Wednesday, March 18, 2020

Recession + deflation = real panic

What's worse: a steep recession or falling prices? Answer: A steep recession AND falling prices. That's is the underlying reality that is shaking markets to the core right now. There are three factors which are creating those conditions: the coronavirus, government-ordered shutdowns, and a war between Saudi Arabia and Russia over oil production, and they are all inter-connected. We have to be getting very close to a resolution of this conflict, because the level of panic is rapidly approaching an intolerable extreme.

The news could hardly be worse. We're in the midst of a global pandemic that, apart from a handful of countries (China, S. Korea, Singapore) is spreading geometrically. Governments everywhere are ordering quarantines and outright shutdowns of activity. Global travel has collapsed, potentially bankrupting nearly every cruise ship and airline company. The entire restaurant industry is teetering on the edge of failure, and take-out is only a band-aid solution. Vaccines and therapeutics won't arrive for many months. Millions of people are being laid off. GDPs are sure to plunge at dizzying rates.

Bottom line: fear, uncertainty and doubt have reached epic heights. The market cap of global equity markets has plunged by over $30 trillion in just the last month. Nearly every major equity market is down between by 30-40% year to date, and some prices are plunging and surging at double-digit daily rates.

To continue on the present course—shutdowns, price wars—until the virus is vanquished is madness. Something has to give. Saudi and Russia need to declare a truce. Politicians need to call off the shutdowns: at some point the economic damage caused by shutdowns will greatly exceed the possible damage from the virus, which is already losing intensity thanks to shutdowns, hand-washing, and social distancing. The contagion curve is already beginning to flatten in Italy and Spain, and it can't be long before the U.S. also sees a slowing in the growth of new cases.

Yes, 8,000 people have died around the world as a result of the coronavirus in the past three months, but more than 20,000 people in the U.S. died last year of run-of-the-mill flu and no one sounded any alarm. Let's keep things in perspective, please.

When conditions become intolerable, as they are today, something's gotta break. And it will, soon.

Here's a look at the key variables impacting the markets today:

Chart #1

Chart #2

As Charts #1 and #2 show, fear has reached the same extreme as we saw at the height of the 2008 financial panic. Equity prices are down over 30%. It's a rout; everyone's headed for the exit. 

Chart #3

Chart #4

As Charts #3 and #4 show, plunging oil prices have caused inflation expectations to collapse. We are very close to the deflationary expectations that existed at the height of the 2008 panic. We are living in extreme times. No amount of QE will fix the virus threat, but QE will help the market cope with dislocations caused by extreme panic. The Fed needs to accommodate the market's need for safety and liquidy. Inflation is NOT a problem. Fiscal stimulus fueled by new Treasury issuance is NOT a problem and will directly help the consumer and small businesses to survive the (largely unnecessary in my opinion) government-mandated shutdowns.

Chart #5

Recession is now likely, and credit spreads agree, as shown in Chart #5.

Chart #6

As Chart #6 shows, it's plunging oil prices that are at the root of the credit market's concerns. High yield energy-related bond spreads (shown here as of yesterday) are most likely now at record-breaking levels, higher even than we saw at the height of the 2008 panic. Oil prices MUST stop falling; Saudi and Russia MUST call a truce. Both need to cut production dramatically, and SOON.

Chart #7

As Chart #7 shows, the prices of gold and TIPS are plunging. That's odd, because both are safe--haven assets. The explanation for their decline can be found in mounting deflation fears: who needs inflation protection if prices are falling? On the bright side, however, rising real yields on TIPS suggest that the market is beginning to look to the future and beginning to expect that fiscal and monetary stimulus—combined with a cessation of the oil price wars—will lead to a much stronger economy tomorrow. There IS light at the end of this dismal tunnel!

Chart #8

A marked steepening of the Treasury yield curve is also good news. The curve is steepening not because the Fed is easing, but because the market  sees better times ahead. And anyway, 10-yr yields are ONLY 1.25%, hardly a level to worry about. The Treasury has plenty of room to sell loads of bonds and at a very low cost. And they should.

