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The economic health of a nation can often be gauged by examining a variety of interconnected indicators. In the United States, a synthesis of lending standards, commercial lending, and employment trends provides a composite view of the economy's trajectory. Recent data suggests that the US economy remains in a cyclical pattern, with indicators pointing towards a looming economic downturn. This article is based on a recent video published by Jeff Snider on Eurodollar University's YouTube channel.

Lending Standards and Commercial Lending

The Senior Loan Officer Opinion Survey (SLOOS) from the Federal Reserve is a critical tool for understanding bank behavior. It queries senior loan officers about their lending standards across various credit types. Focusing on commercial and industrial (C&I) loans, SLOOS data from the third quarter of the previous year reflected a net 50.8% of respondents tightening lending standards for commercial borrowers. This number has since decreased to 14.5% in the first quarter of 2024.

While this decline might seem positive, it does not necessarily indicate an easing of standards. Instead, it may suggest that the initial wave of tightening has already occurred, and the subsequent economic impact is pending. Historically, SLOOS data shows that maximum tightening aligns with the onset of recessions, with standards typically loosening much later.

Relationship Between Lending Standards and Loan Volumes

When examining the correlation between lending standards and the actual volume of C&I loans, a strong relationship is evident. Adjusting the SLOOS data to account for an approximate 18-month lag between tightening standards and reduced loan volumes reveals a near-exact alignment. This suggests that the full effect of tightened lending standards in the third quarter of the previous year will likely manifest by the end of 2024.

The Impact on Employment

A significant correlation also exists between the volume of C&I loans and the unemployment rate. A decrease in C&I loans on a year-over-year basis tends to correspond with an increase in unemployment. The implication is that a reduction in commercial borrowing could lead to fewer employment opportunities, either directly or as a response to broader economic conditions.

Additional SLOOS Findings: Commercial Real Estate and Consumer Loans

The SLOOS data also sheds light on other segments, such as commercial real estate and consumer loans. Recent findings, including those from New York Community Bancorp, have shown troubling developments in commercial real estate lending. Banks have reported a remarkable tightening of lending standards, and demand for these loans remains weak, potentially foreshadowing a crisis.

For consumer loans, banks have continued to tighten lending standards through 2023, with a slight reduction in the number of banks tightening in 2024. However, the willingness of banks to issue consumer credit remains low, reinforcing concerns about the state of the consumer economy.

Conclusion

The synthesis of lending standards, commercial lending volumes, and employment trends paints a picture of an economic cycle that has yet to reach its most challenging phase. Despite some positive labor market statistics, the historical patterns and current data suggest that the US economy may face increased difficulties by the end of 2024. The interplay between bank behavior and the broader economy continues to signal the potential for a recession, challenging the notion of a soft landing in the year ahead.

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Key Takeaways

In this episode of The Last Trade, Gary Brode joins Marty, Jesse and Michael to cover a broad range of economic and financial topics, responding critically to Jason Calacanis's optimistic view on the economy, as presented on the All-In podcast. The key themes revolve around analyzing current market signals, dissecting government spending, understanding the stock market's true health, and contemplating the implications of the Federal Reserve's policies.

Notably, the episode dissects the apparent contradiction between market highs and economic fundamentals. Despite bullish indicators like all-time high Dow Jones Industrial Average levels, GDP growth exceeding expectations, and positive jobs data, the episode's guest, Gary Brod, brings a nuanced perspective that challenges surface-level optimism. He argues that metrics such as the Dow are not indicative of broader economic health and that government spending is artificially inflating GDP numbers.

Gary also delves into the concern that the reported strong job market is misleading, as it includes people taking multiple part-time jobs due to the loss of full-time positions. He highlights the peculiarities of inflation reporting and the potential geopolitical risks that might lead to higher oil prices, affecting consumers and the Consumer Price Index (CPI) negatively.

The discussion also touches on the potential for a reemerging banking crisis, with Gary expressing skepticism over the Federal Reserve's willingness to save smaller banks, suggesting a preference for fewer, larger, more controllable financial institutions. Additionally, he shares insights on the global macroeconomic front, including China's economic challenges and the impact of El Salvador's Bitcoin adoption.

