Aurelia Butler

The global economy will suffer a hit to growth and higher inflation this year as a result of Russia’s invasion of Ukraine, the IMF said on Tuesday. In its World Economic Outlook, the fund said prospects had “worsened significantly” with countries closest to the war likely to be hardest hit. But it warned that risks had intensified everywhere, raising the chances of even lower growth and more rapid price rises, and upending the fund’s view that there would be a stronger recovery from the pandemic this year.The IMF’s forecasts showed global growth of gross domestic product this year of 3.6 per cent, down 0.8 percentage points since the fund’s January projections and 1.3 percentage points lower compared with six months ago. In 2021, global growth was estimated at 6.1 per cent, the fund said. In a simulation exercise, the IMF warned an immediate oil and gas embargo against Russia would raise inflation further, hit European and emerging economies hard and require even higher interest rates, including in the US.Pierre-Olivier Gourinchas, the IMF’s new chief economist, told the Financial Times that “we’re facing a slowdown in growth [and] facing elevated inflation”, although he was keen to avoid the word “stagflation”, meaning a prolonged period of low economic expansion and rapidly rising prices. “The notion of stagflation comes with some baggage, and I want to be a little bit careful about whether we really want to put ourselves in a frame of mind of the stagflation of the 1970s,” he said. Gourinchas did not downplay the problem of high inflation this year, which the fund has marked up severely in its forecasts. Compared with its October forecast of US inflation of 3.5 per cent in 2022, it now expects 7.7 per cent. The eurozone average inflation rate has been revised up from 1.7 per cent to 5.3 per cent. With the forecast rise in US inflation set alongside a relatively moderate economic hit from the Ukraine conflict, the IMF recommended the Federal Reserve continue to raise interest rates rapidly. But the war was likely to have a bigger impact on European growth, complicating the monetary policy response. The European Central Bank was in a “much less comfortable position” than the Fed, Gourinchas said. “The signals are aligning in the US that something needs to be done about inflation, and because the economy is strong there is room to do that without necessarily going into recession territory. The ECB is facing a situation where if it starts to address inflation, then it’s going to make the softening of aggregate demand worse. That’s never a good situation to be in as a policymaker.” The IMF forecast a 35 per cent collapse in GDP in Ukraine as it suffered from destruction of its infrastructure and mass emigration, while sanctions and a pariah status would lead to an 8.5 per cent drop in Russian GDP. If Europe and the US went further with sanctions they could intensify the economic pain on Russia, the IMF said in its scenario examining the effects of an oil and gas embargo.

This could knock 15 per cent off Russian economic output by 2027, imposing significant pain on President Vladimir Putin’s regime, but would also come at a significant cost, especially to European economies. The IMF estimated the EU would lose 3 per cent of output by 2023, while global inflation would rise more than another percentage point this year and next. There was “relatively little” that could be done to mitigate the effects of an embargo in the short term, Gourinchas said. As for the necessary investment to increase alternative gas supplies significantly, he said “we’re not talking six months, we’re probably not talking one year”, adding there would still be a “sizeable shortfall” even with coal or nuclear supplements.Given limited alternatives, “there would have to be some adjustment [to] energy consumption inside the EU, and there will be some price adjustment as well”.

IMF chief economist Pierre-Olivier Gourinchas did not downplay the problem of high inflation, which the fund has marked up severely in its forecasts © David Paul Morris/Bloomberg

Emerging economies would underperform even more in 2022 and 2023 than advanced economies, the IMF said, because most commodity importers were harder hit by higher prices for energy and food imports. But the good news, it said, was that there had been no significant capital flight from developing nations so far since the Fed signalled it was set to tighten monetary policy significantly this year. “We haven’t had a temper tantrum. We haven’t had capital flows rushing out of emerging markets,” Gourinchas said. Growth is expected to recover in emerging economies in 2023 as prices stabilise but the forecasts were still weaker than those in January. More

