The Energy-Recession Link

0:08Welcome to this live edition of Stemo signals today from Mallorca Spain hot weather sunshine shine all over the place here, but it's not necessarily a sunny outlook for the European economy, nor for the US economy, despite a very, very strong retail report coming out of the US just minutes before going on air here. So when we look at the recession playbook, I always find it very interesting to look at energy in the context of this recession playbook, because it is a very typical pattern to see energy performing in the months prior to a recession commencing. And I think we've seen that exact pattern again.

0:52The question is just whether high energy costs will lead to a very different outcome for the global economy compared to a year ago when we saw the exact same thing develop across energy markets. So let's have a look at the energy demand and supply equation before we get to that recession playbook because energy is always one of the important trigger points and one of the important catalysts to watch in the recession discussion. Last week, we had a discussion on whether the U.S. gasoline consumption had dropped materially over the course of September and the early parts of October. We get weekly numbers from the energy authorities in the U.S.

1:37on the implied demand for gasoline across the U.S. consumer stations. And ultimately, we ended up getting the confirmation that the false flag that we received the week prior was indeed a false flag. I highlighted why it was a false flag, and I'll show the chart again today. When we look at actual congestion, so traffic on roads, traffic in ports, traffic via airlines, etc., we actually still see a very large activity, hence a very strong demand for the actual fuel by the end of the day. So what you have on the chart here is the relationship between traffic in New York and then the implied gasoline demand.

2:23And you can see that we had a jump of, say, roughly 900 ,000 barrels in that implied gasoline demand measure. And I think we will see a further jump in that measure already on Thursday. since, as you can see from the light blue line, we're still running at elevated traffic levels, elevated activity levels in everything that relates to transportation fuel. And therefore, when we look at the supply demand equation for the fourth quarter in oil space, I still think it's relatively fair to assume that the oil supply will be around 100 million barrels a day, given that the Saudi Arabians have decided to cut production all the way until New Year's Eve.

3:07They may decide to prolong it even further, but for now, we know that they've cut supply until the end of the year. And relative to the oil demand, which is now clearly picking up again, also to an extent that we haven't even seen before in nominal terms, it's simply given that there will be an undersupply day in and day out through the fourth quarter. The question is whether the market has already taken this in. I think it's good news, quote unquote, for those who hope for a strong energy case from an investment perspective, that we've seen a squeeze of all of the positioning that we saw being built up over the course of especially September, meaning that this deficit in the oil market can now once again rule, I think, through the fourth quarter, because it is very evident that we have a deficit.

4:03And without intervention, both from the Biden administration or potentially from the Saudi Arabian administration, this deficit is very true. And a physically tight market will sooner or later play a role in the price action in the oil market as well. And if we look at the ramifications for inflation, I've made a very simple study on the Brent oil price in euros versus the contribution to the European Inflation Index. I could have done the exact same study for the US Inflation Index, but the point here is that, as you can see from the very light blue part of the light blue line, the forecasted projection for the contribution from energy to inflation is that energy will contribute with at least a percentage point in inflation into the early innings of 2024, in the US even more.

4:58So the point here is this makes it a whole lot trickier to bring inflation back to target short term, at least for central banks. I think that's the exact reason why we continue to see rising interest rates. steep curves because central banks do not want to react to these rising prices in oil space since it's very tricky for them to find a good excuse to do so. And when we pair that with natural gas, we have a potential cocktail that is very, very tricky ahead of the winter again. If you look at the natural gas consumption, we're, say, a week or from the heating season commencing, meaning that inventories will be drawn down, meaning that we once again should expect markets to have a very clear focus on the weather in relation to the natural gas price.

5:53And we have seen early attempts for the natural gas price to move sharply up, sort of moderated over the past two, three trading days here. But the trajectory also technically looks pretty compelling for the bull case for natural gas markets as well. So ultimately, we will have a lot of pressure on the households, again, from rising energy costs. It is very typical that we see this ahead of the recession. And the ultimate trigger for a recession is the point where households can no longer sort of keep up with the rising prices. And in relation to that discussion, I think it's very relevant to look at so-called excess savings in U.S.

6:37households. So I've built a chart and a methodology on how to measure excess savings relative to trend. And as you can see on the chart called COVID savings and you're depleted, we're approaching a point where there are no excess savings left in U.S. households. The early innings of the pandemic brought massive stimulus, massive build up of wealth. But now we've been drawing on that wealth for, yeah, I don't know, six, seven quarters in a row after all. And at the current pace, these savings will be depleted by roughly mid-January next year. So it is essentially, say, three, four, five months away max.

7:27and that is the exact time where broader ramifications will be filled for services companies for everything related to discretionary spending etc because households cannot cope with rising prices to the extent that they could a year ago and this is one of the things that I'm watching month in and month out to try and gauge how fast this depletion of savings will be in the coming months. And it also goes to show that wages do not really follow suit with rising prices. Wage growth is cooling, as we can see from the next chart with the Atlanta Fed wage growth tracker cooling relatively fast now. We also see that savings as a percent of disposable income is on the decline again after a small rebound through the early innings of the year.

