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June 17, 2024

The theme from the Fed's policy meeting last Wednesday was that inflation is "still too high."
 
That said, while the Fed was in session, determining that theme, inflation data was released that was "better" than "almost anybody expected."  Those were the words of the Fed Chair himself.
 
If history is our guide, given that the data may have swayed some of the decision making in that meeting, with more time to digest it, it's reasonable to expect that the Fed would line up some members to get in front of cameras and walk back on some of the hawkish tone delivered by the Fed last week.
 
Indeed, we've heard from a few already.  But surprisingly, they have held the line.
 
That rate outlook is leading to growing divergence between the performance of cash-rich, big-tech oligopoly stocks … and the rest (as you can see below). 
 
 
In fact, at the worst levels this morning, the small-cap index (Russell 2000) was underperforming the S&P at the extremes of the past year
 
 
 
 
Let's talk about the G7 meeting that took place in Italy late last week.
 
The communique mentioned China 29 times
 
That tops last year, where they mentioned China 20 times, which was the most since 2014.  
 
And last year was the first time since 2019 (in the depth of the Trump trade war), that the G7 leaders said they would work toward "diversifying" supply chains, to reduce reliance on China. They addressed Taiwan, human rights, China's ability to influence Russia, and the importance of "playing by international rules."
 
China's state-controlled media called last year's G7 meeting, an "anti-China workshop."
 
This time, within the 29 mentions, G7 leaders were more forceful and critical of China than they were in 2023.
 
China's Foreign Ministry called the statements an attempt to "vilify and attack China."

 

Keep in mind, the Trump administration called China "enemy number one." 

 

Their multi-decade economic warfare against the United States (and the West) has since expanded into hybrid warfare (economic, psychological, information, political, cyber).   Yet the Biden administration has called China, all along, just a "strategic competitor." 

 

Finally, just in the past year, the administration and its allies are acting as if they are tough on China, one might say provocatively so.

 

 

 

 

 

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June 13, 2024

Yesterday's report on consumer prices (CPI) showed no inflation in May (zero month-over-month change).  And the Fed Chair said when we see the inflation report on producer prices (PPI, which was reported this morning), "we'll know more about what PCE will look like."
 
PCE is personal consumption expenditures.  This is the inflation measure they care most about.  It's the basis of their 2% inflation target.  And we'll get the PCE report at the end of the month.     
 
So again, Jerome Powell and his Fed colleagues were looking at this morning's PPI for clues on PCE.  What did they learn? 
 
The monthly change in core PPI was zero (no inflation).
 
This all aligns with the global inflation picture, which has been tracking Chinese PPI since global inflation peaked.  
 
  
As we've discussed along the way, this is the equivalent of "skating to where the puck is going."  The price of the products we will be buying in the months ahead, will be determined (in large part) by the inputs into Chinese production. 

 

This year-over-year change in Chinese PPI was at 26-year highs when the Fed was telling us, back in 2021, that there was no inflation.  It led on the way up (for global price pressures). 

 

And it has led on the way down.  Chinese PPI has now been in deflationary territory for 20 consecutive months.

 

This inflation view aligns with what the third largest global retailer has experienced over recent quarters.  Costco said selling prices were flat for the past two quarters.

 

With this inflation picture, the Fed had the opportunity to signal to the market yesterday, that they were in highly restrictive territory, and could afford to reduce restriction in the coming months if inflation continued its trajectory — just to maintain the level of restriction as inflation falls. 

 

This is the playbook just executed by the European Central Bank and Bank of Canada in the past week.  They laid the groundwork.  The Fed missed the opportunity.

 

With that, we hear from the Bank of Japan tonight.

 

Remember, the Bank of Japan played the critical role of global liquidity provider the past two years (the liquidity offset to the Western world's liquidity extraction/tightening policies).

 

But they made the first step toward exiting that role in March. 

 

They raised rates, ending negative interest rates.  They ended yield curve control.  They ended ETF purchases.  And it has been reported in recent days that they may begin the end of bond purchases tonight (i.e. taper QE).

