World Bank says goal of ending extreme poverty by 2030 unlikely to be met

Wed, October 5, 2022 
By Andrea Shalal

WASHINGTON, Oct 5 (Reuters) - Shocks related to the COVID-19 pandemic and the war in Ukraine mean the world is unlikely to meet a longstanding goal of ending extreme poverty by 2030, the World Bank said in a new report released on Wednesday.

The COVID-19 pandemic marked a historic turning point after decades of poverty reduction, the report said, with 71 million more people living in extreme poverty in 2020.

That meant 719 million people - or about 9.3% of the world's population - were living on just $2.15 a day, and the ongoing war, reduced growth in China and higher food and energy prices threatened to further stall efforts to reduce poverty, it said.

Barring sharp growth gains, an estimated 574 million people, or about 7% of the world's population, would still be subsisting at that same income level by 2030, mostly in Africa, it said.

World Bank President David Malpass said the new Poverty and Shared Prosperity report showed the grim outlook facing tens of million of people, and called for major policy changes to boost growth and help jumpstart efforts to eradicate poverty.

"Progress in reducing extreme poverty has essentially halted in tandem with subdued global economic growth," he said in a statement, blaming inflation, currency depreciations and broader overlapping crises for the rise in extreme poverty.

Indermit Gill, the World Bank's chief economist, said failure to reduce poverty in developing countries would have profound implications for the world's broader ability to combat climate change and could unleash large new flows of migrants.

It would also limit growth in advanced economies, since extreme poverty rates would prevent these often heavily populated developing countries from becoming bigger consumers of goods on the global market.

"If you care about prosperity in advanced economies, sooner or later you want these countries to have large markets, countries like India, countries like China," he said. "You also want these countries to grow so they actually start to become sources of demand and not just supply."

To change course, the World Bank said countries should boost cooperation, avoid broad subsidies, focus on long-term growth and adopt measures such as property taxes and carbon taxes that could help raise revenue without hurting the poorest people.

It said poverty reduction had already slowed in the five years leading up to the pandemic, and the poorest people clearly bore its steepest costs. The poorest 40% of people saw average income losses of 4% during the pandemic, twice the losses experienced by the wealthiest 20%, the World Bank said.

Government spending and emergency support helped avert even bigger increases in poverty rates, the report showed, but the economic recovery had been uneven, with developing economies with fewer resources spending less and achieving less.

Extreme poverty was now concentrated in sub-Saharan Africa, which has a poverty rate of about 35% and accounts for 60% of all people in extreme poverty, the report said. 

(Reporting by Andrea Shalal; Editing by Kim Coghill and Paul Simao)

Volatility in Europe's oil and gas market ‘is thwarting global climate targets’

Woodside CEO calls Nord Stream incident a setback for cutting methane emissions

Meg O'Neill, chief executive and managing director of Woodside Energy, 

said disruption to oil and gas supplies in Europe has caused concern in Asia. Bloomberg

Laura O'Callaghan
Oct 05, 2022

Disruption to Europe's oil and gas supplies due to the war in Ukraine and the sabotage of the Nord Stream pipelines has resulted in knock-on negative effects for the global effort to lower methane emissions, climate delegates were told on Wednesday.

Russia has denied it was behind recent leaks in the pipelines under the Baltic Sea which saw colossal amounts of methane emitted into the atmosphere. President Vladimir Putin accused the US of "sabotaging" the vital infrastructure.

Methane can represent more than 80 times the warming power of CO2 over the first 20 years after it reaches the environment. The drive to reduce methane emissions was discussed by delegates at the Energy Intelligence Forum in London on Wednesday, where speakers pointed out it was the best opportunity the industry has to slow the rate of global warming.

READ MORE

UK Royal Navy frigate sent to North Sea to protect underwater cables

Meg O’Neill, chief executive and managing director of energy giant Woodside Energy, said the geopolitical challenges gripping Europe have had a ripple effect across other markets and caused coal use to increase elsewhere.

“It’s been really interesting watching what’s been happening in the world, particularly over the last six months,” she said.

“One of the things that we've seen as energy flows to Europe have been disrupted [is that] most of our businesses in Australia and Asia … are very, very concerned about energy security. They are taking steps to try to strengthen their inner energy, their diversity of supply source and where they can, their ability to self-generate.

“From a climate perspective, this has had the outcome of many nations using more coal, so it's not a good outcome. What's happening today with respect to the supply side upsets is driving bad outcomes from a climate perspective.”

Woodside Energy, one of Australia’s largest oil and gas companies, is striving to honour a pledge to achieve zero methane emissions by 2030.

It is one of a string of companies who have latched on to the international movement spearheaded by fossil fuel industry figures.

