Authored by Mike Shedlock via MishTalk.com,

Let’s discuss the warnings of PJM Interconnect, the operator of the nation’s largest competitive market for electricity.

Before reviewing the PJM Interconnect February 2023 report, let’s take a look at policies and regulations.

Policies and Regulations

• EPA Coal Combustion Residuals (CCR): The U.S. Environmental Protection Agency (EPA) promulgated national minimum criteria for existing and new coal combustion residuals (CCR) landfills and existing and new CCR surface impoundments. This led to a number of facilities, approximately 2,700 MW in capacity, indicating their intent to comply with the rule by ceasing coal-firing operations, which is reflected in this study.

• EPA Effluent Limitation Guidelines (ELG): The EPA updated these guidelines in 2020, which triggered the announcement by Keystone and Conemaugh facilities (about 3,400 MW) to retire their coal units by the end of 2028. 14 Importantly, but not included in this study, the EPA is planning to propose a rule to strengthen and possibly broaden the guidelines applicable to waste (in particular water) discharges from steam electric generating units. The EPA is expecting this to impact coal units by potentially requiring investments when plants renew their discharge permits, and extending the time that plants can operate if they agree to a retirement date.

• EPA Good Neighbor Rule (GNR): This proposal requires units in certain states to meet stringent limits on emissions of nitrogen oxides (NOx), which, for certain units, will require investment in selective catalytic reduction to reduce NOx. For purposes of this study, it is assumed that unit owners will not make that investment and will retire approximately 4,400 MW of units instead. Please note that the EPA plans on finalizing the GNR in March, which may necessitate reevaluation of this assumption.

• Illinois Climate & Equitable Jobs Act (CEJA): CEJA mandates the scheduled phase-out of coal and natural gas generation by specified target dates: January 2030, 2035, 2040 and 2045. To understand CEJA criteria impacts and establish the timing of affected generation units’ expected deactivation, PJM analyzed each generating unit’s publicly available emissions data, published heat rate, and proximity to Illinois environmental justice communities and Restore, Reinvest, Renew (R3) zones. For this study, PJM focuses on the approximately 5,800 MW expected to retire in 2030. 

Solar Projects On Hold

Next, consider the Inside Climate News report The Largest U.S. Grid Operator Puts 1,200 Mostly Solar Projects on Hold for Two Years

The nation’s largest electrical grid operator has approved a new process for adding power plants to the sprawling transmission system it manages, including a two-year pause on reviewing and potentially approving some 1,200 projects, mostly solar power, that are part of a controversial backlog.

Over the last four years, PJM officials have said they have experienced a fundamental shift in the number and type of energy projects seeking to be added to a grid, each needing careful study to ensure reliability. It used to be that PJM would see fewer, but larger, fossil fuel proposals. Now, they are seeing a larger number of smaller, largely renewable energy projects.

A new approval process will put projects that are the readiest for construction at the front of the line, and discourage those that might be more speculative or that have not secured all their financing.

Then, an interim period will put a two-year delay on about 1,250 projects in their queue—close to half of the total—and defer the review of new projects until the fourth quarter of 2025, with final decisions on those coming as late as the end of 2027. 

Energy Transition in PJM

Now let’s now take a look at Energy Transition in PJM: Resource Retirements, Replacements & Risks released February 24, 2023.

Our research highlights four trends below that we believe, in combination, present increasing reliability risks during the transition, due to a potential timing mismatch between resource retirements, load growth and the pace of new generation entry under a possible “low new entry” scenario:

The growth rate of electricity demand is likely to continue to increase from electrification coupled with the proliferation of high-demand data centers in the region. Retirements are at risk of outpacing the construction of new resources, due to a combination of industry forces, including siting and supply chain, whose long-term impacts are not fully known. PJM’s interconnection queue is composed primarily of intermittent and limited-duration resources. Given the operating characteristics of these resources, we need multiple megawatts of these resources to replace 1 MW of thermal generation. 

The analysis shows that 40 GW of existing generation are at risk of retirement by 2030. This figure is composed of: 6 GW of 2022 deactivations, 6 GW of announced retirements, 25 GW of potential policy-driven retirements and 3 GW of potential economic retirements. Combined, this represents 21% of PJM’s current installed capacity.

In addition to the retirements, PJM’s long-term load forecast shows demand growth of 1.4% per year for the PJM footprint over the next 10 years. Due to the expansion of highly concentrated clusters of data centers, combined with overall electrification, certain individual zones exhibit more significant demand growth – as high as 7% annually.

For the first time in recent history, PJM could face decreasing reserve margins should these trends continue. The amount of generation retirements appears to be more certain than the timely arrival of replacement generation resources and demand response, given that the quantity of retirements is codified in various policy objectives, while the impacts to the pace of new entry of the Inflation Reduction Act, post-pandemic supply chain issues, and other externalities are still not fully understood. 

Recent movement in the natural gas spot markets across the U.S. and Europe add another degree of uncertainty to future operations. In 2022, European natural gas supply faced many challenges resulting from the war in Ukraine and subsequent sanctions against Russia. Liquefied natural gas (LNG) imports into the EU and the U.K. in the first half of 2022 increased 66% over the 2021 annual average, primarily from U.S. exporters with operational flexibility. This international natural gas demand is a new competitor for domestic spot-market consumers, resulting in significantly higher fuel costs for PJM’s natural gas fleet. 

Along with the energy transition, PJM is witnessing a large growth in data center activity. Importantly, the PJM footprint is home to Data Center Alley in Loudoun County, Virginia, the largest concentration of data centers in the world. PJM uses the Load Analysis Subcommittee (LAS) to perform technical analysis to coordinate information related to the forecast of electrical peak demand. In 2022, the LAS began a review of data center load growth and identified growth rates over 300% in some instances. 

Additionally, PJM is expecting an increase in electrification resulting from state and federal policies and regulations. The study therefore incorporates an electrification scenario in the load forecast to provide insight on capacity need should accelerated electrification drive demand increases.

Impacts of Electrification and Data Center Loads

What Does This Mean for Resource Adequacy in PJM?

