Comment of the Day
Video commentary for July 12th 2022
A link to today's video commentary is posted in the Subscriber's Area.
Some of the topics discussed include: recession risk rising, inverted yield curves, oil weak, copper extends downtrend, financial sector weak heading into earnings, China recession risk.
Anger in Shanghai as Covid Return Spurs Fear of New Lockdown
This article from Bloomberg may be of interest to subscribers. Here is a section:
Tension is spreading through Shanghai as residents watch the Covid-19 caseload tick higher, fueling fears they’re headed back into lockdown little more than five weeks after exiting a bruising two-month ordeal.
The city reported 59 new infections for Monday, the fourth day in a row case numbers have held above 50. The sharp rise from single digits about a week ago follows the detection of the more contagious BA.5 sub-strain of the omicron variant, which has triggered two additional rounds of mass testing between Tuesday and Thursday this week across nine of the financial hub’s 16 districts, as well as other areas where cases have been found.
China’s strict Covid Zero approach is once again being tested as outbreaks flare across the country amid the arrival of a sub-variant that has fueled rising caseloads elsewhere. Already, close to 30 million people nationwide are under some form of movement restrictions to quell transmission, but authorities have so far steered clear of strict lockdowns in key economic regions.
My view - Quarantines work in the initial stages of an outbreak because there is still some hope the rate of infection can be contained. The only reason to sustain a quarantine during a pandemic, where there is no hope of containing the global spread, is to slow the rate of infection. The time bonus gained from slowing the rate of infection can be used to prepare treatments, vaccines and recovery areas, but no one is under any illusion that quarantines can indefinitely turn back a pandemic. Eventually everyone is going be infected.
Heathrow Asks Airlines to Stop Selling Seats to Ease Chaos
This article from Bloomberg may be of interest to subscribers. Here is a section:
London Heathrow is imposing a two-month cap on daily passenger traffic, a dramatic response by the UK’s busiest airport to the flight chaos gripping Europe as airlines and ground crew struggle with a surge in travel demand.
The airport will limit daily passenger traffic to 100,000 departing people through Sept. 11, asking airlines to refrain from selling summer tickets. Current forecasts are modeling for as many as 104,000 passengers a day over the summer, still below the roughly 125,000 passengers that left daily this time before the pandemic.
My view - Anyone who thought demand for international travel would never return to normal has been proven very wrong. If anything, pent up demand is contributing to even higher demand because people have been cooped up at home for so long. If China’s population ever get to travel again, tourist locations will be swamped.
A Deeply Inverted Yield Curve Means Credit Is Set to Dry Up Next
This article from Bloomberg may be of interest to subscribers. Here is a section:
The other constraint is the so-called ‘spot real rate’, which measures the Fed’s target rate minus current headline inflation. The premise is that the Fed cannot tighten financial conditions sufficiently to wring out inflation if it ends rate hikes with the spot real rate still negative.
Putting this together, if the Fed gets to, say, a 4.5% target rate with inflation in 2Q 2023 at the same level, maybe it can call it a day. That’s a very high inflation level but also a restrictive level of policy which will mean significant economic pain. If, for example, the US economy lapses into recession and inflation falls to 4%, the Fed might feel confident that inflation was headed down to its 2% target even if the fed funds rate is only 3.0% when this occurs.
The scenarios above are more akin to the early 1970s when the Federal Reserve allowed real yields to remain negative in the face of double digit inflation. It’s not the crushing blows that Paul Volcker administered to the US economy.
Even so, inflation is so high that there are almost no scenarios where the fed funds rate doesn’t get to at least 3 or 3.5%. More likely we go higher than that.
That’s when banks will likely face problems with defaults and net interest margins.
My view - The 10-2-year yield curve spread is currently at negative 9 basis points. That’s the most inverted the spread has been since 2007. Jay Powell dismissed this indicator as useful and prefers to look at the 10-year – 3-month spread. That measure has contracted by 40 basis points since Friday. In early May it was at 230 basis points. Today it is at 80.