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Central Banks & The Looming Financial Reckoning

Central Banks & The Looming Financial Reckoning

Authored by Willem Buiter via Project Syndicate,

Across the advanced economies, central…

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This article was originally published by Zero Hedge
Central Banks & The Looming Financial Reckoning

Authored by Willem Buiter via Project Syndicate,

Across the advanced economies, central banks have rightly prioritized maintaining financial stability and supporting the real economy over fighting inflation with interest-rate hikes. But with financial fragility rife and public and private leverage at all-time highs, their next big test is coming.

Since early 2020, central banks across the advanced economies have had to choose between pursuing financial stability, low (typically 2%) inflation, or real economic activity. Without exception, they have opted in favor of financial stability, followed by real economic activity, with inflation last.

As a result, the only advanced-economy central bank to raise interest rates since the start of the COVID-19 pandemic has been Norway’s Norges Bank, which lifted its policy rate from zero to 0.25% on September 24. While it has hinted that an additional rate increase is likely in December, and that its policy rate could reach 1.7% toward the end of 2024, that is merely more evidence of monetary policymakers’ extreme reluctance to implement the kind of rate increases that are required to achieve a 2% inflation target consistently.

Central banks’ overwhelming reluctance to pursue interest-rate and balance-sheet policies compatible with their inflation targets should come as no surprise. In the years between the start of the Great Moderation in the mid-1980s and the 2007-08 financial crisis, advanced-economy central banks failed to give sufficient weight to financial stability. A prime example was the Bank of England’s loss of all supervisory and regulatory powers when it was granted operational independence in 1997.

The result was a financial disaster and a severe cyclical downturn. Confirming the logic of “once bitten, twice shy,” central banks then responded to the COVID-19 pandemic by pursuing unprecedentedly aggressive policies to ensure financial stability. But they also went far beyond what was required, pulling out all the policy stops to support real economic activity.

Central banks were right to prioritize financial stability over price stability, considering that financial stability itself is a prerequisite for sustainable price stability (and for some central banks’ other target, full employment). The economic and social cost of a financial crisis, especially with private and public leverage as high as it is today, would dwarf the cost of persistently overshooting the inflation target. Obviously, very high inflation rates must be avoided, because they, too, can become a source of financial instability; but if preventing a financial calamity requires a few years of high single-digit inflation, the price is well worth it.

I hope (and expect) that central banks – not least the US Federal Reserve – are ready to respond appropriately if the US federal government breaches its “debt ceiling” on or around October 18. A recent study by Mark Zandi of Moody’s Analytics concludes that a US sovereign debt default could destroy up to six million US jobs and wipe out as much as $15 trillion in US private wealth. This estimate strikes me as optimistic. If the sovereign default were to be protracted, the costs would probably be much higher.

In any case, a US sovereign default would also have a dramatic and devastating global impact, afflicting both advanced economies and emerging and developing markets. US sovereign debt is widely held globally, and the US dollar remains the world’s senior reserve currency.

Even without a self-inflicted wound like a US congressional failure to raise or suspend the debt ceiling, financial fragility is rife nowadays. Household, corporate, financial, and government balance sheets have grown to record highs this century, rendering all four sectors more vulnerable to financial shocks.

Central banks are the only economic actors capable of addressing the funding and market-liquidity crises that are now part of the new normal. There is not enough resilience in non-central bank balance sheets to address a fire sale of distressed assets or a run on commercial banks or other systemically important financial institutions that hold liquid liabilities and illiquid assets. This is as true in China as it is in the US, the eurozone, Japan, and the United Kingdom.

China’s real-estate bubble – and the household debt secured against it – is likely to implode sooner or later. The dangerously indebted property developer Evergrande could well be the catalyst. But even if Chinese authorities manage to prevent a full-fledged financial meltdown, a deep and persistent economic slump would be unavoidable. Add to that a marked decline in China’s potential growth rate (owing to demographics and enterprise-hostile policies), and the world economy will have lost one of its engines.

