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September 22, 2023

In late June, the four most important central bankers in the world sat on a stage in Portugal, and fielded questions spanning from the inflation outlook and rate path, to geopolitical concerns, fiscal policy, digital currencies, and AI.
Three central bankers on the stage, from the U.S., eurozone and UK, were all well into the process of normalizing interest rates.  And then there was the new governor of the Bank of Japan, Kazuo Ueda.
In my June 28th note, I called him the most important person in the room that day.  He was the only one in the room that has been trying to get inflation UP, and therefore, he was the only one in the room with negative rates and running full bore QE — buying both domestic and global assets each month with no limits
And running that policy, simultaneously, as the rest of the world tightened, is the only way his central bank counterparts were able to raise rates to combat inflation, without losing control of their respective government bond markets (i.e. runaway yields). 
How?  The Bank of Japan became the liquidity offset to the Western world's attempt to extract liquidity.  As importantly, if not more, they have been buyers of foreign government bonds (largely U.S. Treasuries) via freshly printed yen. 
All of this to say, perhaps the most interesting thing said that day:  Ueda said he imagined rates would go up by a large margin in Japan, "IF they GET to normalize policy."
With Western central banks now on pause, and holding rates "higher for longer," as they say in unison, it doesn't appear that Ueda will GET that chance any time soon.  
Indeed, the Bank of Japan stuck with their ultra-easy policy overnight. 
And they added, they will patiently continue with easing, while "nimbly responding to developments in economic activity and prices as well as financial conditions."
This sounds a lot like (head of the European Central Bank) Christine Lagarde's comment at Jackson Hole.  Just as everyone has been hoping the central bankers would step away from manipulating the economy and markets, Lagarde says we need even more "robust policymaking in an age of shifts and breaks."


"Robust policymaking" in this post-pandemic era, seems to translate into breaking things in the financial system, and then simultaneously intervening in markets to fix what they break (as the ECB did with its sovereign bond market, as the UK did with its sovereign bond market, and as the Fed did with its banking system).





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September 21, 2023

With some time to digest the message from the Fed yesterday, the 10-year yield surged and finished on the highs today.  We are now revisiting a 4.5% 10-year yield, for the first time since November of 2007.
With that, stocks finished on the lows of the day.  
And we have some charts that look concerning…  
As you can see in this chart above, this trendline from the March lows has been broken.  And this trend, importantly, was driven by a Fed response to the confidence shock in the banking system.  They stepped in to provide liquidity to depository institutions to backstop deposits.  And the bottom was in.
So, this line has been broken.  And we have similar charts across the stock indices (the Dow, Nasdaq) — all trend breaks.
With this break, the money management community piled into hedges.  The VIX spiked, albeit from very subdued levels.
Even oil, which has been on a tear the past three months, traded down as much as 4% from yesterday's highs.
This, all because the Fed projected two less rate cuts for next year?
Remember, many economists and much of Wall Street have been expecting recession for the better part of the past year.  Why?  The dreaded "inverted yield curve," which has historically been a predictor of recession.
That said, we had a technical recession, already — in anticipation of the tightening cycle. It was the first half of 2022.
Is the Fed hell-bent on inducing another one?  That seems to be the belief, based on the initial response from markets.
But remember, as Jerome Powell ended the press conference yesterday, he had this to say about the economy:
I think overall households are in good shape. Surveys are a different thing. So surveys are showing dissatisfaction, and I think a lot of that is just people hate inflation, hate it. And that causes people to say the economy is terrible, but at the same time they're spending money. Their behavior is not exactly what you would expect from the surveys. That's kind of a guess at what the answer might be. But I think there's a lot of good things happening on household balance sheets, and certainly in the labor market and with wages. The biggest wage increases having gone to relatively low-wage jobs, and now inflation coming down, you're seeing real wages, which is a good thing.
With this assessment, and an economy that is running at a near 5% annual growth rate, the Fed still seems more concerned with throttling a strong economy, rather than tipping a weak economy into recession.
My view:  At this point, they don't want to give the "all clear" signal to markets, which would provide fuel to markets and the economy.