Combining the resource exit, entry and increases in demand, summarized in Figure 7, the study identified some areas of concern. Approximately 40 GW PJM’s fossil fuel fleet resources may be pressured to retire as load grows into the 2026/2027 Delivery Year. 

The projected total capacity from generating resources would not meet projected peak loads, thus requiring the deployment of demand response. By the 2028/2029 Delivery Year and beyond, at Low New Entry scenario levels, projected reserve margins would be 8%, as projected demand response may be insufficient to cover peak demand expectations, unless new entry progresses at a levels exhibited in the High New Entry scenario. This will require the ability to maintain needed existing resources, as well as quickly incentivize and integrate new entry 

The 2024/2025 BRA, which executed in December 2022, highlighted another area of uncertainty. Queue capacity with approved ISAs/WMPAs is currently very high, approximately 35 GW-nameplate, but resources are not progressing into construction.

There has only been about 10 GW-nameplate moving to in service in the past three years. There may still be risks to new entry, such as semiconductor supply chain disruptions or pipeline supply restrictions, which are preventing construction despite resources successfully navigating the queue process. 

About that Queue

After applying the logistical regression model for 10 years of historical project completion (Y-queue to present) without project stage, approximately 15.3 GW-nameplate/8.7 GW-capacity were deemed commercially probable out of 178 GW of projects examined. 

The model results for thermal resources were reasonably in line with expectations. However, the model produced extremely low entry from onshore wind, offshore wind, solar, solar-hybrid and storage resources.  

Mish Synopsis 

• Expect to pay much higher prices for electricity 

• Expect brownouts

• Expect missed targets 

• Expect most of the thousands of project requests on hold to be economically unviable.

• Expect many economically unviable projects to continue anyway paid for by taxpayer subsidies.

• Expect much higher inflation. 

• Don’t expect any of this to do a damn thing for the environment.

Question of the Day – How Fast Will the Shift to EVs happen?

In case you missed it, please consider Question of the Day – How Fast Will the Shift to EVs happen?

The faster the shift, the higher and faster the inflation.

*  *  *

Please Subscribe to MishTalk Email Alerts.

Tesla is slated to hold its most recent investor day today, with shareholders eagerly awaiting CEO Elon Musk’s long-term vision for the electric vehicle manufacturer. 

Shareholders are hoping for a number of updates, including on the company’s Cybertruck, its new subcompact vehicle, a refreshing to the existing product line, a long term vision and new manufacturing ventures the company is putting in place. And, of course, Wall Street will be looking for any information or guidance as to how the year is progressing – and how it may continue to progress – from the auto manufacturer. 

The concept of a new subcompact vehicle is front and center, with investors hoping that a lower priced vehicle could move Tesla even further into the mass market for automobiles, according to the Wall Street Journal.

Investors will also look for how the company plans on meeting its 20 million vehicles sold per year goal by 2030. The increase marks a substantial scale higher from the 1.3 million vehicles the company sold in 2022. 

Musk is expected to deliver his “Master Plan 3”, which he called a “path to a fully sustainable energy future for Earth” earlier this month. He has confirmed that it will be released during today’s presentation. Musk’s previous “Master Plans” have included the goals of making battery powered vehicles affordable and competitive, followed by the idea to buy Solar City – a decision that has come under scrutiny due to the precarious financial position of the acquired company at the time. 

Investors will also be on watch for new information about Tesla’s humanoid robot, as well as an update on the recent Full Self Driving recall and the grappling match that the company is in the midst of with regulators related to its autonomous driving software. The company’s use of AI in the future – both with Tesla and potentially as part of new projects – is also said to be a focus of the event.

Finally, as we wrote about hours ago, the company will also offer up new information on its forthcoming production facility in Mexico. The company is slated to build a new plant in Monterrey, Mexico, it was reported by Bloomberg this week. The announcement comes after weeks of guessing over where the U.S. based EV company would expand its reach next. 

President Andres Manuel Lopez Obrador announced on Wednesday that the facility would help Mexico “build on the millions of combustion-engine vehicles the country already supplies to the US every year,” according to Bloomberg. Companies like BMW and GM have also recently announced new investments in Mexico, also. 

Lopez Obrador reportedly spoke to Tesla Chief Executive Officer Elon Musk about environmental commitments for the plant, which included recycled water throughout the manufacturing process. 

AMLO said of the deal: “He was very responsive, understanding our concerns and accepting our proposals. I want to thank Mr. Elon Musk for being very respectful, attentive and understanding of the importance of addressing the problem of water scarcity.” 

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

As if the 2020s haven’t been strange enough, the United States military recently shot down several UFOs. Equally bizarre as the possibility of aliens, some investment analysts are projecting an economic no landing scenario. They believe economic activity will easily absorb significant headwinds and chug along.

The last few years have been humbling for economists, the Fed, and investment professionals. In late 2021 no one expected the Fed would raise rates by over 4% within a year and inflation would approach levels last seen 40 years ago. In hindsight, had we or any economist foreseen the future, a recession prediction would have been appropriate. Such has yet to happen, but that doesn’t mean a recession won’t happen. Unfortunately, current monetary policy all but ensures the economic cycle will play out as it always does.

While the economy may seem unpredictable, the economic future is predictable. The no landing scenario assumes economic cycles have ceased to exist. The economic cycle is alive and well. But timing its ups and downs with unprecedented amounts of fiscal and monetary stimulus still flowing through the economy and markets is proving incredibly challenging. 

What is a No Landing Scenario

Unlike a soft landing that envisions the Fed action’s dampening economic growth, the no landing scenario believes the economy will continue to grow at or above the trend growth rate. Such optimism assumes that the Fed’s restrictive monetary policy will not cause the economy to stumble.

GDP, as graphed below, in dollar terms (orange line), paints the picture of an economy constantly growing and essentially free of cycles. However, viewing annual growth rates (blue line) and the trend (dotted blue line), we find that GDP cycles regularly, and the growth trend is steadily declining. To forecast a no landing means you believe the blue GDP growth rate line will flatten and stay linear.

That did occur, to a degree, following the financial crisis (2010-2018), but the Fed pegged interest rates to zero and resorted to multiple rounds of QE at the first sign of trouble. The monetary conditions during that no landing period versus the current period are polar opposites. 