8:22So it also sort of speaks in favor of this thesis that savings will soon be depleted and we will soon have issues with rising costs not being covered fully by household budgets. We're going to take a quick break and be right back with more of today's top analysis on the Real Vision Daily Briefing.

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9:50Speaking of budgets, it's fair to say that the US administration is running a budget that is not covered by tax income. If you look at the marketable treasury issues for the fourth quarter using the so-called T-Bank Q4 recommendations. We'll move to basically uncharted territory for the issuance of US treasuries. I know it's relatively old news. We already got the confirmation of that after the summer. But still, it seems like the market rates will continue to react to this story. Since right now, we struggle to find buyers for bonds simply. There is a reason why all banks try to say to clients, buy bonds, buy bonds, buy bonds.

10:41It's because they want someone to buy them. And right now, I struggle to see who are the net buyers outside of US households. Maybe a few hedge funds included in that number. But it simply means that households currently carry the back in the fixed income space. And it's basically sad to watch, in my opinion. So I basically consider the current ongoing events as triggers for renewed turbulence and fixed income space. I'm not sure that we've seen the highs yet in long-run deals in the US, given that we simply lack the bias outside of US households. And the news we got from Japan earlier today, was a few hours before going on air here, was that Bank of Japan now also struggling with inflation above target, they look into hiking their expected inflation in the forecast profile.

11:38And that typically means that they will do something to the yield curve control as well. So I'm starting to convince myself that the yield curve control could be moved, say, 25 or 50 basis points further in Japan. Remember that they control the 10-year point. And if they move that up, say 25 or 50 basis points further, then we will see the ramifications across global fixed income markets also in US treasuries and in European bonds, because the Japanese buyers are typically very large in international fixed income. And they're currently not that large given the local developments in interest rates.

12:17And all of this sounds like a very negative story for the US. But I want to talk a little bit about the other side of the coin, namely Europe and China in particular. If we look at Chinese imports, it's very clear that the weak demand in China that we've seen all year has been one of the main catalysts behind euro dollar moving lower again, so a stronger dollar versus European currency. We once again see pressure on the Chinese one this week. Dollar versus Wang is trading above 730. It's typically been the intervention level for the authorities in China. We see dollar yen trading very close to 150.

13:02Also a reason for the Bank of Japan to do something. So again, the dollar is basically the strongest currency among peers, despite all of the risks that I sort of listed for the US economy. And I think that will remain the case until it's very evident that the US is in a recession. Still some room away from that particular point. And that leads me to discuss the actual recession roadmap. I've refrained from putting a timing on it so far, but now I'm starting to convince myself that the probability is high enough for me to put an actual date on that recession in the US economy. I think Q1 with the ultimate confirmation in Q2 next year is the playbook you should expect.

13:53And as you can see from this short roadmap, I think there are a few steps that we need to understand. First, manufacturing rebounds, energy prices on the rise, et cetera. That's the first part that typically happens just before the recession. Then in the first quarter next year, we start to see service companies suffering because of still sticky wage growth compared to their selling prices. And then after a while, we get that actual confirmation by negative payrolls, et cetera, into the second quarter of next year. And why do I see this roadmap ahead? Let me show a few charts on why that is. If we look at the orders to inventory ratio for the U.S.

14:35manufacturing sector is actually rebounding. That is something we typically see in the beginning of the cycle. And currently, I think there are some pretty compelling signs from the manufacturing sector, both in the US but also elsewhere on the globe, that it is about to rebound. But the cycle in manufacturing has been 100 % off relative to services, and services make up the by far largest components of the economy. So when we look at the recession probability in relation to this manufacturing story, I have a chart on the ISM manufacturing relative to a typical recession model. It's built upon a methodology found within the Federal Reserve.

15:21And as you can see, most recession models, they just track the manufacturing PMI because the manufacturing PMI is volatile. It tells you whether the economy is growing or slowing. But in this cycle, nothing is normal because of all of the distortions from lockdowns and what have you during the pandemic. Meaning that I actually think that we can have a cocktail of short-term positivity in manufacturing at the same time as the service sector starting to show signs of weakness. and therefore currently most people will likely conclude that the recession risks are receding while I actually think the exact opposite is the case.

16:04The reason is the following. If we look at real wages and profit margins, they're basically perfectly inversely correlated. So the next chart here on real wages versus profit margins is very telling for the outlook for service companies. If wage inflation stays at, say, 5 % to 6%, and consumer price inflation is around, say, 2%, 3%, 4%, just that range, I'm using broad ranges to just describe the story now, 5 % to 6 % minus 2 % to 4 % equates a negative development in the margin for a service company because they have such a high component of labor costs. And I think that's the scenario that we're staring directly into for the next few quarters, since wages, they lag the developments elsewhere in the inflation picture.