Ms O’Neill stressed the importance of collaboration between firms and customers “to help them understand the pathway to execute an energy transition and how to do that in an orderly way”.

One of the challenges en route to net zero is that policymakers will always be concerned about the short-term energy needs of their people and thus be drawn towards instant solutions which are not always eco-friendly.

“At the end of the day, all politics are local and politicians are concerned about how do I keep the lights on for my community, how do I keep energy bills down for the citizens that live here,” Ms O’Neill said.

“Unfortunately, that's leading to some outcomes that are not positive from a climate perspective. So we have a role to play to continue to provide the energy that the world is using today in a way that is reliable and affordable, and to work with our customer nations in terms of carbon emissions.”

Australia under pressure to revise tax cuts following UK chaos

Ben Westcott

Bloomberg

October 05, 2022 

-A+A

CANBERRA (Oct 5): The Australian government is under pressure to reconsider tax cuts for high-income earners due in mid-2024 after the chaotic fallout from the UK's planned fiscal boost via the abolition of its top rate.

Australia intends to scrap its 37% tax rate in favour of a 30% bracket for people earning between A$45,000 and A$200,000 (RM134,723 and RM598,769) annually at an estimated cost of more than A$200 billion over 10 years. The upper 45% tax rate would remain in place.

The cuts were legislated in 2018 and 2019 under the previous centre-right Liberal-National government and the Labor party pledged to keep them prior to winning the May 2022 election.

Pressure to scrap or revise the cuts intensified after the UK was forced to abandon plans to abolish its 45% top rate shortly after Prime Minister Liz Truss took office.

Her government's unfunded proposal sparked a plunge in the pound and criticism from the International Monetary Fund as it threatened to exacerbate inflationary pressures that central banks are rapidly hiking interest rates to try to rein in.

The Australian Financial Review reported on Wednesday on growing pressure inside the Labor government to at least modify the tax cuts in the budget. Left-wing parties that hold the power to pass or block legislation in the Senate, or upper house, have been calling for the policy to be ditched since May.

Treasurer Jim Chalmers, who delivers his first budget on Oct 25, said this week that the UK was a "cautionary tale" about what happens when fiscal and monetary policies run at cross purposes.

Chalmers said while he was standing by the tax cuts for now, "any responsible government sees what's happening in the UK and factors that into their own considerations".

Rate hike bonanza among major central banks hits two decade peak in September


Tue, October 4, 2022 
By Karin Strohecker and Vincent Flasseur

LONDON (Reuters) - Major developed central banks delivered in September rate hikes at a pace and scale not seen in at least two decades, ramping up their fight against multi-decade high inflation with little let-up in sight.

Central banks overseeing eight of the 10 most heavily traded currencies delivered 550 basis points of rate hikes between them last month, bringing the total volume of rate hikes in 2022 from the G10 central banks to 1,850 basis points.

"For sure, central banks are focused on killing the inflation beast," said Vincent Chaigneau, head of research at Generali in a quarterly outlook.

"But inflation lags the economic cycle. The risk is that hysteresis forces in the inflation cycle keep central banks on a war path for too long, causing policy overshooting."

Graphics: Developed markets interest rates https://graphics.reuters.com/GLOBAL-MARKETS/byvrjzkylve/DEVMKTWDGT220930-1.1.gif

Growth fears over major central banks ramping up rates too fast and potentially too far had seen markets gyrate in the third quarter and cast a pall over the month ahead.

September central bank decisions did little to soothe these fears with the Federal Reserve hiking interest rates by 75 basis points for a third straight time and chair Jerome Powell vowing to "keep at it" while the Bank of England also raised rates.

Both the European Central Bank and Canada lifted benchmark rates, while policymakers in Switzerland effectively ended a decade of negative interest rates in Europe with their rate hike in September while Sweden's central bank delivered the biggest rate increase in four decades.

There are signs though that some are looking to take the foot off the pedal. Norway predicted smaller hikes ahead after delivering a 50-bps rise on Sept. 22, while Australia, having lifted rates to seven-year highs in early September, surprised markets with a smaller-than-expected move in October, the first bank out of the starting block in the fourth quarter.

Across emerging markets, signs of the rate hike cycle coming to an end were more prominent. Ten out of 18 central banks delivered 600 bps of rate hikes in September, well below the monthly tally of 800-plus basis points in both June and July.

Graphics: Emerging markets interest rates https://graphics.reuters.com/GLOBAL-MARKETS/jnvweqxdqvw/EMRGMKTWDGT220930-1.1.gif

Hungary delivered a larger-than-expected 125 bps rise to end its tightening cycle in September while uber-hiker Brazil took a breather in September. Both central banks have delivered around 1,200 bps each of hikes since early 2021, emblematic of the early hiking efforts undertaken by policymakers in both emerging Europe and in Latin America, while Asia was still somewhat earlier in the cycle.

