Recession whispers, part 2

Good morning. Reading though the weekend papers and research round-ups, it became clear we have crossed a market-sentiment Rubicon. For months, all anyone talked about was inflation. Now recession is the first word on everyone’s lips. We follow the trend below, and look at the financing mess in the commodities complex. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Recession whispers, part 2

Friday’s letter pointed out that low unemployment, such as we have now, looks like a lagging economic indicator, which can persist to the very cusp of recession. Larry Summers, in response, sent along a paper supporting that idea, which he published this month with Alex Domash of Harvard. The argument goes like this:

• The labour market is even hotter now than supply-side measures, such as the unemployment rate and the prime-age employment ratio, suggest. Demand-side measures such as vacancies per unemployed person and quitting rates suggest extreme tightness: “we estimate that the unemployment rate that is consistent with the current levels of job vacancies and worker quits is below 2 per cent.” Here, for example, is a chart of openings per unemployed:

• Historical experience shows that this level of labour-market tightness means that wage growth, currently clocking in at 6.5 per cent, is likely to rise further in the coming months and bring overall inflation with it.

• When wage inflation and employment have been near their current levels, the only way monetary policy has been able to control inflation is by tightening enough to induce a recession, as shown in this depressing table:

• In all recent instances where the Fed has engineered a “soft landing,” the labour market was been much looser, as shown here:

Some economists have technical objections to the job opening data, pointing out, for example, that the way jobs are listed has changed a lot over time. I would raise a broader question. While I’m impressed with the way Domash and Summers marshal the historical evidence, I think that if any time could be different, it might be this one. The pandemic and the government response makes this cycle unlike others. Recession looks likely to me, but not much would surprise me at this point.

Speaking of which: despite many indicators showing a red-hot economy and tight supply chains, domestic US shipping is cooling off, suddenly and meaningfully.

In a striking piece of research, Bank of America transport analyst Ken Hoexter downgraded a raft of trucking, rail, and delivery companies in response to lower demand and weaker pricing. In the bank’s most recent survey of trucking companies, “A large number of respondents commented that pricing is declining rapidly, capacity is available, and these shifts could signal a downturn in the economy and lower demand.” Per-mile truck freight rates are falling fast, as the dark blue line here shows:

Shipping industry leaders have taken note of the shift in conditions:

We recently hosted both UPS [package delivery] and XPO [trucking] management who noted that the labour market had loosened a bit. On our recent call with Judah Levine, [head of research at global freight booking platform Freightos], he noted inflation is starting to impact consumer demand. In yesterday’s BofA Container Shipping Outlook Call, Hua Joo Tan of [ocean shipping consultancy] Linerlytica highlighted that container demand is softening (in excess of seasonality and a new wave of China lockdowns), port congestion is past peak (and less of an issue than weak export demand), and effective capacity is increasing as bottlenecks ease, adding to downward rate pressure

This is not to suggest the global transport market has fallen off a cliff in March. As Oxford Economics’ Oren Klachkin notes: “Transportation pressures increased in March . . . shipping costs rose and air cargo volumes increased on the month. But on the bright side, ocean shipping activity moderated, with reduced queues at LA and Long Beach,” the most important ports for Asian manufactured goods entering the US. A chart:

Perhaps none of this is terribly surprising, given that US wholesale inventories are back to — or even above — their pre-pandemic trend level:

It may be, in short, that the change of mood in shipping is the first indication of what “team transitory” inflation doves have long promised: that inflation, which appeared so suddenly last autumn, might subside equally quickly as supply chains normalise and excessive pandemic fiscal stimulus fades. Is demand winding down on its own, after a single rate increase? If so the Fed may be able to back off before recession takes hold.

Alternatively, it could be that the recent shipping data is a blip in a volatile industry. Or that it is already too late to avoid recession, whatever the Fed does. Watch this space.

The commodities financing crunch is about real assets

A month ago, it wasn’t crazy to worry that western sanctions against Russia might set off a financial crisis. Western banks’ $100bn in Russian exposure could have spread losses around the world and put post-crisis banking rules to the test. Happily, it didn’t happen. A much-watched indicator of bank funding risk spiked in early March, but quickly fell as everyone realised Ukraine wasn’t about to cause a 2008-style implosion:

A big financial blow-up — like banks in 2008 or Treasuries in 2020 — hasn’t been the story of this crisis. Rather, it’s been all about commodities. This time, a problem in real assets is spilling into financial markets, not the other way around.

The action is clearest in energy markets, where prices were already rising before Russia supercharged them. In normal times, oil drillers use derivatives — usually swaps or futures contracts — to hedge. The idea is to short future oil prices and lock in a profit. If prices go up, now your oil is worth more. If prices fall, your short position is worth more. If you hedge wisely, either outcome is acceptable. Other types of energy companies, such as utilities, might make the opposite bet to lock in prices — ie, go long on oil prices to guarantee stable input costs.

But with oil volatility going wild, this commodity-hedging system is under pressure. Some reports suggest hedging costs have increased by 25 per cent or more. Margin calls on existing hedges are rolling in. On Thursday Shell acknowledged that it was forced to divert billions in cash holdings, $3bn by one estimate, to finance its margin requirements. Market measures also suggest dwindling liquidity. The number of active futures contracts on Brent crude oil has fallen sharply since March:

Oil traders have been agitating for weeks for government help. And on Friday, they got something. From the FT’s Martin Arnold:

The German government has announced an aid package to support companies hit by the fallout of the Ukraine war . . . 

The measures include a new €100bn programme of short-term loans from state-owned KfW development bank for energy companies struggling to cover the vastly increased cost of insuring themselves …

“We will cushion hardship and prevent structural breaks,” said [finance minister Christian] Lindner, adding that the plan was “precisely targeted” to avoid discouraging the transition away from fossil fuels.

Something similar to this German “shock absorber” package is being rolled out in France too. The US Commodity Futures Trading Commission has so far played down any need for it to respond, but in an echo of post-2008 financial politics, activist groups are already demanding that it pledge to “unambiguously reject any bailout for commodity traders”. 

Thinking of this as a financial crisis in commodities probably misses the point, though. Commodities are very expensive and that is hurting those who use them. Fixing the financing won’t make that any less severe. (Ethan Wu)

One good read

Janan Ganesh against psychobabble.

Source: Economy - ft.com