The US labour market is slowing down

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  • Is US employment data hot, ‘goldilocks’, or ‘cold’?
  • Have you been inundated by calls and messages with the question, “But have you seen the details of the Household Survey?”
  • Is the Fed right to keep aggressively hiking?

Summary: The US labour market is slowing down despite headline grabbing low unemployment rate and high wage growth rate. The recent details underlying this data show the total number of people employed growing below trend, fewer hours worked and lower quits rate. As a result, the growth rate of total earnings is also going down, the effect being a lower share of national income going to labour and total consumption as a share of GDP stagnating. All this should make the Fed further re-evaluate its aggressively hawkish interest rate policy.

The Household Employment Survey makes the headlines

After a couple of weeks of ‘SBF’ trending, I, for one, was happy to take my mind off to something much more prescient and important as far as my investments are concerned – the US employment situation. At first glance, the November NFP report came much hotter than expected but because the market did not really react the way one would have expected from such a strong report, we started looking for reasons why that was the case.

Which bought us to the US Household Employment Survey. ‘Us’ here does not mean us literally (for those of you who had followed my writings at 1859, there was plenty of discussion on this topic as soon as I spotted the divergence between the two employment reports in September). And this note is not on why the Household Survey is showing different things from the Establishment Survey.

If you want to, you can read zerohedge on this topic here (I know, think what you want but the folks there were one of the first to spot the issue way back in the summer). If you can’t bear some of the conspiracy language at zerohedge, you can read an inferior version (but still good!) of the same at the more balanced Macro Compass. Finally, there are quite a few respected people on Twitter who have talked about it (see here, here, here).

To give you the full  disclosure, there are some legitimate reasons why the Household Survey produces different results to the Establishment Survey – and they have to do with a methodology issue, see here. BLS is actually well aware of that issue and calculates a time series which reconciles the two surveys and which can be found here (also with a very, very extensive comparison analysis between the methodology of the two). This adjusted data does not look that bad as the stand-alone Household Survey data (the November data was actually very good). But over the last 6 months it still points to a weakening employment market, not a stable or even hot one as per the Establishment Survey.

OK, that’s more than I wanted to write regarding the Household Survey. The rest of the note will show why the US employment situation is actually weakening even taking the Establishment Survey as a base.

The three variables of employment

There are three aspects of employment in general as far as assuaging how hot the economy is doing: wages, people employed, and hours worked, i.e., we need to follow this sequence, purchasing power->consumption->GDP) Basically, one needs to know the full product of Wages X Total Employment X Hours Worked (assuming, of course, that wages are per hour worked; not all jobs pay per hour, but those that do have actually increased at the expense of the others – see some of the links above which discuss the prevalence of part-time jobs and multiple job holders).

The economy can be hot even when wages are flat, or even declining, but there are more people entering the workforce or there are more hours worked – there are multiple combinations among the three variables producing various results. The point is to consider all three variables.

Total number of employed is growing below trend

Let’s take the period in the last three years or so after the Covid crisis. Yes, wage growth has picked up, but more people have exited the labour force and there are fewer hours work.  

The labour force participation rate is still below the pre-Covid levels, and close to a 50-year low:

The total number of people employed has risen but, depending on whether one uses the Establishment Survey or the Household Survey, the number is either just above the pre-Covid levels or indeed below. In any case, regardless of which survey one uses, the number is still below trend (and has not been above trend since the 2008 financial crisis).

Higher wages but lower hours worked

Finally, here are wages and hours worked. I have included below a time series chart for only the last 3 years to be able to see better the divergence between the two: while wages continue to rise, hours worked peaked in January 2021 and have now reversed the spike in 2020.

Let’s focus more on the latest NFP report. Here are the relevant tables below.

  • Generally higher-wage industries, like goods producing, tend to exhibit a smaller increase in hourly wages than lower-wage ones, like services.
  • In some cases, like the Utilities sector, which has the second highest wage per hour but also the highest average weekly earnings (courtesy of more hours worked, more on this later), wages have actually declined.
  • Transportation and warehousing sector has an unusual jump in wages, about 5x the average rise in wages – is there something specific going on there?

The growth rate of total earnings is declining

It is important to look at the last columns in Table B-3 above, ‘Average weekly earnings’, which gives a much better picture of take-home pay as it combines wages with hours worked. So, while indeed the trend of declining 12m-growth rate of weekly wages was reversed with this latest report (back above 5%), which some commentators have warned the Fed should be worried about, the trend of declining total weekly earnings continues to be intact.

Note, average hourly earnings are still elevated, hovering at previous peaks but this is hardly a reason for the Fed to get more worried about, especially after already delivering the fastest interest rate hiking cycle in recent memory.

In fact, quite on the contrary. Despite all the excitement about the rise in wages, the share of national income going to workers has been on a decline, with the post-Covid spike now quickly reversed. We are back to the familiar territory of the low range post the 2008 financial crisis which is also the lows since the mid-1960s. If you were worried about a wage-price spiral issue, ala the late-1970s (I actually do not think there was one even back then as real wage growth even then was negative), you really shouldn’t be. It is a very different dynamic, at least for the moment.

Consumer demand as a share of GDP has been stagnant for more than a decade

And if you are really worried that consumer demand will push inflation higher, again, you shouldn’t be, necessarily: consumption as a share of GDP is elevated relative to historical records but it is not even above the highs reached more than a decade ago. In fact, it seems that consumption has not been an issue for inflation for at least the last two decades.

The quits rate is declining

One final observation, there is another labour data series which has been often cited as an example of a tight labour market: the quits rate.  I would though argue two things: 1) labour tightness explains only part of the elevated quits rate, and 2) the quits rate has already started declining.

A higher quits rate is quite consistent with an increasing share of lower paid jobs and with multiple job holders both of which have been trends seen post the 2008 financial crisis, and especially during and after the Covid crisis. It is possible to decompose the quits rates by industry and sector. For example, retail trade, accommodation, and food services, all of which are lower paid/temp jobs by multiple job holders, have much higher quits rates than the average across all industries. This is corroborated by a Pew Research report according to which most workers who quit their jobs cited low pay.

Finally, the quits rate actually peaked at the end of last year (notice the Household/ Establishment Employment Survey discrepancy started shortly after) at about 3%. This is the highest in the series, but the data officially goes back to only 2000. BLS has actually related quits rate data (but only for the manufacturing sector) prior to 2000 which shows that the quits rate has been above 3% in the past, and yes at above 3%, the quits rate is associated with the peak in economic expansion. You can see the full data set and BLS perspective on it here.