 

With those moves by the BOJ, in my March 19th note I said, "global central banks (led by the Fed) may now have less leeway to hold rates too high, for too long." 

 

With the BOJ exiting its role as global liquidity provider, Western world central banks have to start paying closer attention to the vulnerabilities in their respective government bond markets (i.e. the risk of higher yields).

 

That's why, no coincidence, two days after the Bank of Japan's move in March, the Swiss National Bank started the easing cycle with a surprise rate cut (adding liquidity).  And we've since seen cuts from Sweden, Canada and the euro zone. 

 
Conversely, the Fed seems convinced that they can patiently sit with high real rates, until they manufacture their desired inflation rate.  The actions of their central bank counterparts tell a different story.  They don't have the luxury.  They are all a liquidity crunch away from returning to the business of QE. 

 

 

 

 

 

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June 12, 2024

The monthly change in the May headline inflation data reported this morning came in flat (no inflation).
 
That was a positive surprise.  Stocks rallied.  Yields fell.  The dollar fell. Commodities went up. 
 
For a Fed that's been looking for "more progress" in the decline in the inflation rate, they're getting it.  As you can see below, the core inflation rate (which excludes food and energy) has been in a very clean descent from peak levels …
 
 
 
And as we've been discussing here in my daily notes, the two hot spots in the consumer price index have been auto insurance and owners' equivalent rent.  But in May, auto insurance declined for the first time in 29 months!
 
Now, that's just a month-over-month change.  As we've discussed, it will take many more months for the year-over-year change in these two components to normalize due to the base effects of the calculation.  With that, these two components are creating the illusion that inflation is "sticky" at higher levels.
 
We've looked at where inflation would be if we stripped these two components out of the CPI.  It falls well below 2%. 
 
But a better analysis would be "normalizing" the influence auto insurance and OER have on CPI, using pre-pandemic averages.  If we do that, core CPI falls to 2.35%.  Headline CPI falls to 2.25%.  This is quite a different reality than the greater than 3% number in the reports. 
 
This simply gives us insight into whether or not the Fed is sincere, when they say inflation is "still too high."
 
Well, they said it today.  Moreover, they crafted policy ("forward guidance") around that view, by adjusting UP the end of year projection for the Fed Funds rate from 4.6% to 5.1% — which implies just one rate cut this year.
 
So, that's 125 basis point of tighter policy than the market was expecting early this year.  But as you can see in the chart below, the stock market has not been too concerned. 
 
But with stocks at record highs, perhaps the Fed IS concerned about giving the green light to markets (at this stage) to price in an easing cycle.    
 
 
 

 

 

 

 

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June 11, 2024

With the May CPI report due tomorrow morning, let's revisit the two hot spots in the report.
 
As we've discussed here in my daily notes, both auto insurance and owner's equivalent rent make up about 30% of the CPI.  Both have been hot, and have been propping up the overall index, and the Fed's current restrictive interest rate policy is powerless to bring them down. 
 
Here's a visual on why …
 
 
Above is motor vehicle insurance.  This has risen at a 20% year-over-year rate for five consecutive months (the actual data is represented by the blue bars). 
 
Even if this auto insurance index were to flat-line from this point (i.e. zero month-to-month change in this insurance price index), it would still take seven months for the year-over-year measure to fall below double-digits (that scenario represented by the orange bars).
 
So, even if the insurance hikes are over, this year-over-year measure will continue to put upward pressure on the inflation data for months to come. 
 
Next is the heavier weighted component that's been propping up CPI:  Owners' Equivalent Rent (which is also influenced by the sharp rise in insurance rates).  
 
This makes up 27% of the consumer price index.  And you can see in this chart below, it has directly contributed at least 1.5 percentage points to the year-over-year change in CPI for 22 consecutive months.  The streak will likely continue in tomorrow's report.  The orange bars represent the path IF this component were to flat-line over the coming months (zero monthly change). 
 
