Good morning. Here’s your Early Warning for Thursday, 27 January 2022.
TODAY’S BRIEFING:
- Cyberattack takes down North Korea’s Internet
- White House updates cybersecurity strategy
- Build Back Better is back
- FEMA staff burnout impacts response
- Hazards Warning
- In Focus: Interest rate hikes to pop the bubble?
- Economic Warning INTSUM
SITUATIONAL AWARENESS
CYBERATTACK TAKES DOWN NORTH KOREAN INTERNET: A suspected cyber attack took down the North Korean internet on Wednesday. The complete outage was caused by a Denial of Service attack on its Domain Name Service system and lasted for approximately six hours. Though some connectivity was restored, many government websites were still down at the end of the day. The cyberattack and resulting internet outage came after a month of missile testing by the North Korean military, including new hypersonic and cruise missile types. (Analyst Comment: North Korea severely restricts internet access for its 25 million citizens. Analysts believe that only about 1% of North Koreans have access to the internet; therefore, the outage likely affected only government ministries and the ruling class officials and personalities. While attribution has yet to be assigned, the cyberattack was likely a punitive response to North Korea’s latest round of missile tests. – M.M.)
WHITE HOUSE UPDATES ZERO TRUST STRATEGY: The Biden Administration has provided clarifying guidance for executive agencies implementing zero-trust security requirements by the end of fiscal year 2024. The policy memo reinforces previous direction that focuses on changes requiring modifications to password rotation processes, connection authentication systems, and encryption. The initial Executive Order that set the zero trust requirement had some agencies seeking clarity on exactly what the Administration expected regarding zero trust compliance. (AC: The bureaucratic process within the federal government is showing how slow cybersecurity practices are currently being implemented, with clarity of requirements coming eight months after initial notification. Security vulnerabilities in the cyber domain will continue to be exploited as the speed of attacks moves faster than the government can patch exposed vulnerabilities. – D.F.)
BUILD BACK BETTER IS BACK: President Biden held a roundtable with CEOs from General Motors, Ford, Microsoft, Etsy, and Corning, among others. All the executives in attendance previously signaled support for the stalled Build Back Better Act. Senator Manchin (D-WV) remains a key Democrat holdout, indicating the social safety net provisions in the bill could be scaled back or reduced in length. In its current form, the bill will bring about universal preschool, paid family leave, increased insurance subsidies, “green energy” tax credits, and other provisions. (AC: The President needs a political “win” with this legislation. Common tactics to reduce the topline dollar amount include reducing the length of certain provisions, assuming future funding can be paired with more popular bills. Expect increased social & traditional media messaging from private companies to promote the bill, blurring the lines of the 2013 Smith-Mundt Modernization Act. Close message coordination between government initiatives and private sector entities allows U.S. citizens to be relentlessly influenced by Washington and Wall Street. – D.M.)
FEMA STAFF BURNOUT IMPACTS RESPONSE: The Federal Emergency Management Agency (FEMA) is facing key staffing shortages blamed on burnout, lack of training, and an inefficient disaster response architecture. FEMA’s overall workforce has grown in size, but the majority of new positions are for “crisis-activated reservists, temporary and non-career staff.” Government Accountability Office (GAO) witnesses testified to Congress that “up to 48 percent in some cases, declined deployments due…to burnout and austere conditions in the field.” The GAO believes there will be an increase in frequency and intensity of concurrent disasters, which FEMA is unprepared to manage. (AC: Increased FEMA deployments for pandemic response are expected to impact availability for future hurricane and wildfire response efforts. It is prudent to not rely on any timely FEMA response or assistance when developing your own disaster and emergency response plans. – D.M.)
HAZARDS/WX:
InFocus: Interest rate hikes to pop the bubble?