Bottom line: you do not need to believe in conspiracy theories about Household Survey vs Establishment Survey labour data inconsistency to conclude that the US labour market is far from tight. If anything, it has already started to slow down. Do not be confused by headline numbers of high wage growth rate and low unemployment rate, look at the overall employment picture taking into account trends in overall total compensation.  

Fed Funds peaks and UST yield curve inversions

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  • Either the peak in the Fed Funds rate is much higher, or the UST yield curve, 2×10, is too inverted. Whatever the case is, it’s extremely unlikely that the Fed eventually ends up cutting just the 150bps priced in at the moment.
  • Or to be more precise, unless there is a modern debt jubilee (a central bank/Treasury debt moratorium) or a drastic capital destruction caused by a total collapse in the global supply chains, continuation of war in Europe/Asia or a natural disaster (climate change, etc.), the Fed is more likely to pause the hikes next year, wait, and eventually cut by more than the 150bps priced in the market but less than in the past.
  • In other words, the shape of the current Eurodollar curve is totally ‘wrong’, just like it had been wrong in the previous three interest rate cycles but for different reasons.    

The current UST 2×10 curve inversion is pretty extreme for the absolute level of the Fed Funds rate. At -70bps, it is the largest inversion since October 1981 but back then the Fed Funds rate was around 15%. The maximum inversion of the UST 2×10 curve was -200bps in March 1980 when the Fed Funds rate was around 17%. The Fed Funds rate reached an absolute high of almost 20% in early 1981.

Back then the Fed was targeting the money supply, not interest rates, so you can see the curve was all over the place and thus comparisons are not exactly applicable. But still there were plenty of instances thereafter when the Fed moved to targeting the Fed Funds, and the Fed Funds rate was much higher than now, but the curve was much less inverted before the cycle turned.

Take 1989 when the 2×10 UST curve was around -45bps but the Fed Funds rate at the peak was around 10% (almost double the projected peak for the current cycle). The Fed ended up cutting rates to almost 3% in the following 3 years. Or take the peak in Fed Funds rate in 2000 at 6.5% and a UST 2×10 yield curve inversion of also around 45bps. The Fed proceeded to cut rates to 1% in the following 4 years.

Finally, take the peak in Fed Funds rate at 5.25% in 2006-7 and a UST 2×10 yield curve inversion of around -15bps. The Fed ended cutting rates to pretty much 0% in the following 2 years. In the 2016-18 rate hiking cycle, when the Fed Funds rate peaked at 2.5%, the UST 2×10 yield curve never inverted.

So, today we have a peak in the Fed Funds rate of around 5%, so comparable to the 2007 and 2000 cycles, but a much deeper curve inversion, more comparable to the 1980s. If we go by the 2000 and 2007 scenarios, the Fed cut rates by around 500bps; in the 1980s the Fed cut much more, obviously, from a higher base. In this cycle, if the peak is indeed around 5%, 500bps is the maximum anyway the Fed can cut. That is also the minimum which is “priced in” by the current curve inversion. But the actual market currently and literally prices only 150bps of cuts.

Again, neither of the past interest rate cycles are exactly the same as the current, so straight comparisons are misleading, but somehow, it seems that the peak Fed Funds rate today plus the current pricing of cuts in the forward curve do not quite match the current UST 2×10 curve inversion – either the peak is too low, or the curve is too inverted.

What I think is more likely to happen is the Fed hikes to more or less the peak which is priced in currently around 5% but it does not end up cutting rates immediately. The market is currently pricing peak in May-June next year and cuts to start pretty much immediately after; by the end of 2023 there are 50bps of cuts priced in.

In the last three rate cycles (2000, 2008, 2019) there was quite a bit of time after rates peaked and before the Fed started cutting. The longest was in 2007 – 13 months, then in 2019 it was 8 months and in 2000 it was 6 months. Before 2000 the Fed started cutting rates pretty much immediately after the end of each rate hiking cycle, so very different dynamics.

Here are how the Eurodollar curves looked about six months before the peak in rates in each of these cycles. The curve today somewhat resembles the curve in 2006, in a sense that the market correctly priced the peak in rates in 2007 followed by a cut and then a resumption of hikes. But unlike today, the market priced pretty much only one cut and then a resumption of hikes thereafter.  In the interest rate cycles in either 2000 or 2018 the market continued to price hikes, no cuts at all, and a peak in the Fed Funds rate not determined.

Source: Bloomberg Finance, L.P.

And here are how the curves looked after the first cut in each of these cycles (the colours do not correspond – please refer to the legend in the top left corner, but the sequence is the same – sorry about that). The market didn’t expect at all the size of cuts that happened in either of these cycles. Notice that the curve in the current cycle still does not look at all like any of the curves in the previous cycles (noted that in six months’ time, the current Eurodollar curve is also likely to look different from now, but nevertheless, there are much more cuts priced now than in any of the other three cycles).

Source: Bloomberg Finance, L.P.

The point is that the market has been pretty lousy in the past in predicting the trajectory of the Fed Funds rate.

  1. It is strange that the market never priced the pause in any of the actual past three interest rate cycles, and it is even stranger that it is not pricing it now either, given that there has been consistently a pause in the past.
  2. In none of the past three cycles did the market price any substantial cuts; in fact, we had to wait for the first actual cut for any subsequent cuts to be priced – that is also weird given that the Fed ended up cutting a lot.
  3. This time around, the market is pricing more cuts and well in advance but not even as close to that many as in the previous cycles.

However, I do not think we go back to the zero low bound as in the past three cycles. To summarize, the current UST 2×10 yield curve is too much inverted and the Fed would eventually cut rates more than what is currently priced in, but much less than in other interest rate cycles and after taking a more prolonged pause.   

The positive spin on China

It is not surprising that the comments and analysis on the recent protests in China have been overwhelmingly negative. Even Goldman Sachs which said China may end zero-Covid earlier than expected in Q1’23 put a negative spin (“disorderly exit”) and projected a lower-than-expected GDP in Q4’22.

There is no question that Chinese authorities are almost literally pressed to the wall with no easy options here. But what if there is a positive way out? It is no secret to anyone, including Chinese leaders, that there is a need to re-balance the economy towards domestic consumption and the best way to do that is to shift sectoral incomes towards Chinese households. For whatever reasons though Chinese authorities have not done that over the years, with the bulk of any extra income still going to the corporate (both private but mostly state) sector and local governments.

