Abstract:
Mainstream discourse is propagated by the prominent media conglomerates whose prevailing outlook evokes confidence facilitated through the 'soft landing' narrative, purportedly supported by the persistence of moderately high interest rates, the apparent culmination of a three-year massacre in the bond market, and a perceivable convergence of the Consumer Price Index (CPI) toward the Federal Reserve's targeted 2% goal. However, a discerning analysis guided by leading indicators suggests a narrative that diverges starkly from this mainstream portrayal. This narrative posits an ominous reality of gradual systemic disarray attributed to the mounting pressures exerted upon the markets, exacerbated by the lagging effects of both fiscal and monetary policy, which are yet to be fully realized by the populace. Drawing upon the perspectives articulated by renowned economists, the insights derived from historical precedents, and the individual prognostications shaping market perspectives, an unsettling sentiment emerges—one that forewarns of an impending collapse within the financial systems and the global world power structure.
Introduction:
In times of uncertainty, history is the best ally for guidance. Taking a deep dive into various indicators, starting with the yield curve, Reverse Repo, the effects on investment tools, and the correlation to M2 and the Federal Funds rate, a picture is painted, highlighting the potentially bleak near-term future that lies ahead.
Yield curve:
The yield curve is considered the risk free rate for purchasing US treasuries, debt. Below is the yield curve, in a visual representation delineating interest rates across a spectrum of debt maturities, illuminating the intricate interplay between borrowing costs and temporal obligations. Typically the yield curve manifests in a positive sloping curve, wherein, higher interest rates will provide sufficient return on the debt instruments in comparison to their shorter-term counterparts due to incurred risk of longer duration holdings. However, when the curve inverts, assuming a descending trajectory with short-term interest rates, therefore eclipsing their long-term counterparts, it emerges as an infrequent and profoundly consequential phenomenon. This inversion, historically the condition of an ‘inverted yield curve’ is both mechanically and symbolically associated with economic contractions, serving as a poignant harbinger of impending downturns. Its interpretation suggests investors to proceed with apprehension regarding the forthcoming economic landscape and the anticipation of contraction that impels a migration towards the security of longer-term bonds, thereby manifesting their prices and a corresponding diminution of yields. Notably, the inverted yield curve, historically correlated with recessions in the United States, denotes a pivotal indicator wherein the surpassing of short-term interest rates over long-term rates intimates expectations of future interest rate reductions, potentially orchestrated by central banks to invigorate a decelerating economy. However, it is imperative to acknowledge that while the inverted yield curve has exhibited historical reliability, it remains fallible, subject to the vicissitudes of economic conditions, nuanced central bank strategies, and the influence of global economic variables, all of which collectively modulate the yield curve's configuration and prognostic efficacy.
From 1965 to 2023, there have been 12 instances of the 10-year treasury becoming inverted and subsequently reverting. In the past 10 inversions, only once has the inversion not directly followed a recession upon the reversion on the onset, during, or conclusion the recessionary period. However, in the 1950s, twice there was a recession without an inversion. Today in 2023, the inversion is nearly twice as steep as during 2000, during the Dot com bubble, and 2008, the Great Financial Crash.
The question is why does inversion and reversion matter to economists? The synergy of the yield curve inversion and subsequent reversion unfolds as nuanced narratives and perceptions of the future economic landscape by well informed investors. The inversion is characterized by the ascendancy of short-term interest rates over their long-term counterparts, mirroring periods of tightening monetary policy, as central banks elevate short-term interest rates to temper an overheating economy or quell inflationary pressures. This foresight is underpinned by the anticipation that central banks, in response to economic challenges, may lower interest rates to stimulate growth. Consequently, investors, seeking refuge and foreseeing diminished yields, pivot their investments towards longer-term bonds, instigating an ascent in their prices and a concurrent decline in yields. An inverted yield curve often results from central banks raising short-term interest rates to counter inflation or economic overheating as well as providing other investment tools to soak up excess liquidity until the economy is sufficiently tight. During periods of recession or economic slowdown, economic stimulus measures, including interest rate reductions, are employed by central banks and governments. Lowering short-term rates diminishes the appeal of longer-term bonds, leading to an uptick in their yields and aiding in the restoration of a more typical yield curve shape.