US inflation-adjusted bond yields are on the verge of turning positive for the first time since March 2020 in a surge that is heaping further pressure on riskier corners of financial markets. So-called 10-year real Treasury yields have soared more than 1 percentage point since early March, hitting a high of minus 0.04 per cent on Tuesday, in a sign bond payouts are coming close to exceeding medium-term inflation expectations.The jump in real yields has been triggered by the Federal Reserve’s bid to slow intense price growth by aggressively tightening monetary policy. The move is already eroding one of the pillars that has underpinned a powerful rally in stocks and riskier corporate bonds from the depths of the coronavirus crisis two years ago. “The Federal Reserve is going to be draining liquidity,” said David Lefkowitz, the head of US equities in UBS’s chief investment office. “It is those more speculative parts of the market that benefit the most when the Fed is adding liquidity and they [may] face some . . . headwinds when the Fed is going the other way and pulling back.”The plunge in real yields on ultra low risk US government bonds deep into negative territory in 2020 set off a race by investors to hunt down assets that could provide higher returns when accounting for the effects of inflation. Prices of lossmaking start-ups and fast-growing technology groups skyrocketed from the March 2020 nadir until late 2021 as a result, with risky corporate debt also rallying sharply higher.This year’s jump in real yields has prompted investors to reassess the value of owning businesses that may not generate big profits for many years. Some private start-ups such as Instacart have agreed to cut their valuations, while shares of lossmaking technology companies have dropped more than 30 per cent this year, according to Goldman Sachs.Even America’s S&P 500 index, home to the country’s blue-chip listed companies, has declined more than 7 per cent so far in 2022, with rising real yields combining with uncertainty over the war in Ukraine and intense inflation to spook investors. In the corporate debt market, an Ice Data Services index tracking the returns on US junk bonds has dropped 6.3 per cent over the same period. This year’s jump in real yields reflects a surge in nominal, or non-inflation adjusted, borrowing costs spurred by the Fed, which is raising interest rates and moving rapidly to reduce its $9tn balance sheet as policymakers attempt to damp down intensifying consumer price pressures.Treasury yields have risen more sharply than inflation expectations, a divergence that indicates investors have confidence in the Fed’s ability to reduce troubling inflation levels in the years ahead. The 10-year break-even rate, a market-based gauge of investors’ inflation forecasts over the next 10 years, has held in a roughly 2.75 to 3 per cent range in recent weeks, far lower than the March 2022 inflation rate of 8.5 per cent. “There is a reasonable amount of faith in the Fed’s ability and willingness to combat inflation,” Ian Lyngen, a strategist at BMO Capital Markets, said. “What’s at issue isn’t whether the Fed’s response is appropriately calibrated to inflation at the moment but a belief on the part of market participants that the Fed will adjust policy as necessary.”The uptick in real yields also shows how much the Fed has been able to tighten financial conditions over time, a shift that Lael Brainard, a governor tapped to be the next vice-chair, acknowledged last week.“The communications about our policy plans have already been tightening those broader financial conditions over the past really four to five months, considerably more than you might be able to discern from just looking at the policy rate alone,” she said at an event hosted by the Wall Street Journal.

Borrowing costs for companies have shot higher, as have mortgage rates for consumers, which hit 5 per cent for the first time since 2011 last week, according to Freddie Mac.Despite the uptick, financial conditions are “still pretty loose”, said John Madziyire, a portfolio manager at Vanguard. “It could mean the Fed would need to do more, but it’s too early to know.”Economists are divided over how much further real yields could rise given the rapid move already. But some are warning they could jump again as the Fed attempts to rein in inflation. “The $64,000 question is how high do real yields go,” Lefkowitz said. More