  • The Covid pandemic has however accelerated their work on DCEP, their version of CBDC, which allows for targeted transfers directly into people’s accounts. I believe, this is an avenue which will be much more explored as China gradually eases off from its zero-Covid policy.
  • Over the years Chinese authorities have been particularly slow in building the institutional infrastructure of pension and insurance vehicles and social security as a whole. But there has been substantial progress on that front this year.
  • Chinese assets, and in particular equities, have had two consecutive years of underperformance and under an extreme case scenario a third one is a distant possibility. However, the current set-up favours the establishment of a small exposure.

The Chinese household balance sheet

Chinese households’ balance sheet looks very different to US households’ balance sheet. In the US more than 2/3 of household assets are in the financial sector, the rest is in real estate (this is on average; it varies a lot depending on the income percentile though). In China, the split is more 50/50.

Within financial assets, Chinese households hold almost twice more Cash and its equivalents than US households (in % terms of the total household assets). But, on the other hand, they hold six times less Bonds and other Fixed Income equivalents and ten times less pension and insurance assets (all vehicles which come under social security). Equity allocations are very similar for both Chinese and US households, at around 1/3 of all household assets (this is direct ownership of equities; US households’ overall equity exposure is much larger as they own financial assets through their pension schemes, for example). A snapshot of Chinese household balance sheet can be seen here and of US household balance sheet here.

Basically, Chinese households have too much real estate and cash, too little exposure to bonds, and pretty much zero ‘social security’ cover. The protest against zero-Covid come at an opportune moment when the authorities have also been trying to contain the implosion in the real estate market. With Chinese households using real estate as the main source for pension coverage, creating a genuine viable alternative has become the top priority for Chinese leadership (the topic got extended coverage in China’s 14th Five-Year Plan).

The Chinese social security system

China’s pension industry framework consists of tree pillars. The first one is the basic state pension comprising of the Public Pension Fund and the National Social Security Fund. The second one is the voluntary employee pension plan in which the employer and employee make monthly contributions. And the third one is the private pension.

In April this year, China’ State Council released a document which stated that building the private pension system infrastructure is where their priorities now stand. This was followed by an announcement at a State Council meeting in September of new tax incentives to spur the development of private pensions.

The point is that a combination of an aging population, inadequate tax base and very early retirement age (60 for men and 55 for women) would eventually put the state pension system into deficit. At the same time, the employee-sponsored pension scheme is extremely inadequate covering only a tiny proportion of the population. So, the development of the private pension system has indeed taken centre stage.

DCEP can be used to top up household income

Part and parcel of that is ensuring the growth in household incomes. The authorities have been extremely slow in shifting national income more towards the private household sector. It is not clear to me why, especially given their goal of inclusive growth and the recent heavy regulations on the corporate sector in that direction. But these protests could speed up that process. For example, PBOC has been at the forefront globally in developing their CBDC (the Chinese equivalent is called DCEP – Digital Currency Electronic Payment). They have already successfully employed that in several cities on experimental basis.

In the present environment the authorities can use DCEP to help them ease out of their zero-Covid policy by directing payments to households in specific cities, neighbourhoods, even apartment buildings, which are affected by lockdowns. This kind of real-time, targeted fiscal policy can be extremely beneficial – much more so than the blanket free-for-all fiscal policy the US did during the Covid pandemic.   

Chinese assets offer an opportunity

Where does this leave your exposure to Chinese assets? If you are an institutional Fixed Income investor, you should consider the possibility of large flows into Chinese government bonds by both domestic retail as well as private pension providers, based on the analysis above (to a smaller extent, the same holds true for Chinese equities). Otherwise, it is easy to find reasons (see below) to not have any exposure to Chinese equities, but selling now here on the back of (zero) Covid does not make sense to me. In fact, the opposite is a better option.

Case in point, there was a lot of positive signalling at the latest weekly Covid briefing yesterday. For example, the authorities plan to increase vaccinations among the elderly, a move which could mean intentions to start reopening earlier. Some local governments were criticised for implementing severe lockdowns and were urged to adhere to ‘reasonable’ requests from residents. It is even possible, though I doubt it, that Beijing even decides to fully open up.

But there are two main risks to Chinese equities. The first one is regulatory and it is well known. The developments there are still in progress but if you are long CQQQ or KWEB (these are/were the popular China ETFs among foreign retail investors) and still worried US ADR delisting risk, you should know that only a small percentage of these ETFs holdings is still in ADRs. For example, CQQQ has 131 holdings worth about $767m. Of those only 8% (of the holdings and 15% of the market value) are still US ADRs.

Basically, the ETF providers have converted most of their US ADRs to equivalent HK/China listings, so the risk of substantial loss from US delisting for the whole portfolio has substantially diminished. There are though still regulatory risks. For example, the Chinese authorities can ban foreign entities from owning any China/HK listed stocks. I think the probability of this is small.

It could be also the case that US regulators ban US entities from investing in China/HK listed companies. I think the probability of that is also small but bigger than the former above. But, anyway, both of these are possible in a full-on US-China confrontation ala US-Russia now, which is the second risk to Chinese investments, and which is of truly existential nature. If this is your view, either you should not be touching any China-related investments, or, if you are a probability investor, you should appropriately scale your China exposure.

Mistakes were made

Mistakes become mistakes only in hindsight. The mistake I made, for example, in believing in the transitory aspect of inflation stems largely from not anticipating the extended nature of the global supply issue, sure, not helped by the war in Ukraine. I also made a mistake not investing in crypto.

Did Fed forecasters really make the same mistake on inflation? I am not sure. Regardless of what they said in public, a big driver in their decision-making process must have been the recency bias: after more than a decade of unsuccessfully grappling with disinflation, the right risk-return strategy was ‘to give inflation a chance’. And now the Fed is onto a different ‘recency bias’: having gone through the painful experience of the 1970s, the right strategy for them is to kill inflation at all costs.

That’s how decisions are made in the policy world: not based on actual forecasting outcomes but on protecting awful tail events from ever happening again. To a certain extent that’s how we also make decisions about things which concern us personally, even though we employ more of a barbel strategy: long both tails of the distribution tree.

