Pro Perspectives 4/4/24

 

 

 

 

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April 04, 2024

We've been watching this big trendline in stocks. 
 
 
As we've discussed here in my daily notes, this nearly perfect 45 degree angle ascent of the world's benchmark stock market (proxy for economic and geopolitical health and outlook) originated from late October commentary of Fed Chair Jerome Powell, when he signaled the tightening cycle was over. 
 
Since then, the market has gone from anticipating a change for seven quarter-point rate cuts this year, to five, to three.  Meanwhile the Fed has telegraphed three cuts, with some members chattering about the possibility of two, then one.  And today, from non-voting member Neel Kashkari, he suggested maybe none/zero rate cuts this year.
 
That comment from Kashkari hit the wires at a little after 1:00 today. 
 
Stocks did this …
 
 
Remember, from the first chart, stocks have risen nearly 30% since late October, despite the dramatic curtailing of rate cut expectations.
 
With that, there was another headline that hit a little after 1:00 this afternoon. 
 
 
Here's how Bloomberg interpreted it …
 
Markets will ignore domestic political infighting and geopolitical posturing until markets don't. 
 
This communication from the White House, describing the takeaway from a phone call between Biden and Netanyahu may be the tipping point — threatening a policy shift on Israel is a wakeup call for markets.
 
Stocks immediately sold off.  Yields ended lower.  Gold spiked.  The market response was broad-based risk aversion. 
 
But there was more.  Shortly after the White House headline on Biden/Netanyahu, in the daily White House Press Briefing, the White House Security Communications Advisor, John Kirby, fielded questions on Bidens call yesterday with Xi Jinping. In doing so, he said Biden was clear, in that "nothing has changed about our One China policy, we don't support independence for Taiwan."  I was watching it live.  So much for "strategic ambiguity."
 
Also this afternoon, the Secretary of State, Antony Blinken was at NATO headquarters, and said that "Ukraine will become a member of NATO," which is an affront to Putin's 2021 security ultimatum.
 
With these headlines this afternoon out of the U.S. administration, the world became more dangerous.  And just like that, the nuance surrounding tomorrow's job report, and rate cut timing becomes less important for markets.    
 

Pro Perspectives 4/3/24

 

 

 

 

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April 03, 2024

The climb in commodities prices continued today.
 
Let's take a look at the price of gold.
 
It traded above $2,300 this afternoon.  It's up 13% over the past 24 trading days.  Let's take a look at prior moves of this magnitude in the pandemic/post-pandemic environment.
 
 
As you can see above, gold had a move of similar magnitude in mid-April of 2020, in late July of 2020 and in March of 2022.
 
What was going on?  Inflationary policy.  These 2020 dates were pandemic response related.  Specifically, these spikes in gold align with the fiscal response — more specifically, government putting cash in the hands of citizens (checks, unemployment subsidies and the "Paycheck Protection Program).
 
The next spike?  The unemployment subsidy was due to expire (end of July), and was re-upped. 
 
The gold spike in March of 2022:  Inflationary policy.  Russia had invaded Ukraine.  Inflation was already nearing double-digits, thanks in part to supply chain disruption, but mostly to the multi-trillion dollar fiscal response to the pandemic. 
 
Adding fuel to the inflation fire, while the clean energy agenda was already curtailing energy supply, Congress responded to Russia with threats to place sanctions on Russian energy exports.  
 
That brings us to the current spike in gold.  Gold tends to be the global safe haven asset, where global capital flows in times of heightened geopolitical risk.  And gold is the historically favored inflation hedge.
 
That said, geopolitical risk and related uncertainty have become a constant, but these extreme moves in gold tend to be better aligned with episodes of overt fiscal profligacy (devaluation of the money in your pocket).  In this current case, perhaps the catalyst is the $7.3 trillion budget that Biden revealed early last month — an egregious 6% deficit spending plan in a economy that's growing at a 3% annual rate, with an already ballooning record debt.

Pro Perspectives 4/2/24

 

 

 

 

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April 02, 2024

We've started the second quarter of the year with a move up in global government bond yields, up in commodities prices, and down in stocks.
 
This start of the second quarter coincides with the beginning of the new fiscal year in Japan.  And as we've discussed in recent weeks, the Bank of Japan recently "began the end" of its role as the global liquidity backstop/support to Western world economies.
 
They raised rates, ending negative interest rates in Japan. 
 
