On May 2nd, global financial markets once again experienced a significant downturn.
The three major U.S. stock indices collectively fell by over 1%, with the KBW Regional Banking Index dropping by 5.5%, reaching a new low since November 2020. Western Alliance Bank closed down by 15%, while First Republic Bank closed down nearly 28%, and Zions Bancorp fell by over 12%. Among them, First Republic Bank saw the deepest decline, with its intraday drop reaching 42% at one point, triggering a circuit breaker and halting trading.
This round of banking sector crisis originated from the substantial outflow of deposits from First Republic Bank earlier, reflecting that under high-interest-rate conditions, the liquidity issues faced by small and medium-sized banks have not been substantially improved. As the economic environment weakens, the banking sector may face danger in the future (from deposit outflows to increased non-performing loan ratios).
At the same time, international oil prices plummeted on Tuesday. By the end of the day, the price of light crude oil futures for delivery in June at the New York Mercantile Exchange closed at $71.66 per barrel, a drop of 5.29%. The latest API data shows that crude oil inventories have fallen for three consecutive weeks, but gasoline inventories unexpectedly rebounded, ending a two-week decline.
Gold prices surged by 1%, regaining the $2,000 mark and breaking through the consolidation range of nearly half a month. The U.S. Dollar Index fell significantly, returning to 101, and the Chinese yuan against the U.S. dollar returned to 6.91. The yield on the 10-year U.S. Treasury note fell from 3.55% to over 3.41%, and the yield on the 2-year U.S. Treasury note fell from 4.1% to 3.97%.
The VIX fear index soared, jumping from 16 to 19 at one point. All signs indicate that the market seems to have fallen back into the fear experienced during the U.S. banking sector crisis in March, and this may only be the beginning.
In terms of news, the U.S. Department of Labor's Job Openings and Labor Turnover Survey (JOLTS) for March, released on Tuesday, showed that the number of job openings fell for the third consecutive month, dropping from nearly 10 million a month ago to 9.59 million, the lowest level in nearly two years, significantly below the expected 9.775 million. At the same time, layoffs soared to the highest level since December 2020, and the resignation rate also declined, aligning with the lowest level in two years, indicating that people are starting to worry about job security. The upcoming employment data may be worse than expected, and the unemployment rate may rise more than expected.
This forward-looking data indicates that under the interest rate hikes, the U.S. labor market is beginning to cool significantly. Market expectations for interest rate hikes have cooled significantly, with the market believing that even if there is an interest rate hike in May (the Fed's observation tool shows that the probability of a 25 basis point hike in May is still as high as 80%), the process of lowering interest rates may begin as early as September.
However, behind the data on job openings, it also reflects the deterioration of business conditions. The data shows that some industries with the largest reduction in job openings include transportation, warehousing, and public utilities; construction; and other service industries. This also reflects the previous judgment that unemployment is shifting from the technology sector to a broader range of service industries.On the European front, the latest data indicates that the eurozone's April CPI year-on-year preliminary value rose by 7%, significantly exceeding the European Central Bank's (ECB) target of 2%. Investors anticipate that the ECB will announce a 25 basis point interest rate hike this coming Thursday. In the current economic landscape, another interest rate increase by the euro could exert additional pressure on global demand. Regardless, the trend of declining demand is already an established fact.
In my article on April 21st titled "Global Stock Markets May Have Hit a Short-term Peak," I had already mentioned that the market was overly optimistic about the economic trajectory. After the banking crisis, within just one month, the market had regained almost all of its losses. However, the situation in Europe and America has not improved; on the contrary, the specter of recession is intensifying. The banking crisis will shift towards businesses and eventually towards households. We have recently observed an increase in corporate bankruptcies. Although the financial reports of U.S. listed companies for the first quarter were quite good, they mainly reflected the performance of leading companies, with the situation for small and medium-sized enterprises being far from optimistic.
Currently, the market's pricing of risk assets is based on a soft landing and rapid interest rate cuts, without accounting for a hard landing or stagflation. The market believes that the Federal Reserve will soon cut interest rates, thereby driving up stock valuations, which is why it has already started to run ahead.
The reality is that the weak U.S. economic data for the first quarter, along with the stubborn inflation data, suggests that the U.S. economy is very likely to face the risk of stagflation. The risk of economic weakening is rising comprehensively, with interest rate inversion still present and unemployment rates not yet on the rise. The risks of a hard landing and stagflation have not been fully realized. (Reference: Two Surprises—The economy's unexpected downward trajectory and inflation's unexpected upward trajectory)
Recently, Southeast Asia's economic data has also been very pessimistic. Exports of high-tech products such as semiconductors and electromechanical products from South Korea, Vietnam, and China have all experienced declines, and the destocking cycle is underway. The economic downturn is not unique to Europe and America; it is a global chessboard, and the overall decline in demand is an established trend.
The root of all this stems from the loose policies of governments around the world over the three years of the pandemic, leading to an unbalanced state of the economy. After the pandemic, all of this will return to equilibrium (Reference: It's been three years, it's time to pay back the pandemic's debt!).
Since 2020, due to the United States' aggressive policies, the U.S. economy has broken the equilibrium, with unemployment rates and employment long in a very good position. However, this is not sustainable, as debt growth has far exceeded income growth. Therefore, the U.S. economy needs to return to equilibrium, reduce debt growth, and lower wage growth to reduce inflation. The most obvious leading indicator of wage growth is the unemployment rate, which is clearly not here yet.
Before we see a significant rise in the U.S. unemployment rate, this crisis cannot end. Full employment through monetary stimulus requires sufficient unemployment to counterbalance and allow the economy to return to an equilibrium state; otherwise, inflation will not stop.
U.S. Treasury Secretary Janet Yellen wrote a letter to House Speaker McCarthy and other senior members on May 1st, local time. In her letter, she stated that the U.S. government may "default on its debt as early as June 1st," which would be the first debt default in U.S. history.
Of course, the U.S. government cannot default on its debt, as neither party can afford the cost. Such a statement is merely a way to force both parties to reach an agreement sooner. However, behind this matter, it also reflects the consequences of the high spending by the U.S. government during the pandemic. Currently, the U.S. government's annual interest on expenditure has risen from over $300 billion before the pandemic to around $1 trillion, and it may rise to $1.5 trillion by the end of 2023, which is already close to more than 3% of GDP.The United States has two options to address its current fiscal challenges: either reduce government spending, which could also have a negative impact on the economy since government expenditure is also a source of income for residents, or monetize the debt, which, in the context of de-dollarization, will inevitably lead to inflation and a devaluation of the US dollar. High interest rate environments may persist for an extended period, and these conditions are generally unfavorable for risk assets.
It is more likely that the US will opt for debt monetization, that is, printing money, to resolve the current debt issues. They aim to strike a balance between unemployment and inflation, and it is unlikely that the Federal Reserve will significantly ease monetary policy before there is a noticeable increase in unemployment rates. Should the Federal Reserve ease again, we should be vigilant about the issue of stagflation.
Moving forward, we can expect to see rising unemployment rates and declining corporate profits in Europe and the United States. The number of bankruptcies may continue to increase, further impacting the market. The market is far from reaching a turning point, as both the number of bankruptcies and the unemployment rate are still at historical lows, which is not normal and has not yet returned to equilibrium.
In 2023, amidst the de-dollarization cycle, it is advisable to allocate some assets to gold. It is also recommended not to maintain a high position in the market. Even if one is fully invested, it would be prudent to include some gold assets as a hedge.
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