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September 20, 2023

The Fed left rates unchanged today.  
The key takeaways were in the projections on policy and the economy made by Federal Reserve board members and Federal Reserve Bank presidents (the "Summary of Economic Projections").
As we discussed yesterday, the economy has been running at a pace three-times what the Fed was estimating in June.  
So today, they doubled their forecast, from 1% to 2.1% economic growth for 2023 (still looks too low).
Add to that, they lowered their estimate on unemployment on the year, and on core inflation (their favored inflation gauge).
So, the Fed has said we will need to see higher job losses, and below trend growth "for a period of time" to get inflation where they want it.  They've been wrong.  Inflation is going their way (lower).  And yet the job market remains tight, and growth has been hot.
On the inflation front, as we've discussed here in my daily notes, we had a growth shock in money supply, from the 2020-2021 policy response to the pandemic.  That was the inflation catalyst.
We've since had the disinflationary effect (falling inflation) from the contraction in money supply.
And now, money supply growth is normalizing.  The monthly change in money supply has been growing (modestly) for three consecutive months.   A low and stable rate of money supply growth is good for economic growth and price stability.  That's what we're getting.  And that's good! 
With that, what does the Fed really think about the economy?
In a parting comment, Jerome Powell admitted today that the government handouts from pandemic packages were "very meaningful" and have "left housholds in good shape" — still!  That's despite the headwind of increasing interest rates by 525 basis points.
And he said "people hate inflation" … "and that causes people to say the economy is terrible" in surveys … "but at the same time, they are spending money."   





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September 19, 2023

The Fed will decide on rates tomorrow.
Remember, they told us after the July meeting that they would be completely "data dependent" in determining the path forward for monetary policy.
And while the July hike was a unanimous decision (among the 11 voting members), we later found in the minutes from that meeting, that there was indeed some dissension"Almost" all participants agreed to raising rates at the July meeting.  "A couple" (assumably non-voters) favored leaving rates unchanged.
A week later or so, we heard from Jerome Powell at Jackson Hole, and he said the Fed was currently in restrictive territory, putting "downward pressure on inflation," and he reiterated that the Fed is data dependent.  
So, since late July, the Fed has been looking for softening data to validate a pause, if not the end of the tightening cycle.
They've gotten it.  With that, the Fed will leave rates unchanged tomorrow.  The question:  What will the new forecasts look like (the "summary of economic projections")? 
This is from July …
If we step through the July projections, the data point that stands out is economic growth.  The Fed has dramatically (to this point) underestimated the impact of the fiscal spend on real GDP growth.  Through three quarters, actual growth is running about three times higher than the Fed's forecast.  However, the employment and inflation data are closing in on the Fed's targets. 





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September 18, 2023

In my last note, we revisited the mid-term election analogue for stocks. 
The 12-month period following the past eighteen mid-term elections, of the past seventy years, has been positive for stocks — to the tune of a 16% return, on average.
Indeed, stocks are tracking that analogue this year.  
Today, let's revisit another big analogue we discussed coming into 2023.  It has to do with the trusty 60% equity/40% bond portfolio.  
As you might recall, at one-point last year, this portfolio mix was down as much as 30%.  That was tracking to be the worst on record, even worse than 1931 (the depths of the Great Depression). 
This 60/40 portfolio finished last year, down 18%.
Now, it's not rare for this portfolio to be down on the year.  It's happened about a quarter of the time.  But it is rare for both stocks AND bonds to be down on the year. 
It's only happened four times going back to 1928.  And it happened last year. Stocks were down 18% (S&P 500, total return) and bonds were down 18% (10-year bond, total return).
So, let's revisit how stocks performed in the year following these four rare occurrences, that shared the features of a negative 60/40 portfolio return, driven by a negative annual return for both stocks and bonds.
It happened in 1931.  That was followed by a negative return year for stocks (down 9%) and a positive return year for bonds (up 9%).  
It happened in 1941.  That was followed by a positive year for stocks (up 19%) and a positive year for bonds (up 2%).  
It happened in 1969.  That was followed by a positive year for stocks (up 4%) and a positive year for bonds (up 16%).  
It happened in 2018.  That was followed by a positive year for stocks (up 31%) and a positive year for bonds (up 10%).
Now we've had the fifth occurrence, in 2022. And more than eight months into the year, stocks are up 17%.  Bonds are down 1%.
As you can see, this year's performance in the bond market is deviating from history.  This is thanks to the sledgehammer of rate hikes, and threats of more (by the Fed), which have weighed steadily on bond prices throughout the year (prices down, yields up).   
On that note, we head into a Fed meeting this week, with the benchmark 10-year bond yield having printed a new 16-year high overnight — now hanging around the 4.30% yield mark, a level that has marked a high, and a turning point, on two other occasions over the past year.
With this setup, speculators are net short treasury futures (i.e. short bond prices) at record levels
What does that mean?  They are leaning heavily in the direction of a break higher in yields (lower in bond prices).  These extreme positions tend to be contrarian indicators.
The last time the market was positioned near this extreme of a short (against bond prices) was September-October of 2018.  Those bets were wrong.  It was was the turning point, and those levels weren't seen for another four years.
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September 14, 2023