Federal Reserve Chairman Jay Powell this week issued a frank warning on inflation. “There’s a risk that the high inflation we are seeing will be prolonged. There’s a risk that it will move even higher,” Powell said. After announcing that the Fed will not hike interest rates this month, Powell said that lowering inflation through higher interest rates will “take some time. We [the Fed] want that process to be orderly and predictable.” Powell did give a partial outlook, maintaining that the Fed will meet again to discuss a slight raise to interest rates during the March meeting. Investors are speculating an increase of at least 0.25% and a majority expect a second rate increase during the Fed’s meeting in May.
Powell did note, however, that next month, the Fed will again heavily reduce its current monthly asset purchases to around $30 billion per month, with a planned stoppage altogether in March. Some investors and financial pundits have speculated that too steep a drop off in the Fed’s asset purchases and too steep a rise in interest rates will wreck markets. The Fed continues its balancing act, on one side being pressured by the Biden administration to raise interest rates to combat inflation, and on the other side maintaining stability in bond and equity markets. Powell again alluded to as much this week, saying that asset valuations are “somewhat elevated,” which is the same thing he was saying in 2018. Is this an oblique warning to investors? It should be.
The chart below shows when Powell first said asset valuations were high in 2018, and again in 2021, and yet again this week, even with the market nearing correction territory. If asset valuations were “elevated” in 2018 and have risen 75% compared to GDP since then, are they “elevated” or are we in a massive asset bubble?
The Buffet Indicator (above), which measures total market capitalization to gross domestic product (GDP), is probably the best way to understand asset valuations. According to the latest Fed data, the Buffet Indicator ratio only recently fell below 200% with the latest market selloff. This is still exponentially above the same ratio prior to the 2000 bubble pop and the 2008 bubble pop.
For most equities, higher interest rates mean lower earnings and lower stock prices, which means stocks are not only “elevated” but in a bubble, according to the Buffet Indicator. To reiterate a string of previous warnings in this report, you can clearly see the effects of the Fed’s zero interest rate, loose money policies, starting in 2008, on the stock market. Those policies have driven massive bubbles in the US economy. DoubleLine CEO Jeff “Bond King” Gundlach previously explained that most of the past decade’s economic growth has been fueled by the Fed’s policies, not organic economic expansion. What happens when that policy reverses, as it’s about to do? How long can the Fed continue hiking interest rates before tightening leads to an economic slowdown? And which paradigm will the Biden administration accept: the risk of runaway inflation or the risk of an economic recession somewhere between the midterms and the 2024 elections? Either way, this does not support Democrats heading into either election cycle.
As for taming inflation, hiking interest rates will take months, if not quarters, to have an effect. And that’s assuming that hiking interest rates will be effective! The Fed may also be forced into selling off assets to reduce its $9T balance sheet. Regardless of how they try, the Fed has a long way to go in bringing 7% inflation down to their stated goal of 2-3%. This is why Fed officials have maintained that inflation is likely to remain higher than they previously anticipated. If the Fed is unable to undercut inflation, then they’re likely to further diminish their credibility, which will be exploited by competitor central banks such as the People’s Bank of China.
One other note of concern this week: I had a conversation with an acquaintance who’s a full-time commodities trader. We talked about the risk that crude oil will spike to $150-200/barrel following a large-scale Russian invasion into Ukraine. Historically, every US recession since 1970 has been preceded by a spike in oil prices. From the lows of 2020 to the highs of 2022, we’ve seen a 418% price increase. A rise to $175/barrel would represent a 100% increase from this morning’s WTI Crude price. If this were to occur, a commensurate rise in fuel prices would put the national average for unleaded gasoline at $7 or higher. Since oil prices are likely headed higher regardless, gas prices are also expected to rise this year. My particular concern is that, if sustained, high oil prices will cause a recession because of increased consumption costs for consumer. Higher gas prices make nearly everything more expensive – another factor that sustains inflationary pressure. The commodity trader’s concern is that oil prices at that level will force the Fed to hike interest rates even more steeply, which could not only lead to a recession but a financial meltdown and bubble pop.
