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Coronavirus – The Catalyst For System Failure?
Coronavirus – The Catalyst For System Failure?
Overview
Today’s global economic system is more intertwined than at any point in history. For the past 30 years in particular, globalization and the Theory of Comparative Advantage have been alive and well. Technological advancements and transportation improvements have truly ‘shrunk the world’, allowing more countries to participate and benefit from international trade.
The globalized world economy has become a vast network of complex supply chains, interconnectedness and co-dependence. The benefits have been wide-spread and done more to lift the human condition, and more people out of poverty, than any development in history. However, this increase in economic complexity has magnified global vulnerabilities, opening up the risk of rapid and large-scale failure and contagion: a period of anti-globalization. COVID-19 is the catalyst that is triggering a supply-side crisis; one that is further exacerbated by a simultaneous demand-side shock.
Consensus View
The consensus view seems to be that the COVID-19 will die out with warmer weather; after all this is what typically happens with the common flu. In terms of markets, most believe that governments and central banks will come to the rescue with proactive stimulus which will be exceptionally good for markets, because the economy is viewed to be on solid footing already. The stimulus will come to be viewed as an over-reaction that merely serves to provide more economic fuel, particularly once the Coronavirus sputters away. This scenario is logical and possible, but not a view that I share.
US Coronavirus Response
The US has a relatively low number of confirmed cases, but it is in direct proportion to the low number people tested. There is a shortage of testing kits and slow distribution to provide more. This is likely intentional. Trump is on Twitter bragging about the low number of positive cases in the United States as being a result of his administration’s actions.
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Peak Debt, Peak Doubt, & Peak Double-Down
Peak Debt, Peak Doubt, & Peak Double-Down
Time to Hike Rates
It makes little sense to me why the market is only pricing a 6% probability of a rate hike at the October meeting, 30% for December, and only a near 50/50 probability all the way out to March 2016. The statutory mandates of the Fed as stated in the Federal Reserve Act are “maximum employment, stable prices, and moderate long-term interest rates”. All three have been fully realized.
The unemployment rate is 5.1% (full-employment). Core CPI has been stable for years and printed 1.9% yesterday; remarkably close to the Fed’s self-imposed target of 2%. For a few years, Treasury rates have been stable at near-historical low levels. In addition, the 4-week moving average of Unemployment Claims fell to its lowest level since 1973. The most recent employment report was a bit weaker than expected, but it fell within a standard margin of error. Yet, the Fed continues to remain at the emergency rate of 0.0%.
At the September meeting, the FOMC talked up the economy, but refrained again from hiking rates, citing “international developments”. By making this decision, the Fed has to be careful it does not also provide an ‘emerging markets put’.
As the October meeting approaches, international developments have settled down. Emerging market stocks indexes and currencies have bounced since the September FOMC meeting. Chinese markets in particular have calmed down and have traded higher. The US stock market is higher. The trade-weighted dollar is lower. Credit spreads are tighter. The arguments for a hike at the October or December meeting should have increased not decreased.
The recalibration in rate hike probabilities could be the result of the “data dependent” language which has never been adequately defined. It is suspect to believe that monetary policy for an $18 trillion complex global economy is being determined by a backward looking piece of monthly economic data.
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