May 6, 2022

As we end the week, let’s take a look at a few charts.
 
First, here’s a look at the performance of global asset prices over the past week.

You’ll notice, despite all of the financial media hand wringing over stocks, related to the Fed meeting, the S&P 500 (the proxy for global stability and risk appetite) was only down less than 1/2 percent on the week. 
 
Other notables:  The VIX (also known as the market’s ‘fear gauge’) was down on the week, not up. 
 
And crude oil was up more than 5% on the week — not exactly a signal of economic slowdown, but then again, crude is now trading on a supply shortage, brought to us by the design of global (and domestic) policymakers. 
 
On that front, it’s important to remember how we started the week.  On Monday morning, it was reported that the European Union was ready to propose a Russian oil embargo, and Germany was now on board
 
That triggered a 3% decline in the S&P 500 over just a few hours (on Monday).
 
And crude finished up nearly 10% from the Monday morning levels.
 
Here’s how crude looks heading into the weekend — a bullish technical breakout.  
 

Finally, let’s take a look at money supply.  Remember, the policies surrounding the pandemic response, ballooned the money supply by over $6 trillion.  

Now that the Fed has started quantitative tightening (i.e. reversing QE), some are expecting the money supply to shrink. 
 
While money may be extracted from bank reserves (by changing a digital number to a smaller number with a keystroke), it didn't show the desired effect on actual money supply during the Fed's 2017-2019 QT program.  As you can see in the chart above, money supply grew during the period (by a trillion dollars). 
 
What's the point?  The rate of change in prices should subside.  But the level of prices, caused by this tidal wave of new money, isn't going anywhere. 
 
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May 4, 2022

The Fed raised rates yesterday, and announced its quantitative tightening plan to begin on June 1.
 
As we discussed yesterday, markets responded well. 
 
Today, that was not the case.
 
What’s going on? 
 
My view:  Mostly this …

This is the chart of the yield on the 10-year Treasury.  This is the benchmark market-determined interest rate, which is the basis for setting many consumer rates. 
 
It spiked today, 16 basis points (a big move), and above 3%.  Mortgage rates went to 5.27%, the highest level since 2009.  
 
So, is 3% a dangerous level for rates, given that the Fed has just taken the Fed Funds rate up to 75 basis points?  No.
 
The fear is, that this move (in rates) today is just the beginning of a fast repricing of the interest rate market
 
After all, the Fed told us yesterday that they intend to "expeditiously" take the Fed Funds rate to what they deem to be the "neutral" level (maybe this year).  As we discussed yesterday, that's believed to be somewhere between 2 and 3%. 
 
If we consider a 2% spread between mortgages and the 10year … and a spread of about 2% between the 10year and the Fed Funds rate … then the right yield for the 10year should be in the mid-4% area.  That would take mortgage rates to be over 6%.
 
This begs the question:  Why hasn't the bond market already priced this "neutral" Fed rate in?  Why isn't the 10-year yield at 4.5% right now? 
 
Moreover, if the bond market really is the "smart money," why hasn't the 10-year yield adjusted according to an 8.5% inflation economy (i.e. much, much higher yields)?
 
Why?  Because the government bond markets have been highly manipulated by central banks, globally.  
 
The Fed has been explicitly manipulating the bond market, to suppress interest rates, for the better part of the past fourteen years.  But now, they are out of that business (allegedly).
 
So, it's logical to think, now that the Fed is out, that the interest rate market could quickly reset to the reality of the inflation environment.  
 
That would put the economy at risk of a runaway interest rate market.  And that would make the Fed's job of price stability and full employment exponentially more difficult.
 
I suspect that is what created fear in markets today.   
 
But as we discussed over the past few weeks, don't underestimate the appetite of global central banks to coordinate (with the Fed), to keep market U.S. interest rates in check (making the Fed's job to manage inflation expectations and the monetary policy "normalization" easier – and, therefore, the global economic and interest rate environment more stable).  
 
Remember, not only is the Bank of Japan (BOJ) still in the QE business, but they are in the unlimited QE business (buyers of unlimited Japanese Government Bonds as part of their yield curve control program).  They have a stated policy to buy as much as they see fit.  And in Japan, that also means buying stocks, real estate, corporate bonds – it's all fair game.
 
