It’s Wednesday, and so I have some shorter analysis on a range of matters today. First, some discussion of a technical paper from the US Federal Reserve researchers, which makes it clear they think that the interest rate hikes have a high probability of causing a recession. Second, we analyse some Russian data which suggests the sanctions are having the opposite effect to that intended. Third, I consider the stupidity of the new Australian government which is now falling into the ‘we have too much debt’ to even provide basic health care trap. And, I comment on a State Government that is now openly ignoring its professional health advice because the corporate sector told them to. And if all that wasn’t depressing enough, some music that focuses our attention of the vicissitudes of colonial might. All in a day.
No doubts about what the US Federal Reserve is up to
The US Federal Reserve Bank released a FEDS Note yesterday (July 12, 2022) – Monetary Policy, Inflation Outlook, and Recession Probabilities – which gave us more detailed insight into what they expect the consequences of their irresponsible interest rate hikes to be.
The discussion is somewhat technical but can be distilled as followed.
I wrote about inverted yields curves in these blog posts (which you can use as reference for this discussion):
2. When does no evidence mean no evidence? (November 10, 2010).
3. Time to outlaw the credit rating agencies (December 23, 2009).
4. Operation twist – then and now (March 31, 2010) – with a video.
Basically, the yield curve is a graphical depiction of the term-structure of risk-free interest rates and plots the maturity of the government bond on the horizontal axis against the respective yields (return) on the vertical axis. We can use the term maturity and term interchangeably.
The yield indicates the money that will be returned from the investment and is usually expressed in percentage terms (see above blog posts for more detail).
What determines the slope of the yield curve?
- Normal – Under normal circumstances, short-term bond rates are lower than long-term rates. The central bank attempts to keep short rates down to keep levels of activity as high as possible and bond investors desire premiums to protect them against inflation in longer-term
maturities. Combined, the yield curve is upward sloping.
- Inverted – Sometimes, short-term rates are higher than long-term rates and we say the yield curve is inverted. The usual events which lead to an inverted yield curve are that the economy starts to overheat and expectations of rising inflation lead to higher bond yields being demanded. The central bank responds to building inflationary pressures by raising short-term interest rates sharply. Although bond yields rise, the significant tightening of monetary policy causes short-term interest rates to rise faster, resulting in an inversion of the yield curve. The higher interest rates may then lead to slower economic growth.
- Flat – A flat yield curve is seen most frequently in the transition from positive to inverted, or vice versa. As the yield curve flattens the yield spreads drop considerably. A yield spread is the difference between, say, the yield on a one year and a 10-year bond. What does this signal about the future performance of the economy? A flat yield curve can reflect a tightening monetary policy (short-term rates rise). Alternatively, it might depict a monetary easing after a recession (easing short-term rates) so the inverted yield curve will flatten out.
There are various theories about the yield curve and its dynamics. All share some common notions – in particular that the higher is expected inflation the steeper the yield curve will be other things equal.
The basic principle linking the shape of the yield curve to the economy’s prospects is explained as follows.
The short end of the yield curve reflects the interest rate set by the central bank.
The steepness of the yield curve then depends on the yield of the longer-term bonds, which are set by the market. But the short end of the curve is the primary determinant of its slope.
In other words, the curve steepens mainly because the central bank is lowering the official cash rate, and it flattens mainly because the central bank is raising the official cash rate.
Bond traders link the dynamics of the yield curve to their expectations of the future economic prospects. When the yield curve flattens it is usually accompanied by deflation or steady and low inflation and vice versa.
The Federal Reserve article notes that:
An inverted yield curve … is a powerful near-term predictor of recessions.
The following graph shows the US yield curve for various dates up until July 12, 2022.
It is not yet inverted as the shorter rates are still lower than the longer rates.
But the dynamic is certainly heading in the inverted direction.
The Federal Reserve article prefers to look at a different indicator (derived from the yield curve) – the so-called “nominal near-term forward spread (NTFS), given by the difference between the six-quarter-ahead forward Treasury yield and the current three-month Treasury bill rate”.
