Recession or stagflation?

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Author: Qinghe President wechat official account: zhibenshe (id:zhibenshe0-1)

On the night of July 5, international crude oil plummeted, and anxiety about the global economic recession increased significantly.

WTI crude oil index fell 10% and fell below $100 a barrel during the session. The European oil and gas index fell 6%, the largest decline since June 2020. Gold fell 2.46%, breaking through 1770 in the session. Copper, zinc, aluminum and other metal futures, soybean, wheat, palm oil and other agricultural products futures, fell one after another.

The dollar index hit a new high, hitting 106.79 in the session; U.S. stocks fell first and then rose, while European stocks generally fell; US Treasuries and European Treasuries rebounded significantly.

Now, the global macroeconomic trend has reached a critical juncture: is the European and American economies in recession? Recession or stagflation? How will the Fed operate? How does the price of financial assets change? What is the impact on China’s exports and the RMB price?

Logic of this article

1? Recession anxiety or stagflation anxiety?

2? Inflation risk or debt risk?

3? Continue to tighten, or turn loose?

[6000 words in the text, 20 ‘reading time, thank you for sharing]

Recession anxiety or stagflation anxiety?

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First, explain the relationship between asset price changes and recession anxiety. The core is to grasp the relationship between crude oil and economic trends.

Crude oil prices are highly correlated with the expectations of the real economy. Crude oil is the main fuel for aviation, shipping and industry, and the price of crude oil is a barometer of changes in the demand for industrial consumer goods and services. When the economy declines and consumption shrinks, crude oil futures prices take the lead in falling; The contrary is true.

The decline in crude oil prices in 2018 is of reference significance for the present. In the second half of that year, the Federal Reserve raised interest rates aggressively, and the federal interest rate rose to 2.5%, triggering concerns of economic recession. Since October, the price of crude oil has fallen rapidly, from $76 to $45 in three months. Crude oil prices recovered slowly in 2019 and remained at $50-60. In March 2020, the global pandemic of COVID-19 caused a large-scale interruption of international aviation, shipping and production supply, a precipice of demand fell, and the price of crude oil plummeted to $6. Immediately after the “unrestricted” rescue by the Federal Reserve, crude oil prices rebounded and continued to rise as the economy gradually recovered.

The recession anxiety in the last month is similar to that in the fourth quarter of 2018. The difference is that the inflation rate and debt ratio are much higher, and they are also affected by the war.

Today, the interaction between high inflation in the United States and the aggressive interest rate hike by the Federal Reserve has triggered concerns about economic recession. The logic is that inflation remains high, the expectation of the Federal Reserve’s continued aggressive interest rate hike increases, market interest rates continue to rise, market investment and consumption are restrained, and economic growth declines; At the same time, stock and bond prices fell sharply, increasing the risk of government and corporate debt, and the economic recession superimposed financial risks.

We can look at some of the latest economic indicators in the United States.

On July 1, the ISM Association released that the ISM manufacturing index of the United States in June was 53, significantly lower than the expected 54.5 and 56.1 in the previous period, the lowest since June 2020. What does this mean? Two contents: first, the U.S. manufacturing index is still above the boom and bust line and is still expanding; Second, the downward trend is relatively strong, and the demand for commodities slows down. Among them, the new order index and employment index have entered the contraction range. In addition, the UK manufacturing PMI recorded 52.8 in June, the lowest since June 2020; The final PMI value of new manufacturing orders in the euro zone recorded 45.2 in June, the lowest since May 2020.

The production index of the United States is still booming, and the decline of the manufacturing index is mainly affected by the slowdown in demand. Let’s look at the consumer confidence index. The consumer confidence index of the US Chamber of Commerce in June fell sharply to 98.7 from 103.2 in May, the lowest level since February 2021; The consumer expectation index fell sharply to 66.4 from 73.7 last month, the lowest level since 2013.

The United States is a consumer economy, and the decline in consumer confidence will directly lead to economic recession. In the past two months, American households have appropriately reduced consumption and increased savings to cope with uncertainty. Data showed that the US savings rate rose to 5.4% in May, the highest level since February.

Let’s look at investment. Us April s& After the quarterly adjustment, the housing price index of p/cs20 major cities rose by 1.77% month on month, while it soared by 21.23% year-on-year, a record increase; The national housing price index rose 20.4%, lower than the 20.6% increase in March.