Take crypto and the recent developments as an example. See this story. I would say, no, the majority of the people who invested in crypto were not stupid. Most were actually quite rational but lazy. Others, though, were irresponsible.

Private investors who invested a small single digit % of their wealth in crypto were logically simply playing the lottery ticket odds. VCs, which also invested a small % of their assets in crypto entities, were also, but they were lazy to do the proper due diligence.

In both cases, the decision-making process was mostly driven by aiming to hit the right-hand side (positive) tail-risk outcome. The risk-return was skewed to do that. Strictly speaking for the former that was the right decision; the latter should have done the work though. Either way, there was no risk in this case of ever landing on the left side of the distribution tree.

And then there is the third group, the pension funds, and the likes, who were simply irresponsible – they had no business investing in crypto. I think that is where one should search for accountability.

But, sure, there were perhaps some people and entities who invested the majority of their net wealth/assets in crypto. I may be wrong, but I think that is a small % of the overall money pool in crypto. And yes, they were perhaps stupid because the left side of the distribution tree was wide exposed.

I never invested in crypto. For that matter I do not remember ever buying lottery tickets in real life (though I have been the proud owner of many deep out-of-the money options which expired worthless…and a few which hit the jackpot). But to go back to inflation, I did manage to lose money being long bonds in this late cycle. I was too ‘lazy’ to do the proper ‘due diligence’ on the fundamental drivers of inflation. But once the war hit in late February, and sanctions followed soon thereafter, it all became clearer.

It was largely because I had done extensive work on the nature of low rates that I knew their gig was over. To quote from the link above: “[We] must be cognizant that a switch to higher rates will most likely only happen after the economy has first gone through one or a combination of: social unrest, debt jubilee, large increase in the money supply or natural disaster.” It turns out that we kind of almost went through all of them: war in Ukraine, student debt forgiveness initiative, yes, massive increase of the money supply, and climate change worries.

What is the right decision to make when it comes to investing now? Well, if the above framework is right, one has to acknowledge the effect of a higher rate environment not just on asset valuations but also on the incentive structure which retail and professional investors are facing in this environment. At this point, it is the second and third order effect of higher interest rates which matter, i.e., staying short bonds is now a decently negative carry trade with low risk-return profile.

Oh, yes, also, always keep small change to buy lottery tickets: in Bulgaria, where I originally come from, the slogan of the National Lottery under communism was “evert week, with a small amount”.

USTs are expensive to foreigners

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Foreigners have bought record amount of USTs this year: if we look at the nine-month cumulative flow in USTs (YTD as per TIC data), it is at a record high, marginally beating 2009. This is actually in stark contrast to what they have done with US equities: the nine-month cumulative flow in stocks is at a record low, easily beating the previous low in 2018.

While it is more difficult to compare stocks across countries, as there are a lot more idiosyncratic factors at play, with bonds it is a little bit more straightforward, once we take hedging costs into consideration. And by that measure, USTs are the most expensive they have been at least in the last 10 years.


Here at the USD hedging costs for foreign based investors based in these jurisdictions (the calculation is done using 3m FX forward points and – so, an investor buys USD and immediately sells it 3m forward – converted into a ‘yield’/carry, annualized). I have chosen here the largest foreign buyers of USTs: Japan, China, the United Kingdom, and Europe (I have excluded the Cayman Islands which is another large buyer of US assets because even though classified as a foreigner in the TIC data, the hedge funds there are almost all USD-based).

Hedging costs in Japan and China are the highest in the last 10 years; hedging costs for EUR-based investors are close to the highs; hedging costs for GBP-based investors are substantially off their highs. This is what a foreign investor is getting in yield if he or she invests in UST 10yr.

This is in nominal terms – do not be confused by the fact that a JPY-based investor will receive a negative 1.2% yield if he or she invests in UST10yr hedged into JPY for one year. A European would do slightly better, and a Brit would do even better than a European; in fact, until recently a Brit buying USTs hedged in GBP could have picked the highest yield in the last 10 years!


But USTs are really not that attractive anymore to a CNH-based investor – even though he or she still picks up a decent 1% hedged, which is more than a European would gain, this is the second lowest yield in the last 10 years. In fact, this is the same for a Japanese investor – the only other time UST10yr fully hedged yield has been lower was during the height of the Covid crisis in 2020.


Foreigners are much better off buying their own government bonds than UST10yr, if they do indeed hedge the currency risk. In almost all these four cases (GBP is the exception but only recently) foreign bonds offer a record pick up to fully hedged USTs.

So, how do we reconcile the record buying of USTs YTD by foreigners with these findings? First, the hedge funds in the Cayman Islands have been large buyers of USTs but, as mentioned above, they are USD-based. Once we exclude them (and they have bought 40% of the USTs from ‘abroad’ YTD), foreign buying of USTs is not that high. UK-based accounts have actually been the largest buyers of USTs from abroad (pretty much bought the other 60% of the USTs). I think some of those accounts in the UK are actually USD-based. There is also the peculiarity of the UK Gilts market this year – about 40% of the total YTD buying of USTs by UK-based accounts happened in the two months before the LDI crisis.


As to the two behemoths in the UST market, Japan, and China, yes, they have been net sellers of USTs this year, in line with what the relative valuation above would have predicted. Where does that leave USTs? Looking at the sectoral balances in the US, the private sector still has a sizable $1.4Tn of surplus (as of Q2 this year), and as we have seen above, USD-based investors have not been shy to pick up these relatively high yields in the UST market.

A look at shadow banking globally

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The spill-over from the crypto debacle recently was pretty much non-existent in public markets, largely because risk-on positions were relatively low (see my previous note), but also because crypto itself, even at its peak ‘capitalization’, is rather small relative to the other monetary aggregates, and is rather low in the overall hierarchy of money. I have written extensively on crypto before, how it (doesn’t) fit in the monetary transmission mechanism because it resembles shadow money, and why it is therefore not the future of money.

Rather timely in that sense, the Financial Stability Board (FSB) released last week a new report on the state of the non-bank, aka shadow bank, financial intermediation. The report itself is not particularly interesting but I took it as an opportunity to have an update on how financial assets are distributed intra as well as inter-country.

Bottom line is that despite being at the epicentre of the 2008 financial crisis and all the subsequent regulations introduced after that to ‘curtail’ it, shadow banking is still growing, especially in Europe, and in general outside of the US. If one were looking for a systematic risk to the system, it is not crypto per se, and it is still shadow banking.