Chart #9

Chart #9 shows one other problem that is plaguing markets today: a strong dollar (blue line). A strong dollar is the result of global panic, and it is also one source of deflationary pressure on all commodity prices. More QE, please, because the world wants and needs more dollars.


steve said...

"Politicians need to call off the shutdowns: at some point the economic damage caused by shutdowns will greatly exceed the possible damage from the virus, which is already losing intensity thanks to shutdowns, hand-washing, and social distancing."

Be that as it may, your suggestion obviously ain't gonna happen. Virtually guaranteeing more death from covid 19 by calling off shutdowns in the middle of a pandemic is political suicide.

Truth be told, I expect the opposite; federally mandated shutdown of the economy for two weeks
and I'm reasonably certain the market would view this with a sigh of relief. The markets HATE uncertainty above all else and right now we have that in spades.

Rick Jones said...

>...fear, uncertainty and doubt have reached epic heights...Nearly every major equity market is down between by 30-40% year to date, and some prices are plunging and surging at double-digit daily rates.

So much for private sector and deregulation to the rescue, eh?

>Oil prices MUST stop falling; Saudi and Russia MUST call a truce. Both need to cut production dramatically, and SOON.

Not only do they NOT need to call a truce, but I would guess that a truce is contrary to their inherent interests, which is to kill the U.S. fracking industry.

The single biggest thing that could help now -- and that we could have used all along -- is strong, good leadership, and that is sadly, sadly lacking. We need someone who could pull off the equivalent of, "The only thing to fear is fear itself." And instead we have someone who's tweeting about Hillary Clinton's emails.

This is not the end of the world. I'm quite certain that people felt the same way at some point during WWI, after the '29 crash, during WWII, and a few other times. Yes, it will be difficult, but as Nietzche said, "Was mich nicht umbringt, macht mich stärker."

Robert said...

Russia/Saudi truce.

This is assuming that there are no ulterior motives to their price war. Blowing up the american consumer and blowing up the credit markets (swaps), when would this happen in a million years?

Grechster said...

I couldn't help but think of what Putin thinks of your comment that oil prices MUST stop falling. I say this sincerely.

For that matter, I wonder why Trump can't/won't exert any pressure on the murderer who's running Saudi.

Something tells me the good of the American people is not at the forefront of consideration right now. Maybe I'm too cynical.

Scott Grannis said...

It can't really be in Russia's interest to destroy the American and European economies, can it? That's equivalent to killing your only customers, without whom you will starve to death. it can't be in Saudi's interests either; without purchases from the rest of the world they will starve as well.

steve said...

Rick, you are so correct. Trump is way over his head.

steve said...

I never thought being down 1370 points on the Dow would look like a W but compared to the abyss we were looking at...

steve said...

Brilliant. Scott, you gotta love this:

Scott Grannis said...

steve: the UK does indeed have the right idea. If government is going to force an economic shutdown, then it (i.e., society) needs to attend to the consequences for businesses forced to shut their doors. The US needs to do the same. That of course makes it obvious that the cost of this shutdown in measured in hundreds of billions of dollars, all out of the desire to save how many lives? If politicians had left the decision to self-isolate to the people, instead o mandating a shutdown, more intelligent decisions would have been made and we wouldn't be in such a mess.

This morning I corresponded with a friend in London who owns a restaurant and was trying to decide whether to accept the government's offer of a loan with no interest for 6 months or sell a portion of the business in order to stay afloat. I told him the decision was a no-brainer: if the economy hasn't recovered in 6 months we'll all be in the shitter, and the last thing the government would do would be to call the loans or else seize every restaurant in the country. This is a great time to borrow from the government! Government as always makes stupid decisions.

Steve said...

The price of paper gold and physical gold are disconnected. Physical gold is commanding high premiums ($100 or more vs. $30-50 before virus) and is hard to find, probably not be available at all soon. Same for silver - paper prices of ~11 dollars, but coins selling for up to $24. Silver is unavailable as far as I can tell.

Rick Jones said...