Since the second half of last year, U.S. real estate investment has been very hot, but the above data is in April. With the aggressive interest rate hike of the Federal Reserve, the market interest rate rose rapidly, and the 30-year fixed mortgage rate rose to 5.81% at the end of June, the highest since 2008. Such a high market interest rate will inhibit real estate investment and physical investment in the United States.

Finally, look at the unemployment data. Employment in the United States is hot this year, and the unemployment rate fell to a record low. However, the number of unemployed rebounded in June, and the average number of initial jobless claims rose to 223500 in four weeks, the highest since the end of January. JPMorgan Chase and other large companies tend to be pessimistic about economic forecasts and announced layoffs.

In addition, the search popularity of the word “recession” in Google exceeded the peak in 2008.

By the end of June, the U.S. economy could be defined as “recession” from the perspective of macroeconomics, that is, the real GDP fell month on month for two consecutive quarters. The first quarter fell month on month, and the probable rate in the second quarter fell month on month. According to the gdpnow model, which tracks economic data in real time and continues to make adjustments by the Federal Reserve Bank of Atlanta, economic output shrank by 2.1% in the second quarter of this year.

However, the definition of “cooling” may be more accurate in the first half of the year. After all, the growth rate of real GDP in the first quarter was 4.2%; In June, the manufacturing index was still above the critical point, in an expanding state; The job market is still hot. However, various economic indicators show that the economic recovery has entered a turning point, peaked and declined.

Will the US economy continue to decline in the second half of the year?

The latest annual assessment report released by the International Monetary Fund (IMF) significantly lowered the US economic growth forecast: the growth forecast for 2022 was lowered from 3.7% to 2.9%, and the growth forecast for 2023 was lowered from 2.3% to 1.7%. Strictly speaking, the growth rate of 2.9% is not a bad performance for the U.S. economy.

At present, the biggest question is recession or stagflation?

Recession and stagflation are completely different economic phenomena. Recession refers to the overall decline of macro economy, the decline of consumption, investment, employment and income data, and the simultaneous decline of GDP and inflation rate; Stagflation is the economic downturn, the unemployment rate rises, but the inflation rate remains high.

According to the data released by the Bureau of economic analysis (BEA) of the U.S. Department of Commerce, the personal consumption expenditure (PCE) price index rose 6.3% year-on-year in May, with an expected 6.4% and a previous value of 6.3%. The core PCE price index excluding energy and food, which the Fed is most concerned about, rose 4.7% year-on-year, with an expected 4.8% and the previous value of 4.9%.

This shows that in the first half of the year, the U.S. economy was in a stage of cooling and rapid inflation. In the second half of the year, if economic growth continues to decline, will inflation also decline, as in the 1970s.

According to the prediction of the Federal Reserve’s interest rate meeting in June, the US economy showed a stagflation trend in the second half of the year. The Federal Reserve report lowered the real GDP growth rate in 2022 by 1.1 percentage points to 1.7%; Raise the unemployment rate forecast for 2022 by 0.2 percentage points to 3.7%; The year-on-year growth rate of PCE in 2022 was raised by 0.9 percentage points to 5.2%, and the year-on-year growth rate of core PCE was slightly increased to 4.3%.

Among them, the biggest uncertainty may be the international oil price. If the U.S. economic recession is expected to increase, to what extent will oil prices fall? If the international oil price falls below $65 as demand decreases – the level in the first half of 2021 and 2019, big inflation will also disappear. If the international oil price remains above $80, inflation will remain at a certain high level.

This depends on how much of this round of oil price rise is caused by overheated demand and how much is caused by war and supply disruption.

The Federal Reserve of San Francisco analyzed more than 100 goods and services in the personal consumption expenditure price index (PCE) of the United States for more than 30 years. The research results showed that the contribution of supply drivers to inflation was 2.5 percentage points higher than the average level before the epidemic, while the demand drivers were 1.4 percentage points higher. In other words, they believe that half of the big inflation in the United States is caused by war and supply disruptions, and only one third can be attributed to demand growth.

If this study is reliable (without throwing the pot), economic recession can reduce the demand for oil prices, but the impact on oil prices and inflation is relatively limited; If the war and sanctions remain unchanged, oil prices and inflation will remain at a certain high level, and stagflation will appear in the second half of the year.