Good morning. After we said the whole thing is dumb, a few readers still wanted to know what we think about Elon Musk and Twitter, which reportedly might soon receive a competing bid from Apollo Global Management. OK, here’s our take: go read Due Diligence. Unless and until Musk makes a buyout offer for Unhedged, we will continue to cover our ears and hum when he talks. Instead, a few thoughts on economic expectations, and consumer credit, which sure is growing fast.Email us: [email protected] and [email protected]. The economic consensus, and where it might go wrongHere are consensus medium-term expectations about the US economy, taken from Bloomberg’s aggregate of economic forecasts:Real growth will remain above 2 per centCore inflation will continue to slowUnemployment will stay near 3.5 per centHousing demand will tick down a littleS&P 500 earnings per share will grow modestly Interest rates will rise about 200 basis points in the next yearThere’s a one-in-four chance of a recessionNone of these, in isolation, sounds particularly nutty. Taken together, though, forecasters expect one of the softest landings ever — what JPMorgan’s chief economist has called “immaculate disinflation”. Other than maybe housing, this consensus doesn’t leave much to worry about. This is a very odd fit with the sour mood of market participants. Especially since the Federal Reserve shares this rosy outlook, we’ve been wondering — how plausible is it? Possible cracks in consensus include:The housing and corporate credit markets are used to low interest rates. As rates rise, one or both of these markets will stumble, forcing the Fed to choose between fighting inflation and maintaining growth.Unemployment is ridiculously low — even lower if you look at other labour market indicators — and it will have to go up if inflation is to fall. While aggregate earnings have been rising, that growth is becoming more top-heavy and probably more fragile. This chart from FactSet shows that more companies in the S&P 500 are seeing earnings estimates cut by analysts, and fewer are seeing them rise, over recent months:

The Covid recession was short, thanks to vaccines and fiscal stimulus, so we should expect the post-Covid recovery to end rapidly, too. George Goncalves, US macro strategy head at MUFG, thinks the optimistic forecasts reflect a belief that we are early in the cycle — but in fact we’re not.These are not decisive arguments against a soft landing, but they do make us wonder if complacency has set in. Here is a case for optimism. Ian Shepherdson of Pantheon Macroeconomics has been one of the most forceful bulls on the US economy, arguing that healthy household and corporate balance sheets can keep growth firm while inflation moderates. Here’s Shepherdson in a note last month:In short, then, it’s very hard to see why the private sector would feel compelled by a fed funds rate of 2 per cent or so by the end of this year to cut back spending to the point where the economy might tip into recession. That’s not to say the whole economy will roar ahead; we expect a steep drop in housing market activity over the next few months . . . [but] housing aside, we see few reasons to expect private sector spending to weaken, and plenty of reasons to expect solid growth, notably the potential for catch-up spending on services as Covid fear recedes . . . We just don’t buy the idea that the Fed faces a binary choice between letting inflation rip or triggering a recession. Markets love black-and-white stories, but this time we think it will be more useful to think in shades of grey.That last point seems right — the Fed’s trade-off is probably less sharp than many think. The crucial point about a soft landing is that the path is narrow, not that it is unwalkable. Perhaps the consensus suffers from a bit of optimism bias: a perfectly plausible base case with an unsettlingly wide scope to be wrong.Very fast consumer credit expansionConsumer credit, and especially card debt, is rising really fast. In February, total consumer non-mortgage debt rose at an annualised rate of 8.4 per cent (that includes cards, cars, education, unsecured loans, and so on). Within that, credit card loans rose by 21 per cent. Both of these are right up at the fastest rates of the past decade. Here are cards:There are two ways to look at this. One: the American consumer is back on the crack, and we are headed for a debt crisis. Two: the US economy is going to do well, and that’s nice. Unhedged, despite its basically twisted, pessimistic soul, leans toward the latter, happier read.Look at total outstanding revolving debt in the US:Yes, debt is growing at a historic pace, but we are still below pre-crisis debt levels, even though the economy is significantly bigger. Next, look at what three of the biggest credit-card issuing banks in the US told us about credit card use (and misuse) in their Q1 results last week:

Card sharksMeasureJPMorganBofACiti Spending growth, YoY29%25%23%Charge-off rate, Q1 20221.4%1.5%1.5%Charge-off rate, Q1 20213.0%3.5%2.8%30-day delinquency rate, Q1 20221.1%1.3%0.5%30-day delinquency rate, Q1 20211.4%1.8%0.6%Source: company filings

Yes, credit card spending is surging, but for now delinquency and charge-off (bad debt) rates are very low and falling. Americans are not, so far, pushing their credit limits. Data from the Fed’s distributional financial accounts show that the bottom 50 per cent of US wealth distribution saw their net worth double between the first quarter of 2020 and the fourth quarter of 2021. That cohort’s wealth now sits at $3.7tn (the top 1 per cent’s wealth, depressingly, sits at $46tn). Consumer debt/total assets for the bottom half of the distribution, at 27 per cent, is the lowest since 2010. Consumer balance sheets, even excluding the rich, look good.So far this picture all fits together. What doesn’t fit with surging credit use, however, is the absolutely abysmal level of consumer sentiment, which is at decade lows. If consumers think the economy stinks — and they do — why are they racking up debt purchases? And how long can this credit boomlet last?The UBS strategy team, led by Matthew Mish, makes a good point about this, using results from its quarterly consumer finance survey. Americans’ confidence that they are going to keep their jobs is rising, among both the more- and less-educated:

Inflation makes everyone thing that the economy is bad, for excellent reasons. But if Americans don’t think they are going to get fired, they will spend. There are two stings in the tail here. One is that it might be better, all things considered, if Americans would cool it a bit with the spending, so inflation would cool off, too. Strong balance sheets and propensity to borrow are not unalloyed good news in this environment. The other is that the improvement in the balance sheets of the bottom 50 per cent of Americans was driven primarily by rising real estate values. Property accounts for well over half the increase in their assets since the pandemic began. Rising US consumer spending and consumer credit are underwritten by house prices, for better or worse.One good readPeople finance pets, and other people threaten to repossess them. More

China’s central bank unveiled measures to support the economy after official data highlighted the worsening impact of a wave of lockdowns on consumer activity.The 23 measures, which were published late on Monday, encouraged financial institutions to support local government infrastructure projects and the country’s struggling property sector, as well as provide financial services to industries hit by the pandemic.China’s monetary policy has come under growing pressure from a property slowdown and wider loss of economic momentum, which has been exacerbated in recent weeks by a spate of lockdowns that aim to curb the country’s worst Covid-19 outbreak in two years. Shanghai, the country’s biggest city and financial hub, imposed a citywide lockdown in late March and remains largely sealed off, while restrictions have since spread to dozens of other cities.On Friday, the People’s Bank of China cut the reserve requirement ratio for banks by 25 basis points, a method of injecting more liquidity into the financial system that is part of a gradual easing cycle. The PBoC has stopped short of any dramatic shifts in policy.Alicia Garcia Herrero, chief economist for Asia Pacific at Natixis, the French investment bank, said the PBoC “has been quite cautious” and pointed to an expectation “that fiscal policy could also share more responsibility of supporting growth at the current juncture”.On Monday, data published by the National Bureau of Statistics showed China’s economy grew 4.8 per cent in the first quarter compared with the same period last year, beating expectations and surpassing the year-on-year growth rate in the previous quarter. But statistics for March revealed a contraction in retail sales for the first time since July 2020, highlighting the effect of the government’s strict zero-Covid approach.Economists expect activity in April to worsen and several banks have lowered their projections for economic growth for 2022. Standard Chartered this week lowered its forecast for the second quarter to 3.5 per cent from 5 per cent, while Barclays cut its full-year estimate from 4.5 to 4.3 per cent. The government has set a target of 5.5 per cent, its lowest in three decades.

“If there is a monthly year-on-year real GDP growth measure, we believe it will most likely be negative in April,” noted Ting Lu, chief China economist at Nomura. He thought there could be “notable downside risks” to the bank’s own forecast of 4.3 per cent growth.“We still believe global markets underestimate China’s growth slowdown and supply chain stress, which we feel are set to ripple to the rest of the world,” he added.Analysts at Goldman Sachs said they “continue to expect fast credit growth and more expansionary fiscal policies to help buffer downward pressures on growth from strict anti-pandemic measures”. But they suggested the PBoC decision reduced the chances of a broad interest rate cut and easing was more likely to come through targeted measures.The PBoC in January reduced the benchmark rate for mortgage lending for the first time in nearly two years. More

WELLINGTON (Reuters) – New Zealand’s finance minister said on Tuesday the government should continue to be careful about spending and flagged the introduction of new fiscal rules in the budget next month.”It’s really important that we use fiscal policy sensibly to be able to make sure New Zealand not only keeps a lid on debt but that we invest in the right things,” finance minister Grant Robertson told a news conference.He said new fiscal rules would be introduced at this year’s budget in May after some fiscal targets were previously suspended as the government responded to the COVID-19 pandemic. But Robertson stressed that even as New Zealand must be careful with spending, infrastructure projects such as the overhaul of the country’s health system remains important. “It is important that we don’t cut our nose off to spite our face and take away funding,” he said.New Zealand’s central bank has raised interest rates at four consecutive meetings and signalled more hikes in coming quarters as it expects annual inflation to peak around 7% in the first half of this year.Rising costs have also prompted calls from opposition parliamentary members for the government to use fiscal policy to help temper inflation. More

