Authored by Mike Shedlock via MishTalk.com,

Think carefully about my question and the measures you use to define inflation.

Milton Friedman famously said: “Inflation is always and everywhere a monetary phenomenon.” 

M2 from the Fed, CPI from the BLS, Monthly Data Through November, Chart by Mish

Most people parrot Friedman because the quote sounds good. 

The actual quote is:

“Inflation is always and everywhere a monetary phenomenon, in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

M2 Weekly Chart Percent Change From Year Ago

M2 from the Fed, Weekly Data Through December 5, Chart by Mish

Last Five Weekly Readings

• 2022-11-07:  0.3 Percent

• 2022-11-14:  0.0 Percent 

• 2022-11-21: -0.1 Percent

• 2022-11-28: -0.4 Percent

• 2022-12-05: -0.7 Percent

Is Inflation Always a Monetary Phenomenon?

If you insist that increases in money supply constitute inflation, then you must also insist that we are in a period of deflation right now.

Does it feel like it?

I have been waiting for this moment for a long time just to ask these questions. 

I was sure money supply growth would go negative because the Fed’s balance sheet unwind would shrink money supply as measured by M2. 

Quoting Friedman 

People love that Friedman quote, but ask anyone: How do you measure money? Is it M1, M2, MZM, or M3? Expect blank stares. 

Then ask them how they measure inflation. If it’s by prices, not increases in money supply, then their answers are inconsistent. 

What About Velocity?

At the time Friedman made his claim, he believed the velocity of money was relatively constant or stable in a narrow band.

Velocity was relatively stable then. It isn’t now. Few are aware of that major difference.

Changing Definitions 

The 1959 Miriam-Webster definition of inflation was an increase in money supply and credit. Apologies offered, but I cannot find that reference. 

The Fed, academia, and governments managed to change the definition to hide asset and credit bubbles.

The Fed seldom if ever discusses money supply or total credit. That is on purpose.

Total Credit Market Debt

Total Credit Market Debt Owed data from the Fed, chart by Mish

TCMDO is $92 trillion. Data is through the third quarter of 2022.

How the heck is that supposed to be paid back? 

From 2006-2009, using a credit view of inflation, I confidently predicted deflation and it happened. 

Will it happen again?

I say yes, but when is the key question. This is not 2008. We do not have the degree of housing liar loans and people walking away from debt.

But we do have masses of zombie corporations that will go bust and all their debt with them. 

Housing Bubble Deflation 2007-2010 Flashback

Total Credit Market Debt Owed and M2 data from the Fed, chart by Mish

That’s one hell of a deflation flashback to the housing bubble bust. We had an unprecedented 4 consecutive quarters of declining credit year-over-year and a 5th quarter that was flat. 

Coupled with an enormous asset bubble bust, that’s deflation by any sensible measure. 

At the time, however, I was routinely mocked for my deflation take because M2 was still positive. Well now it isn’t.  

Is the US in a Period of Deflation Right Now?

The answer depends on what one means by inflation, deflation, and money. If you insist on a M2 measure, there is only one possible answer, and that is yes.

If you point at the CPI or grocery prices today while pointing out M2 yesterday, what does that say about you?

If you view things from the perspective of asset bubbles then heck yes, deflation has started. It also has a long way to go.

If you look at things from a credit perspective, you have a much better leg to stand on if you say there is still inflation. 

Deflation In the Batter’s Box

It’s asset bubble and credit deflations that are the most damaging. Of course, it’s periods of credit inflation and cheap interest rates that sponsor asset bubbles. 

To control inflation, the Fed has popped another asset bubble, largely of its own making. 

Deflation, via another credit bubble bust, is in the batter’s box. 

The Fed would pivot if it causes a credit event, but how low will asset prices go first?

Regardless, if you think either M2 or the CPI is the thing that matters most, you are wrong no matter what the Fed says. 

The credit picture is more important than either of them. So are deflating asset bubbles. The latter is what led to a credit bust in the housing bubble period and it can easily happen again. 

Meanwhile, the Fed is hell bent on destroying asset prices to control inflation. Good luck with that. 

How Did We Get Here?

Why the Fed is in this position for the third time since 2000?

The short answer is the Fed is clueless about what inflation is, how to measure it, and what’s really important. 

The Fed only looks at consumer inflation. It ignored (make that sponsored) asset and credit bubbles in a perpetually foolish effort to promote routine consumer price inflation of 2 percent.

But the Fed can only make money cheap, it cannot control where money goes. The money (credit expansion) went into assets especially housing.

Case-Shiller Home Price Index

Case-Shiller home price data via St. Louis Fed, chart by Mish

CS National ,Top 10 Metro, CPI, OER Index Levels

Case-Shiller home price data via St. Louis Fed, CPI, OER, and Rent from the BLS, chart by Mish

Chart Notes

• OER stands for Owner’s Equivalent Rent. It it the price one would pay to rent a home, unfurnished and without utilities.

• Home prices wildly disconnected from the CPI in 2000 and in 2013. The disconnect accelerated in 2020.

The Fed ignored all three occasions hoping to make up for “lack of inflation”. The Fed “succeeded” beyond it’s wildest dreams. 

For discussion, please see Home Prices Sink in Every Major Market, What About Year-Over Year?

In late 1990s the Fed ignored obvious bubbles and the DotCom mania. Then to bail out banks in the wake of the DotCom bust, the Fed either purposely or ignorantly blew a massive housing bubble.

My chart shows a clear disconnect in housing. The Fed ignored soaring home prices that on the pretense that homes are not a consumer expense and thus not in the CPI.

The Fed made the same mistake, using the same faulty logic in the entire 10-year period from 2012 on. 

The Fed wanted to make up for lack of inflation as measured (idiotically) by the CPI.  

Historical Perspective on CPI Deflations: How Damaging are They?

Hello Fed, it’s not consumer inflation that matters, it’s inflation that matters. 

I have been making that case ever since 2006, to no avail. To become a decision maker at the Fed you have to believe total silliness instead of reality.

I have referred to this article before but now is a great time for a refresher course.