As we discussed yesterday, going into the August inflation report, we’ve had a 30% rise in oil prices and a 55 basis point move in the 10-year yield, all since the end of the first half (the end of June).

Meanwhile, stocks (Nasdaq, S&P 500, DJIA) are left virtually unchanged over the same period.

With the inflation data now behind us, is it time for stocks to make a strong run into the end of the year?  Maybe. 

Stocks are trading at 18.6 times next year’s earnings (forward twelve months).  That’s more expensive than the long-term average of around 16 times.  But it’s cheaper than the average trailing twelve month P/E of the past 30 years (which is north of 20 — even if we exclude the high multiple years following recession).

If we apply a P/E of 20x for earnings expected over the next twelve months, we get a price target on the S&P 500 that implies another 7-8% higher (from current levels). 

With that in mind, let’s revisit the midterm election year analogue we’ve talked about since last November …

Going back to 1950, there has never been a 12-month period, following a midterm election, in which stocks were down.

And the average 12-month return, following the eighteen midterm-elections of the past seventy years, was +16.3% (about double the long-term average return of the S&P 500).

This phenomenon has been playing out.  The S&P 500 opened at 3,750 on November 8th, 2022 (election day).  Today it trades 4,510.  That’s a rise of 20% over the past ten months.

What was the best 12-month period following a midterm election (over the past eighteen periods observed)?  It was under Kennedy.  Stocks rose 31% in the 12-months following the 1962 midterm election.

And interestingly, the worse stocks did in the 12-months prior to the midterm elections (over the 70-year period observed), the better they did after.  In the current case, stocks were down 22% prior to last year’s election. 






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September 13, 2023

As we've discussed many times here in my daily notes, we need a period of hot growth, rising wages (to restore the standard of living), and stable, but higher than average inflation to inflate away debt.
Today's headline inflation for August came in at 3.7%.  That's a second consecutive uptick in inflation, following twelve consecutive months of declining inflation.  
It's far from the 9% of early last year.  But it's double the inflation of the decade prior to the pandemic.
Remember, the Fed spent the better part of that decade using all of its tools to promote inflation — to escape the deflationary forces of a weak post-global financial crisis economy.  Now, with this inflation number today, we're probably looking at what will be a persistently "higher than average inflation" level — something hanging around 4%.
With the rise in oil prices, over the past two months, the upward pressure on this headline number, from here, is pretty much assured.
That said, as we discussed yesterday, this rise in oil prices further squeezes the consumers ability to keep spending (i.e. softening demand).  
So we may have a scenario in the coming months where the inflation that the media talks about is "hot," but the inflation the Fed is focused on (excluding food and energy prices) is not hot, but falling. 
As you can see in this chart, if both core and headline inflation were to grow at around the average of the past three months (monthly rate of change), the paths would cross by the end of the year, and the core (what the Fed cares most about) would be in the mid-2s by mid-2024, which happens to be when the market sees the beginning of rate cuts
With all of this in mind, we end the day with an "outside day" (a technical reversal signal) in the very important 10-year yield.  That's a reversal signal into this 4.3% area in yields, which has proven a top on two other occasions.   
And, consider this:  Going into today's inflation report, we've had a 30% rise in oil prices and a 55 basis point move in the 10-year yield, all since the end of the first half (end of June). 
Meanwhile, stocks (Nasdaq, S&P 500, DJIA) are left virtually unchanged over the same period.  