From my April 28 note: How do you prevent a global economic shock that may (likely) come from reversing the mass liquidity deluge of the past two years (if not 14 years, post Global Financial Crisis)? 

 

You keep the liquidity pumping from a part of the world that has a long-term structural deflation problem, and that has the biggest government debt load in the world (exception, only Venezuela). Japan.

 

The Bank of Japan, in this position, can be buyers of foreign government debt (namely the U.S.) to keep our market rates in check (keeps the world relatively stable), which gives the Fed breathing room on the rate hiking path.  

 

And Japan's benefit?  The world gives Japan the greenlight to devalue the yen, inflate away debt and increase export competitiveness (through a weaker currency).  They hit the reset button on an unsustainable, debt-laden economy.  We will see.

 
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May 4, 2022

Let's talk about the Fed meeting today …
 
First, there were no surprises.  The Fed had telegraphed a 50 basis point rate hike.  The market had it priced in.  That's what they delivered. 
 
The Fed had also telegraphed the start of quantitative tightening.  As we discussed yesterday, given the recent history of their 2017-2019 failed effort to trim the balance sheet (they were forced to return to QE), we expected them to tread lightly on the balance sheet issue.  They did.
 
They are starting small, and watching.
 
As we discussed yesterday, a careful and conservative Fed messaging should be positive for stocks.  
 
Markets liked it. 
 
Then, when Powell said they are not considering something as aggressive as 75 basis point hikes, stocks took off. 
 
Add to that, the Fed has projected to return the Fed Funds rate to what they deem to be the neutral level (neither accommodative, nor restrictive to economic activity).  That's around historically normal levels of 3% (maybe between 2% and 3%).
 
And, importantly, he said that they will not consider whether or not they need to get restrictive until they get to the neutral level
 
As it stands, that will be in early next year.  And in case you think they might surprise us with something in the interim, he said, flatly, that the world is uncertain, and that the Fed would do nothing to add to the uncertainty.
 
So, the Fed has just told us that they will not raise rates in a way that will become "restrictive" to the economy, until at earliest next year.  Moreover, for much of the rest of the year, they will continue to be accommodative.  
 
So much for slamming the brakes on the economy. 
 
With this in mind, we came into the year expect a major "regime shift" for markets — to adjust for a high inflation, rising interest rate world. 
 
The adjustment hasn't been pretty.  When we heard the December minutes from the Fed, on January 5th, as they discussed strategy for rate liftoff and balance sheet reduction, markets began to price in the worst case scenario.  
 
That was anticipation of Fed action. 
 
Today, we got the actual Fed action (which included QT).  As you can see in the chart below, this looks like the classic, sell the rumor (assume the worst), buy the fact (on a rational action).

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May 3, 2022

As we head into tomorrow's Fed meeting, we've talked about three supply issues that are driving inflation, which the Fed can do nothing about.
 
1) The reset of wages at the low end of the scale.  Not only did the government establish a new living wage through pandemic subsidies, but employers are in a position of weakness to negotiate pay, as they compete in a labor market that now has one job seeker for every two open jobs.    
 
2) The global supply chain disruptions, from the lockdown period has now been exacerbated by war in eastern Europe, and new lockdowns in China.  
 
3) High energy prices, sustained by a self-inflicted supply shortage, by the design of global anti-fossil fuel policies. 
 
These are reasons the Fed will likely not even attempt to raise rates, over the course of this tightening campaign, beyond what are historically normal levels (around 3%).
 
And I suspect they will be very, very careful and conservative in reducing the balance sheet.
 
If we get this message from the Fed tomorrow, it should be positive for stocks.  
 
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May 2, 2022

On Wednesday, we will get the second move from the Fed in this early stage tightening cycle.

We go into this meeting with the last inflation reading at 8.5% (year-over-year). If we extrapolate out the monthly change in prices from February to March (which was 0.9%), we are looking at double-digit annualized inflation.

Now, as we know, the Fed has done an about face on the inflation threat.

They spent much of last year telling us that inflation was due to supply-chain disruptions (bottlenecks), and “base effects” (i.e. the inflation data was misleadingly high, as measured against depressed prices of the lockdown period). And Jay Powell told us, flatly, that the Fed didn’t have the tools to solve the supply chain disruption (not their job).