This scenario may not happen, but this is one of those specific risks that we can identify. I avoid “catastrophizing” because the worst case scenario is rarely the most likely. That said, given what we expect, if you’re not preparing for another catastrophic failure this year, I believe you should be. – M.S.
ECONOMIC WARNING INTSUM
Bass: “No way” markets go up this year
Hayman Capital Management’s Kyle Bass said this week that equity prices are headed down this year. “With interest rates [rising] concurrently with quantitative tightening, there’s no way the stock market goes up this year. It probably goes down pretty aggressively if they [the Fed] stick to that plan.” While equities may have a bad year, Bass believes that commodity prices are headed even higher. A lack of investment in the energy industry will lead to a sustained supply crunch, causing prices to soar, he said. Bass believes we could see oil prices “well north of $100” this year. (AC: Raising interest will impact markets negatively due to the decreased risk of actual return via bonds and other investment instruments. Excess rate increases made by the Fed could spell recession. Economists such as Mohamed El-Erian have reiterated the importance of the Fed’s decision-making process to ensure the Fed acts responsibly and promptly to avoid runaway inflation or recession. – T.W.)
Global economic outlook
The Atlantic Council recently held its yearly economic discussion, which featured talk about the risk of a global economic slowdown, among other topics,. The panelists included Goldman Sachs chief economist Jan Hatzius and the Kroll Institute’s chief economist Megan Greene. Hatzius mentioned that Goldman Sachs recently revised its global growth forecast twice in the wake of two developments; the Omicron variant and a change in Goldman Sachs fiscal assumptions, which they had “previously assumed would include a comprehensive fiscal package with an extension of the child tax credit at the levels that prevailed in late 2021.” However, Hatzius says that Q1 will likely be the hardest hit by the Omicron variant and that the hit to global economic activity should be mainly in the rearview mirror at this point.
Greene stated that she broadly agrees with Hatzius’s views and highlighted that she believes there will be a “massive fiscal drag” on the economy as the Federal Reserve rolls back its Covid stimulus policies. Greene said that “this year will make the second biggest retrenchment relative to the year before ever in the U.S.’s history, second only to 1946 unless new things are passed. I do think that parts of Build Back Better will be passed, but that wouldn’t change my outlook for this year, given that very little of that spending will probably happen in 2022.” (AC: A common belief among bankers and economists is that fiscal spending through the Build Back Better plan is unlikely to happen in 2022, and that combined with likely interest rate hikes from the federal reserve, will lead to lower economic growth in 2022 than in 2021. – J.B.)
Growth forecasts cut again
The International Monetary Fund (IMF) again cut its global growth forecast for 2022 from 4.9% to 4.4% in its updated economic outlook released on Tuesday. The IMF expects global growth to be 3.8% in 2023. The two nations primarily responsible for the slow down are the U.S. and China, which the IMF projects to grow at 4% and 4.8%, respectively. The IMF states that the disruption in the housing sector in China is a reason for the broader slowdown and a reduction in private sector spending. The IMF also said that the slowing growth in the U.S. can probably be attributed to less fiscal spending than expected, as Build Back Better legislation has stalled. The IMF also believes that reducing fiscal spending and the Federal Reserve moving away from its pandemic stimulus policy stance and continued supply shortages will lead to lower growth in 2022. (AC: This follows a long string of downward revisions for growth forecasts by major investment banks and global economic firms. Between the potential for more aggressive interest rate hikes by the Fed and the potential for major energy disruption from a Russian invasion of Ukraine, these firms are likely to issue further downgrades to growth expectations this year. – M.S.)
The information provided by Forward Observer in this report is for informational purposes only. It should not be considered financial advice. You should consult with a financial advisor to determine what may be best for your financial needs.
— END REPORT
M.S. indicates analyst commentary from Mike Shelby
D.M. indicates analyst commentary from Dustin Mascorro
T.W. indicates analyst commentary from Troy Watson