They ended ETF purchases (exchange traded funds).  This was the Japanese central banks explicit involvement in, not just Japanese equity markets, but global equity markets — via ETFs. 
 
They ended yield curve control.  And by the design of that policy, in order to defend the upper limit of the 10-year Japanese government bond yield, they had the license to buy Japanese bonds in unlimited amounts (which pushed bond yields down). Those bonds were bought with freshly printed yen, which finds its way into foreign asset markets (like Western world government bond and stock markets).
 
With the above in mind, as we've also discussed in recent weeks, this move by the Bank of Japan may afford global central banks (led by the Fed) less leeway to hold rates too high, for too long — with the risk of global liquidity swinging in the direction of too tight (i.e. a liquidity shock). 
 
That (risk) includes the potential for rising government bond yields, which we are getting — the 10-year yield has jumped as much as 20 basis points to open the quarter …
 
 
The pop in rates is putting pressure on stocks.  And the S&P futures are testing this big trendline, after a 29% run-up from the late October lows (when Jerome Powell signaled the end of the tightening cycle) …
 
 
Add to this trendline test, yesterday the S&P futures put in a technical reversal signal (an outside day).  So did the Russell 2000.  So did the Dow.  And the German stock market (DAX futures) did the same today. 
 
So, this looks like a set up for some more weakness in stocks, as we head into this Friday's big jobs report.  Remember, the Fed is watching the job market "carefully" for "cracks" as a condition to start the easing cycle.  
 
Meanwhile, commodities are breaking out. 
 
Is it demand driven, given the outlook on the technology revolution? 
 
Or are commodities (finally) repricing against fiat currencies, now that the BOJ has signaled the final exit from the global central bank money printing era, which has delivered record (and unsustainable) global government debt.  
 
Maybe a bit of both. 
 
The chart below is silver.  We have a technical breakout.  It was up 4% today …  
 
 
We have a breakout in copper …
 
 
We have a breakout in crude oil …
 
 
And gold is making new record highs by the day. 

Pro Perspectives 4/1/24

 

 

 

 

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April 01, 2024

The Fed's favored inflation gauge was reported this past Friday morning (February PCE).  
 
Of course, markets were closed for Good Friday.  And with markets closed, it created the potential for a Sunday night reaction to the data in what is a very illiquid time for the futures markets.  
 
Probably no coincidence, hours after the PCE data, the Fed Chair was sitting on a stage at a San Francisco Fed conference for an interview on monetary policy.
 
The first question he was asked, was on the morning's inflation report. 
 
His response: "Pretty much in-line with expectations."
 
As you can see in the chart below, despite all of the hand-wringing on the inflation data, the path has been clear, and the target is nearly achieved. 
 
Arguably, as the pace of disinflation has slowed, it has created the perfect scenario for the Fed to sit and watch.  Inflation is low, and despite the highly restrictive policy stance of the Fed, the economy remains good (despite being throttled) and the job market remains solid.
 
This scenario actually plays into the Fed's historical policy making tendencies/preferences, which is reactive, not proactive.  
 
And as we discussed last week, Jerome Powell happened to lay out some conditions in his post-FOMC press conference last month, that would warrant a Fed reaction: 1) unexpected weakening in the labor market, 2) the continued trend of falling inflation, toward the target and/or 3) any stress bubbling up in money markets (i.e. a liquidity shock).
 
So, with the Fed Funds rate nearly 300 basis points above the rate of inflation, the Fed has restocked the ammunition (to stimulate or protect downside risks with rate cuts), and now can respond to any negative event, or deterioration in the economy (or markets).
 
This is a Fed stance that markets are very familiar with, unlike the stance throughout the tightening cycle, where the Fed was explicitly trying to bring demand down, trying to destroy jobs and was happy to see a weaker stock market (the latter, to help achieve the former).
 
As we discussed last week, the evolving current stance looks like a return of "the Fed put."  

Pro Perspectives 3/27/24

 

 
 

 

 

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March 27, 2024

The stock market rally broadened today, with the equal-weighted S&P 500 and the Russell 2000 (small caps) leading the way.  Importantly, this represents broader stock market strength.

As we discussed in my note yesterday, the Fed’s Financial Conditions Index had a turning point in October, from an historically tight level.  That turning point was triggered when Jerome Powell verbally signaled the end of the tightening cycle.

