Pro Perspectives 10/9/23





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October 09, 2023

We've been watching what looked like run-away global government borrowing rates for the past two weeks (led by U.S. yields).
That, added to record debt and deficits, would historically be a toxic formula for financial market stability.  That said, things have been relatively steady (yet confusing), because the Fed and other major central banks have made it explicitly clear that the balance sheet is now a tool used to fix financial dislocations.  
In fact, the San Franscisco Fed President (Daly) said just that last week.  She said interest rates are for achieving their dual mandate (of full employment and price stability), while the balance sheet is a tool in the Fed toolbox, to stimulate in the case of zero rates, AND to fix in the case of financial dislocations.  She becomes a voting member in January of next year.  
This enlightenment from Daly is in line with ECB Lagarde's comments at Jackson Hole, where she said: "There is no pre-existing playbook for the situation we are facing today – and so our task is to draw up a new one."  And she went on to say, they need even more "robust policymaking" in "an age of shifts and breaks."
All of this said, we've talked a lot about the pressure building in the financial system and economy (domestic and global) resulting from the rising rate environment.  Nothing has broken in a while (since the March bank shock), because the central banks are there to backstop. 
But there has also been equally extreme pressure building in both the domestic and global political environment.  Along the way, it's fair to say that people have been waiting for something to break there.
And we may have it, with the attacks on Israel over the weekend.
This looks like a global war flashpoint.
We have a dividing line in the global climate agenda, where the Western world's war on fossil fuels has pushed the Middle East, Russia and China closer together.  We have a dividing line in the Ukraine/Russia war. 
The dividing line becomes broader and clearer now.  The U.S., UK, France, Italy and Germany have stated support for Israel.  At this point, Iran, Qatar and Saudi Arabia have stated support for Palestinians.
In a war escalation scenario (global war), we would see global capital move to relative safety.  That would mean U.S. Treasury prices up (yields down), gold up, and the dollar up. 
Do we have any clues? 
Treasuries were closed today for the Columbus holiday.  But if we look at German yields as a proxy, indeed, the 10-year German bund yield was down 12 basis points today.  The top in yields should be in.
The dollar isn't participating, yet.
Gold was up 1.5%, among the biggest movers in global markets on the day.
As for oil, we should expect much higher prices.  Oil was up 4% today.  When Russia invaded Ukraine, crude oil was trading around $92.  Within eight days it traded as high as $130.