>...the cost of this shutdown in measured in hundreds of billions of dollars, all out of the desire to save how many lives?


Rich said...

I thought Kushner had influence with MBS???

randy said...

Rick - Yes, there's no good way to discuss the value of individual lives. It can only come off as callous.

For a nuanced take, WSJ took a stab:

The cost to Americans of the economic shutdown is vast. What are they getting for their money? Essentially less excess demand for respiratory ventilators and other emergency care than can currently be supplied.

This demand will come largely from the elderly and chronically ill, who would be competing for these resources with the usual large number of old and ill people already suffering from acute respiratory distress as a result of routine flu and cold infections.

Some number of respiratory deaths will be avoided (really delayed since we all die) but we’ll be spending a lot more than we’ve ever been willing to spend before to avoid flu deaths.

This will have to last months, not weeks, to modulate the rate at which a critical mass of 330 million get infected and acquire natural immunity. Will people put up with it once they realize they are still expected to get the virus? Wouldn’t it make more sense to pour resources into isolating the vulnerable rather than isolating everyone?

Gerard said...

As a professional mariner: only use "full rudder" in extremis. When your sitting on 70,000 tons of displacement and 90 feet of draft it is very hard to undue a turn. Same can be said of the circumstances we find ourselves in. Always scale the response. We are in an epistemic crisis as much as a healthcare crisis. The social cost of putting the economy on ice may exceed whatever good trying to be achieved. Scale your response.

Bryon said...

Millennials have the idea that only the elderly need to stay home and isolate from everyone else. Perhaps they are right.

John said...

"If politicians had left the decision to self-isolate to the people, instead o mandating a shutdown, more intelligent decisions would have been made and we wouldn't be in such a mess."

Really an absurd statement and strong evidence the author has no idea how most Americans live. It takes resources to self isolate. An awful lot of people live paycheck to paycheck.

Unknown said...


You mention the 10 year yield (1.237% as of 9:40 pm CDT on 3/18) as good news. I agree. However, are there any technical or "financial plumbing" or rush to safety reason for that yield to increase? The yield has really moved quite remarkably and, over the past 12 months, has a very good predictive record.


Rick Jones said...

>Government as always makes stupid decisions.

I moved to France from the U.S. a few years ago, and I'm sure that libertarian and conservative economists reserve a very special place in Hell for France.

But as I look at how things operate here -- and especially under the lockdown -- I would tell you that the French government has made a lot of very good decisions.

In particular, I look at food distribution and accessibility.

When I was in the U.S., buying food was pretty much limited to just a few major supermarket chains: Whole Foods, Harris Teeter, a few more. The mom-and-pop grocery stores were long gone because, you know, the free market had free reign and the mom-and-pop grocery stores could not compete with the far more efficient chains.

Well, here in France the government has taken steps -- and I don't know what, exactly, all the laws are -- to ensure the mom-and-pop stores continue to function. There are giant supermarket chains, like Carrefour and Monoprix, but pretty much every block has a bakery or a butcher or a fish monger or a small produce store. And twice a week every neighborhood has a large open-air market. There are so many choices here for buying food that I often joke it's the hardest part of living here.

When the lockdown happened -- and believe me, it's much more severe here than it is in the U.S. -- I saw remarkable unintended consequence of this decision.

The supermarkets were jammed with people, and quickly depleted of things like toilet paper, pasta, rice, and any number of other things. Lines were often a block long to get in.

But there are just so damned many small shops that if you were willing to walk around a little bit you could easily get all you needed or wanted without any waiting at all.

I was reminded of the Internet -- another example of a GREAT government decision -- and the old circuit-switched systems it replaced.

The Internet can accommodate node failures and congestion in ways the circuit-switched systems could not.

Similarly, the plethora of small merchants can accommodate node failures and congestion in ways the larger chains would have difficulty with.

I am absolutely certain this was not what the French had in mind when legislating whatever it took to keep the smaller merchants in business. But what they understood was that there are often more important values in a society than the most efficient allocation of resources, which is the only thing the invisible hand offers.