Please consider Historical Perspective on CPI Deflations: How Damaging are They?

Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.

The Bank of International Settlements (BIS) took a look at the Costs of Deflations: A Historical Perspective. Here are the key findings.

Concerns about deflation – falling prices of goods and services – are rooted in the view that it is very costly. We test the historical link between output growth and deflation in a sample covering 140 years for up to 38 economies. The evidence suggests that this link is weak and derives largely from the Great Depression. But we find a stronger link between output growth and asset price deflations, particularly during postwar property price deflations. We fail to uncover evidence that high debt has so far raised the cost of goods and services price deflations, in so-called debt deflations. The most damaging interaction appears to be between property price deflations and private debt.

Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.

Once we control for persistent asset price deflations and country-specific average changes in growth rates over the sample periods, persistent goods and services (CPI ) deflations do not appear to be linked in a statistically significant way with slower growth even in the interwar period. They are uniformly statistically insignificant except for the first post-peak year during the postwar era – where, however, deflation appears to usher in stronger output growth. By contrast, the link of both property and equity price deflations with output growth is always the expected one, and is consistently statistically significant.

The exception to the general rule was the Great Depression but, that was also an asset bubble deflation coupled with consumer price deflation.

Paying Attention to the Wrong Things

Instead of paying attention to credit growth and asset bubbles, every Fed member is in an echo chamber following useless economic metrics like inflation expectations, the Phillip’s Curve and all sorts of other silliness.

For discussion, please see Inflation Expectations are Crashing. So What? It Doesn’t Matter.

Worse yet, in their attempts to fight routine consumer price deflation, central bankers create very destructive asset bubbles that eventually collapse, setting off what they should fear – asset bubble deflations.

And here we are, with asset bubble deflation at hand with the Fed wringing its hands over the wrong things, after finally succeeding in creating the CPI inflation that it no longer wants. 

Forget about M2, for now. Watch TCMDO instead. If credit collapses, the economy and the Fed is in deep trouble.

By the way, please note M2 money supply is $21.4 trillion while total credit owed TCMDO is $92.2 trillion. 

Will these converge? Which way, how, and when?

*  *  *

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One year ago in keeping with its annual tradition, Goldman’s economics team published a list of 10 questions and answers for 2022 and while the end results was a mixed bag (professional subs can read the 2022 predictions and their outcome here), where Goldman was catastrophically wrong was in the only item that matters: inflation. Specifically, when asking if core PCE will fall below 3%, Goldman’s rhetorical answer was “yes” and boy was it wrong. And if you got inflation wrong, nothing else mattered (just look at the $20 trillion loss in global market cap as a result of unprecedented central bank tightening).

Of course, being wrong never stopped Goldman before, and earlier this week the bank’s chief economist Jan Hatzius published his list of most pressing questions for 2023, including a discussion on the bank’s most “out of consensus” forecast for the coming year, namely that the US will avoid a recession and will “continue progressing toward a soft landing.” Well, if nothing else, it appears that Goldman wants to extend the tradition of being right about the irrelevant stuff while being dead wrong about what truly matters.

Before we get into the weeds, here is a summary of Goldman’s broader economic outlook as laid out by Hatzius

• Our most out-of-consensus forecast for 2023 is our call that the US will avoid an recession and instead continue progressing toward a soft landing. This forecast partly reflects our view that a period of below-potential growth is enough to gradually rebalance the labor market and dampen wage and price pressures. But it also reflects our analysis that indicates that the drag from fiscal and monetary policy tightening will diminish sharply next year, in contrast to the consensus view that the lagged effects of interest rate hikes will cause a recession in 2023.

• We see the first steps in the rebalancing process this year as quite successful. Our jobs-workers gap has shrunk quickly at little cost, with all of the decline in labor demand coming from a drop in job openings. But there is much further to go in 2023. We expect the jobs-workers gap to narrow steadily next year due mainly to a further drop in job openings, but also to a limited increase in the unemployment rate to just over 4%. Both labor market rebalancing and a more moderate inflation environment should lower wage growth toward a more sustainable rate.

• Supply chain recovery and the deflationary impulse in the goods sector that it promised to bring took much longer than we expected but have finally arrived. We expect this ongoing process to push core goods inflation negative next year, driving most of the decline in overall core inflation. This should help to push elevated short-term inflation expectations back toward normal levels.

• We expect the FOMC to deliver 25bp rate hikes in February, March, and May, and then to hold the funds rate at 5-5.25% for the rest of 2023. We are skeptical that the FOMC will cut the funds rate until the economy is threatening to enter recession, and we do not expect this to happen next year.

• The debt limit likely poses the greatest political risk next year, and we expect it to rival the 2011 episode in its disruption to financial markets and the economy. That said, we do not expect Congress to enact major fiscal changes. Republicans might press for spending cuts in a debt limit deal, but we do not expect substantial cuts next year. The White House might press for increased fiscal support, but this also looks unlikely as we believe a soft landing is more likely and a divided Congress would have difficulty responding to a recession even if one occurs.

Incidentally, while Goldman may be wrong about everything else, we agree that a divided Congress will be unable to respond to a recession (which will occur), which means that the only support possible in 2023 and 2024 will be from the Fed, and yes: the firehose is coming.

Without further ado, here is a look at the top 10 questions (and forecasts) from Goldman’s econ team:

1. Will the US economy enter recession in 2023?

No. The consensus 12-month recession probability stands at 65%, well above our own 35% probability.

Part of our disagreement with consensus arises from our more optimistic view on whether a recession is necessary to tame inflation. We have argued this year that an extended period of below-potential growth can gradually rebalance supply and demand in the labor market and dampen wage and price pressures with a much more limited increase in the unemployment rate than historical relationships would suggest. We see this adjustment process as having gone quite well so far, though there is much further to go in 2023. We agree both that calibrating policy just right to stay on this low-growth path is difficult and that there is still uncertainty about how sticky inflation will prove to be, and for that reason our 12-month recession probability is about double to triple the unconditional historical average.

