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BNZ Interest Rate Strategist Nick Smyth explains how financial markets are behaving in a recessionary manner

Bonds / news
BNZ Interest Rate Strategist Nick Smyth explains how financial markets are behaving in a recessionary manner
Of Interest podcast
Illustration by Ross Payne

By Gareth Vaughan

Markets and prices for a number of asset classes are currently behaving as they tend to around the time of a recession, says BNZ Interest Rate Strategist Nick Smyth.

Speaking in the latest episode of interest.co.nz's Of Interest Podcast, Smyth also says financial markets pricing in Federal Reserve rate cuts as soon as next year, despite the Fed's current aggressive hiking and US Consumer Price Index (CPI) inflation of more than 9%, suggests markets are worried about recession risk.

"The market has got circa 90 basis points of rate hikes over the remaining three [Fed] meetings this year, so still got the Fed hiking quite aggressively over the remainder of this year. And then next year it's pricing just over 50 basis points of rate cuts with the first rate cut fully priced by June," Smyth says.

"So why is that?"

"The logical way to interpret it would be to say markets are worried about recession risk. And I guess you can kind of see evidence of that in various parts of the financial markets," says Smyth.

"So for instance the S&P 500 is down more than 20%. That's that definition of a bear market. Bear markets are often, but let's be clear not always, associated with a recession. The US yield curve is inverted, which historically has been quite a reliable leading indicator of recession."

"We've got industrial commodity prices like copper, and copper's kind of used in lots of different things [and] historically that has been quite a good barometer of the strength of global demand. And that had fallen more than 30% from its peak," Smyth says.

"So you've got a number of asset classes that are behaving in a way they normally would in the lead up to, or around recessions. And this is taking place in the context of central banks really aggressively lifting interest rates over a short period of time, and in quite a synchronized manner."

Excluding China, which has its challenges around zero-Covid, and Japan which still has relatively low inflation, Smyth notes even the European Central Bank is raising interest rates, having not done so for 10 years.

"So a synchronized global tightening cycle will certainly slow [economic] growth. And then we've got these other contributing factors that are giving markets concern about the rising risk of recession including the risk of lockdowns and restrictions in China, and the situation in Europe where you've got potential gas shortages and power rationing later this year."

"So I think asset markets are kind of telling you that there's at least a reasonable, if not a high chance, of recession next year. And historically during recessions the Fed cuts interest rates."

The Fed increased the Federal Funds Rate, its equivalent of the Official Cash Rate (OCR), by 75 basis points to a range of 2.25% to 2.50% on July 27. Smyth says markets see it peaking at between 3.25% to 3.50% in the current tightening cycle. And they see the OCR, currently at 2.5%, peaking at between 3.75% and 4%.

"And the New Zealand market now is reflecting that same profile as what the US is, so there are some rate cuts, albeit not as much as in the US, that are priced in to the short-end of our curve as well," says Smyth.

Meanwhile, Smyth says markets see US CPI inflation, currently running at a "staggeringly high" annual rate of 9.1%, dropping to about 7.5% by the end of the year, and then down to about 2.7% by the end of 2023.

"So that is a really big fall. And again that's consistent with the market thinking there'll be a recession or some kind of miracle with global supply chains," says Smyth.

In the podcast Smyth also talks in detail about this week's market reaction to the Fed's rate hike, what the yield curve is telling us at the moment, Reserve Bank and Fed quantitative tightening, or moves to decrease liquidity, or money supply in the economy, and expectations for Wednesday's Household Labour Force Survey from Statistics NZ, and what this will say about the labour/job market.

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59 Comments

The Vested Interest are saying Interest Rates are going down next year.

Translation

The Interest Rates will continue to go UP next year !   And Stay UP .

-30% Crash in Home Prices by December.

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20

The Roman Numerals  Master is 100% right!