What Drives the Economy?

The economy’s trend growth rate is around 2.0%, well below the rates of prior decades. The Fed predicts the long-run growth rate (beyond 2025) to be 1.8%.

Growth is and has been declining for decades. The two leading factors supporting economic activity, productivity, and demographics, contribute less and less each year to economic activity.

In Capital Neglect is Killing Capitalism, we elaborated on the importance of productivity growth and how the Fed’s aggressive monetary policy in years past has stifled productivity growth.

Not surprisingly, GDP growth followed the declining path of productivity growth. As we share below, it’s possible GDP could run much higher if the pre-1970 productivity trends continued. 

The following graph, also from the article, shows how the trend in productivity growth changed about 50 years ago.

In addition to declining productivity growth, demographic trends in the U.S. and other developed countries are problematic. Population growth among the world’s leading economies is growing at a trickle and, in some cases, starting to decline. Consider the following population growth rates for the top five economies:

• United States +0.1%

• China +0.1%

• Japan -0.5%

• India +0.8%

• Germany 0.0%

Equally alarming is the increase in the elderly population as a percentage of the entire population. For example, the chart below from the United Nations shows the dramatic shift in China’s population between 2015 and forecasts for 2040.

Similar, albeit less severe shifts are expected in the U.S. Declining population growth, and a growing financial dependency by the baby boomers will reduce GDP.

Barring any trend changes in productivity or demographics, we should expect GDP growth to continue to drift lower.

Fed Juice Counteracts Productivity and Demographics

The Fed uses monetary policy to boost the economy and counter the aforementioned deteriorating economic building blocks. Lower interest rates and the accompanying debt-driven consumption grew the economy above its natural growth rate. However, in the wake of this strategy lies a highly leveraged economy that is exceptionally vulnerable to higher interest rates.

The table below shows that debt as a percentage of GDP has risen from 210% to 275% this century. Over the last 22 years, GDP grew by $16 trillion while debt increased by $52 trillion. Is that sustainable?

The more leveraged an economy, the more sensitive it is to interest rate changes. Reducing interest rates makes servicing the debt and repaying the principal easier. However, higher interest rates make servicing and repayment more costly.

We can think of higher interest rates as a tax on the economy. The Fed’s juice of years past, low-interest rates, is being replaced with the highest interest rates in fifteen years. High-interest rates are stifling new debt creation. More importantly, borrowing to repay old debt introduces a financial shock to the borrower and a tax on the economy.

Current Scenario

If the expected growth rate is sub 2% and higher interest rates are and will be extracting a heavy tax on the economy, why is the economy running hot? The answer likely lies in the pandemic-related stimulus and the psychology of consumers. Both stimulus and irregular consumer behaviors support extra growth.

While the no landing crowd likes to think the relatively high economic growth is sustainable, we got news for them. The means supporting such strong economic growth is not likely to continue.

The blue line below shows that personal savings have fallen to a 12-year low. The growth of credit card debt has swelled to a 25+ year high. Unless wages spike higher, many consumers will cut back as savings deplete and credit card limits are reached. Further, higher interest rates on credit cards will reduce their spending ability.

We remind you personal consumption accounts for nearly 70% of economic activity.

Is this Time Different?

The no landing scenario crowd assumes this time is different. Therefore, by default, they argue the graphs and bullet points below are irrelevant.  

• A recession occurred every time the 10-year/ 3-month yield curve inverted and then un-inverted.

• Fed rate hikes have preceded each of the last ten recessions.

• Except once, in 1965, every time the ISM manufacturing index fell below 45, a recession occurred.

• A recession occurred each time the Philadelphia Fed Index was at its current level.

• A reading of over 50% of Deutsche Bank’s recession probability gauge preceded each recession.

• The current level on the 85-factor Chicago Fed National Activity Index (CFNAI) and the OECD leading indicators are commensurate with prior recessions.

Summary

Maybe UFOs have wealthy aliens onboard wanting to buy a lot of stuff and boost our economy. Most likely, those forecasting a no landing have a false sense of optimism as the economy has thus far proven resilient.

Time is not on the no landing scenario’s side. With every passing day, the effect of yesterday’s interest rate hikes will weigh more on the economy. As we wrote in Janet Yellen Should Focus on Hope, understanding the progression of economic activity deterioration and the time lag between monetary policy changes and full consequences helps us appreciate that a no landing scenario is a pipe dream.

We hope for a soft landing but fear the more typical hard landing is the likely course. We caution those who believe the economy is unaffected by interest rates. It is dangerous to believe this time is different!

By Michael Every of Rabobank

Yesterday’s European inflation data surprised to the upside. Who could have known that inflation would not just fade away, as the market tried to peddle two months ago? We have more key numbers to focus on today, including German CPI and global PMIs, but it would take a shock along the lines of what we just saw in Aussie CPI (7.4% y-o-y vs. 8.1% expected despite the surge in that month’s retail sales) and GDP (Q4 0.5% q-o-q vs. 0.8% consensus, in line with y-o-y expectations at 2.7%) to shift sentiment back towards the median ‘2023 Outlook’ view of disinflation and a looming rates pivot. I have been mocking that in my own counter-outlook presentation called ‘The Pause That Doesn’t Refresh’. Data like China’s PMIs (manufacturing at 52.6 vs. 50.6 expected, services at 56.3 vs. 54.9 expected) are certainly not going to refresh any disinflation or rates pivots calls – unless they are just to freshen up the atmosphere at the National People’s Congress starting this weekend.

Indeed, the big picture still matters more. Much as I try to veer away from what I’ve flagged would be THE topic since early 2016, the news-flow doesn’t let me: the Global Markets Daily is increasingly the Deglobal Markets Daily. The global architecture shifting rapidly. And when I say rapidly, I mean *every day* brings shocks for those paying attention. Then, after a lag, shocks for markets not paying attention. So what is new in the last 24 hours?