Many other factors play a role in the uninversion, such that market expectations, changing economic conditions, and market forces play a crucial role in the yield curve's reversion by investors adjusting their expectations. To date, there is no word of a recession by the mainstream media nor Federal Reserve or National Bureau of Economic Research (NBER). However, the yield curve is currently nearly 2x as long as the inversion of the dotcom bubble and almost 4x deeper than the GFC.
Bond rally:
The bond market appeared undecided into November, as rates saw the persistently longer tails until Tuesday November 14th of 2023 (October 5th). The mainstream media believed that the bond market rally was indicative of the CPI showcasing its 7th consecutive week of reductions (BLS). However, the larger news was that Japan’s bond market yield curve controls were “unshackled” as the BOJ appears to turn ever more hawkish (unshackled, hawkish). In relation to this bond market rally is the emptying of the reverse repurchase facility, commonly referred to as the reverse repo market. serves as a pivotal mechanism employed by financial institutions and central banks to navigate short-term liquidity dynamics within the financial system. When this facility is "emptying," it signifies a contraction in the funds supplied by financial institutions to the central bank through reverse repo transactions. Numerous factors contribute to this phenomenon. Firstly, shifts in central bank policy play a crucial role; if the central bank opts for a monetary policy geared towards diminishing excess liquidity in the financial system, it might curtail opportunities for financial institutions to engage in reverse repo transactions, forming part of a broader strategy to manage inflation, normalize interest rates, or address concerns regarding liquidity abundance. Additionally, financial institutions may divert their capital away from the reverse repo market due to the allure of more favorable investment opportunities elsewhere, possibly driven by higher yields on alternative short-term investments. Changes in market sentiment also wield influence, as optimistic financial institutions anticipate enhanced returns in riskier assets amid positive economic conditions, which may exhibit diminished interest in reverse repo transactions. Furthermore, alterations in regulatory requirements can reshape the incentives for participation in the reverse repo market, impacting the risk-return calculus for financial institutions. To simplify, guidance emanating from the central bank’s monetary policy, coupled with broader market conditions encompassing shifts in interest rates, economic data releases, and global economic events, collectively shape the demand for and supply of funds in the reverse repo market. Recognizing the complexity and multifaceted nature of the reverse repo market, it becomes imperative to comprehend that the factors driving the facility's "emptying" are contingent on specific economic and financial circumstances. At the current trajectory and without intervention from the Federal Reserve, the RRP will be emptied by or before January of 2024 and access liquidity of roughly 1 trillion dollars will be deployable by market participants.
The Banks:
The surge in global technological advancement throughout the preceding century can be ascribed immensely to the intricate mechanism of fractional reserve banking. Within this framework, only a fraction of a bank's holdings necessitates formal acknowledgment under the rubric of 'cash on hand.' The ensuing consequence is the emergence of inherent ebbs and flows, epitomized by boom-and-bust cycles, as investments were financed and cross-collateralization, thereby instigating inflation to enter the market followed by low interest rates, the ebb has come, and the flow is imminent.
2023 revealed a trend, with five banks succumbing to insolvency, surpassing the cumulative assets lost during the banking crisis of 2007-2008 when adjusted for inflation, which saw the demise of 28 banks (FDIC). A pivotal factor contributing to the contemporary malaise in the banking sector is the meteoric expansion of M2, a phenomenon precipitated by post-Covid economic stimulus measures. The catalyst for this surge, however, lies in the Federal Reserve's policy of reducing cash requirements to an unprecedented 0% (FED). This strategic maneuver impelled banks to undertake investments with the foresight of an inevitable surge in inflation to keep businesses afloat and people employed, as the effects of the pandemic would be cushioned by the flow of money, thereby precipitating a conundrum wherein liquidity inundated the system, imperiling investors whose capital, if idle, would succumb to dilution (M1).
Evidently, the confluence of heightened interest rates and their inevitable repercussions on the real estate market, which constitutes a substantial proportion (15%-18%) of the United States' Gross Domestic Product, portends a cascade of deleterious effects (NAHB). The downturn in housing sales, a direct consequence of elevated interest rates, has forecasted a scenario for financial institutions, as a multitude find themselves submerged in mortgage rates significantly below prevailing loan rates. Concurrently, the commercial real estate (CRE) sector, beleaguered by the enduring ramifications of the Covid pandemic, remote work paradigms, and a contracting workforce, has served as an additional tribulation for banking portfolios. A disconcerting average of approximately 10%-25% of banks' portfolios is ensnared in the vicissitudes of the CRE market, exacerbating the sectoral distress.