The Oneroof property spruikers,  such as the always present.......AC and TA  - have told many stories,  often varying,  as one recent prediction of 5% gains in 2022 (haha) have have actually gone into negatives bigtime!
This "advice" from the obvious property laden,  heavily invested property magnates,  masquerading as "helpful public speakers"   - lead many new,  young,  property investors completely up a twisted and now very dangerious jagged path.   Have they broken any "expert" investment advice laws??

THE LAST BUYERES ARE NOW HOLDING THE DEADLY DEBT GRENADES........they have been led on and told to  " buy now"  by the likes of the neferious AC and TA.

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... but but but ... Nikki Conners of Propeller Investments says house prices double every 10 years in NZ ... an average 7 % p.a. ... always has , always will ...

Nikki's not telling porkies , is she ? 

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Looking at past history,  you are always right....aye:)

So as Property sellers.... Propeller says - Buy the new housing we have for sale now!!!   Don't delay,   buy today. We can "help" you!

So who helps the indebted smucks when the rates go up,  inflation soars and they cannot afford the mortgage payments??  You wont see the likes of AC, TA or the Conners for dust!

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If house prices double every 10 years, then they have to drop for a while now, as a 40% rise in last 2 years would lead to way higher than 100% rise in 10 years.  Seems to make sense.

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Amazing how myths can have such power.  Even grown men believe them.    

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Not sure they are grown. Seems obvious form the postings 

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Experts with any opinions that alter from yours are just vested interests? This is just conspiracy theory rubbish.

 

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Hi Jarmin,   Everyone has a vested interest.
When I see the "expert" commentators,  exhorting to the masses to load up (Buy now!  Dont wait!) at debt at levels that are at near record highs and out of any reasonable relation to  acceptable LVR or DTI's - yes I will call them out.
But don't worry what I say - the banks are now saying "No"  these prices are silly,  "you cant loan that much"   or are demanding large deposits to protect themselves.

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Good that you see that the people cheering on a crash in house prices, also have vested interests.

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Mr. Roman numerals 2022, I think Gareth's interesting article is discussing the swap rates (interbank lending), not vested interest. The swap rates represent the wider market expectation of future interest rates, not by words but with paid money (billions). 

You can see these swap rates here on this website.  They represent the objective market expectations of banks as they lend to each other.  No talking or spruiking can influence these big money decisions.

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30 % by Xmas or early 2023 guaranteed.

it was all candy floss from early 2020

Softly softly though  from RBNZ and bank economists etc though … Wouldn’t want to spook the market 😊

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MMXX11,

Nonsense. The best indicator of recession has been US treasury 2 and 10 year yields-when the longer term yield inverts-as it is now-then a recession is likely. This has nothing to do with Vested Interests, whoever they may be, but with the market's view of where economies are headed. 

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When many countries go into recession and inflation stays persistently higher than their central bank target ranges, it will be interesting to see how the markets react then. 

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Good point Adam - I agree that its a possibility. If we have rising unemployment due to recession, but inflation remains persistently high, then central bankers are really in a pickle. 

I think its more likely we see disinflation in the coming 12-24 months....but there is always the chance that doesn't unfold...because there will be no mandate for central banks to pump even more money into the system to solve the rising unemployment issue and high debt servicing cost issue. 

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I agree. We will see a bit of disinflation but inflation will stay high due to multiple factors. 

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Stagflation is coming Adam and you called it!  (albeit a few years too early, lol).  I'm with you now, inflation won't go down to 2-3% by end of 2023 but Central Banks will have to stop rising rates as they will realise they have destroyed their economies… Outcome… you dreaded stagflation!

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Adam and Yvil and other investors, how does leveraged real estate tend to perform in stagflation compared to unleveraged real estate and gold?

I think unleveraged real estate may stagnate in nominal terms and lose in real terms, does that make sense? Or do you think the current downtrend even in nominal terms may continue?

And leveraged real estate, is that better or too risky, ie. would the debt get inflated away or would high interest rates prove dangerous?

And gold, in the 70ies it went through the roof, but only late. And it doesn't provide cashflow and it could get outlawed and it is not a productive asset. What do you think?

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I have never lived through a stagflationnary period, so I can't talk from experience.