If views on what it will take to reduce inflation were the sole source of disagreement, then we would expect the consensus Fed forecast to be more hawkish than our own. Instead, both the consensus Fed view and market pricing are a touch more dovish than our forecast of a 5-5.25% terminal rate. This implies that much of the disagreement arises instead from differing views on near-term growth momentum and especially on the lagged impact of the rate hikes already delivered on the economy.

We expect more resilience in underlying demand next year than consensus because our analysis indicates that policy restraint has played a very large role in slowing demand growth this year but will fade quickly next year. Exhibit 2 shows that the combined drag from fiscal policy tightening and from monetary policy tightening via financial conditions has been very substantial but will diminish in 2023.

In contrast, the consensus forecast reflects a view that the “long and variable lags” of monetary policy will push the economy into recession next year. We recently showed that other macro models support the conclusion of our financial conditions index growth impulse model that the peak impact of rate hikes on GDP growth is front-loaded, as shown in Exhibit 3.

Much of the disagreement between our view and the implicit consensus view likely arises from two sources. First, our approach recognizes that rate hikes affect the economy via broad financial conditions as soon as markets anticipate them, which in 2022 was well before they were delivered. Second, some forecasters seem to confuse lags from monetary policy to GDP growth with lags to GDP levels—in fact, Milton Friedman’s famous assessment that policy acts with long and variable lags clearly referred to the time until the peak impact on the level of GDP.

2. Will consumer spending grow at least 1%?

Yes. Real disposable income fell from the spring of 2021 through the summer of 2022 as inflation outran wage growth and special transfer payments included in pandemic relief packages expired. Exhibit 4 shows that we expect real income to rise 3.5% in the year ahead, supported by positive real wage growth, large cost-of-living adjustments on transfer payments including Social Security and food stamps, a jump in interest income, and a decline in the effective tax rate as a spike driven by capital gains and bracket creep reverses. While gains from interest income and tax rate normalization will accrue mostly to high-income households and have less impact on spending, the turnaround in real income is nonetheless a key reason that we have a relatively optimistic 2023 consumer outlook.

The impact of firmer real income growth on consumption should be partially offset by a rise in the saving rate next year. We expect the saving rate to increase in part because higher interest rates have reduced household wealth by lowering home and equity prices, and in part because the lower- and middle-income families that tapped excess savings to support their spending this year as transfer payments expired will have less to draw on next year. One important form that drawing on excess savings has taken is the rebound in consumer credit use, and while it remains below its pre-pandemic level as a share of income, its recent rapid growth rate is not sustainable and will have to slow next year.

We expect these forces to net out to consumption growth of roughly 1.5% in 2023.

3. Will core goods inflation turn negative year-over-year?

Yes. One of our largest forecast misses in both 2021 and 2022 arose from mistiming the supply chain recovery, which was delayed by further global shocks and in turn delayed the disinflationary impulse from the goods sector that we had expected to push core inflation meaningfully lower this year. But now supply chain recovery finally appears to be underway, lowering costs and enabling production of scarce items like autos to recover, as Exhibit 9 shows. As inventories are rebuilt, competition should reverse the scarcity effects that raised retail margins and consumer prices earlier in the pandemic.

More moderate commodity price inflation, falling transportation costs, and downward pressure on import prices from past dollar appreciation should also help to reduce core PCE goods inflation, which has already fallen from a peak of 7.6% year-on-year to 3.8% in November and should turn negative next year. Core goods inflation ran modestly negative last cycle, and we expect it to run somewhat more negative than usual for a while as elevated prices of items like used cars revert to more normal levels.

We expect a more limited decline on the services side, with core services PCE falling from 5% to a still high 4.5% by December 2023, in part due to lags in the official data for the two largest categories, shelter and health care. However, Chair Powell’s recent focus on the sharp decline in alternative measures of rent inflation that will lead the official data by longer than usual suggests that Fed officials are comfortable looking ahead to an eventual deceleration and will not overreact to the lagged official data next year.

4. Will the Fed cut the funds rate?

No. We expect the FOMC to deliver three 25bp rate hikes in February, March, and May, and then to hold the funds rate at 5-5.25% for the rest of 2023. In contrast, market pricing implies a peak funds rate of 4.75-5% and declines to about 4.4% by the end of 2023, as shown in Exhibit 13.

There are two possible rationales for cutting the funds rate in the future. The first rationale would be that if inflation declines, Fed officials might decide that policy does not need to be as restrictive anymore. We are doubtful that the goods-driven decline in inflation that we expect in 2023 would be sufficient to give the FOMC confidence that inflation is moving down in a sustained way, which Powell has said is the criterion for cutting. But more than that, we remain skeptical that the FOMC will cut just for the sake of returning to neutral because we suspect that the Fed leadership does not have enough confidence in its neutral rate estimate for it to exert much gravitational pull on the policy rate.

The second and we think more likely rationale for cutting at some point would be that the economy is entering recession or threatens to do so without an easing in monetary policy. We see this as the more natural path—if tighter monetary policy succeeds in convincingly reducing inflation, we expect the FOMC to just leave the policy rate unchanged until something goes wrong. We have cuts in our forecast over 2024-2026, but we do not intend for the timing to be taken literally and instead think of our path of cuts as a placeholder for an uncertain future date when something goes wrong.

We often caution that market pricing is a probability-weighted average of many scenarios and is not directly comparable to our modal forecast of the Fed path, which assumes that the economy will avoid recession next year. We suspect that the downward slope in the yield curve in 2023 mostly reflects some probability of cuts in a possible recession scenario, while the downward slope in 2024 likely reflects both some probability of cuts in a recession and some probability of cuts if inflation moderates without a recession. Our own probability-weighted average forecast of possible Fed paths also implies that the yield curve should slope downward but is somewhat more hawkish than market pricing.