In total, emerging market central banks have raised interest rates by a total 6,340 bps year-to-date, more than double the 2,745 bps for the whole of 2021, calculations show.

"Emerging markets are way ahead of many developed markets' central banks including the Fed, the ECB and Bank of England," Claudia Calich, head of emerging markets debt at M&G Investments.

"From the rates perspective, we are towards the end of the tightening cycle."

(Reporting by Karin Strohecker and Vincent Flasseur in London, additional reporting by Jorgelina do Rosario in London; Editing by Emelia Sithole-Matarise)

Analysis | The Bank of England Promotes Moral Hazard — Again.

Back in the 20th century, banks formed the foundation of the global financial system. No more. If there were any doubts about the shifts that have taken place in finance in the past several decades, recent events in the UK should dispel them.

The Bank of England made two important interventions in the past two weeks to support financial stability; neither of them directly involved banks. In response to violent moves in long-dated gilts — following the government’s since-discarded proposal to cut income taxes for the highest earners — the central bank hastily rolled out a program to buy up to £65 billion ($74 billion) of the government bonds. And, in partnership with the UK Treasury, it announced £40 billion of emergency funding for energy companies struggling to meet margin calls.

Together, they reflect the evolution at the heart of the global financial order: No longer is the system based around banks; rather, it is increasingly centered around markets. It’s an important distinction, with wide-ranging implications.

When banks served as gatekeepers, central bankers had a simpler life. To fulfill their obligation to ensure financial stability, they served as lenders of last resort to banks – a role they fulfilled extensively during the global financial crisis. By restricting the number of banking licenses, they maintained control of the sector and by extension the financial system.

But over the years, lenders ceded market share to a diverse roster of financial institutions. Twenty years ago, banks held 46% of global financial assets, according to data from the Financial Stability Board; that’s now down to 38%. In contrast, non-bank financial institutions – comprising insurance companies, pension funds and others – make up 48%, up from 41% in 2002. While the trend reversed briefly during the global financial crisis of 2008, it resumed its prior course at an accelerated rate shortly afterward.

To fund their operations, non-bank institutions rely on wholesale markets and, in particular, government bonds, which serve as collateral allowing them to borrow. Many also use the same collateral to support hedging programs.

The system has many merits, providing institutions ready access to financing and hedging solutions using the security of a safe, liquid asset. But it does have an unfortunate tendency towards pro-cyclicality: periods of market turbulence can drive sharply higher collateral requirements, which can prompt more turbulence if that leads to forced selling – such as we saw in the UK last week.

In the past, banks may have stepped in to manage the fallout, but due largely to tighter post-crisis rules on trading and capital, their balance sheets have been left very small relative to the size of collateral markets. In the UK, for example, the assets of UK government bond market makers have fallen by 25% since 2008 at the same time as the stock of UK government bonds outstanding has increased by 2.7 times.

So when the gilt market wobbled last week, there was no one left other than the Bank of England with the firepower to intervene.

Fortunately, the BOE had already laid the groundwork. In January 2021, its executive director for markets, Andrew Hauser, made a speech in London outlining a case for its role as “market maker of last resort.” Central banks had already broadened their focus from backstopping banks to backstopping markets. But given the shifting sands under the overall system, he warned that the pace may increase: “There is every reason to believe that, absent further action, we will see more frequent periods of dysfunction in the very markets increasingly relied on by households and firms.”

When it came, that dysfunction didn’t show up only in gilt markets but in energy markets, too, where greater volatility strained funding among participating companies. Here, the bank had a ready-made solution borrowed from its traditional playbook: Any energy company “in sound financial health” would be able to approach the bank as a lender of last resort.

All the features of Walter Bagehot’s famous dictum are evident in the scheme: The bank will lend freely, to sound institutions, against good collateral, at rates materially higher than those prevailing in normal conditions. The only difference is that banks won’t be the ultimate beneficiary of the funding (even though they may be used as conduits) – rather, it’ll be firms that “make a material contribution to the liquidity of UK energy markets.”

While central banks have adapted to the new reality of markets, other participants remain fixated by the old paradigm, where the vulnerability lies with intermediaries rather than markets themselves. The widening of Credit Suisse Group AG credit spreads and the plunge in its stock price aren’t great news for its investors, but they are unlikely to presage a “Lehman moment.” Similarly, the selloff in UK life insurance stocks when the UK government bond market sold off last week reflected their role as intermediaries. BlackRock Inc., one of the largest managers of pension funds under pressure, put out a press release reminding investors that “we are not a trading counterparty to these risk-mitigation strategies.”