They say that movements in this statistic can help predict recessions – because it is:
… an informative gauge of market-participants’ expectations about future near-term monetary policy actions, such as the raising and lowering of the federal funds rate by the Federal Reserve. Thus, it carries information about current and near-term real interest rates, future expected inflation, and the interest rate forward risk premium (or term premium), which in turn are linked to expectations of future business cycle outcomes.
The forward rate is a measure of the expectations of the market participants of what is likely to be the interest rate situation at that maturity.
So changes in this forward spread are meant to reflect by changes in the market participant’s expectations for the trajectory of interest rates set by monetary policy over the next 6 quarters.
So a rising NTFS suggests that the market is expecting rates to be higher in the period ahead and vice versa.
A negative NTFS suggests that market participants think monetary policy is going to ease and vice versa.
This, in turn, suggests the investors think a recession is nigh, which will force the central bank to cut interest rates.
So when the NTFS is low, there is a chance of a recession emerging.
That is the theory at least.
The article itself is very technical so I won’t summarise that part.
The results of their statistical work are as follows:
1. “While the NTFS is currently positive, market participants anticipate further monetary policy tightening in the upcoming months.”
2. “If such interest rates hikes indeed materialize, they could result in a lower NTFS and thus an increase in recession probabilities. ”
3. The data shows that “the NTFS does not currently forecast a recession”.
4. “Going forward, however, the model expects monetary policy to become more restrictive, and thus it estimates a higher likelihood of a downturn.”
5. “In our baseline case, we forecast increasing real rates, a narrowing policy gap, and a 35% recession probability by the end of 2023.”
6. If the Federal Reserve tightens more than expected at present, then they predict this will be “at the cost of a higher downside risk for economic activity, as the one-year ahead recession probability approaches 60% by the end of 2023”.
So the number crunchers in the Federal Reserve Bank are in no doubt as to what the Monetary Policy Committee is up to.
It is clear they know that the monetary policy changes are likely to force the US economy into recession with rising unemployment and poverty rates.
It seems unconscionable that such a policy stance would be taken when there is no certainty that the policy levers actually can influence the inflationary pressures other than oil prices (which will be responsive to demand shifts).
Central banks are falling back into form.
It is a form that is destructive of prosperity.
Sanctions against Russia – recent evidence
On July 11, 2022, the Russian Central Bank released its latest – Balance of Payments data – which shows:
… widening of surplus in the balance on goods and services as a result of significant growth in exports driven by favorable market environment and a decline in imports …
The December-quarter 2021 current account surplus was $US41 billion and the June-quarter 2022 estimate is now $US70.1 billion.
A hefty increase.
Between the first-quarter and the second-quarter 2022 there was a small increase in the current account surplus ($US68.4 billion to $US701.1 billion) driven by a fall in exports ($US166.4 billion to $US153.1 billion) being more than offset by a fall in imports ($US88.7 billion to $US72.3 billion).
However, in the 12 months to the June-quarter 2022, the current account surplus rose from $US17.3 billion to $US70.1 – with exports up from $US127.9 billion to $US153.1 billion and imports down from $US93.2 billion to $US72.3 billion.
This chart is taken from their data release.
And here is the exchange rate evolution for 2022 (from January 3 to July 13, 2022).
Prior to the invasion, the exchange rate was steady with 1 USD buying around 75 to 76 roubles.
Then the sanctions hit and the rouble depreciated sharply against the US dollar – but only for 3 weeks or so from early March.
Since then it has appreciated strongly and is now selling at 1 USD for 58 roubles.
No currency collapse going on.
I have not had time to dig further into the micro details of the Russian economy as yet.
But these aggregates tell me that if the sanctions were designed to damage the Russian economy by choking off its external sector and dumping its currency, then the opposite has happened and that could be interpreted as failure.
Labor Governments in Australia losing the plot – again
On May 21, 2022, we finally got rid of the worst government in our history – the conservative coalition, which had become a climate change denying, do nothing government.
Hopes were somewhat elevated that things might be different.
But everytime the Treasurer talks now, we hear “we were left with a trillion dollars of debt”.
The Prime Minister also claims, whenever he is asked something – “we were left with a trillion dollars of debt”.
