How will the fiscal cliff talks end? Will the leaders reach a last-minute deal, saving the economy from disaster, like a script of a typical television drama?
Spoiler alert: We could already be in a recession. This is not the conventional wisdom. The common narrative goes some like talks look ugly, but in the end things will get resolved either before Jan. 1 or later in the month and the economy gets a new lease on life. See MarketWatch’s fiscal-cliff page.
The recession signal is being sent from the latest U.S. current account deficit reportreleased earlier Tuesday.
According to the data, imports are now down two months in a row having fallen 8.4% in the third quarter and 2% in the prior quarter. This is a rare event and has definitely raises the recessionary “red flag,” according to Robert Brusca, chief economist at FAO Economics. When the economy weakens, imports weaken rather quickly, Brusca notes.
The last time imports declined for two quarters was in 2009, the end of a four-quarter slide in imports during the Great Recession.
Fewer imports is a sign that domestic demand is faltering. A recession is “a real risk,” Brusca said.
After growing at a 2.7% annual rate in the third quarter, the gross domestic product probably expanded only one-third as fast in the fourth.
As for the first quarter of 2013, it may not grow at all. What is more, the rest of the year does not look a whole lot better.
Here are the top 10 reasons why:
10. Business will be reluctant to hire. Firms are still shell-shocked by the brouhaha over the fiscal cliff, and markets are too weak to justify expanding payrolls.
9. Consumers won’t be so quick to spend. Holiday sales were a bust, as shoppers reeled under the effects of high unemployment and soaring prices of food, energy and, especially, health care. Hurricane Sandy didn’t help, either.
8. Taxes will go up. Fiscal cliff or no, taxes will have to go up in order to generate enough revenue to cut Washington’s budget deficit and stabilize the ratio of debt to the GDP that the pols claim they are seeking.
10 Outrageous Predictions
1. DAX plunges 33 percent to 5,000 (Peter Garnry)
The leading German stock market index DAX was one of the world’s best performing stock markets in 2012 as Europe’s economic juggernaut continued to fare better than most Eurozone countries, despite the crisis on the continent and weaker activity in China. This will all change in 2013 as China’s economic slowdown continues, thereby putting a halt to Germany’s industrial expansion. This causes large price declines in industrial stocks due to stagnating revenue and declining profits at major industry players such as Siemens, BASF and Daimler. This market stress deflates consumer confidence and as a result domestic demand, highlighted by weak retail sales. With domestic demand failing to offset weakening exports, approval ratings for Chancellor Angela Merkel plunge ahead of the German election in the third quarter, and ultimately the deteriorated economic situation obstructs her re-election attempt. With a weak economy and uncertainty about a new government, the DAX index declines to 5,000, down 33 percent for the year.
2. Nationalisation of major Japanese electronics companies (Peter Garnry)
Japan’s electronics industry, once the glory of the ‘Land of the Rising Sun’, enters a terminal phase after being outmatched by the roaring South Korean electronics industry, with Samsung the winner. The core driver of the industry’s decline is a too domestically oriented approach which has led to a high fixed cost base due to Japan’s extreme living costs, pensions and the strong yen. With combined losses of USD 30 billion in the last twelve months ending September 30, 2012, for Sharp, Panasonic and Sony combined, creditworthiness deteriorates greatly and the Japanese government nationalises the electronics industry in déjà-vu style – similar to the government bailout of the US automobile industry. There has been no nominal growth in Japan’s gross domestic product in eight out of the last 16 years and as a consequence of the bailouts, the Bank of Japan formalises nominal GDP targeting. The BoJ expands its balance sheet to almost 50 percent of nominal GDP to spur inflation and weaken the yen. As a result, USDJPY goes to 90.
3. Soybeans to rise by 50 percent (Ole S. Hansen)
Bad weather during 2012 caused havoc to global crop production and we fear this will continue to play an unwanted role during the 2013 planting and growing season. The US soybean ending stock, which improved slightly ultimo 2012, is still precariously tight at a nine-year low. This tightness leaves the price of new crop soybeans, illustrated by the January 2014 contract on Chicago Board of Trade futures, exposed to any new weather disruptions, either in the US or South America (which is now the world’s largest producing region) or in China (the world’s largest consumer and biggest importer). Increased demand for biofuel, in this case soybean oil to cover biodiesel mandates, will also play its part in exposing the price to spikes should worries about supply resurface. Speculative investors, who reduced their soy sector exposure by two-thirds towards the end of 2012, will be ready to re-enter and this combination of technical and fundamental buying could potentially push the price higher by as much as 50 percent.