5. Will the debt limit have as negative an impact on financial markets in 2023 as it in 2011?

Yes. The political and fiscal conditions next year will be similar to the last two extremely disruptive debt limit increases, in 1995 and 2011. Like next year, in those periods a Democratic President in his third year faced a Republican House after losing the majority in the midterm election. Those episodes also followed a run-up in public debt as a share of GDP and/or a rise in federal interest expense, similar to the experience over the last few years. However, midterm gains of 54 seats in 1994 and 63 in 2010 gave Republicans a clearer political mandate and the votes to carry it out, at least in the House. By contrast, Republicans netted only 9 seats in the 2022 midterms and enter 2023 with a very thin House majority. Public focus on the public debt is also much lower compared to those prior periods, and Republicans have not emphasized fiscal restraint nearly as much recently as they had in the mid-1990s or early part of the Obama Administration.

Prior disruptive debt limit standoffs led to increased market volatility and a sell-off in Treasury securities maturing around the debt limit deadline, and we would expect this to occur next year. In 2023, we would expect yields on bills maturing around the deadline to rise by at least as much as they did in 2011 and 2013, and for volatility in financial markets to rise similar to those periods (Exhibit 14).

There is also a real chance that Congress fails to raise the debt limit in time next year, forcing Treasury to reduce daily payments to the level of receipts (i.e., immediately eliminating the budget deficit), resulting in a spending cut of around 10% of GDP at an annualized rate. While we think it is more likely that Congress manages to avoid this and raise the debt limit before it constrains Treasury’s ability to pay its obligations, the risk appears higher than at any point since 2011.

The deadline for Congress to raise the debt limit before Treasury must cut back net borrowing will likely be sometime in August but could be as late as October depending on Treasury cash flows (Exhibit 15). An early signal of the risk the debt limit poses will come at the start of 2023, when the new House of Representatives is seated. If Republicans reinstate the “motion to vacate” that allows any member of the House to call for a vote for a new speaker of the House—several Republican House members have recently called for this in return for their vote for speaker—it could be difficult for the next speaker to put a clean debt limit increase to a vote until forced by financial markets.

Quickly running through the other five questions (and answers) we have the following:

1. Will the jobs-workers gap fall below 3 million? – Yes
2. Will the job openings rate fall from its peak by more than the unemployment rate rises from its trough? – Yes
3. Will wage growth slow at least 1pp? – Yes
4. Will one-year Michigan consumer inflation expectations fall below 4%? – Yes
5. Will Congress enact substantial fiscal policy changes in 2023? – No.

For more detailed on these, and other questions and predictions, read the full note available to pro subs.

By David Finnerty, Bloomberg Markets Live reporter and analyst

Look for the dollar to have a good first quarter on the back of a hawkish Fed and deteriorating risk sentiment.

There are good reasons to expect the Fed to follow through on its hawkish dot plot given US core PCE data is proving to be sticky, and US employment data next week is forecast to show the labor market remains tight. China’s reopening has the potential to add to inflationary pressures if the surge in Covid cases spurs supply disruptions or via an increase in demand pressures.

Should the US central bank fulfill its hawkish predictions it would be a positive for the dollar as it would force investors to revise higher their expectations for the terminal rate, which are currently under 5%.

Deteriorating risk sentiment also tends to be a dollar positive. US equities are ending the year on the back foot which is an ominous sign for the start of 2023, particularly with earnings season fast approaching. Where US equities go other nation’s equities tend to follow. In addition, worries about a global slowdown aren’t going to help risk sentiment which is good news for dollar bulls.

Of course there are two sides to the dollar equation. How it performs will also depend on the euro, yen and sterling, which have large weightings in both the Bloomberg Dollar Spot Index and the Dollar Spot Index. Here though again there is reason to be optimistic for the dollar.

Both the euro’s and sterling’s rallies have stalled with them likely to come back under pressure in first quarter amid recession fears.

As for the yen, while the BOJ will more than likely amend its policy further next year, the summary of opinions to its December meeting signals that it may not be until after Gov. Kuroda leaves in April. That means US-Japan interest rate spreads should remain wide in the first quarter limiting the yen’s

The Kremlin has clarified its position on being ‘open’ to peace negotiations with Ukraine, after over the weekend Ukraine’s leadership floated a proposal to enter into UN-brokered ceasefire negotiations in February. 

Kremlin spokesman Dmitry Peskov on Wednesday said any future “peace plan” must involve formal recognition that the annexed eastern territories have joined the Russian Federation.

“There can be no peace plan for Ukraine that does not take into account today’s realities regarding Russian territory, with the entry of four regions into Russia. Plans that do not take these realities into account cannot be peaceful,” Peskov said.

Last week the Kremlin stated something similar, according to The Associated Press:

…no Ukrainian peace plan can succeed without taking into account “the realities of today that can’t be ignored” — a reference to Moscow’s demand that Ukraine recognize Russia’s sovereignty over the Crimean Peninsula, which was annexed in 2014, as well as other territorial gains.

Ukraine’s position has been to denounce the “sham” referendums Russia held in Kherson, Zaporizhzhia, and the breakaway Donbas republics of Donetsk and Luhansk (DPR and LPR), while vowing its forces will not stop fighting until every inch of Ukraine is “liberated”.

President Zelensky has even in the recent past said that Crimea must be returned from Russian control as well, and there’s been a handful of Ukrainian attacks on the Russian-held peninsula.

Both sides at this point see in the other’s position unrealistic demands. The Kremlin, for example, sees as a completely unserious non-starter the latest Ukraine assertion that the proposed February talks can only happen if Moscow agrees to a “war crimes tribunal” for its officials. This position will only become even more entrenched after Thursday’s massive Russian missile attack across Ukraine, reaching as far West as Lviv…

⚡️British Ambassador to Kyiv: The Russian attack on Ukraine today confirms that Moscow wants to subjugate Kyiv, not peace

— War Monitor (@WarMonitors) December 29, 2022

In addition to dismissing this “war crimes court” demand, the Russian foreign ministry has pointed to the greatly ramped up supply of weapons from Western countries, especially from the United States, which has derailed any legitimate move toward peaceful negotiations.

Fresh analysis in The New York Times says that at this point each side is still seeking a military solution, remaining hardened in their positions: 

As the battle for Ukraine turns into a bloody, mile-by-mile fight in numbing cold, Ukrainian and Russian officials have insisted that they are willing to discuss making peace.