How is this going to play out? Very general, shadow banking comprises all financial institutions without access to the central bank, i.e., without the cover of a lender of last resort. So, yes, crypto falls under that umbrella. And yes, it is crypto, or rather the tech behind crypto, which would eventually usher the solution – central bank digital currency (CBDC) which would allow direct access to a central bank balance sheet for pretty much everyone.

But that is unlikely to happen immediately now (too much wokeness about ‘privacy and liberty’ which completely misses the point about CBDC): we might have to go through another crisis to force our hands.    

As of the end of 2020, there were $462.6Tn of financial assets globally. And this is how they were distributed:

Roughly speaking, we can break column one into two subsections: traditional banking (Banks, Central bank, Public Financial Institutions) and shadow banking (Non-bank financial institutions=NBFI: Insurance corporations, Pension funds, OFIs=other financial institutions, Financial auxiliaries). As of 2020, the two comprised roughly a 50/50 split of the total with shadow banking catching up to traditional banking in the last few years (see the chart below, panel on the left).

Within traditional banking the share of bank financial assets is little changed over time (down marginally since 2002), but the share of central bank assets has grown substantially at the expense of public financial institutions. Within shadow banking, the share of OFI has grown substantially at the expense of pension funds and insurance companies.

How are total financial assets distributed inter-country? The chart above (panel on the right) shows the breakdown between Advanced Economies (AE) and Emerging Markets (EM): while in 2002 EM comprised just 2% of the total, in 2020, they were up to 20%!

Within AE, shadow banking now dominates, rising from 45% of the total in 2002 to 54% in 2020 (see the chart below, the panel on the left): it seems that QE has favoured a built-up of assets there. On the other hand, traditional banking is still very much dominant in EM even though its share has fallen over the years: shadow banking’s share has risen from 17% of the total to 27% (right-hand panel).

While central bank activity in financial markets has risen in AE, from 3% in 2002 to 8% in 2020, it has declined substantially in EM, from 43% in 2002 to 10% in 2020 (see the chart below, panel on the left). And while the social safety net (pension funds, insurance corporations) share of total financial assets has been fairly stable in AE around 20%, it has declined in EM from 12% in 2002 to 7% in 2020 (panel on the right).

USA comprises a little more than a quarter of all global financial assets but one-third of the total shadow banking assets. The shares of traditional and shadow banking assets to total US financial assets are little changed over the years at 37% and 63% respectively. The share of the central bank financial assets has increased over the years from 2% to 6%.

The Euro-area share of total financial assets is a bit less than a quarter of all global financial assets, but it has seen an explosion of shadow banking – its share of the total assets has risen from 20% to 51% since 2002. The share of the central bank financial assets has increased over the years from 4% to 12%.

Financial assets in Japan are about 10% of total global financial assets. Shadow banking in Japan is about 30% of the total financial assets in the country – and it has been fairly stable over the years. The share of the central bank financial assets has risen from 4% in 2002 to 16% in 2020.

China overtook Japan as the third largest global centre for financial assets in 2013 and currently it comprises about 15% of all global financial assets. Shadow banking in China has risen from 4% in 2005 (that’s when proper data becomes available for China) to 25% in 2020 but it is still below the ones in the other major financial centres. China bucks the trend whereby its central bank assets as a share of total have fallen from 22% in 2005 to 9% in 2020. The social safety net in China is pretty much non-existent – there is no pension funds industry, for all intends and purposes, while the insurance corporations’ share of financial assets has barely moved, risen from 4% to 5% since 2007!

What explains the spectacular bounce in risk?

The prevailing sentiment among the people I speak to (predominantly hedge fund managers) is to sell this rally. The reasons given are (also see below for a complete list): 1) One CPI is unlikely to change the Fed’s interest rate trajectory (basically we are data dependent), 2) China has not changed its zero-Covid strategy in earnest, 3) There is still a risk of a winter energy crisis in Europe, 4) JPY weakness will not reverse before YCC is over.

All these are valid, but I will stick with a risk-on attitude a bit longer. In any case, what caused this drastic change in sentiment?

Positioning was really lopsided. See this article citing research from GS which believes CTAs were forced to buy $150Bn in equities and $75Bn in bonds. Real money is also very light risk after being forced to reduce exposures throughout the year. But what were the main drivers which changed sentiment to begin with?


It was weird to see markets actually not really selling off after Powell’s hawkish FOMC press conference. Perhaps the fact that we had a bunch of FOMC members (see here and here, for example), calling for a slowing down of the pace of Fed Fund Rate (FFR) increases, may explain to some extent the positive reaction at the time. And of course, the catalyst came when the US CPI was released lower than expected.


FFR actually does not give anymore a precise indication of the stance of US monetary policy – this is the conclusion of a new paper by FRBSF. If all data such as forward guidance and central bank balances sheet effect are taken into account, the FFR is more likely already above 6% vs the current target of 3.75-4% (the paper puts the FFR at 5.25% for September and I add the 75 bps of hikes since then).

This means monetary policy today is even more restrictive than at the peak before the 2008 financial crisis and approaching levels last seen during the tech bust in 2000. The findings in the paper make intuitive sense. Quoting from the paper:

[W]hen only one tool was being used before the 200s, the stance of monetary policy was directly related to the federal funds rate. However, the use of additional tools and increased policy transparency by FOMC participants has made it more complicated to measure the stance of policy.

The new tools the authors refer to are mainly forward guidance, which started to be actively used after 2003, and central bank balance sheet management, which started after 2008. The proxy FFR (see chart above) actually includes a lot more, a total of 12 market variables, including UST yields, mortgage rates, borrowing spreads, etc. It is perhaps intuitively easier to see that monetary policy was much looser at times when the FFR was at the zero-low bound and QE was in full use than it is a lot tighter today when FFR is firmly in positive territory and QT is in order, but the logic is the same.


So, I think somehow or other, the market now believes that we have seen the peak in FFR (forward) – that provided the foundation of the risk bounce.

China provided the other pillar of support for risk. Ironically, in a similar fashion to how it played out after FOMC, i.e., the consensus was that the 20th CCP Politburo meeting was an overwhelming negative for Chinses assets. And even though they sold off, there was no immediate follow through. In fact, we started hearing that Chinese authorities are looking into taking the first steps to pivot from the Zero-Covid policy, and are very serious about providing a floor for property prices. Finally, there was a genuine improvement on the US-China relations side as US regulators finished their inspection of Chinese companies in HK ahead of schedule and US President Biden and Chinese leader Xi Jinping met at the Group of 20 summit in Bali.

