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Why a Bear Market in Bonds Points to a Weakening Economy

After closing at 0.53 percent in July 2020 the yield on the ten-year US T-bond moved relentlessly higher, closing on Tuesday, September 28, 2021, at 1.55…

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This article was originally published by Mises Institute

After closing at 0.53 percent in July 2020 the yield on the ten-year US T-bond moved relentlessly higher, closing on Tuesday, September 28, 2021, at 1.55 percent. There is a growing likelihood that the July 2020 figure of 0.53 percent might have been the lowest point.

How should we view this in the context of historical trends in bond yields?

First, it is important to consider the behavioral foundations of bond buying.

As a rule, people assign a higher valuation to present goods versus future goods. This means that present goods are valued at a premium to future goods. This stems from the fact that a lender or investor gives up some benefits at present. Hence, the essence of the phenomenon of interest is the cost that a lender or an investor endures.

An individual who has just enough resources to keep him alive is unlikely to lend or invest his paltry means. The cost of lending or investing to him is likely to be very high—it might even cost him his life if he were to consider lending part of his means. Therefore, he is unlikely to lend or invest even if offered a very high interest rate. Once his wealth starts to expand, the cost of lending or investing starts to diminish. Allocating some of his wealth toward lending or investment is going to undermine to a lesser extent our individual’s life and well-being at present.

From this we can infer, all other things being equal, that anything that leads to an expansion in the wealth of individuals gives rise to a decline in the interest rate, i.e., the lowering of the premium of present goods over future goods. Conversely, factors that undermine wealth expansion lead to a higher interest rate. Observe that while the increase in the pool of wealth is likely to be associated with a lowering in the interest rate, the converse is likely to take place with a decline in the pool of wealth.

People are likely to be less eager to increase their demand for various assets, thus raising their demand for money relative to the previous situation. All other things being equal, this will manifest in the lowering of the demand for assets, thus lowering their prices and raising their yields.

Note again, that increases in wealth tend to lower individuals’ time preferences whereas decreases in wealth tend to raise time preferences. The link between changes in wealth and changes in time preferences is not automatic, however. Every individual decides how to allocate his wealth in accordance with his priorities.

Changes in Money Supply and Interest Rate

An increase in the supply of money, all other things being equal, means that those individuals whose money stock has increased are now much wealthier than before the increase in the money supply took place. Hence, this will likely give rise to a greater willingness in these individuals to purchase various assets. This leads to the lowering of the demand for money by these individuals, which in turn bids the prices of assets higher and lowers their yields.

At the same time, the increase in the money supply sets in motion an exchange of nothing for something, which amounts to the diversion of wealth from wealth generators to non–wealth generators. The consequent weakening in the wealth formation process sets in motion a general rise in interest rates. This implies that an increase in the growth rate of money supply, all other things being equal, sets in motion only a temporary fall in interest rates. This decline in interest rates cannot be sustainable because of the damage to the process of wealth generation.

Conversely, a decline in the growth rate of money supply, all other things being equal, sets in motion a temporary increase in interest rates. Over time, the fall in the money supply encourages a strengthening of the wealth formation process, which sets in motion a general fall in interest rates. We can thus see that the key to the determination of interest rates is individuals’ time preferences, which are manifested in the interaction of supply and demand for money. Also note that in this way of thinking the central bank has nothing to do with the determination of the underlying interest rates. The policies of the central bank only distort where interest rates should be in accordance with time preferences, thereby making it much harder for businesses to ascertain what is really going on.

Assessing Historical Long-Term Yield Trends

From 1960 to 1979 the yields on the long-term US Treasury bond had been following a visible uptrend (see chart). From 1980 until now, the yields were following a downtrend (see chart).

10-year T-bond yields vs trend
10-year T-bond yields vs trend

From 1960 to 1979 we can also observe that the yearly growth rate of money supply (AMS) followed a visible uptrend (see chart). This caused a strong weakening in the wealth generation process on account of the exchange of nothing for something. The weakening of the process of wealth generation due to the uptrend in the growth momentum of money supply lifted individuals’ time preferences, and this placed the underlying long-term yields on a rising trend.