But with a drumbeat of statements in recent days making clear that each side’s demands are flatly unacceptable to the other, there appears to be little hope for serious negotiations in the near future.

The Times then quotes the following analyst:

“This suggests there is not necessarily a push for a negotiated peace or even some sort of negotiations, but still a push for whatever endgame is being sought militarily,” said Marnie Howlett, a lecturer in Russian and Eastern European politics at the University of Oxford.

Lavrov this week said all of Russia’s objectives must be met… “Otherwise,” he said, “the Russian Army will deal with this issue.”

Interestingly, no less than former US Secretary of State Henry Kissinger penned an op-ed this month wherein he called for Ukraine and the West to get serious about territorial concessions in order for the war to end, with the ‘alternative’ being a continued spiral toward nuclear-armed direct confrontation between the US-NATO and Russia.

Authored by Alex Pollock via The Mises Institute,

The 21st century, only 23 years old, has already had two giant, international housing bubbles. It makes one doubt that we are getting any smarter with experience…

Among the countries involved in the second bubble, both the U.S. and Canada fully participated in the newest rampant inflation of house prices. Prices this time reached levels far above those of the last boom peak. In the U.S., the S&P/Case-Shiller National House Price Index by mid-2022 had risen to 67% over its 2006 bubble peak (130% over its 2012 trough). In Canada, the Teranet-National Bank House Price Index had soared to 143% over its 2008 peak (168% over its 2009 trough). What the Federal Reserve and the Bank of Canada both wrought with their hyper-low interest rate policies, were house prices which would be unaffordable as soon as mortgage interest rates returned to more normal levels. For a number of years, one could ask: When would that ever happen? Now we know: in 2022.

Now, in late 2022, with mortgage interest rates higher, housing bubbles are deflating, and house prices are dropping on a nationwide basis in both the U.S. and Canada. Here we go again into another house price fizzle following another house price boom.

How is it that we could find ourselves caught up in the problems of another housing bubble so soon? It is only ten years since 2012, the year house prices stopped falling in the U.S., and formed the trough of the painful bust which had followed the preceding bubble of 1999- 2006. Up to the point when house prices started falling across the U.S. last time, expert voices pronounced that U.S. house prices could fall on a regional basis, as they had numerous times, but that it was not possible for house prices to fall on a national basis in an economy so large and diversified. That theory could not have been more mistaken, and national average house prices fell 27%. In 2022, the theory is again being shown to be wrong, but how big the fall will be this time is not known or knowable.

We can take as a key ironic lesson that when large numbers of people believe house prices cannot fall, especially when they are emboldened by central bank behavior, it makes it more probable, and finally makes it certain, that the prices will ultimately fall. When they do, what had been built into everybody’s financial models as “HPA,” or “House Price Appreciation,” becomes instead “HPD”— “House Price Depreciation.” It would be better all along to refer to it as “HPC,” or “House Price Change,” thus reminding ourselves that prices of any asset can go both up and down, perhaps by a lot.

Ten years, it seems, is long enough to dim the memories that prices can move dramatically in both directions, even on a nationwide basis. A bubble market when extended for years makes a great many people happy, since they are making money and seem to be growing richer, and the higher their leverage, the faster they seem to be growing richer. As the great financial observer Walter Bagehot wrote 150 years ago, “the times of too high price” mean “almost everything will be believed for a little while.”

Then the reversal comes and different beliefs come to prevail. In just four months, from June to October 2022, U.S. median house prices dropped a remarkable 8.4%, with prices declining from their peak in all 60 of the largest metropolitan areas in the country. In October, sales of existing houses declined for the ninth month in a row, and were down 28% from a year earlier. Applications for a mortgage to buy a house were down 42% from the year before. Mortgage banks reported they were on average losing money on mortgage originations and many were laying off staff. The share price of 2021’s largest mortgage bank, Rocket Companies, was down 70% from its 2021 high. The CEO of the National Association of Home Builders stated, “We’re heading into a housing recession.”

In Canada, average house prices fell 7.7% from May to October, the largest five-month drop in the history of the Teranet index, which goes back to 1997. In Toronto, the country’s financial capital and a former star of rapid house price inflation, the May to October house price drop was a vertiginous 11.9%. Successive headlines in monthly Teranet-National Bank House Price Index announcements read: “Record price drop in August”; “Another record monthly decline in September”; “Another monthly decline in October.”

In spite of these rapid percentage rates of decline, house prices in both countries are still at very high levels. How much further can they fall from here? For the U.S., the Federal Reserve carefully stated in its latest Financial Stability Report, “With valuations at high levels, house prices could be particularly sensitive to shocks.” Coming to specifics, the AEI Housing Center predicts a 10%-15% nationalaverage fall in house prices during 2023. That would wipe out a lot of housing wealth that the bubble made people think they had, a reduction of perhaps $4 or $5 trillion of perceived wealth on top of the $3 trillion lost so far this year. It would put many houses bought near the top of the market, especially under government low- down payment programs, into no or negative owner’s equity.

For Canada, the Wall Street Journal suggested that its housing market is “particularly sensitive to monetary tightening,” and reported that Oxford Analytics “estimates that home prices in Canada could fall 30%.”

Recall that a price has no substantive reality: it is an intersection of human expectations, actions, hopes and fears. I like to ask audiences, “How much can the price of an asset change?” My proposed answer: “More than you think.”

Of course, nobody, including the Federal Reserve and the Bank of Canada, knows just where house prices will go, but we can all guess. Noted economist Gary Shilling wrote in November, “Price declines are just starting,” and “recent weakness probably has far to go.” This seems to me likely.

In any case, the second great housing bubble of this still young century is over and a new phase has begun.

*  *  *

Originally published in the Housing Finance International Journal.

Oil prices are lower this morning (despite a small crude draw reported by API overnight) amid concerns about a jump in Covid-19 cases after China suddenly rolled back pandemic rules (which is ironic because prices were down just weeks ago because of the Zero-COVID rules). Rising infections may dampen enthusiasm for the possible rise in demand as the country works to restore productivity.