COLOMBO (Reuters) -The International Monetary Fund will consider providing quick financial assistance to debt-burdened Sri Lanka following representations by India, Sri Lanka’s finance ministry said on Tuesday.A delegation headed by Sri Lanka’s Finance Minister Ali Sabry kicked off formal talks with the IMF in Washington on Monday for a programme the government hopes will help top up its reserves and attract bridge financing to pay for essential imports of fuel, food and medicines.Shamir Zavahir, an aide to Sabry, said on Twitter (NYSE:TWTR) that Sri Lanka asked for a loan under the rapid financial instrument (RFI) window, meant for countries needing urgent balance-of-payment support. But the global lender was initially not inclined to grant the request, he said.”The IMF has subsequently informed Minister Sabry that India had also made representations on behalf of Sri Lanka for an RFI,” Sri Lanka’s finance ministry said in a statement.”It had been communicated that IMF will consider the special request made despite it being outside of the standard circumstances for the issuance of an RFI.”Sri Lanka’s sovereign dollar-denominated bonds came under pressure again on Tuesday, with longer-dated issues falling as much as 1.4 cents in the dollar to trade at deeply distressed levels of just over 40 cents, Tradeweb data showed.The country’s devastating financial crisis has come as the effects of COVID-19 exacerbated mismanaged government finances and as rising prices of fuel sapped foreign reserves. Fuel, power, food and medicines have been running low for weeks.Street protests have erupted against President Gotabaya Rajapaksa and his brother, Prime Minister Mahinda Rajapaksa, in the island nation of 22 million people.INDIA WEIGHS INSri Lanka is seeking $3 billion in the coming months from multiple sources including the IMF, the World Bank and India to stave off the crisis, Sabry told Reuters earlier this month.Both India and China have already extended billions of dollars in financial support to Sri Lanka. Sabry met his Indian counterpart Nirmala Sitharaman https://twitter.com/finminindia/status/1516125985044779011?s=24&t=OhOONxIQc0DoHQoNssRmeg on the sidelines of the IMF deliberations, and both sides said they agreed to deepen their cooperation.”India will fully support the deliberations of Sri Lanka with the IMF, especially on the special request made for expediting an extended fund facility,” Sabry’s office said, citing his meeting with Sitharaman.Sources have told Reuters India would keep helping out its neighbour as it tries to regain influence lost to China in recent years. Beijing is one of Sri Lanka’s biggest lenders and has also built ports and roads there.Last week, Sri Lanka’s central bank said it was suspending repayment on some of its foreign debt pending a restructure.In the commercial capital Colombo, protests demanding the ouster of the Rajapaksas have dragged on for more than a week.In parliament on Tuesday, the prime minister reiterated a call for a unity government that the opposition has rejected.In a bid to quell the protests and demands for their resignation, the Rajapaksa brothers have also offered to reduce the executive powers of the president by amending the constitution.”Together with the support of the president, we will move towards broad constitutional reforms,” said Mahinda Rajapaksa, a former president himself. “We request for support from the public, the opposition and all other stakeholders.” More

The world’s top steel producer met its annual target last year by slashing steel output to 1.035 billion tonnes from 1.065 billion tonnes in 2020.The industry has been expecting the government to maintain output controls as it aims to bring its carbon dioxide emissions to a peak by 2030. The ferrous sector contributes some 15% of China’s total greenhouse gas discharge. The National Development and Reform Commission would strictly implement requirements in line with energy consumption and environment controls while ensuring the steel sector’s supply-side reform, a commission spokeswoman, Meng Wei, told a briefing.”The target is to make sure that national crude steel output will fall in 2022 from a year earlier,” said Meng, adding that key areas for cuts include Beijing-Tianjin-Hebei and the Yangtze river delta.China’s first-quarter crude steel production stood at 243.4 million tonnes, down 10.5% from the same period a year earlier, data from the statistics bureau showed on Monday. More