 
This too, will continue to put upward pressure on CPI for the months ahead.
 
What does it mean?  The year-over-year computation of these two components is creating the illusion that inflation is "sticky" at higher levels.   

 

 

 

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June 10, 2024

Last week, we discussed the easing cycle that is underway in developed market economies.

And as we’ve discussed, we should expect the easing cycle to be coordinated among the major central banks (excluding Japan), just as it has been in the post-global financial crisis era.

If we needed any clues, just look at the shared language they use to describe policy decisions.  The most recent has been the need for more “confidence” that inflation is coming down.

The Fed started using this “confidence” condition in its policy statement in January of this year:  “The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.”

The Bank of Canada cut last week.  And said, “If inflation continues to ease, and our confidence that inflation is headed sustainably to the 2% target continues to increase, it is reasonable to expect further cuts to our policy interest rate.”

The European Central Bank cut, on the condition of “confidence.”  Here’s what ECB President (Lagarde) said about it in the press conference last week:  “What we wanted before making that decision was collectively to increase our confidence level that the path ahead was on its disinflationary rhythm that we needed in order to make our decision.”

What else looks carefully coordinated?

The way both the BOC and ECB described the rate cut last week.

As we discussed in my Thursday note, Lagarde made a clear effort to shape opinion on the cut, as “moderating restriction” on the economy, rather than stimulating the economy. So, she wanted everyone to know that they are still in an inflation fighting stance.

The Bank of Canada Governor, similarly, focused on removing restriction:  “We don’t want monetary policy to be more restrictive than it needs to be to get inflation back to target.”

So, with all of this in mind, we’ll hear from the Fed on Wednesday.  And also on Wednesday, we’ll get May CPI.

The market is now pricing in just one cut by end of year, and CPI is being propped up by two components that restrictive interest rate policy is powerless to bring down (for at least a few more months).

With that, when the Fed presents its update projections on Wednesday, the market will be prepared to see ticks higher in the inflation forecast for this year, and a higher Fed funds rate projection by year end (adjustments UP in the highlighted areas below).  

So, given that set of expectations, a negative surprise for markets on Wednesday seems unlikely.  And given the actions taken last week by the Fed’s counterparts, there’s a better chance that they (the Fed) telegraph more and sooner cuts than the market is expecting, of course, just to “remove some restriction.”

We will see.

On CPI, remember we looked at this chart last month on what CPI would look like if we stripped out auto insurance and owners’ equivalent rent?

Both auto insurance and owners’ equivalent rent make up about 30% of the CPI.  And both of these CPI components are lagging features of an asset price boom.

 

 

 

 

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June 06, 2024

This morning, the European Central Bank became the fourth G10 central bank to cut rates.
 
Let's talk about the nuance Lagarde (ECB President) used to insist that they are still in the inflation fighting stance (headline below).
 
In September, euro zone inflation was running 2.9%. 
 
The ECB's policy rate was 4%.  That's 110 basis points ABOVE the inflation rate (i.e. the "real" interest rate).  
 
Today, AFTER the cut, the real rate is 115 basis points.  So, as she said, policy is tighter today, even after the rate cut. 
 
This is what we've been discussing along the path of the fall in inflation in the U.S.  Once the annual rate-of-change in prices fell below the Fed's policy rate (effective rate of 5.33%), the Fed's stance has only become tighter and tighter as inflation has declined. 
 
Here's what that looks like …
 
 
So, the Fed is currently 268 basis points above the rate of inflation.  That's historically very restrictive monetary policy.  Similar to the ECB, they could cut rates right now, and still be left with a tighter policy stance than they had last October (which, coincidentally, is when Jay Powell signaled the end of the tightening cycle).
 
As you can also see, the current real interest rate is more than 200 basis points higher than where the Fed projects the longer term real Fed Funds Rate ("the Fed's Projected Real Neutral Rate" … where they deem the rate to be neutral — not stimulative, nor restrictive).  
 