Best Quotes

1. "The Dow is at all-time highs. That is completely irrelevant. That's 30 some companies. I don't know that the performance of 30 some companies is indicative of the economy." - Gary Brode, critiquing the use of the Dow as a health indicator for the broader economy.
2. "We had GDP up by something like $1.5 trillion, and debt was up by $2 trillion... That's kind of a ridiculous way to calculate GDP." - Gary Brode, on the artificial inflation of GDP through government spending.
3. "Jobs number... That's kind of mixed news as well. Certainly, having 9 million jobs available would indicate a healthy economy. Except a lot of those jobs aren't real, right?" - Gary Brode, discussing the complexity behind the optimistic job growth numbers.
4. "There's competing narratives in the market right now... All is rosy, all is well, the economy is as strong as ever... I disagree with some of his analysis." - Gary Brode, responding to Jason Calacanis's positive economic outlook.
5. "If you want to have a decent quality of life, that means higher energy usage without having more carbon emissions, nuclear is the option." - Gary Brod, advocating for nuclear power amidst energy policy debates.
6. "Bitcoin is for everybody. It's not just for the 25-year-old crypto punks... Anything that makes bitcoin more accessible, I think is long-term going to be a good thing." - Gary Brode, on the importance of making Bitcoin accessible to a wider audience through mechanisms like ETFs.

Conclusion

This episode provides a comprehensive critique of the current economic narrative, which posits that the economy is thriving based on certain traditional metrics. Through an in-depth analysis, the episode reveals the complexities and potential misrepresentations within these metrics, highlighting the discrepancies between surface-level data and the underlying economic realities.

Gary Brode's insights offer a sobering reminder that economic health cannot be gauged solely by stock market indices or government-reported figures. Instead, a more critical examination of factors such as government spending, job quality, and the true state of the banking system is required.

The discussion around Bitcoin and its role in countries like El Salvador underscores the transformative potential of cryptocurrency in global finance, particularly in areas affected by inflation or reliant on remittances. In conclusion, the episode calls for a more nuanced interpretation of economic signals and emphasizes the need for vigilance and adaptability in uncertain financial times.

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Performance Review of 2023

In 2023, financial markets experienced a generally positive year outside of the commodity and currency complexes. Notable performances included:

• Equity Markets: The S&P 500 increased by 26%, closely mirrored by the Euro Stoxx 50, up 27% in dollar terms. The Nikkei 225 also saw a significant rise, with a 22% increase, and the Nasdaq surged by nearly 45%.
• Bond Market: There was an unexpected bond rally during the final two months of the year. The Bloomberg Barclays Aggregate Index outperformed, with treasuries yielding 4.1% for the ten-year and 3.5% for the two-year. Investment-grade corporate bonds were up by 8.5%, outperforming treasuries by a substantial margin.
• Currencies: The U.S. dollar ended down for the year after a period of volatility.
• Commodities: Gold and copper were among the few commodities with positive returns, both around 2%.

Recession Indicators and Economic Analysis

Yield Curve Inversion

Historically, a yield curve inversion has been a precursor to recessions. In 2023, the yield curve had been inverted for a length of time generally preceding economic contractions, suggesting a high probability of a recession in 2024.

Leading Economic Indicators

The leading economic indicators have shown a negative trend, with manufacturing weakening followed by a handoff to a stronger services sector. This pattern, coupled with the distortionary effects of monetary stimulus from previous years, makes economic analysis challenging.

Unemployment Rate

The unemployment rate, traditionally a lagging indicator, began to show signs of increasing. Historically, once unemployment starts rising, it tends to accelerate quickly, particularly in the context of recessionary periods.

Payroll Revisions

There have been significant downward revisions in employment data, raising concerns about the reliability of initial employment reports.

Federal Budget and Interest Expenses

The U.S. budget deficit remained high despite low unemployment, diverging from historical trends. As interest rates rise, the federal interest expense as a percentage of tax revenue is also increasing, foretelling potential fiscal stress.