I don't see why leveraged and freehold house values would perform differently? 

Yes the mortgage gets eaten away by higher general earnings but as long as interest rates stay high, it won't be good for real estate.  Also there are numerous other new anti RE rules. CGT, end of interest deduction from income, supply having caught up to demand.

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Thank you Yvil, I think we may see a comeback of ancient relics. 

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I have had these stagflation risks on the table since 2020 and what is currently playing out now. Started calling it though early 2021. 

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And your qualifications in support of this claim ..?

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The market will be that every western government will lose office over the next few years, not necessarily for the better ,because of inflation

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God help NZ if Conehead and Airhead lead the next Government. 

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This is a Pendulum Swinging. If you watch for a very SHORT time you will understand the concept of a market correcting itself.

If you watch for a LONG time you will believe Everything the Vested Interest Brigade tells you.

 

https://www.youtube.com/watch?v=3VLLw6dVDeI

 

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If you listen and learn from real experts with financial credibility you can navigate tricky waters and plan for a financially secure future.

If you listen to MMXX11 you can remain in perpetual fear waiting for the almighty crash and flush any future down the toilet.
 

https://youtu.be/nyhKZSXt2FM

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Will certainly be interesting times to see if govt and RBNZ run out of ideas to prop up traditionally favoured speculators and the market is left to sort Taleb's Turkeys from actual investors.

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Run out of idea's, How about some good ole 'bailouts'.

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There is no need to wait for the prophecy. The time has arrived.

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Hi Jasmine.

"If you listen and learn from real experts with financial credibility you can navigate tricky waters and plan for a financially secure future."

Oh please do entertain us. Who are these "financial experts" ?  And what advice have they got ?

 

The Pendulum Always Swings.

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Name calling, classy!

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Sorry Dr Yvil

Would you like to call me a name ?  I hope it rhymes or something.

https://www.youtube.com/watch?v=7iR98IWG0ms

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Jamin,

MMXX11 hasn't a clue-he just makes a lot of noise.

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How our 'GDP complex' prevents us from asking — happiness or growth?: Morning Brief

Vox notes: “To Prime Minister Jacinda Ardern, the purpose of government spending is to ensure citizens' health and life satisfaction, and that — not wealth or economic growth — is the metric by which a country’s progress should be measured. GDP alone, she said, 'does not guarantee improvement to our living standards' and nor does it ‘take into account who benefits and who is left out.'"

"The really important thing which New Zealand understands is that subjective well-being data can be used to unlock the policy situation," says John Helliwell, professor emeritus at the University of British Columbia.

Some U.S. economists scoff Bhutan and New Zealand (or is it Aotearoa?): "Fringe economies," kind of stuff. These same dismal scientists disparage Italy, Spain, and France too, which to my mind have budgeted — inadvertently to a degree — along these lines for centuries. And as I pointed out, they’re decent places to live too.

GDP is hardly a hallowed metric, nor is it infallible.

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I think a high GDP will almost always be a happier place than a low one, providing it gets dispersed reasonably evenly. But govt need to make sure that people are getting the advantages from GDP growth, for example by increasing leave entitlements, improving workers rights, decreasing working hours, etc.  

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All comes down to inflation, no one is sure. Lets see what our inflation comes in at on Oct 1, could still be over 5.

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If we go into a recession because of the cost of fuel they will be stuck. 

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I'm not seeing any Reserve Bank get a handle on inflation yet, markets and economists are getting too far ahead of themselves. Inflation is really hard to subdue once it's been allowed to run.

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Exactly and that's the problem it's been running unchecked for a year.

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How do you know that, we haven’t had any substantial inflation for decades.  It could go either way really, but there are certainly signs that the current causes of inflation are disappearing. 

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Uhhh, hello, housing market here.  