Debt:
In accordance with the insights propounded by macro analyst Michael Kantrowitz and his 'HOPE framework,' it is imperative for experts to exercise prudence before wagering against the veracity of his findings. The acronym 'HOPE' encapsulates the pivotal dimensions of Houses, Orders, Profits, and Employment, thereby delineating the trajectories of leading indicators amid the looming specter of an impending recession (HOPE). Within the current economic milieu, an amalgamation of disparate factors is poised to exert strain upon the banking system, with discernible repercussions manifesting in the broader economic landscape. Kantrowitz posits a foreboding prognostication, asserting that a precipitous 22% contraction in stock values is on the precipice, extrapolated from levels observed in June of 2023 (BI).
Recent market perturbations on November 16th, as evidenced by an 8% decline in Walmart stock, serve as a poignant illustration of the palpable repercussions of consumer belt-tightening, as elucidated by Forbes (Forbes). While such substantial deviations in stock valuations are ostensibly exceptional, particularly amidst a backdrop where the majority of companies are surpassing anticipatory metrics, it is noteworthy that analysts entered the fiscal year 2023 harboring recessionary apprehensions, consequently setting conservative benchmarks for earnings expectations. Paradoxically, a recurrent pattern emerges wherein corporations consistently outperform these circumscribed expectations, only to witness a concomitant depreciation in their stock valuations. This phenomenon, symptomatic of the prevailing economic climate, compels companies to institute measures aimed at safeguarding shareholder value.
Notably, within the technological sector, a bellwether industry in forecasting economic trends, a surfeit of workforce contractions has been recorded, with over 240,000 layoffs documented (Yahoo). Furthermore, financial behemoth Citigroup is prognosticating a consequential 10% reduction in senior-level personnel, thereby perpetuating the escalating trend of workforce downsizing within the financial sector. These developments underscore the pervasive and burgeoning nature of layoffs within sectors that traditionally serve as precursors to broader economic shifts, thereby amplifying concerns regarding the overarching trajectory of the economy.
In the fiscal year of 2023, the United States witnessed an unprecedented surge in governmental expenditures, constituting the most assertive fiscal policy in its historical trajectory. This financial endeavor manifested in a palpable escalation of deficits, ascending from $31.4 trillion in the inaugural month of January 2023 to a formidable $33.75 trillion by the denouement of November 2023, marking an appreciable elevation of approximately 7.5% in the national debt (debt). This monetary proliferation translates to an indebtedness per denizen amounting to approximately $100,000, an onus borne collectively from the most seasoned inhabitant of the republic to the nascent progeny gracing the demographic tableau. To illuminate the sheer magnitude of this fiscal encumbrance, one may envisage a conceptual structure wherein each monetary unit, represented as a one-inch square block, is successively stacked to compose a tower. Remarkably, this tower, if erected from sea level to the solar zenith, would achieve a towering stature of 5.4 times the distance. A more expansive visualization involves the conceptualization of each monetary unit as a one-square-inch block, whereby the entirety of the United States debt could hypothetically blanket the expanse of India with a staggering overabundance, encapsulating the nation 11.5 times over. Serving as an illustrative adjunct to this numerical exposition, Visual Capitalist has ingeniously crafted a chart that delineates the monumental scale of this fiscal indebtedness. The resonating import of this numerical narrative is underscored by the metric of debt-to-Gross Domestic Product (GDP) ratio. Historical precedence portends a portentous trajectory, as no sovereign entity, excluding the anomaly of Japan, has withstood the sustained strain of a debt-to-GDP ratio surpassing the ominous threshold of 77% (77%). Evidently, breaching this fiscal Rubicon has invariably precipitated deleterious consequences, culminating in the specters of hyperinflation, stagflation, and the inexorable demise of the credit cycle.