Bottom line:  The Fed could make the same case Lagarde made this morning, cutting rates but continuing the inflation fighting stance — given that real rates would continue to be very restrictive. 
 
Lagarde may be the Fed's test subject on a way to start the easing cycle, without stoking much excitement in markets, consumers and businesses (which could translate into renewed inflation pressures). 
 
Let's talk about Nvidia.
 
Nvidia will split at the close of business tomorrow (shareholders get 10 shares for every 1 share owned).  As we discussed following the Nvidia earnings a couple of weeks ago, this split looks a lot like the 2014 Apple split.  
 
Apple announced a 7-for-1 split when the stock was in the mid $500s, and ran up to around $700 by the time of the split.  Nvidia has nearly replicated the pre-split premium (just shy of 30% added since the announcement).
 
As we also discussed, as with Apple, Nvidia's post-split lower share price creates an opportunity for inclusion into the Dow (DJIA).
 
That should turn market attention to the Dow, which has been lagging the Nasdaq, as you can see in the chart.  Moreover, the Nasdaq has more than doubled the performance of the DJIA since the "Nvidia moment" in May of last year. 
 
  
We get the May jobs report tomorrow morning
 
Remember, the Fed has told us they are watching the job market "carefully" for "cracks" as a condition to start the easing cycle.
 

 

 

 

 

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June 05, 2024

Back in my March 21st note, we discussed the Swiss National Bank's surprise quarter point rate cut.
 
And I said, "if there were doubt on whether or not this easing cycle would materialize, there shouldn't be now."
 
The major central banks of the world had coordinated closely throughout the crises of the past 15 years.  They all went to ultra-easy emergency level policies in response to the pandemic, and then all (exception Japan) took interest rates ABOVE the rate of inflation (restrictive territory).
 
And as we discussed back in that March note, we should expect them to all be cutting rates, in coordination, in the coming months, mostly to ensure that global liquidity doesn't become too tight, and (related) that their respective government bond yields (borrowing rates) don't run away (higher).
 
We've since had the beginning of the easing cycle in Sweden.  And this morning, in Canada (with a quarter point cut from the Bank of Canada).  
 
And tomorrow morning, the European Central Bank should be cutting rates, after taking rates up 450 basis points in fourteen months.
 
That leaves the Bank of England, which has perhaps the easiest case to make for cutting rates at its June 20 meeting.
 
And, of course, the Fed meets next Wednesday.
 
Is the market getting the message on the easing cycle?
 
Stocks are back on record highs. 
 
The U.S. 10-year yield is down 36 basis points in five days!    
 
 
As you can see in the chart, today it traded below the levels of the May 15th CPI report (April inflation).
 
And at 4.28% on the 10-year today, that's the lowest level since April 1st. 
 
And April 1st is an interesting date.  It's the Monday after the Good Friday PCE report (where the market re-opened to digest the report).
 
Both of those prior inflation reports took yields higher.  And as you can also see in the chart, the recent PCE report has resulted in lower yields. 

 

 

 

 

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June 04, 2024

As we discussed yesterday, the interest rate easing cycle is underway in the advanced economies (excluding Japan).  And we should see more evidence of that this week (in Europe, and likely Canada).
 
As for the Fed, Jerome Powell has told us they are watching the job market "carefully" for "cracks" as a condition to start the easing cycle.
 
And this week, we get jobs data. 
 
It started this morning with the report on job openings.
 
Let's talk about why this report is of particular interest. 
 
If we look back to March 2022, when the Fed started the tightening cycle, they immediately made it known that they wanted to "bring demand down," and the sacrificial lamb would be jobs.
 
And Powell incessantly cited the job openings-to-job seekers ratio.  At that time, there were two open jobs for every one job seeker.  And he told us they intended to bring the ratio down one-to-one.
 
So, what was today's number?
 
The job openings fell to the lowest level since February of 2021.
 