Investment Landscape for 2024

Equities

The S&P 500 reached a double top, signaling a potentially unfavorable trade location. Earnings growth in 2023 was minimal, and there is skepticism about the forecasts for 2024, particularly in the face of a possible recession.

Fixed Income

The credit market, especially high-yield bonds and bank loans, performed well in 2023. However, with the potential of a recession in 2024, investors may need to reassess positions in riskier bonds.

Currencies and Commodities

The dollar's decline could lead to better performance in gold and emerging market equities during a recession. Commodities performed weakly in 2023, which may continue until recessionary policies potentially drive prices up.

Conclusion

Markets rallied in 2023 and ended on a positive note, but leading indicators and economic analyses suggest the potential for a recession in 2024. This looming threat will likely require active management and a strategic response to the evolving investment landscape. Investors should prepare for volatility, with a potential decline in interest rates followed by inflationary responses to economic weakness.

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Introduction

The interplay between global asset prices and liquidity is a critical area of focus for investors and policymakers alike. Understanding the dynamics that drive these financial variables provides insight into the broader economic climate. The above video by Luke Gromen examines whether global asset prices can decline amidst increasing global liquidity, the impact of oil sales on currency valuations, and the implications of shifts in monetary and fiscal policy.

Global Liquidity and Asset Prices

One of the fundamental questions raised regards the possibility of global asset prices decreasing while global liquidity is on the rise. Historical trends suggest that as liquidity increases, asset prices tend to rise due to the availability of more capital to invest. This increased demand for assets typically inflates prices. However, the sensitivity of different assets to liquidity changes can vary. For instance, Bitcoin has been cited as a particularly sensitive indicator of liquidity changes, often reacting positively to increases in liquidity.

Currency Dynamics and Oil Transactions

The currency market dynamics are influenced by numerous factors, including how commodities like oil are transacted. When Saudi Arabia sells oil to China in renminbi (RMB) instead of US dollars, it ostensibly reduces the demand for dollars from the Saudis. However, given the entrenched nature of the dollar in global finance, particularly through the offshore dollar-denominated debt markets, even a marginal shift can lead to a strengthening of the dollar. This is because a reduction in the supply of dollars to meet the persistent demand can drive up the value of the dollar. Conversely, a surplus of RMB, with comparatively less demand, could lead to a weaker RMB.

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Implications for Gold and Treasury Demand

The shift away from pricing oil exclusively in dollars has ramifications for gold and US Treasuries. As central banks diversify their reserves away from US Treasuries and towards gold, the demand for the latter increases. This trend has been observed over the past decade. In the long term, the move away from dollar-centric oil transactions could diminish the demand for US Treasuries, which, in turn, could be negative for the dollar.

Inflation, Deflation, and Interest Rates

The prospect of a return to a deflationary environment versus the potential for long rates to surpass 5% is a critical issue. Given the current fiscal landscape in the United States, it is argued that neither deflation nor excessively high long-term interest rates are sustainable. The fiscal situation may necessitate a period of secular inflation with persistent negative real interest rates. This would have a significant impact on long-term bond portfolios, which could face losses either nominally or in real terms adjusted for inflation.

Legal Constraints and Treasury Management

Questions regarding legal limitations on the proportion of short-term to long-term debt that the US Treasury can issue have been raised. While there may be legal frameworks in place, historical precedence suggests that such regulations can be amended if deemed necessary by policymakers, implying that these constraints may be more procedural than absolute.

Peak Cheap Oil Debate

Finally, the discussion on whether the era of "peak cheap oil" has ended and if we have entered a time of abundance requires careful consideration. While some argue that technological advancements and new supply sources are mitigating scarcity concerns, others maintain that the economics of oil extraction still point to a world where cheap, easily accessible oil is becoming scarcer. This has implications for energy pricing in various currencies and the relative cost of oil in dollar terms versus gold.

Conclusion

In summary, the relationship between global liquidity and asset prices is complex and multifaceted. Currency valuations, particularly the US dollar's status in global markets, play a significant role in these dynamics. The interplay between fiscal and monetary policy, commodity pricing, and legal frameworks all contribute to the evolving economic landscape. Understanding these interconnected elements is essential for navigating the global financial system.