And speaking of the Internet...when I lived in the U.S. I had two choices: Cox or satellite. Cox was the better of the two, but Cox was not -- in any way, shape, or form -- going to run fiber where I lived. And we paid well in excess of $170 a month for phone, Internet, and television.

Here, the French have not allowed the entire space to be taken over by one or two giant telcoms. When I asked around about who I should use as an Internet service provider, the choices were so large that it was hard to get my head around. The bottom line is that there's so much competition that we get fiber to the apartment for Internet, phone, and television at the unbelievably low price of about $25 a month. And all cell phone service is 4G.

So no, I don't agree that the government always makes stupid decisions. And in fact, as calls for airline bailouts increase, you can hold some of them up as "Stupid Decisions: Exhibit 1."

Kenneth said...

Regarding oil prices and the damage it is causing to our economy, financial system. It is too big a risk to believe that Saudi Arabia will soon stop the price war because our economy is declining at a rapid rate and we need immediate relief. So I would urge Trump to tell the Saudis that we will no longer provide them military support if they don’t end the price war. They have plenty of enemies. It’s a battle we can win with a phone call.

steve said...

Scott does bring up a point that nobody wants to talk about: what is the economic value of a life? And don't be so fatuous as to say "priceless" because that is simply not correct. We COULD build cars that are like tanks but at what cost? I don't have an answer BTW but at he end of the day, it's THE essential question.

Clearly wiping out ten of trillions of dollars of value literally kills people and without question many more than covid 19 BUT it's had to measure whereas virus deaths are relatively easy. I'll leave you to cogitate on that.

Dave said...

Of course we are not able to change what has already happened but this morning was talking with the CEO of a large non-profit that was struggling because he had to layoff 300 people. The non profit provides fitness facilities, reading programs, childcare, etc. and every community has one of these non profits.

If Washington has considered the "unintended consequences" of a shutdown and maybe passed a bill that mandated that employers could not fire an employee who chose not to work out of fear of the disease (but the business did not have to pay the employee). In addition business that operate via voluntary customers (ie. restaurants, fitness facilities, service businesses) could not be sued if I as the customer voluntarily chose to use that establishment and contracted the virus.

That would allow businesses who chose to stay open to show their customers why they were safe to use (ie. we test our employees weekly, here is how we are sanitizing, etc.)

Allow the free market to self-police themselves in this situation so that the solution (as it is today) is not potentially greater than the problem.

George Madison said...

Toilet paper is the precious metal of the poor.

Charlie said...

I'm happy to see that most folks (and even the president) now understand the seriousness of the situation, even if months late.

But now many are framing the way forward as either 1) destroy the economy or 2) let millions die.

I've been following Trevor Bedford (viral genomics scientist at UW & Fred Hutch) since the first days of US cases. I believe the way forward is a not either of the two scenarios above. See twitter thread:

johnheider1 said...

Once the public health people got unfettered control of policy it was game over. How is Trump going to go to the microphone in 12 days and say "go back to your daily routines" when the the infection rate is still rising exponentially.

We are heading for a long period where the U.S. will be like Venezuela. Usually the power and water will be on, sometimes not. Crime will rise dramatically and public health in general will deteriorate. Food? Sometimes plentiful from WalMart, sometimes from the back of a truck where you wait the whole day to get a couple of MREs.

Hopefully enough of the logistics structure will remain in place so that a vaccine can be manufactured and distributed nearly universally in a couple of years.

Until then, this is the biggest event outside of the Civil War in U.S., and mostly self inflicted.

Global warming? Never cared about it because there were so many ways the game ended first. Could have been an EMP bomb or a limited nuclear war. But the game was always going to end.

Scott Grannis said...

Some good news: Trump is going to apply pressure on the Saudis and Russia to cut production, and crude oil futures are up over 20% today.

One the margin (which is where all the important things happen), things are getting better, not worse. Finally!

Tom L said...

Indeed Scott that is some good news and the market is far at least.

Thanks again for your insightful commentary and evidence based research, much appreciated!