The third pillar of support came from Europe. First, European energy prices (see a chart of TTF) have come a long way down from their peak in the summer (almost full inventories and mild weather helped). Second, the UK pension crisis was short-lived after the change in government and did not have any spill-over effects on other markets. And third, there is genuine hope of a negotiated solution of the war in Ukraine after the Ukrainian army made some sizable advances in reclaiming back lost territory, with both the US and Russia urging now for possible talks. My personal view is that the quick withdrawal of Russia from these territories is a deliberate act to incentivize Ukraine to come to the negotiating table – even though the latter does not seem eager too . Yesterday’s missile incident, and Ukraine’s quick claim that it is Russia’s fault, which is contrary to what preliminary investigation has led to so far, might be a testament to that.

Finally, and that falls under positioning, there is the unwind of USDJPY longs spurred by heavy intervention by Japanese authorities. If there is any proof that policy makers are taking the plunge in the Yen seriously it is in the details of Japan’s Q3 GDP which shrunk unexpectedly by 1.2% (consensus was for a 1.2% increase). The bad news came almost entirely from the negative contribution of net trade. Net trade has been a drag on GDP for the last four quarters primarily from the rise in imports, i.e., the weakness in the Yen. The good news is that the economy otherwise is doing fine: private demand had a big bounce from the previous quarter and has been a net positive overall (all data can be found here): in other words, the problem is the Yen, and YCC makes that worse.

Another piece of data, released last week, which caught our attention, is Japan FX Reserves. The decline from the high in July 2020 is $241Bn, about 18% – that is a substantial amount. The interesting thing, and we kind of know this from the TIC data is that the decline is coming entirely from the sale of foreign securities; deposits actually went up marginally (some of the decline is also valuation). But we know now that when Japan was intervening in USDJPY in September/October, it was selling securities, not depos – most analysts thought Japan would first reduce depos, while intervening, before selling their security portfolio. All data is here.

In summary, CTAs’ sizable wrong way bets long USD and short equities and bonds and real money light risk exposure overall coincided with dovish economic data, reopening China and improving geopolitics (all of these happening on the margin).

The multifaceted collapse of SBF and FTX

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There are at least three different angles to the SBF/FTX/Alameda collapse.

  • The most obvious one is that the crypto industry as a whole is still standing on shaky foundations and there are at least some Ponzi-style elements in some parts of it. See, for example, this Odd-Lots podcast with SBF himself and Matt Levine from April this year, which compares crypto yield farming as a ‘black box’, without an economic purpose, where people keep putting money “and then it goes to infinity and everyone makes money”. This note is not on this as the topic has already been profoundly explored in the media space.
  • Then there is the political angle which is related to SBF personally contributing substantial amounts of money in both Democrat and Republican primaries but having a clear agenda for the 2024 presidential election.
  • Finally, there is the technical angle in which there is this great ‘battle’ between centralised and decentralised banking/finance, tradfi vs defi. The rest of the note will dwell on these two, with an emphasis on the latter.

Bottom line is that it seems SBF was trying to move FTX more towards traditional finance and thus make it more stable and bullet proof, which ironically links all these three different angles together. Which begs the question, did someone want SBF down and out? And while going down, can FTX take the whole crypto industry in the gutter?

Many comments in the media regarding the collapse of FTX focus on the supposedly shambolic due diligence process on SBF/FTX/Alameda by some venerated names in the private equity, hedge fund and pension fund industry. Unfortunately, the likes of “SBF was playing video games in the due diligence process meetings” (the original Sequoia note was taken down before this was ready to be published, but a copy can be found here: https://archive.ph/xy4MR) are taken hugely out of context and despite the shortcomings and Ponzi-like structures in parts of what FTX was doing (see above, yield farming), the vision and ideas SBF was projecting did perhaps deserve the money thrown at them. Their execution, however, left a lot to be desired.

SBF himself was a big political donor. Even though he had contributed most recently to both Democrat and Republican causes, he had said he would spend up to a $1Bn “to help influence the 2024 US presidential election campaigns”($1Bn is a humongous amount of money in politics; the largest single donors currently are Sheldon and Miriam Adelson, to the Republican Party, with $218m in 2020), specifically if he were to bankroll the person running against former President Donald Trump.

It seems SBF was not a fan of Bitcoin as a payment network because its proof of work system does not allow scaling up. FTX US exchange was much more tradfi than defi, for example. SBF had testified before the House Financial Services Committee and had slightly different crypto regulation ideas from the other market participants there.

This stance by SBF did not win him many sympathizers in the crypto community. For example, see here main rival CZ/Binance: “We won’t support people who lobby against other industry players behind their backs”.

From that point of view, the collapse of FTX is somewhat intriguing. On November 2, Coindesk leaked supposedly Alameda’s balance sheet which showed that, “Bankman-Fried’s trading giant Alameda rests on a foundation largely made up of a coin that a sister company invented, not an independent asset like a fiat currency or another crypto”.

Even though Coindesk admitted that “[I]t is conceivable the document represents just part of Alameda”, and even though Alameda’s CEO Caroline Ellison later tweeted that this leaked balance sheet was indeed not complete and there were $10Bn of assets not listed there, the damage was already done and competitors were starting to pile on – for example, Binance sold more than $500m of FTT tokens.  

SBF wanted to incorporate the best features of rivals Coinbase, a basic US-regulated crypto exchange, and Binance, an unregulated exchange which offers much more advanced transactions. In the process he wanted to become filthy rich but only so that he can give away all his fortune in the spirit of effective altruism: “The math … means that if one’s goal is to optimize one’s life for doing good, often most good can be done by choosing to make the most money possible—in order to give it all away.”

Also in the process, did SBF ‘anger’ some very important people in politics and in business who eventually did their best to take him down? Conspiracy theories aside, the tale of the collapse of FTX is one which we have seen over and over again in banking and finance: unregulated entities which manage other people’s money cannot last forever: without the explicit backing of a lender of last resort they eventually fold when trust suddenly evaporates. If that is indeed the case, what is the future of decentralised finance?