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Inflation outlook all depends on wage growth.  If wages go up more than productivity then longer inflation (and interest rates higher for longer) will be locked in.  If wages don’t increase there will be significant reduction in spending power and a recession almost unavoidable.  Take your pick.  Central bank also has some control over these outcomes - if they keep rates high to kill inflation there will be a recession; if they don’t go high enough or reduce too soon they won’t control inflation and rates will subsequently end up higher for longer….  

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"We've got industrial commodity prices like copper, and copper's kind of used in lots of different things [and] historically that has been quite a good barometer of the strength of global demand. And that had fallen more than 30% from its peak," Smyth says.

The logic here is a bit circular. Copper demand has not actually changed that much at all - the price spikes have been the result of commodities traders betting that supply would not meet demand in the future (political situation in south america etc). This pushed up the futures price (the price of a promise to deliver in X months or years), and this pulled up the market price, which was already inflated a bit due to supply chain issues etc. The copper price (and other commodities) are now returning to more realistic prices. However, because we live in a stupid world, bond traders are reading the drop in copper price as a signal that we are heading for a recession! So commodity traders' reckons sent commodity prices on a surge and fall, and now bond traders are reading the fall as a signal to do the same with bond prices.

The lesson here. Consign monetary policy to the history books - it creates chaotic swings in over-financialised markets - driving the instability that traders and other parasites feed off.    

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jfoe. Thank goodness someone here has common sense and can read through the bulls##t in this article. In fact It is so unbelievably farcical, I reckon Mr Smythe is somehow upset with the bank and made it all up while a bit high on something. How anybody reading this be sucked into believing that inflation will reduce by easing the bank interest rates to borrowers is a wonder to behold.  The banks are lowering their rates to continue to maximise their profit during the upcoming hard times ahead and forcing the government to come up with some other support incentive to prevent mom and dad from extreme hardship. 

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kazadi, putting aside your despicable language, it is apparent that you don't even understand what this article is talking about: This is about swap rates, they represent interbank lending rates. Swap charts are linked on this website. You can currently see an inversion (long-term rates below short-term rates). This is a sign of:

1. high likelihood of a recession coming shortly;

2. expectation of large banks that the RBNZ will reduce the OCR back down in the medium or long term.

I personally find BNZ's economic analysis to stand out positively from that of other banks, in particular I like BNZ's Mr. Toplis and Mr. Smyth, streets ahead of ANZ's Ms. Zollner.

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FED said inflation was transitory this was incorrect, if they start lowering rates with inflation above set levels it will put USD in danger of losing status as reserve currency, rates are historically low with inflation at these levels. I think we should expect rates to go higher and maybe lower slightly as inflation comes down but it would be crazy to go back to really low rates again and just put up asset prices again over here that means house prices. Housing market is just going to keep tumbling until average wage earners can afford to to buy and still live .

 

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USD is already losing its reserve currency status.  Putin has started the ball rolling.  BRICS will follow, Saudi's are waking up.  What would you rather have, a ruble backed by energy, or a dollar backed by nothing but a printing press.  

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I’ll take the dollar please. 

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On that we can agree!      

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Backed up by 11 carrier strike groups... More navy than everyone else combined.

Thats also excluding the UK and France...

Also.. The US is a net energy exporter.

https://en.wikipedia.org/wiki/United_States_energy_independence#%3A%7E%….?wprov=sfla1

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DTRH, further official cash rate (OCR) hikes and falls in property prices will likely trigger a financial crisis worse than 2008. This would NOT make property more affordable for first home buyers because:

1. Rising mortgage costs would offset purchase price reductions

2. Banks would tighten lending

3. Many prospective first home buyers would lose their job in a recession.

1. and 2. already happening.

Instead, we need a lower OCR. This would help first home buyers because:

1. The boom in property prices is unlikely to return

2. Inflation would reduce the cost of property in real terms over time

3. Inflation would devalue mortgage debts.

Regarding the USD as a reserve currency, that is going to be history anyway. Remember, the US themselves have sanctioned Russia and effectively expropriated their savings. So who wants to invest in USD anymore? Also, it is likely that Russia and China may set up a new reserve currency. The US is overindebted and the USD seems to be toast.