“The lack of clarity over the virus situation in China has prompted some new travel rules from various countries, which could serve as some dampener for previous optimism,” said Jun Rong Yeap, market strategist at IG.

The U.S. refilling its strategic petroleum reserves “should be supportive for the market and could have put a bit of a floor in place,” said Craig Erlam, senior market analyst at OANDA.

The impact of the huge winter storm is unlikely to have hit these data yet.

API

• Crude -1.30mm

• Cushing -338k

• Gasoline +510k

• Distillates +38k

DOE

• Crude +718k

• Cushing -195k

• Gasoline -3.105mm – biggest draw since Sept

• Distillates +283k

Following API’s reported small crude draw, the official data showed a small crude build (+718k), but gasoline stocks plunged for the first time since early Nov…

Source: Bloomberg

The small commercial crude build was more than offset by a 3.mm barrel drain from the SPR, which dragged the emergency reserve for to Dec 1983 levels…

Source: Bloomberg

US crude production remained flat last week…

Source: Bloomberg

WTI hovered around $77.75 ahead of the official data and extended losses after the surprise build

Amid the extremely low liquidity, volatility is heightened this week after the Kremlin said this week it would ban exports of Russian crude oil and refined products to foreign buyers that adhere to a price cap.

“The outlook remains highly uncertain for the oil market,” said Craig Erlam, senior market analyst at Oanda.

China’s success in pivoting away from Covid-Zero could be key to a recovery but it will take time to understand the implications on oil demand, he said.

But oil still looks set to close the year with a gain.

Ukraine has been hit with a “massive” attack of over 120 missiles across the country Thursday, its military and presidency’s office said. “December 29. Massive missiles attack… The enemy is attacking Ukraine from various directions with air and sea-based cruise missiles from strategic aircraft and ships,” Ukraine’s air force said in a public statement. 

It marks the largest barrage of missiles since there was weekend talk from both sides of mutual ‘openness’ in getting to the negotiating table. Ukrainian leadership floated the proposal of UN-brokered talks by the end of February, but its insistence on Russian officials facing a war crimes tribunal first was seen in Moscow as not serious and a non-starter.

Regardless, at this point, Thursday’s fresh aerial attack effectively slams the door shut on the possibility of talks. According to a blistering statement from Zelensky aide Mykhaylo Podolyak, the missiles were launched:

…by the “evil Russian world” to destroy critical infrastructure & kill civilians en masse. We’re waiting for further proposals from “peacekeepers” about “peaceful settlement”, “security guarantees for Russian Federation” & undesirability of provocations.

Thus with the obvious sarcasm Zelensky’s office has clearly signaled talks at this point are all but an impossibility from its point of view.

The Ukrainian military said missiles reached as far West as Lviv, parts of which were left without electricity Thursday morning. “Ninety percent of the city is without electricity,” Lviv’s mayor said in a social media post. “We are waiting for more information from energy experts. Trams and trolleybuses are not running in the city.”

🇺🇦Air-Defences under attack according to the woman filming pic.twitter.com/P9thsLkKND

— Tony (@Cyberspec1) December 29, 2022

The capital of Kyiv also saw limited strikes, and is still facing rolling blackouts and even bouts of water shortages. The military said two residences were hit by falling missile debris after an intercept while an industrial area was damaged, as well as a playground. Kharkiv in the east was rocked by major explosions, along with a number of other towns and cities, including the port city of Odesa.

As for Kiev, its mayor Vitaliy Klitschko has estimated 40% of homes are now without power, writing on Telegram: “40 percent of the capital’s consumers are without electricity after the missile attack. In connection with the necessary safety measures used by power workers during an air alert. Power engineers are currently working on restoring the power supply.”

Ukraine’s military claimed to have shot down dozens of inbound Russian missiles, with Ukraine’s top general, Valery Zaluzhny, confirming of the large-scale attack: “This morning, the aggressor launched air and sea-based cruise missiles, anti-aircraft guided missiles to the S-300 ADMS at energy infrastructure facilities of our country.”

Today, 54 missiles out of 69 were shot down. Because of the attack, energy facilities were damaged. The most difficult situation is in Odesa, Kyiv and Western Ukraine.

📷 Missile shot down in Kyiv region pic.twitter.com/DVzzNm4xm9

— Maria Avdeeva (@maria_avdv) December 29, 2022

Ukraine’s intercept efforts may have also resulted in a missile entering neighboring Belarus, with Belarusian state-run BelTA news agency reporting finding a Ukrainian S-300 missile after falling on its soil.

Belarusian President Alexander Lukashenko “was immediately informed,” according to reports. The Belarusian defense ministry says it’s investigating whether its air defense systems had shot down the rocket, or else “the missile flew into Belarus’ territory similarly to a recent incident in Poland.”

⚡️Footage of the Ukrainian S-300 that fell in Brest, Belarus. pic.twitter.com/kMpZEzUEGF

— War Monitor (@WarMonitors) December 29, 2022

Meanwhile, concerning the possibility of peace talks, Russian Foreign Minister Sergei Lavrov the day prior to the fresh Thursday missile attack said “We are in no hurry” and pledged that Moscow’s military objectives in Ukraine will be achieved through “patience” and “perseverance”. It’s expected that there are more major Russian missile attacks against Ukrainian energy infrastructure on the horizon, already as the national grid is in crisis mode amid freezing temperatures.

The number of Americans filing for jobless claims for the first rose last week from 216k to 225k (in line with exp), with the non-seaonally-adjusted pace of initial claims trending notably higher…

We do note that the state with the biggest drop in claims (which helps make the picture less ugly) is California… but that number was ‘estimated’…

But it is the ongoing rise in continuing jobless claims that should be a worry for Americans (and ‘cheer’ for The Fed?).

1.710 million Americans are filing for jobless claims on a continuing basis – the most since early February…

This is the largest rise in continuing claims since the peak of the COVID lockdowns in June 2020.

So the labor is still “tight”?

The 11 straight weeks of increasing continuing claims suggests that Americans who are losing their job are having more trouble finding a new one.

Perhaps the Establishment survey is completely decoupled from reality…

Source: Bloomberg

With claims and the household survey both signaling weakness in American jobs… ‘great news’ for The Fed?!