First, the new US House committee on the Chinese Communist Party’s threat to America is underway: as I type, witnesses are pushing for a massive increase in US military spending; an urgent investment in Taiwan’s defences; preventing US supply-chain vulnerabilities stemming from China; breaking China’s Great Firewall; and blocking Chinese investment in US agri. Second, the word on the street is that if the White House executive order to impose capital controls on US firms investing in China is more limited than first floated, Congress will impose its own tougher version. Third, the Wall Street Journal reports the US may revoke export licenses for Huawei. Fourth, any US chipmaker given part of the $39bn Federal funding for onshoring is to be banned from expansion in China for a decade.

But it gets worse. Ignored by the mainstream media and most of social media despite officially running in 2024, and some polls showing he could win, former President Trump just launched his trade plan that “takes a SLEDGEHAMMER to Globalism” via “Universal Tariffs” – “Total Independence From China” – “Patriotic Protectionism” – “Reviving Mercantilism for the 21st Century”. In short, his proposed “America First” policy would phase in a system of universal, baseline tariffs on most foreign products, the revenue from which would reduce taxation on firms producing in the US. Moreover, tariffs “would increase incrementally depending on how much individual foreign countries devalue their currency.”

Honestly, I am not shocked. I am sure no other markets Daily uses the word “mercantilism” as freely as this one has for around a decade – I had to explain the word in 2015, and then how pre-WW2 US presidents were mercantilists; when Trump floated his first tariffs, I argued phasing them in to allow onshoring FDI before imported goods got more expensive would be logical; ‘Weaker currency = higher tariffs’ was factored into our report on ‘Balance of payments -and power- crises’; and clearly there is still US momentum to change things even if means breaking things, which we factored into our ‘The World in 2030’ report  – which we may arrive at early; moreover, as argued last year, and this, ‘Bretton Woods 3 Won’t Work’.

As Twitter discussions over this topic continue in less Trumpian size-100 font-all-caps-bold-underlined form, I think @matthew_pines summarises things, and the arguments in this Daily since 2014, when he notes:

“A key function of the economic system post China-in-WTO has been to allow western capital to (1) arbitrage labor costs & (2) grow FIRE sector to direct resulting USD mercantilist surpluses into scarce, desirable assets (NYC real estate, Ivy degrees, UST/Agencies, farm land).

(1) has just about reached its limit, and (2) will face headwinds (if not outright reversal) for national security and domestic political reasons. What new system will result? TBD, but these shifts typically don’t happen smoothly (or peacefully)…”

That’s as this weekend’s National People’s Congress in Beijing is set to see an overhaul of China’s government agencies, including the PBOC, key industries and sectors, bringing them all directly under the CCP in a “relatively intensified” manner, in Xi’s words. What this means is the CCP, not state institutions, will be running things openly from hereon out. These changes will affect the interests of many, he added. And not only in China.

Meanwhile, things are already the opposite of smooth and peaceful in Russia-Ukraine. Look at headlines like:

• ‘Lukashenko Proposes Unifying Russia, China, and Belarus’ Industrial Policies’; or

• ‘Russia’s Medvedev floats idea of pushing back Poland’s borders’; or

• ‘Putin orders tighter security at Russia-Ukraine border after spate of drone attacks’.

It should be screamingly obvious that all of the above has an structural inflationary implication far above what we just saw in France and Spain, or may see elsewhere this week. Indeed, in an argument running parallel to that of Matthew Pines, but absolutely linked to it, @S_Mikhailovich notes:

“40 years of falling rates were the engine of financialism – optimizing the real economy around leveraged finance and asset prices. Without the ever-falling rates, financialism is over. The next 40 years can’t be like the last 40. Investors are yet to see it.”

So, is this the Deglobal Definancialisation Markets Daily? That might sound like biting the hand that feeds, but it’s actually trying to guide that hand to avoid it getting bitten off entirely.

After reporting last week that production volume had spooled up at Tesla’s new Germany plant, this week we are learning that the Tesla production expansion continues: this time to Mexico.

The company is slated to build a new plant in Monterrey, Mexico, it was reported by Bloomberg this week. The announcement comes after weeks of guessing over where the U.S. based EV company would expand its reach next. 

President Andres Manuel Lopez Obrador announced on Wednesday that the facility would help Mexico “build on the millions of combustion-engine vehicles the country already supplies to the US every year,” according to Bloomberg. 

Companies like BMW and GM have also recently announced new investments in Mexico, also. 

Lopez Obrador reportedly spoke to Tesla Chief Executive Officer Elon Musk about environmental commitments for the plant, which included recycled water throughout the manufacturing process. 

AMLO said of the deal: “He was very responsive, understanding our concerns and accepting our proposals. I want to thank Mr. Elon Musk for being very respectful, attentive and understanding of the importance of addressing the problem of water scarcity.” 

AMLO had said in the past that permitting could be called into question for the plant if there wasn’t enough water in the area of the proposed production sight. Nuevo Leon, where Monterrey is located, even had to have its water access cut last summer due to dams being at risk of emptying. Tesla had similar water scarcity issues that it had to deal with when building its most recent plant in Germany. 

So far, neither Tesla nor AMLO has specified what Tesla will be building at the new plant, though over the past week there has been renewed talk of Tesla producing an even more affordable subcompact vehicle. The company is also expected to begin producing its Cybertruck within the next 18-24 months.

Tesla will hold its investor day this week, where it is expected to announce further details of the plan. 

The Kremlin said Wednesday that it prevented another ‘massive’ drone attack on its territory – this time in Russian-held Crimea, stating that a total of 10 drones were shot down or disabled through electronic warfare measures.

“An attempt by the Kyiv regime to carry out a massive drone attack on the facilities of the Crimean peninsula has been prevented,” the Russian defense ministry (MoD) said in a statement, as cited in TASS.

“Six Ukrainian attack drones were shot down by air defense systems. Another four Ukrainian drones were disabled by electronic warfare. There were no casualties and destruction on the ground,” the MoD said. 

It comes a day after a spate of drone attacks on and near multiple Russian cities were reported. Some of them were reported downed, but others appeared to have hit their targets – including against an oil facility in Tuapse, which lies about 150 miles southeast of the Crimean peninsula, about 500 kilometers from the nearest Ukrainian-held territory.