And if that is indeed the case (no lender of last resort), can FTX take the whole industry down with it? It may certainly do. Everything in crypto land is ‘tethered’. Both literally (courtesy of USDT being the most widely adopted stable coin) and figuratively (as seen lately by the collapse of so many crypto-related firms). So, it is unlikely we will get to the bottom of this before all this gets fully ‘untethered’.

While Tether was quick to point out that it has no exposure to Alameda/FTX, it’s not a given that the opposite exposure does not exist to the point that it could affect USDT itself. According to this article (arguably from a year ago, I wonder how current it is now) two firms account for the majority of Tether/USDT ever received. Alameda is at the top with about 30% of the total.

And according to SBF himself today, “Alameda Research is winding down trading”, which means that they may be unloading a good portion of their USDT stack. In fact, it seems the selling has already started. And this selling may be just part of the normal process of unwinding Alameda Research, or it may have other ulterior motives as well. SBF closed his Twitter thread today, November 10, with this:

The Apple of my eye

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After a nearly two-year hiatus due to compliance requirements (I was consulting a hedge fund start-up), I will attempt to continue writing on this blog in a more frequent format until further notice.

The Apple of my eye

One of the most enduring questions I have encountered lately is, “How come Apple is still ‘standing’ when not only other big techs are falling apart but also given that Apple is one of the most heavily exposed, amongst them, on China?”. The best answer to this was given this week by Scott Galloway here.

At the core of Apple’s recent outperformance (the stock is down only 20% from peak vs 40-50% for the other big tech and even more for the smaller tech) is a decision the company made a year ago to the effect that the upgraded Apple iOS “forced apps, including Facebook… to ask users for permission to track their data”. Here is the story on this from October 22, 2021.  

As it turns out, only about 16% of users agree to such tracking which is a big problem for companies using sophisticated data to direct ads to potential customers. As Prof. Galloway succinctly says in his note, ”[W]ithout data, the digital ad ecosystem doesn’t work”.

Here is a chart of Meta’s global ad revenue growth rates YoY until 2021. Unfortunately, in Q3’22 the company reported its first ever annual decline on a quarterly basis in ad revenues ever. Needless to say, when ad revenues make up more than 95% of the total, this development is a big problem going forward.

What about Apple? The company’s share price performance is perhaps a better indication of the drawdown one would expect stemming from all macro forces for a leading monopoly-like big tech. Yet, its overreliance on revenues from Greater China and Europe (the two combined are bigger than revenues from Americas), two regions which are grappling with idiosyncratic issues such as zero-Covid and an energy-crisis, is probably a reason to be cautions on the stock, nevertheless.

Alibaba and the 40 risks

China tech (CQQQ) trades at a record ‘discount’ to US tech (QQQ): the underperformance of the former from a year ago is staggering.

This underperformance is primarily due to regulatory issues which first started in the beginning of 2021 in China. Then at the end of that same year, US regulators independently added further pressure on Chinese companies listed on US bourses. Some of the big China tech ADRs, like Alibaba, are not only trading below IPO price, but also are down 80% from their highs.

I have no idea where this is going to end. However, I do believe that there is legitimate progress in easing of the regulatory burden from both the Chinese side as well as the US one. In any case, given that Chinese ADR positioning is now much cleaner, the regulatory risk from the US side can be easily avoided if one buys the HK-listed shares.  I do not know if this is the right time to do that, but I do know that, given their extreme undervaluation, it makes little sense to sell Chinese tech stocks on the risk of a continuation of the zero-Covid policy.

On the other hand, a China pivot on this policy would provide a massive boost to their share prices. From such an angle, the risk-return profile favours some exposure to HK-listed China tech. Still, for any investor in China, the risk of an (almost) ‘total ruin’ is quite real in the extreme scenario of a China-Taiwan conflict which leads to the freezing of Chinese external assets as well as closing access for foreigners to China/HK-listed company shares – something akin to what happened in Russia.

Ultimately, it is this unquantifiable risk which probably holds foreign investors off from dipping their feet in the China market. But, as always, the risk to any trade is not in whether one has the exposure or not, but rather what size it is and how it is timed.

European energy security in the context of the Russia-Ukraine war

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European leaders keep talking about energy security, but it seems to me that, when it comes to Russian energy, it was them who took their countries from a state of relative stability to a state of extreme uncertainty. Two main points I want to make: 1) I am not aware of Russia ever unilaterally stopping or even threatening to stop the flow of energy to Europe before the Ukraine war started this year; 2) even if it was smart to diversify their energy sources (and let’s face it, even for Germany only about 50% of the imported gas was from Russia before the war), it would have been smarter to do it gradually, having secured plentiful of alternative resources in advance.

Two further points. First, it seems to me that there was a lot of scaremongering about the relative dependence of Europe on Russian energy in the last few years, which obviously subsequently affected European energy policy making. There was only one instance when Russian gas did not reach Europe. In January 2009, Russian gas flow through Ukraine was halted for about two weeks because Ukrainian gas company Naftogaz had refused to pay its debt to Gazprom for previous supplies. In addition, there were many documented instances when Ukraine was siphoning transit Russian gas thus threatening European deliveries.

The 2009 gas standoff between Russia and Ukraine was the main reason Russia decided to redirect its gas supplies to Europe away from Ukraine – that was the beginning of the Nord Stream 1 (NS1) and South Stream gas projects. There is a good paper which you can read here https://www.oxfordenergy.org/publications/the-russo-ukrainian-gas-dispute-of-january-2009-a-comprehensive-assessment/ documenting all this.

Here are the important bits:

  • “If the Nord Stream and South Stream had been in place on 1 January [2009], the consequences of this dispute would barely have registered in the majority of European countries”;
  • “One certain outcome of the dispute is that there will be an even greater determination from Gazprom – and perhaps also from European countries – to build the North Stream and South Stream transit avoidance pipelines, which will impact heavily on Ukraine’s gas transit business.”;
  • “The problem for the Ukrainian side is that this crisis will have hardened Russian determination to greatly reduce its transit dependence by building the Nord Stream and South Stream pipelines; a development with serious financial consequences for a country in an already difficult economic situation.”

You see, Russia was working to increase European energy security, NOT to decrease it!

Of course, there are many other reasons for the construction of NS1/NS2 and South Stream/Turk Stream. On the technical side, the pipelines through Ukraine/Poland were very old, built during Soviet times, subject to constant leaks and reliant on Ukrainian/Polish work for maintenance (hardly forthcoming in those days). On the financial side, it was not in the interest of Russia to continue paying transit fees if there were an alternative. Finally, the new gas transit lines allowed for a higher capacity, a more direct and faster route to the main European market. Better, cheaper, faster, more -> European energy security was getting enhanced!