Across the advanced economies (and in many emerging markets), risk assets, notably equity and real estate, appear to be materially overvalued, despite recent minor corrections. The only way to avoid this conclusion is to believe that long-run real interest rates today (which are negative in many cases) are at or close to their fundamental values. I suspect that both the long-run real safe interest rate and assorted risk premia are being artificially depressed by distorted beliefs and enduring bubbles, respectively. If so, today’s risk-asset valuations are utterly detached from reality.

Whenever the inevitable price corrections materialize, central banks, supervisors, and regulators will need to work closely with finance ministries to limit the damage to the real economy.

Significant deleveraging by all four sectors (households, non-financial corporates, financial institutions, and governments) will be necessary to reduce financial vulnerability and boost resilience. Orderly debt restructuring, including sovereign debt restructuring in several highly vulnerable developing countries, will need to be part of the overdue restoration of financial sustainability.

Central banks, acting as lenders of last resort (LLR) and market makers of last resort (MMLR), will once again be the lynchpins in what is sure to be a chaotic sequence of events.

Their contributions to global financial stability have never been more important. The goals of 2% inflation and maximum employment can wait, but financial stability cannot. Since LLR and MMLR operations are conducted in the twilight zone between illiquidity and insolvency, these central-bank activities have marked quasi-fiscal characteristics. Thus, the crisis now waiting in the wings will inevitably diminish central bank independence.

Tyler Durden Tue, 10/05/2021 - 05:00

Economics

Stocks Stink As Curve Pancakes On Stagflation Fears

Stocks Stink As Curve Pancakes On Stagflation Fears

It was another choppy day in the market which saw an overnight attempt to recover from…

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Stocks Stink As Curve Pancakes On Stagflation Fears

It was another choppy day in the market which saw an overnight attempt to recover from losses get sabotaged at the open when a sell program knocked spoos lower and the result was a rangebound, directionless grind for the rest of the day as the continued pressure of negative gamma prevented a move higher, and since they couldn't rise, stocks sold off closing near session lows. 

Granted, there was the usual chaos in the last 30 minutes of trading, when a huge sell program was followed by an almost identical buy program...

... but it was too little too late to save stocks from another down day.

While the Russell, energy stocks and banks managed to bounce and drifted in the green for much of the day - perhaps as investors looked forward to good news from JPMorgan tomorrow when the largest US bank kicks off earnings season - the rest of the market did poorly with most other sectors in the red.

Earlier today we noted that the SPY remains anchored by two massive gamma levels, 430 on the downside and 440 on the upside...

... however that may soon change. As SoFi strategist Liz Young pointed out, "It's been 27 trading days since we hit a new high on the S&P 500. The last time we went this long was...exactly this time last year. New highs happened on Sept 2nd, both years, before a pause."

In rates we saw a sharp flattening with another harrowing CPI print on deck tomorrow which many expect to roundly beat expectations...

... with the short end rising by 3bps, a move that was aided by a poor 3Y auction which saw a slump in the bid to cover and a plunge in Indirect takedown, while the long end tightened notably, and 10Y yields on pace to close 4bps lower.

The dollar went nowhere, and while oil tried an early break out and Brent briefly topped $84, the resistance proved too much for now and the black gold settled down 31 cents for the day at 83.34 although WTI did close up 4 cents, and above $80 again, at $80.54 to be precise. Still, with commodity prices on a tear, it's just a matter of day before Brent's $86 high from October 2018 is taken out.

With stocks failing to make a new high in over a month, investor sentiment has predictably soured with AAII Bulls down to the second lowest of 2021, while Bearish sentiment continues to rise.

There is another reason sentiment has been in the doldrums: traders are concerned that price pressures and supply-chain snarls will drain corporate profits and growth, and expect disappointment from the coming earnings season which according to Wall Street banks will be a far more subdued affair compared to the euphoria observed in Q1 and Q2.  Quarterly guidance, which improved in the runup to the past four reporting periods, is now deteriorating, with analysts projecting profits at S&P 500 firms will climb just 28% Y/Y to $49 a share. That’s down from an eye-popping clip of 94% in the previous quarter.

Meanwhile, adding to the downbeat mood, Atlanta Fed President Raphael Bostic finally admitted that inflation is not transitory, and the Fed should proceed with a November taper amid growing fears that inflation expectations could get unanchored. Earlier in the day was saw that 3Y consumer inflation expectations hit a record high 4.3% confirming that the Fed is on the verge of losing control.