During those prior attacks, inbound enemy UAVs had been observed outside of Moscow, St. Petersburg, and over the Belgorod region. On Tuesday there were in total possibly half-a-dozen to a dozen or more inbound drones which had been sent against various Russian cities.

Given the air raid alerts and sirens that went out warning heavily populated areas over a span of Monday into Tuesday, The Daily Beast had described it as a day of chaos for Russians:

The strikes were part of what local media described as a “mass drone attack” that appears to have intensified in the last 24 hours.

On Monday morning, residents of an apartment building in the Belgorod region, near the border with Ukraine, were forced to evacuate in the middle of the night after one of four drones crashed into the building, according to Baza. Another drone landed on the roof of a supermarket and exploded, scorching the premises.

The fresh drone attack on the Crimean peninsula comes amid fresh denials by the Ukrainian government that it’s targeting Russian soil using drones.

⚡️The drone that crashed near Kolomna in the Moscow region the day before was reportedly filled with explosives

According to Russian media, it had a C4 explosive weighing about a kilogram. Also, during the examination of the aircraft, several charges for RPGs were found. https://t.co/cacYUnHKSP

— War Monitor (@WarMonitors) March 1, 2023

According to regional reports, the alleged attacks have led to new tit-for-tat accusations:

Kremlin spokesman Dmitry Peskov on Wednesday said Moscow does not trust Ukrainian authorities when they say the country’s military is not carrying out drone attacks on Russia.

“We don’t trust them,” Peskov told a press briefing in Moscow, commenting on remarks by Ukraine’s presidential adviser Mikhaylo Podolyak who denied Kyiv carries out strikes on the territory of the Russian Federation.

Russia’s Defense Ministry on Tuesday accused Ukraine of launching drone strikes targeting infrastructure in several Russian regions.

But this comes after a past year which witnessed a number of sporadic drone and alleged sabotage attacks on sensitive Russian facilities, including military bases, as Ukraine and its backers grow more emboldened. 

One December investigative report written by a US special forces veteran said the CIA was behind many of the covert sabotage operations happening with increasing frequency on Russian soil. President Putin has recently said he sees the conflict in Ukraine and West-backed proxy war there as a fight for the survival of the Russian people, alluding to it as an ‘existential threat’ in fresh comments. Likely these attacks on Russian soil will only serve to convince much of the Russian public of the accuracy of his words.

Coming on the heels of yesterday’s hotter than expected inflation prints in France and Spain, this morning’s German CPI printed hotter than expected (+9.3% YoY vs +9.0% exp vs +9.2% prior) as the continued slowing of inflation narrative busts.

The hot German CPI prompted Goldman to upgrade their Euro area headline inflation forecast to 8.46%yoy, from 8.36%yoy previously, and mark up their core inflation tracking estimate by 10bp to 5.38%yoy. This raises their estimate for seasonally adjusted Euro area core inflation to 0.47%mom, 9bp above January’s 0.38%mom.

The reading for Europe’s biggest economy puts more pressure on the ECB to hike higher for longer, prompting markets for the first time to price a 4% peak in the ECB’s deposit rate which currently stands at 2.5%.(as we detailed yesterday)…

As Bloomberg economist, Martin Ademmer, noted,“For the ECB, a sequence of upside surprises to readings for the euro area’s biggest economies is awkward. That the bulk of the misses are accounted for by food and energy is cold comfort.”

The expected terminal rate in Europe has risen by almost 90 bps since mid-January…

As Bloomberg’s Simon White notes, further inflation pressures from China would only embolden the ECB, but with a still-fragile European economy, the bank could end up doing too much, too late – the ghost of Trichet’s 2011 rate hikes lurk in the background.

Addressing reporters in Frankfurt earlier Wednesday, Bundesbank President Joachim Nagel warned that core price pressures remain very elevated and that the inflation rate is only likely to retreat gradually — averaging between 6% and 7% in Germany this year.

“One thing is clear: the interest-rate step announced for March will not be the last,” he said in a speech. “Further significant interest-rate steps might even be necessary afterwards, too.”

…and that is knocking into US yields…

And dragging US stocks into the red…

It appears the inflation monster is more sticky than the ivory tower believed.

Everyone knows that monetary policy acts with a lag, but the $64 trillion question – and in the case of global capital markets, literally – is how big said lag is at a time when central banks have engaged in one of the most aggressive hiking cycles in history to stem the runaway inflation spawned by the Helicopter Money unleashed during the covid shock, and not just by the Fed, which in 2022 saw the most rate hikes in a calendar year in history…

… but by all developed central banks.

Why this obsession with the lag? Because, as DB’s head of thematic research (and in house credit guru not to mention aspiring piano player) Jim Reid writes in a recent note, “Most (but not all) big hiking cycles bring recessions with a lag”…

…  and the ones that do “tend to be when the Fed is furthest away from its dual mandate and that invert the curve.” In case it’s unclear, both apply to this cycle, but certainly inflation is the outlier with prices still rising at a 6%+ annual clip.

So with that in mind, let’s take a look at some of the key “lag” indicators, starting with the US Senior Loan Officers Survey (SLOOS), which as we noted recently has painted a “dire picture” for the economy as “Loan Standards Are Approaching Record Tightness As Loan Demand Plummets“, and which leads GDP by two quarters…

… and leads a surge in HY defaults by around 3 quarters…

To be sure, the banks may not discuss it openly but they are ready: as shown below, we’re halfway between 2007 and 2008 in terms of banks’ forecasting 2023 delinquencies; specifically, US banks forecasting rising 2023 delinquencies is worse than Jan’07 levels.

Taking another look at the SLOOS, the survey showed expected delinquencies across a broad range of sectors, which to Reid is “a good correlation to future charge-offs.”

Then there is the yield curve: the 2s10s has inverted before ALL of the last 10 US recessions, and it takes 12-18 months for the lag on average but some cycles take longer….

But here is a way to improve the fit: as Reid notes, the “3-month rule” tightens up the gap between US 2s10s inversion and recession to 8-19 months. That takes us to March ‘23 – February ‘24. The one exception is the Fed policy error of mid-60s.