AMS vs trend
By contrast, the declining trend in the yearly growth rate of AMS that we can observe from 1980 to 2007 was instrumental in the strengthening of the process of wealth generation (see chart). This was an important factor in the declining trend in long-term yields during this period.
AMS vs trend
AMS vs trend

From 2008 to 2011, the yearly growth rate of AMS followed a visible rising trend (see chart). This most likely undermined the process of wealth generation again. The uptrend in the money supply growth rate enriched the early recipients of the newly pumped money, and as a result, their demand for various financial assets including Treasurys increased, in the process lifting the prices of these assets and lowering their yields. Despite large increases in money supply, the early recipients of the monetary increases benefited by being ahead timewise of the overall wealth erosion effect. This in turn also prevented the upward pressure on interest rates.

The massive increases in money supply from 2019 to February 2021 have likely severely undermined the process of wealth generation (see chart). Note that the yearly growth rate of AMS stood at 79 percent in February 2021. Also note that the yearly increase in dollar terms stood at an unprecedented figure of $4.2 trillion in February 2021. If one adds to this the reckless fiscal policy of the government this amounts to a severe weakening of the process of wealth generation and has likely placed long-term yields on a rising trend, which may have started in July 2020.

AMS vs trend

The erosion in wealth formation has already set in motion the weakening in economic activity and the decline in the momentum of inflationary bank lending. This type of lending is an important ingredient in the growth rate of money supply. The likely further decline in the pool of wealth raises the likelihood of a further decline in the growth rate of inflationary lending and the growth rate of money supply (see chart).

AMS vs inflationary credit

A fall in the growth rate of money supply will weaken the wealth increases of the early recipients of money. Consequently, they are probably going to reduce their demand for financial assets, exerting an upward pressure on yields. If the economic slump is of a severe nature, this will result in a prolonged decline in the momentum of inflationary credit. Consequently, a strong decline in the money supply growth rate will emerge. As a result, the uptrend in long-term rates could be of long duration.

This uptrend is likely to take place despite the positive influence of the expected decline in the momentum of money supply on the wealth generation process. Note that the likely Fed and government policies to counter the emerging economic slump will delay the liquidation of various nonproductive activities, thereby slowing down the revival of the pool of wealth.

These activities, also known as bubble activities, have emerged on the back of loose monetary and fiscal policies. As a result, bubble activities are likely to continue to undermine the process of wealth generation with such policies in place. This in turn is going to prolong the bear market in Treasury bonds.

Conclusion

It is likely that the bull market in T-bonds ended around July 2020. On account of past strong increases in money supply, the process of wealth generation has probably been weakened significantly. This has set in motion the decline in the inflationary credit momentum and the consequent decline in the momentum of money supply.

As a result, this is expected to set in motion a visible rise in long-term interest rates. Attempts by the Fed and the government to counter the economic slump are likely to weaken further the pool of wealth and make the economic climate much more severe.

Note that once the pool of wealth starts to decline, aggressive monetary and fiscal policies can only weaken this pool, thereby weakening the heart of economic growth. If loose monetary and fiscal policies could strengthen the pool of wealth, then world poverty would have been eliminated a long time ago.

Economics

Slowing Down, Yes, But To What?

A couple of Economists have caused some noise by reviewing consumer confidence estimates in the United States, associating big declines in them with imminent…

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A couple of Economists have caused some noise by reviewing consumer confidence estimates in the United States, associating big declines in them with imminent recession, and then pointing out such substantial drops in both of the major consumer sentiment surveys just recently. If valid, their correlations would seem to suggest a US contraction.

We’re meant to take these seriously for one of those academics, David Blanchflower of Dartmouth, had once “set interest rates at the BOE during the 2008 financial crisis.” Hardly a good place to start winning converts.

He and his co-author Alex Bryson of UCL are pretty adamant:

The economic situation in 2021 is exceptional, however, since unprecedented direct government intervention in the labor market through furlough-type arrangements has enabled employment rates to recover quickly from the huge downturn in 2020. However, downward movements in consumer expectations in the last six months suggest the economy in the United States is entering recession now.

The Conference Board’s more optimistic measure has indeed become far less lofty very quickly. And while the University of Michigan’s sentiment index never rebounded near as much, it has likewise fallen backward when it should be surging in recovery. The latter’s newly released preliminary assessment for October 2021, increasingly free from delta COVID’s influences on governments, wasn’t good; slightly lower after a slight gain in September.

Scraping along the bottom:



Whether this means recession or not may be beside the point. What is the point is how even academic Economists can’t help but notice how the US and global Economy is not in any shape like what’s been said all year and predicted for the rest. I seem to recall the term “red hot” being thrown around by unassailable luminaries as if a certainty.