Inflation risk or debt risk?

02

Recession or stagflation, this judgment is very important. From the perspective of investment, the asset price trends corresponding to recession and stagflation are different.

In the second half of the year, if the U.S. economy declines, the dollar index will gradually decline, the prices of energy such as oil will fall, precious metal commodities such as gold will fall, the bulk prices of agricultural products such as grain will also fall, and the inflation rate will fall; Treasury bonds rebound, stocks may rebound at the bottom, and bitcoin and digital currency rebound. In this way, the “dual core” impact is relieved.

Why did treasury bonds rebound and stocks hit the bottom?

Expect to go ahead. If inflation declines with the economic recession, the expectation of the Federal Reserve to cut interest rates and quantitative easing increases, the liquidity of the financial market increases, quantitative easing directly purchases treasury bonds, the price of treasury bonds rebounds, and stocks will also rebound. Since 2009, the price of US stocks has deviated from the real GDP, and the rise of US stocks is mainly stimulated by the easing policy of the Federal Reserve. In this way, the debt risk is temporarily mitigated.

However, there is a premise for this judgment, that is, “inflation declines with the economic recession”. If the economy is in recession and inflation is still high, this is stagflation. Under stagflation, how do asset prices go?

In the second half of the year, if the US economy stagnates, the US dollar index will maintain a certain strength, and the prices of oil, gold, grain and other bulk commodities will decline but remain high; Government bonds fell and fluctuated, stocks fell and fluctuated, and bitcoin and digital currency were in the doldrums. In this way, the “dual core” impact is still online.

Why don’t stocks and bonds rebound during stagflation?

This is also related to the operational expectations of the Federal Reserve. Stagflation means that inflation remains high, which restricts the fed from implementing easing policies. On the contrary, if inflation becomes rigid, the Federal Reserve has to maintain high interest rates, thereby curbing the expectations of rising stocks and treasury bonds.

However, if stagflation occurs this time, compared with the 1970s, the performance of “inflation” has not changed much. In addition to economic recession and rising unemployment, the “stagflation” also superimposes debt risk. It can even be said that the biggest risk is debt risk.

Since 2008, the U.S. economy has experienced a financial crisis and epidemic crisis, with large-scale market clearing and violence to leverage; At the same time, the federal government and the Federal Reserve rescued the market twice, and the leverage of households and enterprises was transferred to the government. At present, the balance sheets of American households and enterprises are relatively healthy, and the debt ratio is low. The main risk lies in the federal government, and the debt ratio of the federal government has increased significantly. If there is a stagflation crisis, the risk of the U.S. real economy will be lower, and the damage to the balance sheets of households and enterprises will be smaller; Financial markets are more risky, especially bond and stock markets. In the second half of the year, we need to pay high attention to debt risk. On the whole, the risk of European debt and Japanese debt is greater than that of American debt.

The yield of U.S. 10-year Treasury bonds hit a peak of 3.49% in the first half of the year, the highest in nearly 20 years; In the past month, due to the anxiety of economic recession, it fell to around 2.8%, and the pressure on US debt eased. The possibility of substantial default risk of U.S. debt is very low. The biggest risk comes from the depletion of liquidity, the sharp rise of market interest rates, and the impact on the entire financial market, similar to the liquidity crisis in September 2019. At that time, there was no inflation risk in the United States, and the Federal Reserve quickly expanded bond purchases and cut interest rates to save the bond market and financial markets. However, if the bond market encounters liquidity risk under inflation, how should the Fed operate?

The risk of European debt has been warned. In the first half of the year, the European Central Bank remained loose and European bonds were relatively stable; However, after the announcement of the interest rate hike plan in July in June, bond yields of European countries soared one after another. The yields of 10-year Treasury bonds of Italy and Greece both exceeded those of the United States, significantly exceeding those of Germany and France, and Spanish treasury bonds also fell sharply; Both reached or approached the level during the European debt crisis in 2012.

We can look at a key index, namely the difference between the yields of 10-year bonds of Italy and Germany. This index is regarded as a “barometer of European debt risk”. When the yield difference between the two countries reaches 2.5%, it means that they have entered the danger zone of the European debt crisis. At present, what is this index? In June, it was once expanded to 2.4%, just a step away from the dangerous area.