Never did they talk about demand. Never did they talk about the government handouts, which inflated demand: the overly generous and prolonged government subsidized unemployment checks, the PPP loans, debt moratoriums, the “child tax credit” handouts (that neither required a child, nor a taxable income … nor was it even a credit — it was a direct payment).

It was clear to see, on the ground, as consumers, that these easy money fiscal policies had distorted prices. But it wasn’t politically palatable to admit it. Why?

All along the path last year, the administration was trying to push through even more excessive spending (the most profligate of them all = “Build Back Better”). Acknowledging the demand distortions would have been a disqualifier for a new spending bill. Ultimately it was, thanks to a couple of democrat hold outs in the Senate.

Suddenly, the switch flipped.

This year, the talking points from the Fed, the Treasury and the President have been about “bringing down demand.”

But the economy is slowing — contracted in the first quarter. The savings rate has gone from ballooning in 2020, back to pre-pandemic levels, if not below.

The velocity of money is at record lows. This is the rate at which money circulates through the economy. It’s supposed to represent the demand for money.

What’s the takeaway?

The Fed, may indeed have no tools to deal with the rise in the level of prices. Demand destruction is already happening.

There is nothing they can do to reverse bad energy policy-making, which has choked off investment in new oil exploration and production, and regulated away incentives to produce — which has led to structural supply problem – guaranteeing high prices.

And there is nothing they can do to influence food supply disruptions, driven by the Russia/Ukraine conflict (which has resulted in elevated grains prices).

Short of inducing a deflationary collapse, the solution will be higher wages, to close the gap with higher prices.

That has started, but there is a long way to go. It will take a while, and will be painful.

And I suspect the pain will create a political opportunity to push through “Build Back Better.”

April 29, 2022

We close the week, and month, with stocks near the lows of the year.
 
Let’s take a look at what earnings are telling us.  
 
We’ve seen the formerly loved streaming stock, Netflix, nearly halved after a bad earnings report.  We’ve heard a lot about “higher costs” on earnings calls.  And yesterday we got a negative GDP number for Q1.  
 
Still, Q1 corporate earnings have come in broadly better than Wall Street expectations.  
 
Half of the S&P 500 has now reported for Q1.  Eighty-percent have beat estimates.  Earnings growth is running about two-and-a-half percentage points better than was expected coming into earnings season.  And with rising costs, this is the most important point: profit margins are still strong, at 12.2% (the fifth highest since 2008, only topped by the prior four quarters). 
 
So, higher costs continue to be successfully passed through to the consumer. 
 
Is it sustainable?
 
On that note, this is important to know:  The level of prices isn’t going lower (anytime soon), despite what the Fed might have in store for us. 
 
The $6 trillion of new money floating around the economy, since the initial pandemic response, isn’t going anywhere. In fact, it continues to grow.  
 
It’s the rate-of-change in the increase of prices that will slow, we hope.
 
With that, as we’ve discussed, the only offset to the reset of prices that the government knowingly unleashed in March of 2020 (through direct payments to businesses and consumers, subsidies and debt moratoriums), is a wage reset (i.e. a broad-based shift in the wage scale, up).
 
You can see the wage issue clearly in this chart …

Despite some wage gains at the low end (driven by federal unemployment subsidies and “hazard” pay), after adjusting for inflation, wages are well below pre-pandemic trend.
 
That said, the wage reset is happening, but slowly.  There are roughly five million more job openings than job seekers.  And the number quitting jobs is the highest on record.  Job switching is the driver of the highest future wage growth. 
 
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April 28, 2022

The big Fed meeting is next week.  And global markets have been out of sorts in anticipation of a more aggressive rate hiking path, and the beginning of “quantitative tightening” (i.e. draining liquidity from the financial system).
 
That said, stocks bounced today, and did so in the face of a weak GDP report. 
 
Why?   
 
Remember, the world’s top central bankers and finance ministers met in D.C. last week.
 
And if there is one common theme we hear from almost all government officials and agencies, it’s the promotion of global “coordination, collaboration and cooperation.”  And if there is a commonality in market turning points, historically, it’s that they tend to come with some form of intervention.
 