The economy certainly had accelerated earlier but not for economic reasons; the non-economic interference of global fiscal policies, especially those of the US federal government.

Typically, academics see such intervention as thoroughly positive not just in the short run more so believing these programs dependably contribute much to the intermediate and longer-term trajectory – even as experience consistently shows they never do.

Since April or May, a global slowdown at first denied has slowly become practically undeniable as more and more the weak data comes back and sticks around. This is also true of “inflation”, the other side of transitory, the downslide of the camel humps in whichever consumer, producer, or now trade price index.



The third of the BLS’s series after first the CPI then next PPI is import prices, along with export prices. Even the latter, export prices, which have been more impressive than the far less impressive import index (though it might seem from mainstream commentary it would be the other way around), these indices are more clearly bending.

Toward what? Recession?

Not necessarily. Given consumer confidence as well as more substantial indications like real yields (TIPS; see: below), it may be a more reasonable question to ask whether or not the global economy ever actually got out of the last one.

If that’s really the case, then for all Uncle Sam’s efforts all it did was fool people into believing inflation and recovery (which many, maybe the vast majority still believe) when in fact those weren’t really happening. That technically makes this current weak spot at least a slowdown, but more appropriate one toward an economy merely reverting to its actual economic state increasingly unbound by non-economic interventions.



The growing response to the downshift is somewhat interesting; “everyone” is beginning to sense and admit the weakness, but they won’t let go of the inflation. Therefore, more and more the term stagflation is being thrown around regardless of the recession question – because people have been led to believe inflation is something it is not.

As I noted recently, however, if this really is serious and enduring weakness, a reversion back to the non-recovery state, the type of “flation” has already been decided.

The Economist considers this as higher potential for “stagflation”, a term popularized during and about the Great Inflation of the 1970’s. It also made a comeback around 2010 and 2011 – not that anyone remembers now. Quite simply, without the money for inflation what’s left is just the stagnation; which very succinctly and accurately describes the decade which followed 2010 and 2011.

Is this time really different? So far, the stagnation is proceeding almost as if right on schedule; the non-central bank schedule.

No need to call it stag-deflation because that’s just redundant. In other words, as the renewal of stagnation grows larger on the horizon, settling the label’s other half is already being taken care of.

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Economics

China Coal Prices Soar To Record As Winter Freeze Spreads Cross The Country

China Coal Prices Soar To Record As Winter Freeze Spreads Cross The Country

One week ago we discussed why the "worst case" scenario for China’s…

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China Coal Prices Soar To Record As Winter Freeze Spreads Cross The Country

One week ago we discussed why the "worst case" scenario for China's property crisis is gradually emerging; to this we can now add that China's worst case energy crisis scenario is also about to be unleashed as cold weather swept into much of the country and power plants scrambled to stock up on coal, sending prices of the fuel to record highs.

Electricity demand to heat homes and offices is expected to soar this week as strong cold winds move down from northern China, according to Reuters with forecasters predicting average temperatures in some central and eastern regions could fall by as much as 16 degrees Celsius in the next 2-3 days.

Shortages of coal, high fuel prices and booming post-pandemic industrial demand have sparked widespread power shortages in the world's second-largest economy. Rationing has already been in place in at least 17 of mainland China's more than 30 regions since September, forcing some factories to suspend production and further disrupting already broken supply chains.

On Friday, the most-active January Zhengzhou thermal coal futures closed at a record high of 2,226 per tonne early. The contract has risen almost 200% year to date.

China's three northeastern provinces of Jilin, Heilongjiang and Liaoning - also among the worst hit by the power shortages last month - as well as several regions in northern China including Inner Mongolia and Gansu have started winter heating, which is mainly fuelled by coal, to cope with the colder-than-normal weather.

Meanwhile, even though Beijing has taken a slew of measures to contain coal price rises including raising domestic coal output and cutting power to power-hungry industries and some factories during periods of peak demand, so far all measures have failed with coal surging by 40% in just the past three days. Beijing has also repeatedly assured users that energy supplies will be secured for the winter heating season, and went so far as to order energy firms to "secure supplies at all costs." Well, the energy firms heard it, because on that day, thermal coal closed at 1,436 yuan. Two weeks later it is some 800 yuan higher.