Worse, the debt ratios of Italy and Greece are much higher than those during the European debt crisis. The country with the highest public debt ratio in the world is Japan, followed by Greece, whose government debt reached US $396.8 billion, with a debt ratio of 181.1%; The third is Italy. Italian government debt is 2749.8 billion US dollars, with a debt ratio of 132.7%.

Since 2012, the European Central Bank has implemented super loose policy for a decade, and the debt foam is getting bigger and bigger. The so-called mountain rain is coming, and the wind is blowing all over the building. This time, before the European Central Bank raised interest rates, Italian and Greek government bonds trembled and swayed. Recently, the global economic recession is expected to increase, European bonds have rebounded as a whole, and the risk has decreased, but the contradiction is still acute. European debt risks are superimposed on inflation. Will the European Central Bank still insist on raising interest rates?

The risk of Japanese debt also appeared. The “June 15” short event challenged the Bank of Japan. The Bank of Japan insisted on extreme quantitative easing, purchased unlimited treasury bonds, and controlled the yield of 10-year Treasury bonds within 0.25%. Compared with Europe and the United States, Japan’s inflation rate is low, but the sharp fall of the yen has hampered the easing operation of the Bank of Japan. Some international capital believe that the Bank of Japan will not be able to bear the consequences of the yen rout and will eventually have to give up the yield curve control to save the yen, so Japanese government bonds may fall in retaliation. As a result, the Bank of Japan, caught in a dilemma, has become a counterparty to international capital, which is shorting Japanese government bonds. The Bank of Japan hopes to see the U.S. economy decline, inflation decline, the dollar callback, the yen rise, so as to carry out easing to the end.

If stagflation occurs in the second half of the year, the United States and Europe will face both inflation risk and debt risk. The risk of stagflation has evolved from the deviation between inflation and employment in the past (Phillips failure) to the contradiction between inflation and debt. The dollar and oil remain at a certain high level, and the “dual core” impact has not been lifted.

How should the central bank operate?

Continue to tighten, or turn loose?

03

If you choose between recession and stagflation, the Federal Reserve, the European Central Bank and the Bank of Japan are willing to choose recession.

In fact, modern central banks are not afraid of recession. If the economy declines simultaneously with inflation, it is in line with the operational logic of modern central banks (Keynesian Monetary Policy), that is, the headwind flies. If the recession reaches a certain extent and the long-term inflation rate is less than 2%, the central bank will implement loose policies.

However, stagflation will break the operational logic of modern central banks and restrict monetary policy. In the era of stagflation in the 1970s, it was difficult for the Federal Reserve to achieve the dual mission of inflation rate and employment rate at the same time; In the next round of stagflation, it is difficult for the Federal Reserve to balance inflation risk and debt risk. If the interest rate is raised to control inflation, but the debt risk rises; Stop raising interest rates to mitigate debt risks, but inflation will continue.

In fact, the Fed is now implementing the most aggressive tightening policy in nearly 28 years. In June, the interest rate was raised by 75 basis points, and the target range of the federal funds rate rose to between 1.5% and 1.75%. Is there another 75 basis points in July?

The interest rate will probably increase by 75 basis points. Although the rise of personal consumption expenditure (PCE) price index and core PCE price index weakened in May, and may decline month on month due to the decline of oil prices and commodity prices in June, interest rates may remain strong in July. Why?

Compared with Europe, a considerable part of inflation in the United States is caused by the excessive issuance of money by the Federal Reserve, which leads to overheating demand. In the two years since the epidemic, the US financial subsidies have increased by $2.5 trillion compared with those before the epidemic, which has prompted us households to have an “excess” disposable income of $1.4 trillion. At present, the retail scale has been 28% higher than that before the epidemic, while the production is only 4% higher than that before the epidemic when the employment rate is quite high, which shows that the demand is overheating significantly more than production can support.

Therefore, it is the responsibility of the Federal Reserve to continue to raise interest rates to curb inflation caused by overheated demand. It is expected that the federal funds rate will exceed 3% by the end of this year. This will be the highest level since 2008. Can the current financial market, especially the bond market, still bear the 3% federal funds rate?