Vice Chair Richard Clarida agreed and said that conditions required to begin tapering the bond-buying program have “all but been met.”

Finally, the IMF delivered more bad news today when it cut its global GDP forecast while warning that inflation could spike, and cautioned about a risk of sudden and steep declines in global equity prices and home values if global central banks rapidly withdraw the support they’ve provided during the pandemic. In short, the world remains trapped in a fake market of the Fed's own creation.

Tyler Durden Tue, 10/12/2021 - 16:02
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Economics

Carbon prices are on the rise and businesses already decarbonising are ahead of the pack

Remember the carbon tax? Back in 2012 PM Julia Gillard got slammed for putting a price on carbon emissions, and … Read More
The post Carbon prices are…

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Remember the carbon tax?

Back in 2012 PM Julia Gillard got slammed for putting a price on carbon emissions, and the heat is on current PM Scott Morrison with the issue set to be a hot topic at the Glasgow Climate Conference later this month.

Many governments around the world have either introduced an Emissions Trading Scheme (ETS) or imposed carbon taxes – because carbon pricing is one of the most effective ways of reducing greenhouse gas emission levels on the domestic and international level.

With ETS, governments set the quantity of emissions permitted and let the market find the market-clearing price.

For carbon taxes, governments impose a tax on emissions and then let the market find the market-clearing quantity of emissions.

According to CRU Group research analysts Clifton Hoong and Frank Eich, ETSs come out on top.

“When comparing their respective contributions in addressing greenhouse gas (GHG) emissions, ETS does come out top, covering 16.1% of global GHG emissions, almost three times the 5.5% that carbon taxes cover,” they said.

The UK and Europe have adopted emissions trading schemes and even China – the world’s largest carbon emitter – launched a nationwide ETS in July after experimenting with regional ETSs.

And in Singapore, a new global carbon exchange, Climate Impact X, is expected to launch by the end of the year.

Pic: Range of external carbon price forecasts (2020 prices $/ tCO2).

 

Carbon prices are set to rise

The analysts said that the sharp increase of the carbon price on the EU ETS over recent months gives an idea what might be in store in the years and decades ahead.

“In 2021, European carbon taxes averaged $42/tCO2, which is relatively cheaper compared with the $56/tCO2 average that has been traded in the EU ETS so far in 2021,” the analysts said.

“We have conducted a survey of recent carbon price forecasts published by international organisations, governments, think tanks and corporates to get a sense of where carbon prices are headed.

“The range of forecasts is huge, but we should not be surprised to see a global carbon price of around $100/tCO2 by 2030 and around $300/tCO2 by 2050 if the world gets serious about climate change mitigation.”

And as carbon prices keep rising, commodity markets across the value chain will need to adapt.

“In some markets, carbon prices have been rising rapidly over the recent past and are forecast to do so for years to come,” Hoong and Eich said.

“The commodities markets across the value chain will need to prepare for and adapt to these new prices.”
 

EU and UK carbon market outlook

The EU was first to launch a major ETS in 2005 and by making carbon permits an increasingly scarce ‘good’, the EU is raising the market-clearing carbon price.

“These measures appear to be delivering,” CRU said.

“Having in the past frequently been criticised for being too low to make a difference, the EU ETS carbon price has increased sharply since the beginning of the year, reaching a new record €65/tCO2 (i.e., $75/tCO2) on 26 September.”

And word on the street is that the UK Government might have to step in and intervene in its national carbon market in December if crises remain elevated through November, given the current energy crisis causing the prices to average £58.36 per metric tonne in September.

“Even small increases in energy or fuel costs frequently lead to protests or even social unrest,” Hoong and Eich said.

“How to sell the necessity of increasing the price of energy to the electorate in the name of climate change mitigation when increasing prices are deeply unpopular and – often – also considered to be socially unfair?

“The latest spike in European natural gas prices is a reminder of that.

“Finding a way through this conundrum will be one of the biggest challenges for policymakers in the years ahead.

“As the recent outcome of the Swiss referendum on tougher climate change legislation forcefully demonstrates, we should be ready for major setbacks on the way to net zero over coming years.”