As the national indebtedness burgeons, the inexorable gravitational pull of the debt spiral looms. The concomitant escalation of interest rates on this mounting fiscal obligation portends a precipitous descent, that of which propels the nation's currency closer to the edge of hyperinflation. This trajectory, once embarked upon, inexorably converges towards the onset of stagflation, thereby forming the collapse of fiat currency. In addition, consumer debt, unemployment,
Prediction:
In the current economic landscape, two divergent narratives unfold simultaneously. On one front, the Federal Reserve projects a dovish stance, buoyed by optimistic analyses of a soft landing, perpetuated by mainstream media and grounded in lagging indicators. However, beneath this surface narrative, tensions are escalating within the banking sector, marked by businesses strategically laying off workers to safeguard shareholder value. The HOPE framework, signaling a critical juncture in certain industries, suggests that heightened interest rates may precipitate a domino effect, compelling businesses to roll over debt and inevitably leading to a surge in unemployment. Additionally, consumer debt is rising to new heights, roped in by mounting costs, inadequate compensation growth to that of inflation, and exacerbated by 21% interest rates. Approximately 20% of S&P companies face the imperative of debt rollovers for survival, with the gains of the top 10 corporations overshadowing those of the bottom 400. Simultaneously, indicators such as elevated gold prices, an inverted yield curve, and the prolonged bear market status of the Russell 2,000 index further underscore the complexity of the economic landscape. While predicting market outcomes in the short term is inherently impractical due to myriad unpredictable factors, a forecast posits a potential bearish reversal of the yield curve (bear steepener), prompting the Federal Reserve to enact policy loosening and triggering an investor exodus. Historical precedent suggests that such economic turmoil has culminated in inflation, fostering societal discontent and, ultimately, leading to geopolitical strife in the form of international or civil war. The cyclical nature of history, manifesting in a 250-year credit or empire cycle has occurred over the past 2000 years with the current cycle beginning in 1780 with the Articles of Formation, rising in 1941 under Bretton Woods, peaking during the 50s, and declining in the late 60s (med). Historical analysis, shows two distinct paradigms materializing, delineated as the Dollar Milkshake Theory and the Flight to True Value, expounded by the minds of Brent Johnson and Matthew Piepenburg, as elucidated in a comprehensive video exposition (video). Grounded in an independent evaluative framework, this discourse proffers a prognosis wherein a pervasive shift toward quality becomes evident, mirroring extant trends observed in preeminent revenue entities within the S&P index, the venerable domain of gold, and the expansive terrain of the bond market.
Anticipating the imminence of an economic recession, the proposed trajectory posits a concomitant flight to quality. This anticipates a scenario wherein fiat currencies undergo widespread divestiture in favor of the US dollar, gold ascends in response to the inflationary augmentation designed to stimulate economic growth, and assets experience an ascent calibrated against the backdrop of a diluted dollar denomination. The convergence of the Dollar Milkshake Theory and the Flight to Gold unfolds concurrently, albeit with a nuanced divergence in the investment predilections of American-centric portfolio managers, who pivot towards domestic investments, while regions fraught with heightened geopolitical tensions evince a proclivity for divesting fiat currencies in favor of tangible reserves—chiefly, gold and silver. To underscore these assertions, empirical validation is sought through the examination of inflationary spikes and their correlative impacts on gold and silver, juxtaposed against the performance of the world reserve currency in periods of economic downturn. Discerned from this scrutiny is the discerning wisdom of parking capital in assets of pronounced demand; however, a caveat arises in the form of the latent risks' attendant to an overweight portfolio. Indeed, the ostensibly risk-free realm harbors its own vulnerabilities, exemplified in the erosive potential of escalating inflation, while gold and silver emerge as stalwarts capable of retaining intrinsic purchasing power. It is imperative to acknowledge historical imperatives, as evinced by the 17 instances of governmental proscription on private gold holdings over the past century, notably exemplified by Executive Order 6102 in 1933 (6102). The historic enfeeblement of the British pound consequent to deficit spending during World War I, setting the stage for subsequent geopolitical realignments in World War II, further underscores the exigency of prudence in asset allocation. The comprehensive insights encapsulated in Ray Dalio's treatise, "Principles for Dealing with the Changing World Order provide a nuanced exploration of the geopolitical tapestry underpinning these dynamics (CWO).
In contemplation of the proximate and discernible horizon, judicious financial positioning is imperative, advocating the strategic allocation of resources toward high-value, exceptionally liquid non-fiat assets, with the singular exception being accorded to the US dollar.