If the federal funds rate rises to 3%, the market long-term loan interest rate may exceed 6.5%, investment loans and consumer loans will decline, and demand will fall significantly. The Federal Reserve will reduce the inflation rate to a certain level. For example, by the end of this year, the PCE and core PCE will be reduced to between 5% and 4%, and then act according to the risk of US bonds and oil prices. If the oil price is still above $80 and the war and sanctions continue, the Federal Reserve will not force oil prices and choose to slow down the intensity of interest rate hikes and table contraction; If the risk of U.S. debt increases, the Federal Reserve will also slow down the tightening policy; If the U.S. debt liquidity crisis and inflation occur at the same time, the Federal Reserve may take alternative distortions, while maintaining a certain interest rate to curb inflation, while opening bond purchases to save the bond market.

Look at Europe. The situation in Europe is different from that in the United States. Last year, the inflation rate in Europe was not high. In other words, the overheating of demand caused by excessive currency has little effect on European inflation. On the contrary, before the war this year, inflation in Europe began to soar rapidly. Inflation in Europe is mainly determined by oil prices, and oil supply constraints have pushed up prices, which is the so-called cost driven inflation (this definition is inaccurate).

Without this war, there may be no inflation in Europe this year, and the European Central Bank will maintain loose policy. Conversely, the European Central Bank began to raise interest rates in July. Can the tightening policy curb supply constrained inflation? Can tightening policies reduce oil prices?

If the interest rate hike inhibits investment and consumption, and the demand for oil and commodities decreases, part of the inflation rate can be reduced, but the range should be smaller than that of the United States. As long as the war and sanctions continue and oil prices remain high, it is difficult to ease the inflation rate in Europe. The inflation rate in Britain exceeded 9% in May and that in the euro zone reached 8.6% in June. The demand for oil and natural gas increased at the end of the year, and the inflation rate may continue to rise.

This is the problem of Europe and the European Central Bank. Interest rate hikes have limited effect on curbing inflation, and inflation without interest rate hikes has become increasingly rampant; Unfortunately, raising interest rates may also trigger a new round of European debt crisis. The European Central Bank is expected to raise interest rates by pegging Italian, Greek and Spanish bond yields. If the risk of treasury bonds is too great, the European Central Bank will take a distorted operation, that is, while buying bonds, while raising interest rates. On the whole, the European Central Bank will not raise interest rates aggressively. European inflation issues are more likely to be resolved politically, including Russia’s foreign policy and increasing oil purchases by OPEC countries.

Although treasury bond futures were short, the Bank of Japan still guaranteed treasury bonds, even at the expense of the yen. This operation is equivalent to playing a clear card. The world knows that the Bank of Japan will control the Treasury bond yield below 0.25%. In times of crisis, such a central bank is easy to become the opponent of short selling institutions. In the past, such “widow trading” failed repeatedly. Can the Bank of Japan win this time?

Recently, the economic recession in Europe and the United States and the decline in oil prices are good for the Bank of Japan. This year, the yen was the hardest hit area hit by the “dual core” impact. As an energy poor and importing country, the decline of international oil prices can curb the rapidly rising inflation rate and reduce the pressure of yen depreciation. As long as the yen does not fall sharply, the Bank of Japan will buy bonds to the end. However, if the oil crisis continues, the Bank of Japan will fall into difficulties and take alternative distortions to save the yen and protect the national debt.

In conclusion, inflation risk is the result of loose policy, and it is also the possibility of ending loose policy. Debt risk is the result of loose policy, and it is also the possibility of ending tightening policy. When inflation risk and debt risk erupt at the same time, the central bank does not know whether to maintain easing or tightening. The distorted operation of the central bank is essentially a helpless structural easing policy. In fact, the major central banks all over the world hope that the Federal Reserve will raise interest rates slowly, or even cut them instead. In this way, the global economy continues to support debt with debt and cover the big foam with a bigger foam. But the foam is ultimately a foam. The distorted Central Bank tries to play the God of saving the world, and it is the source of everything.

Finally, let’s talk about China. China’s financial cycle is contrary to that of Europe and the United States. China now maintains loose liquidity, and the Federal Reserve is aggressively raising interest rates. If the European and American economies decline and consumption and imports decrease, China’s exports will also decline, and the pressure of RMB devaluation will drop; At the same time, the prices of upstream energy and raw materials will also fall, easing the price distortion that has lasted for two years.

Of course, the first problem for China’s economy at present is how to get rid of the epidemic as soon as possible, which is the primary task of macroeconomic recovery and the return of people’s lives to the right track. Solve the epidemic as soon as possible!

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