4. Gold corrects to USD 1,200 per ounce (Ole S. Hansen)
The strength of the US economic recovery in 2013 surprises the market and especially financial investors in gold, who in recent years have come to dominate the market thereby making the yellow metal extremely sensitive to expectations for the global interest rate environment. The changed outlook for the US economy combined with a lack of pick-up in physical demand for the precious metal from China and India, which both struggle with weak growth and rising unemployment, trigger a major round of gold liquidation. This is particularly a result of the US Federal Reserve’s decision to reduce or completely cease further purchases of mortgage and treasury bonds. Hedge funds move to the sell side and once the important USD 1,500 level is broken a massive round of long liquidation follows, especially by investors in Exchange Traded Funds who have been accumulating record holdings of gold. Gold slumps to USD 1,200 before central banks, especially in emerging economies, eventually step in to take advantage of lower prices.
5. WTI crude hits USD 50 (Ole S. Hansen)
US energy production continues to rise beyond expectations, primarily brought about by advanced production techniques, such as in the shale oil sector. US production of West Texas Intermediate crude oil rises strongly and with inventory levels already at a 30-year high and export options limited, WTI crude oil prices come under renewed selling pressure and slump towards USD 50 per barrel. Weaker than expected global growth compounds this process triggering a surprise drop in global consumption of oil and the price of Brent Crude, the global benchmark. The supply side, led by the Organization of the Petroleum Exporting Countries and Russia, reacts too late to this challenge as its members – desperate for revenues to pay for ever increasing public expenditure – hesitate to reduce production, so the supply glut rises even further.
6. USDJPY heads to 60.00 (John J. Hardy)
The Liberal Democratic Party comes back into power with its supposedly JPY-punishing agenda. But the reality of office, an uncooperative parliament and resistance from the Bank of Japan, mean that only half-measures are introduced. Meanwhile, the market has become over-enamoured with the potential for LDP leadership to bring about change and over-positioned for JPY weakness. As the market loses its enthusiasm for global quantitative easing and risk appetite retrenches, the yen vaults to the fore again for a time as the world’s strongest currency due to deflation and repatriation of investments, and carry trades find themselves turned on their head. USDJPY heads as low as 60.00 and other JPY crosses head even more violently lower, ironically paving the way for the LDP government and the BoJ to reach for those more radical measures aimed at weakening the yen.
7. Hong Kong unpegs HKD from USD – re-pegs to RMB (John J. Hardy)
China deepens its political commitment to turn away from its managed peg to the US dollar. A big step in this direction is taken as Hong Kong moves to unpeg the Hong Kong dollar from the US dollar and repeg it to the Chinese renminbi. Other Asian countries show signs of wanting to follow suit in recognition of Asia’s shifting trade patterns and as national policies of accumulating endless USD reserves begin to erode. China also takes steps to increase RMB convertibility to grab a larger share of global trade – part of its large ambition to hold more sway over developing and frontier economies and commodity producers. This starts a process of wresting some of the advantages of holding a major reserve currency away from the US currency. RMB volatility increases as China loosens its grip on the currency’s movements, and Hong Kong quickly grows to become a major world currency trading centre and the most important centre for trading the RMB.
DoubleLine Capital CEO Jeff Gundlach told Bloomberg Television’s Erik Schatzker and Stephanie Ruhle on “Market Makers” today that “investors should be holding cash” in this environment.
Gundlach said that risk assets have “diminishing returns” on each round of QE and “it’s almost like a half-life of a radioactive particle.” Investors shouldn’t turn to risky assets as a “Pavlovian response.” Gundlach also said that, “I don’t see a lot of value in the U.S. stock market and I think you have to play it safe in the U.S. bond market.”
“The real killer is going to be the next recession. And there will be one. The policymakers are trying hard to have it both ways…Ultimately as you address the fiscal situation, you’re going to run the risk of a recession. When the next recession comes, it’s going to be a real killer because what exactly is going to be the policy response. It will be policies in terms of raising taxes and cutting spending that help to bring on the next recession I think, so I don’t think it’s very plausible that you’re going to just turn around and go back to the old method of pumping up the economy with debt…Next recession comes. So the next recession probably is going to be somewhat cleansing, which means that you’re going to see things repriced lower.”