(heading back to self quarantine and avoiding financial media - except you and BWesbury)

Scott Grannis said...

More important news that, on the margin, is good:

Several drugs (e.g., chloroquine, Remdesivir) are popping up as reasonable therapeutics. The FDA is reluctant to approve them for covid-19, but the FDA will soon be steamrollered by Trump and by popular demand. Read more about the drugs here:

As evidence accumulates, there is reason to believe that the mortality rate of Covid-19 is much less than feared. See this analysis of the amazing stats we now have regarding the cruise ship Diamond Princess:

Unknown said...

"Yes, 8,000 people have died around the world as a result of the coronavirus in the past three months, but more than 20,000 people in the U.S. died last year of run-of-the-mill flu and no one sounded any alarm. Let's keep things in perspective, please."

Yes, but the flu is fairly stable and predictable. COVID19 could ramp up to much higher numbers if left unchecked, and because the healthcare system is design to absorb the flu peaks but not the COVID peaks, a lot of people could die or suffer a lot if the system is overrun, including people with other issues unrelated to COVID19. This isn't the same situation at all, and it's not a good idea to compare them. It's like comparing a T-bill and a super volatile microcap that may grow at 50% CAGR for a while or totally crash, nobody knows. Not the same animal.

Scott Grannis said...

More good news on the mortality rate of covid-19. This particular study suggests the case fatality rate may even be as low as 0.1%.

Glenn Reyolds adds further clarification:

The current COVID outbreak seems to be following previous pandemics in that initial CFRs start high and then trend downward. In Wuhan, for instance, the CFR has gone down from 17% in the initial phase to near 1% in the late stage. Current testing strategies are also not capturing everybody: at least 50% on Diamond Princess were asymptomatic who usually wouldn’t get a test; in South Korea, considerable numbers who tested positive were also asymptomatics. Asymptomatic people and mild cases are likely driving the rapid worldwide spread. Early CFR rates are subject to selection bias as more severe cases are tested – generally those in the hospital settings or those with more severe symptoms. Mortality in children seems to be near zero (unlike flu) which will drive down the CFR significantly. In Swine flu, the CFR was fivefold less than the lowest estimate in the 1st ten weeks (0.1%)

Therefore, to estimate the CFR, we used the lowest estimate, currently Germany’s 0.25%, and halved this based on the assumption that half the cases go undetected by testing and none of this group dies. Our assumptions, however, do not account for some exceptional cases, as in Italy, where the population is older, smoking rates are higher and antibiotic resistance is the highest in Europe, which all can act to increase the CFR. It is also not clear if the presence of other circulating influenza illnesses acts to increase the CFR and whether certain populations (e.g., those with heart conditions) are more at increased risk.

Scott Grannis said...

Glenn Reynolds link (Instapundit is at the very top of my reading list every day):

amritsari said...

assuming a 0.1% CFR on a population of 300 million is 300,000 deaths. Is that cost low enough for you to justify NOT having a shutdown ?
Remember when there was huge propaganda against obamacare in that it was going to have death panels ? Your argument is tantamount to having death panels so that the economy can keep humming along and your stock portfolio keep rising.
People who are not responsible for life and death decisions find it easy to use peoples' lives as pawns in the chess game in their minds.

Scott Grannis said...

amritsari: you are making some extreme assumptions. 1) every single person in the US gets infected, and 2) they all get infected around the same time. Otherwise it would be logical to talk about annual deaths, of say, 60,000 per year over 5 years. Which is approximately what has been happening for a long time, yet we have not shut down the economy.

And let's not forget that Obama waited about 6 months to declare a health emergency over H1N1, after more than 1,000 people had died because of it.

Every one of us face death risks every day we wake up, and every day we hit the freeway. We cannot make the world risk-free, otherwise we would sacrifice most of our freedoms.

Scott Grannis said...

Look at this another way: Let's say that next year another virus shows up on the radar screen. It too has a case fatality rate of 0.1%. Are we going to shut down the economy—provoking a recession and great distress for millions of people who lose their jobs every time that happens? One of the sad facts of life is that people routinely die for a number of reasons, one of which is a novel virus. We can't take extreme measures every time there is a new virus or source of modest risk for the average person. Much better to decentralize our health care system, deregulate it as much as possible, and give the private sector incentives to deal with the problem of infectious diseases.