With that in mind, last week we talked about the prospects of the Bank of Japan (BOJ) coordinating with the Fed to keep market U.S. interest rates in check (making the Fed’s job to manage inflation expectations easier).  
 
Remember, not only is the BOJ still in the QE business, but they are in the unlimited QE business (buyers of unlimited Japanese Government Bonds as part of their yield curve control program).  They have a stated policy to buy as much as they see fit.  And in Japan, that also means buying stocks, real estate, corporate bonds – it’s all fair game.
 
So, this brings us back to our discussion we’ve had on currencies.  The dollar hit a 20-year high today (the dollar index).  The yen has been getting destroyed, down 13% just in the past month.  And inflation, globally, is running wild…  
 
With all of the above said, the Bank of Japan met and announced a decision on monetary policy overnight.  Did they start positioning for the big inflation fight, as the rest of the world is doing? 
 
No, they didn’t.  They continued the course:  Unapologetic, pedal-to-the-metal QE.  
 
This only amplifies the extreme monetary policy divergence between the U.S. and Japan (the Fed hiking and QT, while the BOJ still full bore QE).  It’s an insult to the already injured Japanese yen.  Just like that, the yen was down another 2% today. 
 
What’s the point? 
 
This looks increasingly like the Bank of Japan is taking the baton from the Fed and other central banks that are being forced into an inflation fighting role. 
 
How do you prevent a global economic shock that may (likely) come from reversing the mass liquidity deluge of the past two years (if not 14 years, post Global Financial Crisis)? 
 
You keep the liquidity pumping from a part of the world that has a long-term structural deflation problem, and that has the biggest government debt load in the world (exception, only Venezuela).
 
The Bank of Japan, in this position, can be buyers of foreign government debt (namely the U.S.) to keep our market rates in check (keeps the world relatively stable), which gives the Fed breathing room on the rate hiking path.  
 
And Japan’s benefit?  The world gives Japan the greenlight to devalue the yen, inflate away debt and increase export competitiveness (through a weaker currency).  They hit the reset button on an unsustainable, debt-laden economy.   
 
My view:  It all looks like global central bank coordination.  And this BOJ decision overnight may have lifted the clouds that have been hovering over markets the past few months.  We will see. 
 
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April 27, 2022

We talked yesterday about the warning signals in the currency markets.  Today the euro may have officially joined the tumult.
 
We came into last weekend’s French election with risk of a crumbling of the euro, and a sovereign debt crisis in Europe, if Le Pen would have won (the anti-globalization, anti-EU candidate).
 
She lost.  And yet the euro has done this …   

This yellow line in the chart represents the trend from the inception of the euro in 1999.  The line has broken. 
 
The euro has now lost 7% against the dollar, since the beginning of the year, and a sharper decline looks to be in the early stages.  The yen has lost 12% in a little more than a month. 
 
Almost every currency (except the Brazilian real) has lost, and continues to lose, meaningful value against the dollar. 
 
Here's where this gets very interesting …
 
Through much of the past two years (the pandemic period), the change in the relative value of currencies has been very mild, if not uneventful. 
 
Meanwhile, the massive global policy response to covid created devaluations in paper currencies (collectively) against pretty much everything (goods, services, hard assets, financial assets … everything).
 
As we know, this translates into "inflation," which on its own, is lowering the global standard of living. 
 
That's about to intensify.
 
Consider this:  The dollar index (the dollar measured against a basket of major currencies) is up 14% from this time last year.  The price of oil is up 69% during the same period.  Guess what oil is priced in?  Dollars.
 
Guess what else is priced in dollars?  Pretty much every other important commodity in the world (food, energy, metals). 
 
This is why the value of the dollar tends to have an inverse relationship with the price of commodities.  That inverse correlation gives stability to global buying power.  But that relationship has broken down in this current environment.
 
The rising dollar, coinciding with rising commodities prices, is destroying the affordability of necessities across the world.  Remember, last month we talked about a "coming food crisis" (you can review that note here).  This is a formula for it. 
 
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April 26, 2022

The Fed meeting is a week away, and the markets are coming unhinged. 
 
It's not just a decline in stocks, but there are warning signals in the currency and interest rate markets — something isn't right.
 
