win this war. This is not an irrational belief, as some complacent western analysts are thinking. The biggest problem for Putin is not so much the likely sanctions from the west, but the political consequences of a dirty war back home. Ukraine has a formidable army of some 100,000 troops, and several hundred thousand reservists and army veterans. This would not be a walkover, but a real war.
Joe Biden said last night that it looks like Putin will go in. There will be a last minute diplomatic effort tomorrow. According to the Centre for Strategic and International Studies, Putin has three access routes into Ukraine: a northern thrust, coming from Belarus towards Kiev; a central thrust, east-west; and a southern thrust, alongside the Black Sea coast. We agree with his main conclusion that the west must not allow him to annex Ukraine. This would massively raise Russia’s industrial capacity, natural resources and its military strategic capacity. And as we keep writing, it would cause havoc to a disunited EU.
According to French site Telos, Putin acts with visible emotion on this point, and is seeking to accomplish a historical mission. There is an element of truth to that statement, but be careful not to misinterpret Putin’s emotional state of mind. What he is doing is not strategically irrational, so long as he is willing to do what it takes. He needs to keep Europe divided, and the only way to do so is to blackmail the EU over gas supplies. Nord Stream 2 is not even the main issue. He could cut off supplies via the Ukraine transit network, and reduce throughput through the other pipelines, including Nord Stream 1. The article also makes the point that Putin is not really interested in the Donbas region. This is about Ukraine.
It is worth pondering on the degree to which Europe is dependent on Russian gas.
For Europe, liquid natural gas deliveries from the US can provide some relief, but they are no replacement. Russia accounts for some 42% of European gas imports, compared to about 30% ten years ago. This is to a large extent the consequence of Europe’s exit from nuclear power. LNG imports makes up 23%. Its share has been rising, but there is no way it can plug the gap in the short run. If Putin were to decide to end all deliveries, it would be lights out and no heating fuel in some parts of Europe, especially in Germany. Reading the German media, we gaze in wonderment at assertions that it is Russia that is dependent on Germany as its largest customer, not the other way round. It will be interesting to see what happens if you put that theory to a test.
This is why Germany is sitting on the fence in this conflict. A Russian annexation of Ukraine is not the worst case scenario from a German perspective. A long-drawn-out war, and western military support for Ukraine is. There is a direct link between Angela Merkel’s fateful decision to bring forward the end to nuclear power to this year and her veto of Nato weapons exports to Ukraine. Germany’s unilateral exit from nuclear power constituted one of the strategically most important events this century. It was the decision that turned Russia once again into a global power.