For years, we got used to the concept of moral hazard in banking – the lack of incentive for banks to guard against financial risk given their protection from potential consequences. Post-crisis reform may have tamed that hazard among banks, but it could be spreading elsewhere. A recent regulatory review of the policy response to market turmoil in March 2020 concluded that clients “varied in their level of preparedness for margin calls.”

In the event, even the ill-prepared benefited from central bank actions. If that’s the lesson others take away, it will have the effect of incentivizing risk not just in the UK, but everywhere.

Analysis | UK Pension Funds Shouldn’t Be This Exciting

Pension funds are supposed to be among the least exciting financial institutions. Their job is to make long-term investments to meet the predictable needs of future retirees. They should be immune to short-term shocks. Yet last week in the UK, they were the center of an incipient financial crisis.

What led to this was a novel variation on a well-known theme: Leverage meets unforeseen events. The danger when these two collide isn’t confined to any one country or market, so regulators everywhere ought to take note. Banks are somewhat safer than they were before the crash of 2008, but risks that start outside the traditional financial system still require greater attention.

The UK pension funds’ embarrassment shows how subtle those risks can be. The funds used derivatives, so they believed, to hedge their positions — that is, to make their portfolios safer. Using a popular technique called “liability driven investment,” they guarded against the risk that lower interest rates would increase their liabilities (the present value of future pension payments) more than it boosted their assets (government bonds, stocks and other investments). They did this, in effect, by borrowing to increase their exposure to government bonds.

Unfortunately, reducing the risk from lower interest rates failed to take account of the possibility that rates might abruptly and dramatically rise — which is what happened after the UK government announced a reckless new fiscal policy on Sept. 23. Higher rates (lower bond prices) reduced the pension funds’ long-term liabilities — but also caused the funds’ derivative counterparties to demand more collateral up front. That meant selling bonds, driving their prices still lower, which called for more collateral, and so on — a vicious cycle that, for many, evoked the Lehman Brothers moment of 2008.

The Bank of England interrupted this downward spiral by promising to buy bonds at “whatever scale is necessary” to restore orderly markets. It’s too soon to say how the story ends. The debacle has made investors everywhere more anxious, and the central bank’s intervention, to put it mildly, complicates its efforts to tighten monetary policy and curb inflation.

For regulators, the lesson is this: The details of last week’s breakdown are new, but the central dynamic isn’t. Just about every case of financial contagion and crisis, from the 2008 mortgage meltdown to last year’s implosion of Archegos Capital Management, shares the same basic features.

The more leverage held by non-banks such as pension funds, hedge funds and insurers, the greater the chance that dislocations will proliferate and threaten the broader system. Regulators limit bank leverage by imposing capital requirements. In the world of so-called shadow banking, this is largely up to the counterparties. In good times, they often set collateral requirements too low, leading to huge calls for additional collateral in bad times, when markets are most stressed and least able to deliver it.

Back in 2018, the Bank of England was aware that pension funds would be hit with margin calls when interest rates went up — yet concluded all was well. Its worst-case scenario envisaged interest rates rising by 100 basis points. At the time, that seemed a lot. Already moving up, they spiked by more than that in the space of a few days — and would have gone up much more if the bank hadn’t stepped in.

Regulators need to remember that low-probability events aren’t zero-probability events: Eventually they happen, and when they do, the damage can be huge. Looking beyond banks across the ever-widening landscape of non-bank finance, they need to examine leverage in all its forms more closely — and set margin requirements and other rules that reflect how much markets can move when things go wrong.

One day, if regulators do their job, pension funds will be boring again.

More From Bloomberg Opinion:

• UK Pensions Got Margin Calls: Matt Levine

• Problems Facing the Gilt Market Aren’t Unique to the UK: Richard Cookson

• Corporate Bond Doomsayers Are a Little Premature: Jonathan Levin

The Editors are members of the Bloomberg Opinion editorial board.

More stories like this are available on bloomberg.com/opinion

UK

Pension fund problems are the canary in the coal mine of lost economic credibility

Commentary

Posted on: 5th October 2022
Jeegar Kakkad
Head of Productivity and Innovation


The mini-budget on 23rd September was an earthquake for the UK economy, leaving financial markets questioning the new government’s economic credibility and its ability to deliver growth in the long run.

It wasn’t just the package of £45bn in unfunded tax cuts, expected to deliver little economic growth while raising debt interest costs significantly, that spooked markets. The charge sheet also included sacking HM Treasury’s Permanent Secretary, the Chancellor’s promise of further tax cuts, the failure to allow the OBR to produce an independent assessment, and questions raised by Liz Truss about the Bank of England’s mandate.