They are also pulling the stunt as they cut essential health care spending – on provision of RAP tests for low-income groups, the abandonment of isolation payments for people with Covid, the cessation of telehealth assistance to allow people (especially low-income workers) to access speedy health care, and more – that these were the policies of the previous government and “we were left with a trillion dollars of debt” so we cannot afford these things any longer.
Around 60 people die each day from Covid in Australia and our health system is starting to collapse.
Ambulances are ramping and red alerts are being announced (this is when an ambulance service cannot get a patient to hospital in time).
Infection rates are rising fast.
Death rates are rising fast.
Other health care needs are being abandoned because the hospitals are being overrun with Covid patients.
Long Covid statistics indicate an increasing number of people are finding they can no longer work.
Testing is being cut back.
And so on.
I had to turn the radio off this morning when the Treasurer was being asked to justify the cuts to these health care measures when Covid infections and deaths are rising massively.
He said – “we were left with a trillion dollars of debt and cannot afford these measures any longer”.
The statement is false.
There are no shortage of, for example, rapid antigen test kits for sale. So there is no real resource constraint.
The Australian government can buy whatever is for sale in Australian dollars whenever it wants. There is no concept applicable that says it can or cannot afford something.
Either something is available for sale in AUD or not.
They then claim that because RATs are cheaper now (down from $A24 or so to $A8) that the need to subsidise them is no longer there.
Tell that to a minimum wage worker who is on the borderline of poverty with basic food and other essentials rising in prices.
By abandoning these workers to the market the result will be – no tests!
No tests – means workers will go to work with Covid.
And that becomes even more likely as the isolation payment is also going to be terminated.
More people going to work with Covid – more workers sick – more people ultimately unable to work – and we will endure on-going shortages, late deliveries, food constraints etc.
Short-termism at its worst.
Then think about the announcement by the Victorian State Labor government yesterday.
Up until now, I have supported their handling of the pandemic with lockdowns when necessary etc.
They have also continually said they will take the advice of the health professionals, particularly the Chief Public Health Officer.
That Officer has become particularly alarmed at the hospital and ambulance situation in Victoria recently and indicated to the Health Minister that the government should reintroduce mask wearing mandates in indoor settings given the rapid rise in infection rates and sickness.
Yesterday, the Minister announced that (paraphrasing):
After consulting business, we have decided to ignore the health advice from the health care professionals and not mandate mask wearing or allow workers to work from home where possible.
1. The government goes to election in November and is obviously fearful of a backlash if a simple mask mandate for indoors is reinstated.
2. They are prioritising the greed of the corporate sector over the quality of public health care.
This is the first time a government in Australia has blatantly announced it is ignored the best health advice available.
At a time, when the deaths are rising and thousands are becoming sick, it is a disgrace.
They deserve to lose office for this.
Music – The Capital Sessions 1973
This is what I have been listening to while working this morning.
Here is Bob Marley and the Wailers at the peak of their skills.
This Billboard story tells us about the release – Bob Marley and The Wailers’ ‘Capitol Session ’73’: How the Lost Footage Came to Light.
1973 was the year the band, in this format, released their first studio album – Catch a Fire (released April 13 on Island Records).
After that release – Bunny Wailer (Livingstone) – one of the original Wailers with Marley and Peter Tosh, left the trio to begin a solo career.
The trio concept of – The Wailers – was giving way to having Bob Marley out front of a band.
This song was the title track of their first album – Catch a Fire. While it tells the story of slavery, which was a significant and depressing part of Jamaican history, the themes resonate today given the vestiges of colonialism and exploitation remain a major constraint on the progress of many nations, particularly in Africa.
By the time this US session (recorded in LA) came to fruition, the band consisted of:
1. Bob Marley – vocals and guitar.
2. Peter Tosh – vocals and guitar.
3. Earl Lindo – keyboards (the fabulous organ you hear).
4. Carlton Barrett – drums.
5. Aston Barrett – electric bass.
6. Joe Higgs – percussion.
This version of the Wailers broke up soon after and only Aston Barrett remains alive.
This video is magic because it was shot before they were successful among white audiences and had not yet become an ‘act’.
That is enough for today!
(c) Copyright 2022 William Mitchell. All Rights Reserved.