US index futures rebounded on Thursday from another painful selloff the day earlier, as technology shares rallied on the second to last trading day of what’s been a brutal year for financial markets, even as growing concerns over a surge in China’s Covid cases snuffed optimism over the nation’s reopening of its border. At 7:45am S&P futures traded 0.4% higher to 3,823 while Nasdaq 100 futures rose 0.6% to 10,837 following gains for Asian tech stocks earlier amid signs China is easing a regulatory crackdown. Treasuries were steady and the Bloomberg dollar index declined.

In premarket trading, Tesla climbed more than 3% in, with tech giants including Amazon.com Inc. and Netflix Inc. also among the biggest gainers. Tesla rose after Morgan Stanley analyst Adam Jonas said a de-rating in the electric vehicle company’s stock has created an opportunity, and even though Jonas lowered his price target to $250 from $330, he stuck to an overweight rating. Among other EV stocks: Rivian Automotive +2.6%, Lucid Group +2.8%, Hyzon Motors +6.4%, Cenntro Electric Group +8.1%, Mullen Automotive +7.8%. Jonas wrote that his new target reflects “lower pricing and lower valuation of adjacent businesses;” and expects 2023 will be “a ‘reset’ year for the EV market, where the last 2 years of demand exceeding supply will be substantially inverted to supply exceeding demand.”

And speaking of Tesla a quick look at yesterday’s record, blowout put-to-call ratio suggests that much of the recent plunge in TSLA stock may have been due to a surge in 0DTE put buying on TSLA which has helped send the stock tumbling in an illiquid environment as the negative gamma forced dealers to short the stock the more it slumped.

Here are some other notable premarket movers:

• Getaround rises 3.3% as the stock was initiated with an overweight rating and $1.50 PT at Piper Sandler, with the broker saying the platform looks well-positioned to provide its peer- to-peer car-sharing marketplace.
• Gaotu Techedu falls 4.6% in US premarket trading after China said it will tighten oversight of private tutors that offer non-curricular services to primary and middle school students, including rules on fee charges and operating time.
• Keep an eye on Skechers shares after it was started with a neutral rating and $42 PT at Piper Sandler, which says the opportunities and challenges the footwear firm faces look balanced and mean its current valuation is fair.

Global equities have lost a fifth of their value in 2022, almost $20 trillion in market cap, the largest decline since 2008 on an annual basis, and an index of global bonds has slumped 16% amid sticky inflation and rising interest rates.

Thursday’s tech rally was a small ray of light as the year draws to a close with investors again focused on risks arising from the the spread of Covid-19. The US said it would require inbound airline passengers from China to show a negative Covid-19 test prior to entry. In Italy, health officials said they would test arrivals from China after almost half of passengers on two flights from China to Milan were found to have the virus.

Amid fears that China’s aggressive, accelerated reopening may lead to another global wave of covid infections, China’s CDC top epidemiologist Wu Zunyou said that covid outbreaks have peaked in Beijing, Tianjin and Chengdu, though the situation in Shanghai, Chongqing, Anhui, Hubei and Hunan remains serious. He added that the virus is still spreading fast in Henan, Jilin and Fujian provinces, and warned of the disease spreading during Lunar New Year, with many expected to travel around the holiday. Separately, Liang Wannian, China’s senior official overseeing epidemic response, says the country is strengthening the monitoring of the Covid variant and will report to the World Health Organization if it discovers any new variant.

Hong Kong removed limits on gatherings and testing for travelers in a further unwinding of its last major Covid rules, offering a boost to the global economy but sparking concerns it would amplify inflation pressures and prompt US policy makers to maintain tight monetary settings.

“Investors are going into 2023 with a cautious mindset, prepared for more rate hikes, and expecting recessions around the globe.” said Craig Erlam, a senior market analyst at Oanda Europe Ltd. “And then there’s China and its u-turn on Covid prevention. It’s been quite the shift from fighting every case to living with the virus and that creates enormous uncertainty for the start of the year.”

Going back to markets, the Stoxx Europe 600 index erased losses to trade little changed, with gains for technology stocks offsetting declines for retail and consumer-focused shares. The Stoxx 600 index was flat after erasing a drop of 0.6%. The gauge, which is down 12% this year, posted declines earlier in the session, as US and Italy joined an increasing number of nations requiring Covid tests for travelers from China. European airline stocks dropped on, leading the Stoxx 600 Travel & Leisure Index lower, amid concerns over the spread of Covid-19 from China. Long-haul carriers Deutsche Lufthansa -4.1%, IAG -1.7%, Air France-KLM -1.3%.

Investors are worried about any potential emergence of a new variant of the virus which might bring restrictions back onto the table and “hammer growth,” Ipek Ozkardeskaya, senior analyst at Swissquote Bank.

Earlier in the session, Asian stocks declined, heading for their worst annual loss since the 2008 financial crisis, as growing concerns over a surge in China’s Covid cases snuffed optimism over the nation’s reopening of its border.  The MSCI Asia Pacific Index dropped as much as 1.1%, pushing its annual slump to about 20% in the final trading week of 2022. Tech stocks including Alibaba and Samsung Electronics were among the biggest individual drags on the benchmark. South Korea’s Kospi was the worst performer with a near 2% slump, while gauges in Hong Kong also underperformed. 

“Investors are starting to pay more attention to the spreading virus given that the pandemic could set back the pace of economic recovery in 2023,” said Jun Rong Yeap, a market strategist at IG Asia. “Investors may have prematurely priced in that the worst was over.”  Tencent, Asia’s biggest social media and gaming company, was the best performer on the Hang Seng Tech Index after China approved its new game titles in the latest sign Beijing is easing up crackdowns on the sector.  

Japanese stocks declined for a second day, following US peers lower as investors continued to worry about the spread of Covid-19 on China’s reopening. The Topix Index fell 0.7% to 1,895.27 as of 3 p.m. Tokyo time, while the Nikkei declined 0.9% to 26,093.67. Out of 2,162 stocks in the index, 1,231 rose and 833 fell, while 98 were unchanged. “The rise in Covid-19 infections in China could cause supply chain problems in the short term, which could lead to inflationary concerns,” said Tomo Kinoshita, a global market strategist at Invesco Asset Management. “Japanese stocks declined less than the US or Europe as China’s reopening has some positive effects on Japanese companies that are exporters.”