On the morning of 26th September, market doubts turned into a record low for the pound and into rapidly rising interest rates (yields) on UK government bonds (gilts). UK pension funds and mortgage markets were left struggling to adjust to the rapid rise in interest rates and market volatility.

The most acute pressure was felt in pension funds, leading the Financial Policy Committee (FPC) of the Bank of England (BoE) to commit up to £65bn over 13 days to stabilise the gilt market and prevent wider financial instability.

Why were pension funds the source of potentially systemic problems?

As interest rates fell over the past two decades, defined benefit schemes in the UK found that the accounting value of their liabilities (the amount pensions owe people both now and in the future) started to rise: when interest rates on government bonds fall, funds’ future obligations are discounted at a lower rate, thus raising the present value of those longer-term obligations. The Pensions Regulator estimates that every 0.1 percentage point fall in interest rates on government bonds increases the obligations of UK pensions funds by at least £23bn.

While rising interest should have made pension funds’ long-term obligations more affordable, they also had a side effect that not only limited this upside but also created significant cash flow problems for pension funds.

This liquidity problem stems from the investment strategies – called liability-driven investments (LDI) – that pension funds adopted to protect themselves from falling interest rates. LDI seeks to ensure that a fund’s assets match its long-term funding obligations by allocating part of the portfolio to high-growth investments and part of the portfolio to government and corporate bonds. These bonds are then leveraged via interest rate swaps to protect the pension fund valuations from swings in interest rates.

It’s these latter hedging strategies that have created trouble for pension funds: pension funds used interest rate swaps to buy access to a stream of fixed-rate interest payments that were tailored to match their obligations, and in return agreed to provide a stream of variable interest payments to the other party. Not only do pensions’ bonds act as collateral for these leveraged investments, funds are also required to set aside additional collateral if variable interest rates rise too high.

As interest rates on UK government bonds rose sharply at the beginning of last week, pension funds were increasingly being asked to post additional collateral for the interest rate (and inflation) swaps that formed part of their LDI strategies. Pension funds were not insolvent, they were just illiquid: they didn’t have enough assets or cash to meet the collateral demands. To raise funds for the additional collateral, pension funds then sold assets, primarily government bonds, pushing down gilt prices and pushing up their interest rates. But the cycle of higher interest rates and falling gilt prices led to more demands for collateral, creating what markets call a self-reinforcing ‘doom loop’.

This growing financial instability came to a head on 28th September when the FPC decided it needed to step in. This intervention has proved effective at shoring up gilts without the BoE having to make the maximum intervention: long-dated gilt yields have fallen even though, as of 3rd October, the BoE had bought only £3.7bn in long-term gilts.

Mortgage markets, on the other hand, are still reeling from rises to the short-term gilt rates used to price mortgages. As rates rose sharply on 28th September, mortgage providers found that newly agreed deals were rapidly becoming unprofitable, especially for smaller banks operating on fine margins. Providers began withdrawing mortgages, leaving would-be home buyers in the lurch, and raising the prospect of a collapse in house prices.

As of 3rd October, almost 1,700 or 42% of mortgage products had been withdrawn from the UK market as mortgage provider struggled to price products in the wake of market volatility. Interest rates on two-year fixed mortgages are up a full percentage point compared with a fortnight ago, and with 1.8mn households due to come off fixed-term mortgages next year, the full economic pain of the shift in the mortgage market is yet to be felt.

Markets have stabilised as the government’s u-turn on the unfunded 45p rate cut and its decision to bring forward the OBR assessment have signalled a helpful shift away from its cavalier approach to economic policy making. This means that, barring any further surprises from the government, the BoE should be able to withdraw its temporary support for long-dated government bonds on 14th October as planned without seeing a return to instability.

Beyond these immediate aftershocks of the mini-budget, the longer-running challenges of economic credibility and competitiveness remain. The unfunded tax cuts have proved to be all pain with little economic gain. In addition, the government no longer has the political capital to deliver either its proposed supply side reforms or the deep, painful spending cuts needed to fund their tax cuts if the OBR does not accept that a change in growth rates is now in prospect.

The pressure on pensions has only abated, not disappeared, and the mortgage pain is only beginning. Markets abhor a vacuum, and in the absence of a clear and credible path forward from the government on growth and the public finances, the UK is likely to continue to suffer from the fallout of the disastrous mini-budget.

Authors
Jeegar Kakkad
Head of Productivity and Innovation

“Canary in a Coal Mine”: FedEx Signals Recession Ahead

William Greiner, CFA
Chief Economist

October 5, 2022

The Bridge of Sighs (picture below) is an enclosed bridge located in Venice, Italy, which was built in 1603. It connected the city’s courthouse to the city jail. Legend has it that following their conviction, prisoners were escorted through the bridge to the jail. The view from the bridge was their last view of the beauty of Venice, prompting “sighs” from the convicted.