That brings the ratio down to 1.24 job openings for every one job seeker.  It's not one-to-one, but it's the lowest ratio since mid-2021.
 
More importantly, as you can see in the chart, that's in-line with pre-covid (2018-2019) levels
 
 

 

 

 

 

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June 03, 2024

We have five major global central bank decisions over the next two weeks, which includes the Fed next Wednesday.
 

Remember, the easing cycle has already started for the "advanced economies."  It started with a surprise rate cut from the Swiss National Bank in March.  Then the Swedish central bank cut in May.  The European Central Bank is expected to follow on Thursday, with its first rate cut after a 450 basis point tightening cycle. 
 
The Bank of Canada will kick things off on Wednesday.  The policy rate there is 230 basis points above the inflation rate.  But rate cut expectations have diminished over past three weeks, from a 70% probability of a cut to just 36%.  
 
It sets up for a surprise.  The Canadian economy has grown less than 1% over the past four quarters, and just undershot expectations on Q1 growth in a report this past Friday. 
 
The Bank of England decision comes on June 20.  Of all the central banks mentioned, with the plunge in the recent inflation reading to 2.3%, the Bank of England now has the tightest policy (i.e. the highest real interest rate).  Not surprisingly, the economy is growing at  sub-1%.  They should be cutting
 
With all of the above in mind, as we've discussed often in my daily notes, we should expect the closely coordinated policies of the past fifteen years by major central banks to continue in this easing cycle.  
 
But as we've also discussed often, the pendulum of rate expectations in the U.S. has swung from one extreme to the other over the past five months.  
 
The current extreme is represented in this cover of Barron's over the weekend …

 
  
 
This, as the Fed has the second tightest policy of the central banks discussed, and with Q1 growth having just been revised down to just 1.3%.   
 
We should expect more and sooner action from the Fed than the market has priced in. 
 

 

 

 

 

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May 31, 2024

We get the Fed's favored inflation gauge tomorrow morning — personal consumption expenditures (PCE).
 
For the month of April, the market consensus is for 0.3% m/m and 2.7% y/y, which would be a continuation of this leveling off under 3% (but above the Fed's target).  
 
 
That said, it may have become a less important event for markets after the guilty verdict of the President's political opponent was announced this afternoon.
 
We won't know if Trump will be jailed until July 11th, conveniently four days before the Republican National Convention, where delegates of the party will officially select the party's nominee for president.
 
As we discussed in my note yesterday, the potential jailing of a U.S. presidential candidate driven by partisan lawfare should raise concerns for every investor about America’s role in the world as the reliable anchor of law, fairness, and stability.
 
As we've also discussed, this has the potential to be a tipping point for trust in the historical global safe haven role of the U.S. Treasury market and the dollar.  Will we see selling/ capital flight? 
 
With that, this chart will be an important one to watch.  Yields have been climbing back toward this trendline – a break of which (higher) would bring about risk of another visit to the 5% area, a level the Fed wasn't comfortable with back in October. 
 
 
As for the dollar, we sit on this trendline …
 
 
For more perspective, let's revisit the long-term dollar cycles, which we've kept an eye on throughout the history of my daily note. 

Since the failure of the Bretton-Woods system through the onset of the Global Financial Crisis, the dollar traded in five distinct cycles – spanning 7.4 years on average.  And the average change in the value of the dollar (in those five cycles), from extreme to extreme was greater than 50%. 

 

As you can see, the era of quantitative easing (QE) has seemingly distorted this last bull cycle. 

 

 

The top was in late 2022, just after the Fed started QT (quantitative tightening/reversing QE). 

 

And now we're early into a dollar bear cycle, as the dollar's world reserve currency status is being opportunistically challenged by, primarily, China.  And as the vulnerabilities created by U.S. fiscal profligacy are being exacerbated by the potential erosion of trust in the U.S government.  

 

Interestingly, both Chinese and Hong Kong stocks (indices) gapped higher on the open tonight, following the news of the trial verdict in the U.S.