Australian stocks dropped to a seven-week low; the S&P/ASX 200 index falling 0.9% to close at 7,020.10, marking a third straight session of declines. The benchmark settled at its lowest since Nov. 10. Energy stocks led sector losses on weaker oil prices. Real estate shares trading ex-dividend also weighed. In New Zealand, the S&P/NZX 50 index was little changed at 11,538.45

In FX, the US dollar fell against most Group-of-10 currencies while Treasuries rallied as investors monitored the spread of Covid-19 within and from China. The Japanese yen bounced after two days of losses. US employment data in focus later. The yen led Group-of-10 currency gains after performing the worst on Tuesday and Wednesday. USD/JPY fell as much as 0.7% to 133.47, the biggest drop in more than a week. Swiss franc is the other outperformer amid concern over the spread of coronavirus, with the US and Italy among countries requiring Covid tests for travelers from China. The Bloomberg Dollar Spot Index declined 0.3%, with the greenback only higher against some risk-sensitive currencies including the Australian dollar and Norway’s krone. Traders will be watching data on US initial jobless claims later Thursday for more clues on the Federal Reserve’s policy path.

In rates, Treasury yields were mixed in early US trading with the curve modestly flatter as the short end cheapens by ~1bp. The 10-year TSY is lower by 1bp at 3.873%, but remains near the highest since mid-November and just above 50-DMA level; most euro-zone 10-year yields are higher ~1.5bp on the day; UK yields are leading the way higher with 10-year up 4bps. Treasury market was firmer overnight until a selloff in UK gilts dented global bond market sentiment. Final coupon auction cycle of the year concludes with $35b 7-year note sale at 1pm New York time; Wednesday’s 5-year saw a modest tail, after cheapening from session highs.  

Elsewhere in markets, oil dipped amid thin liquidity as investors weighed the fallout from a Russian ban on exports to buyers that adhere to a price cap.

Looking at today’s calendar, it’s a thin docket with just initial (exp. 225K) and continuing claims (exp. 1.690MM) on deck.

Market Snapshot

• S&P 500 futures up 0.3% to 3,820.00
• STOXX Europe 600 little changed at 427.43
• MXAP down 0.6% to 154.83
• MXAPJ down 0.7% to 503.83
• Nikkei down 0.9% to 26,093.67
• Topix down 0.7% to 1,895.27
• Hang Seng Index down 0.8% to 19,741.14
• Shanghai Composite down 0.4% to 3,073.70
• Sensex up 0.3% to 61,097.06
• Australia S&P/ASX 200 down 0.9% to 7,020.06
• Kospi down 1.9% to 2,236.40
• Brent Futures down 2.0% to $81.59/bbl
• Gold spot up 0.3% to $1,810.19
• U.S. Dollar Index down 0.22% to 104.23
• German 10Y yield little changed at 2.48%
• Euro up 0.3% to $1.0639
• Brent Futures down 2.0% to $81.59/bbl

Top Overnight News from Bloomberg

• The US and Italy joined an increasing number of nations requiring Covid tests for travelers from China, with concerns mounting over the risk of any new variants emerging from the surge in infections in the country of 1.4 billion
• Covid outbreaks have peaked in Beijing, Tianjin and Chengdu, though the situation in Shanghai, Chongqing, Anhui, Hubei and Hunan remains serious, China’s CDC top epidemiologist Wu Zunyou says in a briefing
• Russian Foreign Minister Sergei Lavrov said Moscow won’t enter into negotiations with Ukraine to end the war, even after suffering a series of battlefield setbacks
• Goldman Sachs Group Inc. is working on a fresh round of job cuts that will be unveiled in a matter of weeks, Chief Executive Officer David Solomon said in his traditional year-end message to staff
• The Bank of Japan announced two additional rounds of unscheduled bond-purchase operations, fighting back against traders betting it will further relax its yield-curve control policy

US Event Calendar

• 08:30: Dec. Continuing Claims, est. 1.69m, prior 1.67m
• 08:30: Dec. Initial Jobless Claims, est. 225,000, prior 216,000

Twitter users globally struggled to access the social media platform Wednesday evening. There were reports of glitches and other issues; some users said they received error messages or were logged out. Elon Musk tweeted after the disruption that backend upgrades were being completed. 

As the outages spread, the hashtag “#TwitterDown” trended, and by 7:13 pm EST, outage detection website Downdetector reported a surge in users that indicated the social media platform was experiencing outages. More than 9,000 users on Downdetector reported issues. 

Here’s a timeline of the outage. 

The disruption was the largest since Elon Musk’s $44 billion takeover of Twiter, axing three-quarters of its workforce. Users from New York to San Francisco to Hong Kong all reported disruptions. The number of glitches has since dissipated early Thursday. 

My retweets are currently broken. #TwitterDown pic.twitter.com/SK0RAGfLnn

— David Lytle (@davitydave) December 29, 2022

ℹ️ Note: Twitter is experiencing international outages affecting the mobile app and features including notifications; incident not related to country-level internet disruptions or filtering #TwitterDown pic.twitter.com/eA3n5ow1aZ

— NetBlocks (@netblocks) December 29, 2022

More than an hour into disruptions, Musk replied, “works for me,” when asked by one user about outages. 

Works for me

— Elon Musk (@elonmusk) December 29, 2022

Then around midnight, Musk provided an answer to why the disruptions were happening. He said:

“Significant backend server architecture changes rolled out. Twitter should feel faster.” 

Significant backend server architecture changes rolled out. Twitter should feel faster.

— Elon Musk (@elonmusk) December 29, 2022

While it’s hard to say if backend upgrades at Twitter have made the social media experience meaningfully faster, Musk has said he would step down as CEO once he found “someone foolish enough to take the job,” adding that he would “just run software & servers teams.”