It seems to me that many are becoming resigned to the outlook that yes, the economy is probably heading into recession. I sigh and admit that I now count myself in that group. I crossed the “bridge” recently when the announcement from Federal Express’s CEO that he believes the world is coming into a recession. Federal Express is one of the companies that can be viewed as a “canary in a coal mine.”

FedEx’s reach is global, and their business trends tend to precede other trends. On top of all the other indicators that are suggesting the U.S. economy is coming into recession (if it isn’t already there), the FedEx announcement acted as the last straw. FedEx’s announcement suggests the reach of economic weakness has become global.

 
Recession Now Top Economic Probability

I have written and publicly suggested my view of a 50% probability of an upcoming recession. I now believe the probability of an upcoming recession is greater than 50%. Recession is now my “main” economic outlook, with the alternative a “soft landing” view in which economic growth remains slow but positive. In the soft landing scenario, the Federal Reserve succeeds in its attempt to bring inflation down without initiating a growth recession. At this time, I find that outcome possible but doubtful.

Why do I think we will probably see an economic recession occur over the next 12 months? Two of our three main recession timing indicators are now solidly suggesting a recession is on the horizon. The other (PMI Index) is trending in the wrong direction but has yet to call an outright contraction. Indeed, one of our indicators—shape of yield curve, which went negative six months ago—is widening and broadening. The chart shows the percentage of the U.S. Treasury yield curve that is now inverted. This chart shows that the U.S. economy has, over the last seven business cycles, always fallen into recession when 55% or more of the yield curve inverts. Currently, 62.2% of the curve is inverted, indicating financial stresses are building.

The other factor that has turned negative is the six-month rate of change in the index of leading economic indicators (LEI). This chart clearly shows that the LEI is now lower than it was six months ago. The chart shows periods of previous recessions given the deterioration in the rate of change.

Along with the shape of the yield curve and the data from the LEI, we are seeing a broadening in the weakness of a number of indicators. A weakening in the trend of industrial production output, durable goods orders, “real” retail sales growth and a strong contraction in money supply growth rates suggests growth in the economy is starting to fail.



Source: The Conference Board

GDP growth has officially been weak most of this year. According to the Bureau of Economic Analysis, “real” U.S. GDP growth turned negative in the first quarter of this year by -1.6%. It has also reported that real second quarter GDP growth was -0.6%. Some have been suggesting that the U.S. has been in recession all year, citing the thought that recessions occur when we see two back-to-back negative quarterly GDP growth rates.

I have commented on this in detail in prior writings, but according to the National Bureau of Economic Research, which makes “official” recession calls, a recession doesn’t occur because we have seen two negative-growth quarters. By its definition, we see a recession when a contraction occurs in the economy that is deep, broad and long. In its official view, two quarters of negative GDP growth doesn’t enter its definition of recession.

The weakness we saw during the first quarter of this year was driven by weakness in exports and inventory adjustments, both volatile and non-demand-driven factors. Final demand remained positive during the quarter, suggesting the weakness we saw during the first quarter wasn’t broad in scope.

But the trends I am now seeing suggest a weakening in factors that affect growth in final demand. Consider:

Year ChangeQuarterly/Monthly ChangeRetail Sales +9.1% +3.6% Annualized/Quarter

Industrial Production +3.6% -2.4% Annualized/Monthly

Durable Goods Orders +8.8% -2.4% Annualized/Monthly

“Real” Disposable Personal Income Housing Starts -3.7% -6.0% (3-month rate of change)

Source: Ned Davis Research

Some are saying that while real disposable personal income growth isn’t keeping up with inflation, retail sales, which are reported prior to inflation impact, have risen by 9.1% over the last 12 months. How can we fall into recession when retail sales have risen by this amount? That’s a fair question.

But if we consider inflation over that period, real retail sales declined by 0.7% over the last year. If you layer a weak growth rate on top of that, real disposable personal income declined by 3.7% over the last year.1 If real retail sales declined by 0.7% while disposable personal income fell by 3.7%, how did consumers come up with the money to spend?The personal savings rate has fallen by 5.5% year over year. Some consumers have been spending their savings to drive their consumption patterns, which isn’t sustainable.2
Over the last year, credit card debt has risen by 13%. Again, probably not sustainable over the long-term.2

Aside from our main recession-monitoring tools, the evidence of an economic slowdown is upon us, and I would argue the evidence is broadening not narrowing.

With all that being said, what is my forecast for GDP growth and inflation as we prepare to enter 2023?