The human and economic costs of the current covid-19-inspired shutdown are going to be enormous. Probably measure in the trillions of dollars and in the millions of unemployed. Does this make any kind of sense?

amritsari said...

Scott - so much to unravel here. The cfr and the transmission rate are important in making any decision. In the case of covid-19 the transmission rate is definitely high and the cfr is still being determined but non-negligible. Even if I reduce the infected rate to 150 million, thats still 150000 deaths, and thats with a low 0.1% cfr. If its 0.2% then we are back to 300000. Like I asked, what is the number you would be comfortable with ? Lets have it. Don't be coy. 1000, 10000, 100000 ??? See the latest news on how the 24-50 age group is disproportionately high in the US hospitalized case for covid-19.

If some of the other large killers were infectious (heart desease, diabetes etc.), you bet we would be quaranteeing the hell out of the infected. That is the history of mankind, and scientifically justified.

Looks like you get your facts from fox news, which explains some of your misleading claims. Here are facts from

"On April 15, 2009, the first infection was identified in California, according to the CDC, and less than two weeks later, on April 26, 2009, the Obama administration declared a public health emergency. The day before, on April 25, the World Health Organization had declared a public health emergency."

Its true that the national health emergency wasn't declared until October but many more events transpired before that became inevitable. It is also not an apple to apple comparison between covid-19 and H1N1. You can read the full facts here:

In any case, its a sad day when Trumpsters have to use Obama as a standard to justify their leaders actions. I thought he was supposed to be way better ?? :) He is the most inept national leader I have ever seen.

amritsari said...

Remember when Obama said "if you like your doctor you can keep him" ?
Well, just a few weeks ago Trump said "Who ever wants a test can get one". Where are these tests for everybody? What did he do with the time between january and now? How come tests/masks/PPE production wasn't ramped up? Just think how much market carnage could have been avoided if the market saw this administration actually doing things in a planned way. A large reason for the turmoil is that there is no clear strategy. Its all very adhoc. And the guy never stops lying.

amritsari said...

I see news on how republican senators Burr and Loeffler sold millions in stock in Jan/Feb after a private briefing on covid-19, and then were gaslighting democrats for raising alarms about it. Absolute dirt bags.

Christophe said...

Some say "lets do nothing and see what happens" show their ignorance of the issue. Most economist and engineer should easily understand Pandemics. It's a basic number game. A virus war is like a statistical war, a "numeric" war with few parameters and dynamics.

Here are the main parameters. I will try to use numbers in the middle of the various estimates.

- Potential US infected: 50%. The flu with vaccine and natural immunity infects ~10% per year.

- Potential death rate: 0.8% (Death rates skyrocket for Covid-19 and most serious diseases if patients have no IC access because of a saturated medical system).

- Number of sick requiring hospitalization: 5% critical care for 1 month (3 to 6 weeks average). Note 10% need some hospitalization at some point. I will not even count those just the critical care patients..

Number of IC care beds in the US: ~100,000 (lets will assume 100% availability; truth is occupancy is > 65%).

This give us a pool of 165 million sick. 5% will need IC beds so about 8 million. Our medical capacity if 100k/month so we can process 2 million infected per month (5% critical care of 2 million is 100k).

It would take us 80 months (~7 years) to process everyone without saturation even with these pretty optimistic numbers. The dead would be ~ 1.3 million (16k per month).

The 3 weapons we have:
- The rate of contamination: R0 (social isolation)
- Medical capacity (more IC beds and/or shorter medical stay with improved treatment)
- The rate of death (improved treatment; anti-viral drugs...etc..)

Additionally a new virus like this corona-virus can morph at any time (at its discretion), becoming even more dangerous or less. It can also decide we are not a good host and disappear overnight. The virus does not care about our reality or if it is convenient or fair, it has no emotions.