As we know, the Fed is way behind in the inflation fight.   The Fed Funds rate (the short term interbank lending rate, which they set) is 825 basis points below the rate of inflation. 
 
History tells us, to stop this rate of change in prices, the Fed has to ratchet up the Fed Funds rate to exceed the rate of inflation.  Not only do they have a long way to go, but they have publicly played the denial game on what it will take to bring inflation under control.  
 
They've set expectations that it will be a shallow rate hiking cycle (ending somewhere under 3%). 
 
That's a bad way to manage inflation expectations.  And that's a big deal, for this reason:  When people expect more inflation, they tend to behave in ways that promote more inflation (i.e. buying today, what they expect to be more expensive in the future).  
 
Add to this, the Fed has told us that they will be shrinking the balance sheet, starting next week.  This means they will be withdrawing liquidity from the economy ("quantitative tightening"). 
 
But as we've discussed, we have no record of this working.  We don't have an historical reference point of a successful exit of QE.  Not for the Fed. Not for any other central bank.
 
For the reference points we do have, we find that unforeseen consequences arise, and central banks are forced to respond with … a return to quantitative easing.
 
With all of this in mind, I posed this question last week:  "Will the Fed even get the opportunity, this time, to start the process of "normalizing" the Fed balance sheet (i.e. quantitative tightening)?"
 
The answer is looking more and more like, "no."
 
As we discussed last week, the interest rate market is sending warning signals
 
The 30-year mortgage rate is trading at the widest spread to the 10-year yield, since the March 2020 pandemic-induced economic shutdown.  Prior to that, the last time we had seen this wide of a spread was when IndyMac failed in July of 2008 (and the subsequent global financial crisis).
 
Now the currency market is also sending warning signals
 
With the prospect of rising rates in the U.S., global capital is moving into the dollar.  But there seems to be more to it.  The dollar is broadly very strong.  In the past week, China has devalued its currency by 3% against the dollar.  The Japanese yen has lost 12% of its value, relative to the dollar, in the past month.  The Brazilian real has lost 8% in three days.  Something is amiss, and it may be a dollar shortage within the global financial system. 
 
Remember, as we discussed earlier this month, back in 2019, after spending eighteen months shrinking the balance sheet (2017-2019), the Fed quietly started reversing course (back to QE) — due to "strains in the money market."   Things started breaking.
 
Are we, again, seeing cracks (this time, before the Fed even gets started)?   
 
As I've said, we have a better chance of seeing more Fed (and global central bank) intervention in markets, rather than less.  
 
And it may ultimately come in the form of resetting global debt, and a new monetary system — and maybe soon. 
 
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April 25, 2022

The election results in France on Sunday provided continuity for the globally coordinated social and environmental agenda.  That was good for the stability of the European Union, and the euro.  And it should have been positive for broad market stability. 
 
But, then we had this other big issue looming as we headed into the weekend:  China. 
 
China has been devaluing the yuan (their currency) in a way that looks very similar to August of 2015.  And they made the biggest adjustment (weakening the yuan) last night.  And the central bank in China cut the reserve requirement ratio, to encourage lending and borrowing.
 
So, the developed market world (led by the Fed) is tightening money.  And China is easing.
 
Why?
 
Because the Chinese government is locking down their economy again. 
 
It started late last month, has worked its way through Shanghai, and now it looks like they will lock down Beijing.
 
We are seeing similar imagery to what was being circulated through global media/social media back in January and February of 2020.  It was propaganda, and it worked to spread fear throughout the world.  Like last time, we are seeing (again) images of authorities in hazmat suits "disinfecting" the streets, and (this time) barriers erected around residents to keep them in.
 
The promoted policy being enforced by the Chinese Communist Party is "zero covid."
 
Let's hope the political leaders in the developed world don't attempt to follow China's lead again on this one (i.e. "zero covid"). 
 
However, as we discussed last month, when the lockdowns re-started in China, the market behavior suggested that investors believe there is political appetite for more lockdowns (in the Western world). 
 
At the depths of the decline today, the stocks that were UP were stocks that thrive in a lockdown:  Zoom ended up finishing the day up 2.2%.  DoorDash was up 3.4%.  Roku was up 4.1%.  And Docusign finished up 4.3%. 
 
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