Long-Term Average2022 Forecast2023 ForecastU.S. “Real” GDP Growth +3.1% +1.0% -1.0%

Consumer Prices +3.7% +6.5% +3.5%

“Nominal” GDP Growth +6.8% +7.5% +2.5%

Unemployment Rate 5.7% 4.0% (year-end) 5% (year-end)

Source: stlouisfed.org. Long-term average based on data from 1948 – 2021.

The holdout in this poor economic tale is the jobs market, which still shows strength (now at 3.7%;3 a very low number given the long-term average noted above). Something we need to consider: Jobs are the last thing businesses tend to cut when entering a weak period and the last thing added when things are good. Job data tends to be a lagging indicator.

That being said, if my concerns are justified, and we do enter a recession, I believe there is ample evidence that suggests the recession will be mild and rather short. The employment data supports this view, as I believe the jobs market, while weakening, probably won’t see the downturn with large layoffs as we saw during the deep, hard recession of 2008-2009 when the unemployment rate exceeded 10%.4

I expect to see a trough unemployment level of less than 6% next year.

Fed Policy Becoming Restrictive

Before we wrap up the recession issue, I need to comment on Fed policy. The Fed will continue to raise rates until they reach their federal funds “terminal” rate (now at 4.5%, per Fed data). I suggest the Fed will reach its terminal fed funds rate following its December meeting later this year.

Does the risk of recession go away at that time? No. Remember, it takes six to 12 months for Fed policy changes to be felt by the “Main Street” economy. We in the financial market business experience this impact almost immediately but the economy doesn’t. I suspect much of the Fed’s policy decisions won’t be fully felt by the economy until the first half of next year. It has now been six months since the first Fed rate increase, which occurred in March of this year. Main Street is just now facing the impact of those rate increases, as the impact will probably be felt until at least the second quarter of next year.

As the Fed continues down the path of raising interest rates (I am suggesting the fed funds rate will eclipse 4% by the end of this year, up from the current 3.12%), money supply growth will move into contraction and liquidity will be withdrawn from the financial system.

This withdrawal is already happening. The latest data from the St. Louis Federal Reserve shows that M2 “real” supply has declined by 5.1% over the last quarter on an annualized basis. Historically, the long-term average real growth rate of money supply has been +3.2%. As supply of money declines, prices (interest rates) rise, which slows the growth in demand for capital and economic activity contracts.

The Fed has made it clear it is willing to risk a short-term economic downturn to win the inflation battle. This is the Fed’s plan, and it is unfolding before our eyes.
Balancing the Imbalance

As I have often said in the past, recessions are part of the business cycle and occur for a reason—something in the economy is out of balance and needs to be corrected. We have too much or too little of something. This time around, we have too much inflation and that needs to be purged from the system. I see inflation as the culprit, the imbalance, if you will, as the driver of the probable upcoming contraction.

The silver lining to the Fed’s tightening monetary policy is yes, inflation rates should decline. It is the cure for the imbalance. As we see improvement in the inflation data, the Fed will change gears. I suspect the Fed will keep interest rates higher longer than some are currently expecting, as it is centered on not making the same mistake the Fed made in the 1970s by becoming prematurely loose with policy.

I continue to believe the upcoming recession (if indeed we see one) will be of the “income statement” variety. As noted, recessions occur for reasons, and the reason this time around is centered on inflation, an economic income statement issue. Historically, income statement recessions (1973, 1982, 1990) tend to be more shallow and quicker than “balance sheet”-oriented recessions (2008, as an example).

If my timing is reasonable, I expect to see the U.S. economy out of recession by the middle-to-end of 2023, and inflation back down in the 3%+ range.

l sigh and wait for better days.

Sources:

1St. Louis Federal Reserve

2Ned Davis Research

3U.S. Bureau of Labor Statistics, Sept. 2, 2022 press release

4St. Louis Federal Reserve

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Why Russians are not protesting against the war

Since the Ukraine war began, the West has asked why Russians aren’t marching on the streets. The answer is simple

Sergey Smirnov
5 October 2022

Russian law enforcement has targeted the very initiatives

 that call for protests, leaving few routes for mobilisation |
(c) Nikolay Vinokurov / Alamy Stock Photo. All rights reserved

The Kremlin’s war on Ukraine, and especially the mobilisation announced in September, are a real shock for Russian society.

Even if you factor in pro-government opinion surveys, there are millions of people in Russia who are dissatisfied with what is happening. And the people who most disagree with the Russian government are young people. According to the most conservative estimates, the number of under-25s against the war is equivalent to the number of people of all ages who support it.

But why aren’t these people out on the streets of Russian cities?

This is one of the West’s most asked questions since the invasion of Ukraine in February. The simplest answer is this: because Russians support the war and Russian president Vladimir Putin

It’s an argument used frequently by Western politicians, and one that is used to justify closing international borders to Russian citizens. ‘Fight inside your own country’ is a familiar slogan. Eastern European politicians and citizens make this point particularly often. Which is understandable: they feel the pain of Ukraine more closely, remember life under Soviet occupation and fear a Russian invasion themselves.