So, the second point I wanted to make is, with that background in mind, it should become clearer the incentives behind some of the events that subsequently transpired. Obviously, Ukraine and Poland had the most to lose if the new gas transit lines to Europe became a reality. It was not just the transit fees but the fact that both countries were in an extremely privilege situation when it comes to their own energy security – before the 2009 Russia-Ukraine gas conflict, they were paying the cheapest gas prices in all of Europe (they actually continued to pay low prices even after – pretty much until NS1 went on line – you can see the data here https://ec.europa.eu/eurostat/web/energy/data/database ).

But there was one other important event which took place at about the same time: the oil and gas shale revolution in the USA. All of a sudden, both Poland and Ukraine had a potential way out of the energy conundrum they put themselves in, and that outcome actually worked wonderfully also for the US, which saw an opportunity in selling energy to Europe. It should be no surprise that Poland and Ukraine have also seen more shale exploration than any other European country (brownie points for remembering that Hunter Biden went on the board of the Ukrainian gas company Burisma in … yes, 2014, AFTER the Maidan revolution of the same year).

US focus on Ukraine, however, dates further back than that. Here is some more context.

Ukraine was always seen as an integral part of NATO#s expansion eastward. I actually think the 2004 Orange Revolution was the turning point in everything that followed thereafter. In 2004 the Ukraine Presidential election was initially won by the pro-Russian candidate Viktor Yanukovych, but after protests for seeming fraud in the election process (some would claim that these were supported by the US, see this https://carnegieendowment.org/2019/06/20/thirty-years-of-u.s.-policy-toward-russia-can-vicious-circle-be-broken-pub-79323 and this https://www.youtube.com/watch?v=QeLu_yyz3tc – both are reputable US sources), the victory was given to the pro-West candidate, Viktor Yushchenko. Yushchenko’s wife worked in the White House in the Office of Public Liaison during the administration of Ronald Reagan, in the U.S. Treasury in the executive secretary’s office during the administration of George H. W. Bush and on the staff of the Joint Economic Committee of the United States Congress!

One of the things Yushchenko did, was rehabilitate Bandera as a national hero. One of the last things Petro Poroshenko did when leaving office in 2019 was to ban the use of the Russian language. The Ukraine-Russia ethnic split in the country was obvious and it was profound. It dates back to the Holodomor in the 1930s and is probably the basis for the hatred some Ukrainians still harbour towards Russia. Anyway, that is another story.

So, Yanukovych wins back the Presidency in 2010, this time without a doubt, but the country is in dire straits economically. The financial package from the IMF is with draconian conditions, while that from the EU is not enough, so Yanukovych chooses the more generous financial offer from Russia eventually in 2014. What followed is the ‘Maidan’ when power reverted back to the pro-Western candidate, Yatsenyuk.

And, yes, not without some help, perhaps – Victoria Nuland, married to Robert Kagan one of the top neo-con founders of PNAC (project for the new American century – see this https://en.wikipedia.org/wiki/Project_for_the_New_American_Century ). In this story, she is famous for the “F..k the EU” expletive when she was discussing the structure of the new Ukrainian government with US ambassador to Ukraine, Geoffrey Pyatt (that was pre-Maidan) – see here https://www.nbcnews.com/video/audio-of-leaked-nuland-conversation-162208835907 . That was not Nuland’s first rodeo in Ukraine – she had been involved in Ukrainian politics for some time before, directing money in helping Ukraine move closer to the West (see here https://2009-2017.state.gov/p/eur/rls/rm/2013/dec/218804.htm ). Yatsenyuk immediately announces that Ukraine will seek entry into NATO and the country ends its ‘non-aligned’ status.

The Maidan narrative was that overthrowing the democratically elected government in 2014 was morally right. That’s fine, but why then, a free referendum in which Crimea overwhelmingly voted to cede from Ukraine and become part of Russia thereafter was illegal? Which auto-determinations should be allowed and which not? As if Russia would have realistically allowed its own Black Sea naval headquarters to be based in a country potentially part of NATO!? After Maidan, there was never going to be any solution to the fate of Eastern Ukraine without the Minsk Agreement which Ukraine never implemented even though it agreed to it.

The build-up to the current war started with Ukraine in March 2021 adopting a new military strategy by decree, in which one of the goals was the dis-occupation and re-integration of Crimea. In June 2021, NATO reiterated “the decision made at the 2008 Bucharest Summit that Ukraine will become a member of the Alliance with the Membership Action Plan (MAP) as an integral part of the process” (see here https://www.nato.int/cps/en/natohq/news_185000.htm) .

In November 2021, Putin declared that Ukraine’s acceptance into NATO constituted a red line, whose crossing would have grave consequences (he highlighted concerns about the potential arrival of long-range hypersonic missiles with the ability to reach Moscow in ‘five minutes’ – see the Cuban Crisis and the concept of nuclear primacy as part of PNAC above).

In December 2021, Russia officially asked for guarantees that NATO eastward expansion would stop, and if this was not given, Russia would not accept it (Putin: “there is nothing that is not clear about this”). In January 2022, Russia accused the US of provoking a war: “You are almost calling for this, you are waiting for it to happen, as if you want your words to become a reality” (Russian ambassador to UN).

In February 2022, Russia made its final appeal, “Do you understand that if Ukraine becomes part of NATO/EU and it seeks to take back Crimea, European countries will automatically enter a military conflict with Russia, in which there will be no winner?” (Putin, in address to nation). And then Russia asked for a written guarantee that Ukraine would not become part of NATO. This was Blinken’s response: “From our perspective, I can’t be clearer, NATO’s door is open, remains open, and that is our commitment.

And just like in 1962, during the Cuban Crisis, when the US was left with no other option but to invade Cuba, Russia’s only remaining option was to enter Ukraine before the situation became even more serious. Unfortunately, unlike in 1962, diplomacy did not work this time.

It is amazing to me how Ukraine managed to ‘blackmail’ Europe when it comes to its energy policy. Hats off to the Americans who eventually simply took advantage of the situation allowing them to capture new energy and defence markets. Eventually, it all went pear shaped when European leaders decided to follow an (outdated) ideology (‘communism is the enemy’) to solve modern-day logistical and economic problems.