16:58We're going to take another quick break and be right back with more of today's top analysis on the Real Vision Daily Briefing.

17:09And will we ever get inflation back to target, even during a recession, if I'm right, that it will commence in Q1 and be confirmed in Q2 next year? I've spent the first few days here in Spain on a topic of interest to many, but also especially to me and to everyone thinking about the monetary change across the globe. And I think it's very, very interesting, first of all, to look at the supply of US dollars relative to the long-term trend. If we use the so-called M2 measure to measure the amount of US dollars in circulation in the economy relative to the trend seen from 2000 to 2020, we have an enormous spread still.

17:54Despite the, you can see the attempts from the Federal Reserve to bring the light blue line lower, but we still have a massive spread, meaning that there's basically an abundance of dollars in the system relative to the trend. And that is still an ongoing issue. You can even see then we've seen some sort of stabilization, even a slight rebound in the M2 measure. That makes it very tricky to get prices back to where they were. Also from a growth perspective, because we're simply completely out of line with long-term trends in the sort of monetary trends in the US economy. And something will have to give either prices or the development in the broad circulation of dollars.

18:37And so far, we haven't really seen enough damage done to bring inflation back to target soon in the US, I think. While it is much more likely in the eurozone that we will get to that exact target of inflation at 2%, If we look at inflation versus M2 to M1 gaps, this is slightly technical, but it basically means that when you see falling inflation, there is a tendency for the gap between M2 and M1 to be closed from the top side, meaning that the broad circulation of euros will likely drop from here or at least get closer to normal. And you can actually see it in some of our research that the spread between monetary trends in the US and long-term trends is much wider than it is in Europe, in China, in Japan, etc.

19:31And that leaves US inflation much trickier to bring down to 2 % compared to peers. Another reason to buy the dollar, I think. Another reason to find some good companies in the USA able to pass through those prices compared to peers. If we look at the private credit growth, I did a long talk with Ash Bennington on this topic, was it a few months ago, in our business cycle series. If you look at our proxy for private money creation, So we try to sort of clean it for all of the balance sheet developments in the Federal Reserve. Then we are also seeing, first of all, a rebound in the US economy in terms of creating new money, but also still a gap versus long-term trends.

20:21Not as bad as if we include the Federal Reserve balance sheet, but still. And therefore, I think the likely conclusion here is that inflation will not get back to 2%. it will bottom above and then likely remain above 2 % for the foreseeable future. Ultimate conclusion here, I think the safest risk we've got at all in macrospace rise now is still to steepen the yield curve. So the spread between the 10-year point and the two-year point will continue to widen in favor of higher long-term bond yields relative to short-term bond yields. There are various retail products available to treat this two-tense steepener trade as well.

21:09And I think this trade will work if we get to the recession, because then short-term rates will be lowered. And I also think if we get, again, a prolonged discussion on when will this recession actually arrive now that we see rising energy prices, rising activity in manufacturing, then we will also see the steepener perform because we've seen it basically lately. that long-term bond yields are very connected to this story of rising energy and rising manufacturing activity. So it basically gains in both of those scenarios. If nothing happens, then the steepener trade will not really work, but it would just basically fluctuate around where it is, I think.

21:49So I think it's a very strong risk reward as it's got you covered in a recession scenario, but it also helps your portfolio in an environment like we've seen over the past month or two with rising energy prices and all that. So it gives a nice diversification to the broader portfolio setup. Let's have a look for questions. We have one in terms of how the steepener sort of fits together with the policy from the Federal Reserve. And I think it's pretty clear right now that quantitative tightening is a part of this. Because offloading bonds will typically mean that investors, those left basically, will have to ask for a bigger premium to take fixed income risk over time.

22:41So I think QT is a part of this balance you draw down essentially. And therefore, yes, the Fed Reserve Policy is, to a large extent, connected to how the yield curve shape is formed. And ultimately, the U-curve is very driven by expectations. So if we get firmer expectations of a recession, again, currently they're pretty much off the table, I think, then expect the very front of the expectations for the Federal Reserve, so 24, to include more rate cuts. In such case, that could be the driver of the curve in the recession case. I think I will leave it at that for this week's edition of StenoSignals live from Mallorca in Spain.

23:28Once again, thank you very much for watching this show and all of the feedback that we get. Remember that this is a window into my thinking. I cannot guarantee that you have the same risk appetite or the same horizon as I have. But what I can guarantee is that I will cover these macro ideas on a running basis here at Real Vision. And if you like what you saw, then you can also use the exclusive offer for the Real Vision community to join Stenner Research as a subscriber. I will, in a 100 % transparent way, elaborate on trade ideas, how I construct the portfolio, et cetera. And we also produce research on Japan, China, Europe, the US.

24:08We basically couple the whole globe from a macroeconomic perspective, always with the aim of making money. Again, thank you for watching this week, and I'll see you again in two weeks' time for the next edition of Stable Signals.

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25:20Not all applicants will qualify. Plus 500. It's trading with a plus.