In fact, to understand the absence of active protests in Russia, an analogy may help.
Soviet-style repression and rigged elections

In terms of ideology and repression, the Putin regime is similar to the Soviet regime and even tries to use elements of the Stalinist Soviet Union. Since the war began, laws have been adopted in Russia that can result in up to ten years in prison for soldiers surrendering to Ukraine’s armed forces.

If you spread ‘fake news’ – that is, any information about the war that contradicts the official line – you face up to 15 years in prison. In Russia, for even using the word ‘war’ (rather than the officially sanctioned ‘special operation’) you can face punishment.

Mass political protests were never a regular feature in the Soviet Union. While they certainly took place, the Soviet authorities severely suppressed them.

The debate over whether Vladimir Putin is or isn't a dictator misses the point |
Gavriil Grigorov/Kremlin Pool/Alamy Live News

During the 20 years of his rule, Putin has built a repressive apparatus that is almost as effective as that of the Soviet Union. (The media outlet where I'm chief editor, Mediazona, covers it in detail.) Indeed, it was in the late 1970s that Putin began to work for Soviet state security, and this time period of the Soviet enterprise – from the mid-1960s to the mid-1980s – and the regime in East Germany, is probably a role model for the current Russian president.

But as well as the wholesale suppression of dissent, the blocking of independent media and the persecution of journalists, there is another detail that makes Russian society similar to the Soviet one. The Russian state has completely removed citizens from political life, swapping this absence of involvement for stability and a gradual increase in living standards, at least in large cities.

Also, it’s important to realise that, in Russia, there have been no elections in the Western sense of the word for a long time. When you see an election result for Putin and United Russia, Russia’s ruling party, remember the rigged results of the recent fake referendums in southern and eastern Ukraine, where allegedly more than 90% of citizens voted to join the Russian Federation.

(By the way, this is surprisingly similar to the voting results in the Baltic states after the Soviet occupation of 1940. That year, allegedly more than 90% of the inhabitants of Lithuania, Latvia and Estonia voted to join the USSR.)

In short, it makes no sense to talk about popular support for the Putin regime on the basis of election results.

It’s true, Russians are afraid to protest after 20 years of repression. Indeed, they prefer to avoid any contact with the Russian state altogether

Opinion polling data – although not always reliable – is another source of information about what Russian society thinks. Yet independent sociologists speak of a growing number of people who refuse to answer pollsters’ questions. Following the invasion of Ukraine, Russian sociologists have even suggested that the percentage of people contacted who agree to answer questions is as low as 5%.

It gets more complicated if you agree to answer the pollsters’ questions. For example, if you do not support the Russian invasion, how do you answer the question of whether you support Russia’s military actions in Ukraine – when there’s a chance you may face a punishment for speaking out, from a fine to a prison sentence.

So, it’s true, Russians are afraid to protest after 20 years of repression. Indeed, they prefer to avoid any contact with the Russian state altogether. At the same time, despite the huge salaries on offer (up to 4,000 euros per month), the Russian army has failed to find a sufficient number of volunteers for the war in Ukraine. And this is after the Russian state and propaganda have called for volunteers.

The Russian authorities have long taught their citizens that street protests don’t work – and could make things worse.

2020: protests in support of Khabarovsk governor Sergey Furgal captured public attention in Russia |
(c) ITAR-TASS News Agency / Alamy Stock Photo. All rights reserved


In 2020, tens of thousands of residents of Khabarovsk, in Russia’s far east, took to the streets to protest against the arrest – which was largely seen as politically motivated – of the regional governor, Sergei Furgal. Two years earlier, 70% of the region’s inhabitants had voted for him in the gubernatorial elections – despite the authorities and Furgal himself asking them to vote for his opponent.

But the Russian authorities defiantly ignored the public, and the thousand-strong marches simply faded away. The authorities did not make any concessions, they sent another governor to the region, and he won the next election with the help of massive voting fraud.

In today’s Russia, with its million law enforcement officers, protesting is just as scary as it was in the Soviet Union. So people choose other forms of protest, including emigration.

Those who left Russia after mobilisation was announced were frightened of either dying in the army or ending up in prison if they refused to fight. For many of these people, protesting on the street was not an alternative – it was safer to flee. Especially since those who did go out to openly protest in large cities were handed summons for mobilisation. Modern Russia, just like the Soviet Union, considers military service as a form of punishment.

Everyone who criticises Russians for their cowardice, unwillingness to fight for their rights should remember: Russia looks increasingly like the Soviet Union. That’s why people aren’t protesting.