As an aside, Reid believes that Fed hikes to recession and inversion to recession are likely compressed in this cycle: the shortest cycles are very biased to those where the 2s10s curve inverted during the hiking cycle.. The longest cycles tended not to invert the curve during hiking cycles…

Here are some practical consequences of the accelerating rate inversion:

Impact 1. By May US IG (investment grade) should yield same as Fed Funds… “which would you prefer? 11yr credit risk or safe front end risk?”

Impact 2: Whether it matters or not is a moot point but it’s striking that 6m US rates matched the earnings yield (1/PE) for the S&P 500 for the first time since 2001 in mid-February

What about Europe, and the ECB, where today’s red hot inflation data moved up expectations for rate hikes to 3.75% by June? According to Reid, the peak impact from ECB hikes will likely be in Q2 2024…

And while lending standard in Europe might ease in Q1 vs. Q4 as war/energy shock dissipate, will the lag of policy then take over?

And there there is broad money supply, or M2, which has (very) long and variable lags, and has seen a Boom and Bust in last 3 years: the biggest increase since WWII and now first fall since just after..

And since over the very long run the two move in tandem, will the fact that M2 YoY is now negative impact growth with a lag? (spoiler alert: yes).

Turning to markets, Reid then shows S&P 500 Performance in Fed Tightening Cycles since 1955 by day: normally the weakness starts to materialize only 9-10 months after the first hike and lasts a year or so, but not this time since the Fed was hiking when the economy and earnings were already slowing; “So either lag is shorter now or we soon move on from the shock of a once in a generation rates move to the economic lag of monetary policy.”

And while equities may diverge from trendline, all is going to script in rates, as shown in the chart of the average movement in 2s10s US yield curve in Fed Tightening Cycles since 1955 by month.

Where there are variations from trendline, is in core CPI, where Core CPI is declining more than the average…

… and unemployment which is notably falling far less than average at this stage, and which “probably reflects a Fed that was well behind the curve…. On average it turns higher 18 months after the Fed starts hiking”

Going back to capital markets, a nagging question: why have risk assets held in as well as they have? For the answer look not to stocks but bonds, and specifically bond volatility (i.e., the MOVE index). As Reid notes, the risk market bottom on October 12th was exactly when the MOVE index reversed from 2009 highs (ex. one day at start of pandemic): the first 9 months of 2022 was a shock after a decade of ultra low rates and lower and lower bond vol.

Once Fed Terminal rate assumptions plateaued, rates vol fell sharply… hence the sweet spot between max fears over rates and before lag of policy on economy kicks in. But since the shock payrolls print on Feb 3rd, the terminal rate is edging up again though complicating the picture a bit.

The bottom line is that rates vol has driven equities over last year or so. Rates vol falling since March has been a support for equities but when the recession comes this correlation will break down…

Finally, some hard landing slides. First, Reid notes that DB’s recession probability model has risen to 90% over the next 12 months (on the other end, Goldman sees recession odds at 25% over the next year).

Why note a soft landing? Take one look at the Fed Misery Index: according to Reid, soft landings have only occurred in hiking cycles where the Fed was around its mandate (unlike now).

And then there is the actual weakness in the economy with trend growth rapidly weakening. As noted in the last GDP report, we are seeing the softest growth in final sales to private domestic purchasers since GFC (ex-Covid).

… or the Leading Index: anything more than a -1% YoY decline in US LEI has always led to a US recession within a few months. We’re now at -6% YoY

There are similar observations to be made regaring declines in the US new Mfg orders, the Philly Fed index (another one in the camp of “never been this bad without a recession swiftly following”), and others, but understandably all eyes remain glued to the surprising strength in jobs.  And understandably so… but as shown below, that can and will change furiously and on a dime: in the next chart, Reid shows that US unemployment barely budges between recession (R) minus 6 months and R minus 1 month…. and then surges in the recession.

Finally, while payrolls don’t suggest we’re in recession now – not by a long stretch – look at the non-linearity when the recession hits shown by Reid in the chart below: a sharp fall with little warning… this is especially true as we wait to see how much of Jan 23’s gains were seasonals.

The irony here is that not just stock markets (or at least the bulls) are hoping the recession starts as soon as possible: the Fed does too, as it can finally go back to what it does best and brrrrrr. The only question is whether anyone in the Biden admin realizes that hopes of perpetuating the growth fallacy into 2024 – a key election year – will end in disaster, and it behooves the president to push the economy over the cliff now rather than wait…

There is much more in the full must read presentation from Jim Reid, available to pro subscribers in the usual place.

Saudi-backed LIV Golf returned for a second season last weekend with ex-PGA stars, new sponsors, and a major US broadcast television deal to air the tournament on prime-time TV. But even with all of that, ratings for LIV Golf Mayakoba, Mexico, were absolutely disastrous. 

LIV’s official Twitter account begs to differ… 

Huge thanks to everyone who made our first event of 2023 such a big success. pic.twitter.com/oU1p5MQifs

— LIV Golf (@livgolf_league) February 27, 2023

According to Josh Carpenter of the Sports Business Journal, LIV’s first event on The CW Network had about 291k viewers on Sunday. LIV is the rival league to the PGA, entirely financed by Saudi Arabia’s Public Investment. And when compared with the PGA Tour event’s Honda Classic on Sunday, fetching around 2.38 million views, LIV has a long way to go.  

Full golf numbers for last week https://t.co/lel5DSlIom pic.twitter.com/wSNVTNvgXe

— Josh Carpenter (@JoshACarpenter) February 28, 2023

Golf Digest’s Joel Beall pointed out that “World’s Funniest Animals,” which also aired on The CW on Sunday evening, attracted more viewers than LIV. 

For context another CW program, World’s Funniest Animals, outdrew LIV Golf https://t.co/txrkMNW1nq

— Joel Beall (@JoelMBeall) February 26, 2023

LIV has marketed itself as an alternative to the PGA, with three 18-hole rounds taking place over three days. The tournament features a traditional stroke play format with a shotgun start, where golfers start simultaneously on different holes. There are also no cuts. 

The next LIV tournament will be in Tucson, Arizona, and has to go up against the first weekend of March Madness. But don’t worry. The Saudis have large sums of oil money to keep the league alive for at least another year. 