Unfortunately for Beijing, the power shortages are expected to continue into early next year, with analysts and traders forecasting a 12% drop in industrial power consumption in the fourth quarter as coal supplies fall short and local governments give priority to residential users.

Earlier this week, we reported that China undertook its boldest step in a decades-long power sector reform when it allowed coal-fired power prices to fluctuate by up to 20% from base levels from Oct. 15, enabling power plants to pass on more of the high costs of generation to commercial and industrial end-users. read more

Steel, aluminium, cement and chemical producers are expected to face higher and more volatile power costs under the new policy, pressuring profit margins.

Meanwhile, the latest Chinese "data" on Thursday showed factory-gate inflation in September hit a record high; but since thermal coal is the one commodity that correlates the closest to PPI, absent a sharp drop in coal prices in the next few weeks, expect the next PPI print to be far higher. Meanwhile as the power crisis leads to further shutdowns in domestic production, some banks - such as Nomura - have gone so far to predict that China's GDP is set to shrink in coming quarters.

China, which laughably aims to be "carbon neutral" by 2060 even as its president announced he will skip the COP26 UN Climate Change Conference in Glasgow, has been "trying" to reduce its reliance on polluting coal power in favor of cleaner wind, solar and hydro. But coal remains the source for some 70% of China's electricity needs.

Of course, China is not the only nation struggling with power supplies, which has led to fuel shortages and blackouts in many European countries. and threatens to send US heating bills up as much as 50% this winter. he crisis has highlighted the difficulty in cutting the global economy's dependency on fossil fuels as world leaders seek to revive efforts to tackle climate change at talks next month in Glasgow.

China will strive to achieve carbon peaks by 2030, Vice Premier Han Zheng said in a video message at the Russian Energy Week International Forum, according to state-run news agency Xinhua late on Thursday. He also said that China and Russia are important forces leading the energy transition and they should cooperate and ensure smooth progress of major oil and gas pipeline and nuclear power projects.

Translation: Russia better save that nat gas and not ship it to Europe as China will soon be needed even BCF Russia an provide. As for China

 

Tyler Durden Fri, 10/15/2021 - 22:50
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Economics

Aluminum Shortages Next As “Magnesium Supply Dries Up”

Aluminum Shortages Next As "Magnesium Supply Dries Up"

This week, the largest US producer of aluminum billet used to make automobiles and…

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Aluminum Shortages Next As "Magnesium Supply Dries Up"

This week, the largest US producer of aluminum billet used to make automobiles and building supplies told customers and business associates that output capacity might be curtailed in 2022 due to a lack of magnesium supply.

"In the last several weeks, magnesium availability has dried up, and we have not been able to purchase our required magnesium units for all of 2022," Matalco Inc. President Tom Horter said in the letter obtained by S&P Global Platts

Difficult-to-source supplies of raw materials and soaring energy prices are adding to the headwinds, Horter said in the letter. 

"The purpose of this note is to provide this advanced warning that, if the scarcity continues, and especially if it becomes worse, Matalco may need to curtail production in 2022, resulting in allocations to our customers," he said. 

Horter said his company will source as much magnesium as possible and other raw materials, such as silicon, to maintain its planned production output for 2022. The warning comes as he told customers they should have contingency plans if supplies tighten. 

Aluminum billet cannot be produced without magnesium, which is a strengthening agent and allows it to be strong enough to be used in structural applications, such as automobile frames, engine blocks, and body panels. 

"We will provide an update in a couple of weeks," Horter said. "In the meantime, you may want to consider letting your customer base know of this silicon and magnesium availability crisis and also let them know that other products or inputs needed for making billet or slab may also reach a crisis point."

Horter added other challenges such as the cost of energy, labor, and shipping are increasingly mounting. 

Alcoa is another major US aluminum producer that also warned about shortages of magnesium and silicon. Without these two ingredients, both manufacturers cannot produce aluminum billet products. A reduction in US output would tighten global supply even further. 

The macro backdrop of the aluminum industry is a complicated one. First, a military coup in Guinea last month stoked concerns over the supply of bauxite, a sedimentary rock with high aluminum content. Then the closure of energy-intensive smelters in Asia and Europe have tightened global supplies and forced LME prices to record highs. 

The latest surge in industrial metals will continue to pressure inflation higher. 

So much for the Federal Reserve's "transitory" narrative. Higher costs will push up prices for new cars and other products made of aluminum.

Tyler Durden Fri, 10/15/2021 - 22:10
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