EU carbon price
Pic: EU carbon price reaching €65 on 26 September.

 

Commodities markets will have to adapt

“Major setbacks are not the same as abandoning the ambition and the commodities markets – just like all other sectors of the global economy – will need to prepare for and adapt to higher carbon prices,” the analyst said.

“The likely dramatic increase in carbon prices in the future will have fundamental implications for many parts of the economy, more so for businesses in the carbon-intensive industries.”

But not all players will be affected equally.

“For those industries where switching electricity to a low-carbon alternative is a solution (e.g., mine sites, aluminium production), the transition could be ‘relatively’ simple and at lower cost,” Hoong and Eich said.

“By contrast, changing the way how a key raw material is produced (e.g., hydrogen for ammonia) will likely prove more challenging and, almost certainly, more costly.

“Where a wholesale shift in technology is needed (e.g., hydrogen steel production), the transition will potentially be painful.

“Even operations that are already low carbon as a result of access to low-carbon electricity (e.g., hydro feeding aluminium smelters) will see cost inflation as supply contracts are renegotiated in the context of rapidly rising electricity prices.”
 

Businesses already decarbonising will benefit

The analysts said that often implementing decarbonisation plans means a significant upfront investment in electrifying energy inputs, integrating renewables and reducing the carbon footprint.

That cost is a barrier to transformation for many businesses – but inaction isn’t the way to go,” Hoong and Eich said.

“Implementing these decarbonisation plans often incurs substantial upfront investment cost, which can act as a barrier to transformation.

“Up to now this made the alternative route of action – doing nothing – attractive to many.

“But as the opportunity cost of doing nothing increases as carbon prices go up, this alternative route will become increasingly unattractive.

“Those who have already placed their bets on hefty investments to decarbonise their production operations are starting to reap the benefits as the cost of carbon continues its way up.

“We should expect others to follow suit.”

The post Carbon prices are on the rise and businesses already decarbonising are ahead of the pack appeared first on Stockhead.

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Economics

US Close: Stocks drift ahead of CPI/Earnings, JOLTS miss, IMF lowers outlook, Fastenal’s inflation warning

US stocks are mixed as investors refrain from any major positioning ahead of the September inflation report, official start to earnings season, and the…

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US stocks are mixed as investors refrain from any major positioning ahead of the September inflation report, official start to earnings season, and the House debt limit vote. JPMorgan gets to officially kick off earnings season, but Fastenal, the industrial giant gets to be the first S&P 500 company to post results. Fastenal’s results did not deliver any surprises, primarily giving a reminder that supply chain and labor shortages remain and that inflation remains elevated.

Stocks were lower early over both global growth concerns and weakness with China’s property sector but turned positive after House Speaker Pelosi provided a potential path for getting infrastructure spending and the debt ceiling done.  Pelosi noted that Democrats lower the price tag of Biden’s economic agenda by cutting the number of years covered in the agenda.  Risks to the outlook are rising and Democrats know they are running out of time.  Progressives and moderates don’t want to be responsible for disrupting Biden’s economic agenda, so it looks like some major concessions will be made shortly. 

JOLTS

Job openings in August posted the first decline in almost a year and the number of quits rose to a record high 4.3 million.  The delta variant is clearly reflected in the headline miss of 10.439 million job openings, well below the consensus estimate of 10.954 and the upwardly revised 11.098 million prior reading.  The labor market recovery will remain tricky and that should push back expectations on when the Fed will be able to check off the substantial progress box. 

Fastenal/LVMH

The industrial products maker did not deliver any surprises.  The manufacturing sector agrees with Fastenal’s comment that “product and shipping cost inflation remains high; Supply chain disruption and labor shortages remain acute.”  Fastenal did not impress as sales for certain products related to the pandemic eased.  Fastenal will continue to increase prices in the fourth quarter.

LVMH posted slightly better-than-expected third quarter revenue and anticipates continuation of the current growth. 

IMF

The IMF’s World Economic Outlook noted that the global recovery continues, but the momentum has weakened and uncertainty has increased.  The IMF is concerned that surging prices will force central banks into tightening cycles that could trigger selloffs in global equities. An unbalance economic recovery and rising pricing pressures will complicate monetary policy efforts going forward.  

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