Authored by Nick Corbishley via NakedCapitalism.com,

“There are no plans to introduce digital ID. Our position on physical ID cards remains unchanged.” 

These were the words of UK Prime Minister Rishi Sunak’s spokesman a couple of days ago. Note the rather unusual use of the word “physical” to describe what is, generally speaking, a non-physical document (digital ID). This has sown all sorts of confusion in a country that is instinctively distrustful of identity cards and where the debate around digital identity is finally seeping into the public arena.

The statement came in response to former Prime Minister Tony Blair’s latest attempt to peddle digital identity, this time alongside former Conservative Party leader William Hague. In a joint letter, the two former politicians said “[e]veryone in Britain should be given a digital ID incorporating their passport, driving licence, tax records, qualifications and right to work,” as the cornerstone of a “technology revolution” in governance.

The digital ID system would be “secure, private [and] decentralised,” yet would also somehow bring together each individual’s data from across all government agencies. “Other countries are forging ahead,” said Hague. For the UK to keep or get ahead, it “has to redesign the state around technology.”

“A Natural Evolution”

While prime minister Blair tried — and ultimately failed — to introduce mandatory physical ID cards. He was also one of the first prominent proponents of digital vaccine passports. As early as June 2020, before any vaccine had reached the market, Blair told the Independent that people would need a form of “digital ID” so they could prove their “disease status” as the world gradually moved out of lockdown. This, he said, is part of a “natural” technological evolution that encompasses more than just COVID-19 vaccines and public health (comment in parenthesis my own).

“It’s a natural evolution of the way that we are going to use technology in any event, to transact daily life (an interesting choice of words given the potential threat the introduction of central bank digital currencies could pose to people’s ability to transact), and this COVID crisis gives an additional reason for doing that.”

A year and a half later, despite the vaccines’ undeniable shortcomings, Blair’s position remains the same. During a panel discussion at the latest World Economic Forum meeting in Davos, he said:

In the end, you need the data: you need to know who’s been vaccinated and who hasn’t been. Some of the vaccines that will come down the line, there will be multiple shots. So [for vaccines] you’ve got to have — for reasons to do with healthcare more generally but certainly for pandemics — a proper digital infrastructure and most countries don’t have that.

A couple of weeks ago, Blair’s eponymous foundation, the Tony Blair Institute for Global Change (TBIGC) released a report titled “A New National Purpose: Innovation Can Power the Future of Britain.” The report’s seven authors call for “a fundamental re-ordering of our priorities and the way the state itself functions,” which includes the introduction of an all-encompassing digital ID system:

“A well-designed, decentralised digital-ID system would allow citizens to prove not only who they are, but also their right to live and work in the UK, their age and ownership of a driving licence. It could also accommodate credentials issued by other authorities, such as educational or vocational qualifications. This would make it cheaper, easier and more secure to access a range of goods and services, online and in person. A digital ID could help the government to

TBIGC’s Global (i.e. Largely US) Partners

Tellingly, the word “privacy” appears only once in the document, which calls into question just how seriously the report’s authors and endorsers take the potential risks and pitfalls posed by the technological platforms they are hawking.

TBIGC’s partners are largely US based. They include the Bill and Melinda Gates Foundation (quelle surprise!), the Gates Foundation-sponsored Alliance for a Green Revolution in Africa (AGRA), Microsoft Philanthropies APAC, Microsoft Philanthropies MEA, the Washington-based Center for Strategic and International Studies (CSIS), Washington’s soft power arm, USAID, the Rockefeller Foundation and the US Agency for International Development.

On a positive note, Blair and Hague’s letter has at least kindled a discussion of sorts on one of the most pressing issues of out time, not just in the UK but everywhere. Hopefully, the UK will now have an open, wide-ranging public debate on the issue (though I’m not holding my breath).

Biometric-enabled digital IDs have the potential to make life much more efficient and streamlined. But as Brett Solomon warned in a 2018 piece for Wired magazine, they also pose “one of the gravest risks to human rights that we have encountered.” Perhaps most importantly, they can — and probably will — be used to enable or disable our full and free participation in society, just as the vaccine passports did.

In an editorial for The Independent, Sean O’Grady tore Blair and Hague’s proposal to shreds:

Hague and Blair say they want Prometheus unleashed via the Government Gateway. To which I can only reply: “I’m not convinced, and even if I was, I don’t care for it”

I don’t trust the British state, neither to construct a workable system in the first place, nor to guarantee its privacy and security. I’ve had some experience of the Government Gateway and the NHS database, and, while magnificent in some respects, they’re also flawed.

I can also remember the disastrous NHS IT database scheme that was eventually abandoned in 2013, after £10bn had been spent on it and written off (stretching over the period when Blair and Hague were in government, funnily enough). Not to mention when that civil servant left the tax records of millions of people on a train.

Privacy and System Fragility Risks 

Silkie Carlo of Big Brother Watch told the BBC that the proposed digital ID system “would be one of the biggest assaults on privacy ever seen in the UK.”

There are also serious issues with system fragility, as we are reminded on an almost daily basis. For example, in 2021 a hacker stole the ID credentials of the entire population of Argentina through its ‘National Registry of Persons’, as Daily Record reported:

[The hack] targeted RENAPER, which stands for Registro Nacional de las Personas, translated as National Registry of Persons.

The agency is a crucial cog inside the Argentinian Interior Ministry, where it is tasked with issuing national ID cards to all citizens, data that it also stores in digital format as a database accessible to other government agencies, acting as a backbone for most government queries for citizen’s personal information.

But Blair’s messianic zeal remains undimmed. When asked about people’s fears of ID systems and tech errors, Blair told the BBC:

“If you look at the biometric technology that allows you to do digital ID today, it can overcome many of these problems. And by the way, the world is moving in that direction. I mean, countries as small as Estonia and as large as India are moving in that direction – or have moved.”

Blair tries to create the impression that the government has no alternative but to follow the herd of other national governments that have already adopted digital ID systems, regardless of the risks posed to privacy and other basic freedoms. But Blair has been disastrously wrong about hugely important things before (e.g. Iraq, humanitarian intervention, joining the euro, public finance initiative…), albeit at no cost to himself.