God defend New Zealand! 

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Meanwhile in productive land, my business od has gone to 10.2%

How about we have a bit of a rethink, stop obsessing over houses, and start focusing on how things like 10.2% are likely to affect employment. 

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What would any of us do as a Central Bank Governor if we needed to control inflation using the cost of debt as the tool of choice? Scream, "We are going to keep going to 10% to kill this sucker!", and risk collapsing the economy as a consequence? Or press on incrementally, making soothing comments as we went, hoping for a gentle landing?

FWIW.

A soft landing is now officially RIP...as a Fed raising rates enough to fight 9% inflation is the stuff hard landings are made of..... Things can be true in the aggregate, but painfully different in specific cases. Yes, household savings are up, but not for everyone. Half the country has less than $400 in savings....the worst-hit businesses will be those most exposed to higher interest rates on top of all the other rising prices. Yes, that means housing...and seems to be in the early stages of doing so. It’s starting to show in both existing and new home sales. Pending Home Sales are plunging....It is likely that the third quarter will be even softer than the previous two, as the Fed will continue to raise rates at the next three meetings.

And so it goes on.

https://ggc-mauldin-images.s3.amazonaws.com/uploads/pdf/TFTF_Jul_30_202…

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Would be pretty much the same in NZ half the country probably doesn't have more than $1000 that's uncommitted in the bank. That's simply no buffer and therefore things can go bad in only a matter of weeks. The shitstorm is coming it was predicted by many on here and it has arrived.

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Great question. I would say...

"Oi Grant, this cost of debt lever you've given me isn't going to do sod all about CPI. If I pull it, house prices will come down, sure, but we will also see billions of dollars wiped from the consumer spending that keeps us all in work; the wealth of people with money will increase; and tens of thousands more people will be on the dole (so prepare to spend big on welfare whilst your tax takes falls away). If you want to take money out of the economy to slow things down - maybe do something more targeted based on who won out from your fiscal stimulus during Covid. I hear corporate profits are at record levels."

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Hmmmm.. What do about this despot? - MBS: despot in the desert

Grin and bear it?

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So that's your solution on how to reduce inflation?  Keep interest rates at emergency levels and "maybe do something more targeted based on who won out from your fiscal stimulus during Covid. I hear corporate profits are at record levels."  Your very anti raising interest rates.  I think you need to find a better alternative. 

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1. Keep interest rates at a given level (say 2%) but discount credit for productive enterprise (e.g. loans for solar panels) and put a levy on credit for non-desirable investments (e.g. share buy backs, speculation).
2. To tackle inflation - anchor the price level through minimum wage, public service pay, indexed govt contracts, caps on increases in energy prices, local govt rates, rents, pensions (all increase at 2% per year).
3. Add in a job guarantee as an automatic stabiliser, a Govt budget process designed to identify and mitigate inflation risks, and a national investment plan to ensure our productive capacity meets our future needs (e.g. how many nurses will we need in 2030?)
4. Reduce our exposure to international swings in prices - starting with getting off oil (our cost of living rises and falls with oil prices)

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Clearly theres an addiction to rates reducing....so much so that theres probably a school of influencers trying to 'hard sell' negative rates and if I remember correctly they were winning that battle not so long ago.... lessons in sustainability are featuring presently . Whens the last time the state started handing out 'helicopter money' to the masses....the mistake made here is the amount on offer and the leaky tap method of dishing it out is probably making it an exercise in futility.... Lets stimulate for 3 months with $116 its farcical...If you wanted to hammer some life into the economy a onetime  3-5k drop is where you need to be with the under 70k worker.... $7 a week is like ### in the wind. 

It shows how retarded some of the economic policies NZ rolls out are.... If your gonna try and make a dent to Household debt and ease inflation pressures ...You need to wield a hammer....not a 'tickle me' feather. You need also to make sure you get the fundamentals right so that the payout goes solely to folk residing in NZ...otherwise your just burning money. Wait !! Someone forgot to put the hammer back in the toolbox... lol 

 

 

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