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September 12, 2023

We get the August inflation report tomorrow.
As we discussed yesterday, after twelve consecutive months of falling year-over-year headline inflation, the trough might be in, for a while. 
It ticked up last month.  It's expected to tick up again tomorrow, to the mid-3% area.
This should be a comfortable number for the Fed, given they have short-term rates set about 200 basis points higher than headline inflation.
What about oil prices?  Crude oil is up 30% since late June.  This will start showing up in the headline inflation number in the coming months. 
Does that mean the Fed will have to do more (more rate hikes)?
The market is pricing in less than a coin flips chance of a (final) hike next month.  But we should be at the stage, when it comes to oil consumption, of "higher prices solve higher prices" (i.e. higher prices resulting in lower demand).
The consumer is getting squeezed, and $4+ gas in the near future is another major pinch.     
Take a look at real disposable income.  Historically it has grown, throughout various cycles, on average at about the rate of real economic growth.  As you can see in the chart, it's well below trend (the orange line), if we were to extrapolate out from the pre-pandemic levels.  
Consumers are strapped, but government money is flowing (by the trillions). 
We talked about this type of environment in my notes more than two years ago, in the midst of the building inflation: "this type of economy is not a 'feel good' economy.  In an inflationary economy consumers feel like they are sprinting on a treadmill just to maintain status quo."  You can see that May 2021 note here.






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September 11, 2023

We get the August inflation report on Wednesday.

With that, let’s revisit a couple of charts that have been key contributors to the inflation picture.

Below is the change in Chinese producer prices (the producer price index — PPI).

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. 

As you can see in the chart above, the latest year-over-year change in Chinese producer prices (reported over the weekend) is still in deflationary territory (down 3% year-over-year).  And that trajectory of prices for Chinese goods has proven to be a good indicator for U.S. price pressures, which, as we know, have fallen sharply from the 9% inflation of a year ago.  

That said, producer prices in China have now been rising on a month-over-month basis, for two consecutive months.

Does this mean the disinflation in U.S. prices might be over, at least in the near term? 

Maybe.  The last headline U.S. inflation number broke a 12-month streak of falling inflation.  And Wednesday’s number will likely show another uptick in price pressures from August. 

That brings us to our next chart of U.S. money supply growth… 

As you can see, the aftermath of the money supply explosion has been a contraction.

And a contraction in money supply has historically been deflationary.

So, we had the inflation catalyst, which was the growth shock in money supply, from the 2020-2021 policy response to the pandemic.

We’ve had the disinflationary effect from the contraction in money supply.

But now, even though the year-over-year change in money supply remains negative (contractionary), the monthly change has been growing for three consecutive months.

A normalization in money supply growth would be a good thing.  






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September 08, 2023

We've talked a lot about the inflation picture.  We'll get the big August inflation data next week.
Today, for some perspective, let's revisit the difference between level of prices and the rate-of-change in prices.
There's a big difference.  The level of prices is here to stay.  The rate-of-change has to slow, and has been.   
Remember, the massive monetary and fiscal response to the pandemic (plus the subsequent agenda spending binge) ramped the money supply by 40% in just two years.  That was ten years worth of money supply growth (on an absolute basis), dumped onto the economy over just two years.
That tsunami of money rapidly reset the level of prices, of almost everything. 
And it was by design.  It was an explicit decision, out of necessity and opportunity, to inflate asset prices and inflate away the value of debt.
On the former (i.e. inflating asset prices), that translates into the Q2 report released today on household net worth.  It's at new record highs
On the latter (inflate away the value of debt), the nominal size of the economy has grown at an average annual rate of 10% coming out of the pandemic-induced contraction, largely resulting from the nominal price of things.
And with that, as you can see in the far right of this chart, the debt burden has been shrinking from the pandemic policy-response driven peak.  What matters is debt relative to the size of the economy, and as you can see in the chart above, that's been improving (thanks to hot nominal growth).
With the rate-of-change in prices now under control, as we have often discussed we need a reset in wages (higher wages) to offset the reset in prices — to restore the standard of living.
It's a slow, painful, lagging process, but it looks like it's happening.  And we're getting productivity gains, which mutes some inflationary effects of wage hikes.  Below is median hourly wage growth …
And the New York Fed's Labor Market Survey says the average full-time wage received in the past four months increased from $60,764 in July of 2022 to $69,475 in July of this year.  That's 14% — a big number.  It was just 3% growth the prior year. 
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