The current occupant of 10 Downing Street is apparently unconvinced by Blair’s arguments.

If one is to believe his spokesperson, Rishi Sunak’s government has “no plans to introduce digital ID.” But Brits would probably do well to take this pledge with a truckload of salt, for three main reasons (feel free to add more):

1. We’ve been here before, with the vaccine passports.

Many British citizens will no doubt still remember the myriad times members of the Boris Johnson government, including Johnson himself, swore they would never issue vaccine passports. In January 2021, the then-Vaccine Minister Nadhim Zahawi tweeted the following:

.We have no plans to introduce vaccine passports. We have vaccinated, as of yesterday, 2,431,648 first dose and 412,167 second dose. No one has been given or will be required to have a vaccine passport. @NHSuk @Emily_JR_Lawson

— Nadhim Zahawi (@nadhimzahawi) January 12, 2021

Less than nine months later, Zahawi had broken that pledge by confirming plans to introduce a vaccine status certification scheme for entry into large venues. Unlike in many other parts of Europe, the UK’s vaccine passport did not last long, however. On January 19, Boris Johnson took the world by surprise by announcing plans to lift almost all of the “Plan B” measures for England, including the COVID-19 digital certificate. As I noted in Scanned:

The policy u-turn was an act of political desperation by a government brought to its knees by an endless succession of corruption scandals. After so many of Johnson’s cabinet ministers as well as Johnson himself had been caught flouting their own COVID-19 rules, there was only one way to stay standing: to get rid of the rules. But it’s touch and go whether it will be enough.

In the end, it wasn’t. Less than six months later, Johnson and his government had resigned.

2. Digital ID will be needed for the Bank of England’s Digital Pound, which is also currently under development.

The UK is one of more than 110 countries exploring the possibility of developing a central bank digital currency — the so-called Digital Pound. As the Financial Times reported in 2021, based on a report from Goldman Sachs, it is all but impossible to envisage a central bank issuing a digital currency that is universally accessible without first launching a population-wide digital identity:

What CBDC research and experimentation appears to be showing is that it will be nigh on impossible to issue such currencies outside of a comprehensive national digital ID management system. Meaning: CBDCs will likely be tied to personal accounts that include personal data, credit history and other forms of relevant information.

As the Goldman Sachs report notes, it’s the broader banking system that is expected to manage the related identity systems and customer-facing relations. This is has already begun to happen in Canada and Australia, as I reported last September:

[T]he news that banks in Australia are leading the roll out of digital identity is… important, since it would suggest that large banks are already carving out a new role for themselves in the newly emerging [CBDC] paradigm. That role will essentially involve managing at least part of the digital identity system.

One of the many reasons why this development is troubling is that the big banks in Australia, like big banks just about everywhere, have been trying to kill off cash for decades, mainly by shrinking their regional networks of banks and closing their ATMs — for obvious reasons: cash operations can account for as much as 10% of total bank operating costs. No more cash would mean no more expensive ATM networks to run, no salaried tellers and no cash vans waiting to be robbed.

Back in the UK, Bob Wigley, the chair of the lobbying group UK Finance, recently called for a digital identity super app.

“This will be the year that we finally persuade the banking system that we need an economic digital identity system, just like the NHS app,” Wigley said. “[It] will be personal and attached to each citizen as we need a wider fully digital economic identity programme.” If the government does not seize the opportunity to produce an economic super app, “the big tech platforms will do it”, said Wigley, adding “we should be designing it”.

Spawned from the merger in 2017 of the British Bankers’ Association, Payments UK, the Council of Mortgage Lenders, the UK Cards Association and the Asset Based Finance Association, UK Finance is far and away the UK’s largest banking trade association. It represents over 300 firms in the UK’s financial services sector, including the country’s biggest banks. Bob Wiggley is the organization’s founding chairman, and is a highly connected figure both in finance and government.

3. Digital ID Systems Are Already Surreptitiously on Their Way in the UK, But They Will Be Provided by the Private Sector (With Some Public Money).

Unbeknown to most British people, the UK government is already working on digital identity systems such as the DSIT Digital Identity Programme. But in contrast to the system put forward by the Tony Blair Institute for Global Change, it will not be an all-in-one unified platform issued by the government.

Instead, private sector companies in the tech and fintech sectors will do most of the leg work. But the Department for Culture, Media and Sport (DCMS) has agreed to pick up the tab for a “substantial proportion” of the costs incurred. As readers may recall, the UK government has also signed a digital trade agreement (DTA) with Ukraine’s tech-dominated government that includes a commitment to share best practices on digital ID. The Ukrainian government is far ahead of many of its European counterparts in the area of digital governance, and USAID has committed to help export the model to other countries.

The UK government is also in the process of establishing the parameters for regulation — the so-called “digital identity & attributes trust framework” — and real-world applications for digital ID. It has also unveiled a proposed digital government identity verification system under the banner “GOV.UK One Login”. The new system will replace the plethora of existing ways people log into government websites to access public services online.

Digital verification is not the same thing as digital identity though they are closely related and arguably lead to the same outcome:

The latter leads to the first as it’s pretty much digital ID by the back door if you can not borrow, mortgage, rent, or work, without having an identity check conducted digitally.

The right to prove your identity by physical means must be retained at all costs.

— Awakened World & Lawyers of Light (@AwakenedOf) February 27, 2023

Big Brother Watch warns this could give the government a blank cheque to share the personal information of millions of users between government departments. At the same time, a prominent City of London financier has predicted that the private sector is preparing to launch an “economic digital identity super app.”

In other words, digital ID is already on its way in the UK, just not quite in the form proposed by Blair’s foundation. There is one silver lining, however: at least now debate on the issue is beginning to filter into the public arena. But time is of the essence.

UK citizens have until March 1 (i.e., today) to respond to a public consultation on the government’s proposed digital identity verification system. Suffice to say, the consultation was not heavily publicised by the government nor covered in any depth, if at all, by the media, so most members of the British public are none the wiser. For UK-based NC readers, there is still a small but rapidly closing window of time to make your feelings known. Big Brother Watch provides further details, including a template letter, here.