And as we also discussed yesterday, turning points from levels of historically tight financial conditions, have been good for stocks in the subsequent 12-month period — especially for small caps.

With that, as the major U.S. stock market indices have been routinely making new record highs, the proxies for broader stock market confidence and demand have been lagging.  The equal-weighted S&P 500 printed new record highs earlier this month (finally recovering the losses of the past two years).

But the Russell 2000 (small caps) remains 15% away from the 2021 record highs.

 

We’ve talked about the opportunity for small caps, the laggards, to catch up to the performance of the major indices.  The good news, today the Russell traded to the highest level since January of 2022.

With the P/E on the S&P 500 running north of 20, which is historically high, there remains plenty of deeply undervalued stocks for investors to suss out.  That bodes well for this chart above to continue narrowing the losses against its 2021 record highs — and to narrow the divergence in this chart …

For my AI-Innovation Portfolio members, please keep an eye out for a note from me tomorrow morning.  We will be making a new addition to the portfolio.  If you are not a member, you can join us here. 

 

Pro Perspectives 3/26/24

 

 
 

 

 

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March 26, 2024

Yesterday we talked about the Fed’s overly tight policy stance, and the downward pressure it puts on the economy.  And related to that, we looked at the recent percentage point decline in the Atlanta Fed’s Q1 GDP projection.

With that, let’s revisit the Fed’s new financial conditions index, which gauges the impact of financial conditions on future economic growth.

They just made an update to the index last week.  Let’s take a look …

Remember, this index is designed to incorporate the lags of monetary policy, and project (in this case) one-year forward what the impact will be on real GDP growth.

If the line is above zero, it’s a drag on growth (restrictive policy).  If it’s below zero, it’s a boost to growth (stimulative policy).  As you can see to the far right of the chart, it’s still projecting a drag on growth one-year forward. 

They introduced this “new” index back in June, and Jay Powell included a footnote directing attention to this index in a speech he made back in early December.  We discussed it in my December 4th note (here) and stepped through some analysis of the turning points of the index, and the subsequent return on stocks.

Here’s a revisit of that analysis: 

1) Financial conditions were at historically tight levels, as you can see in the chart above (“Oct ’23”).

2) Each of the periods in the chart that shared the characteristic of “historically tight levels,” were soon followed with some form of Fed easing (either rate cuts, QE, or in the case of 2015-2016 – walking back on projected rate hikes). 

And, 3) in each of the turning points in financial conditions, denoted in the chart, stocks did very well in the subsequent 12-month period — and small caps outperformed. 

     

 

 

Pro Perspectives 3/25/24

 

 

 

 

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March 25, 2024

Let's revisit Jerome Powell's comments last week on the employment situation.
 
Remember, the Fed has a mandate from Congress to achieve price stability AND maximum employment. 
 
With that, they've recently started acknowledging that the pursuit of the former (at this stage), might create a problem with the latter (job losses).
 
And that's because of this chart …
 
 
This chart above shows the current level of the Fed Funds rate in purple (where the Fed has set the short-term benchmark rate).  And it shows the most recent inflation reading in orange (January PCE). 
 
Remember, the difference is the "real" interest rate (Fed Funds rate minus inflation).  And that real interest rate is at historically high levels.  So the Fed continues to put downward pressure on inflation and on economic activity.  And with the Fed keeping rates steady, as inflation has been falling the real rate has been rising, which means the Fed has been getting tighter and tighter (i.e. more downward pressure on inflation and the economy).
 
On a related note, the Atlanta Fed's Q1 GDP projection has been adjusted down by over one percentage point over the past few weeks (the green line in the chart below).  And as we know from the most recent jobs report, the unemployment rate ticked up in February.   
 
 
So, what did Jerome Powell say last week about the employment situation? 
 
He said, "unexpected weakening in the labor market could warrant a policy response."
 
So that's a condition to start rate cuts.  And, as he said, they are monitoring "very, very carefully" … for "cracks."    
 
What's another condition?  The continued trend of falling inflation, to satisfy the Fed's need for "confidence" that the stair step toward 2% remains intact.  With that, we get another inflation report this Friday (February PCE). 
 
What's another condition?  Any stress bubbling up in money markets as they try to navigate the end of quantitative tightening, and the level of reserves to be left in the banking system.  As Powell admitted, the last time they tried this (2018-2019), they triggered a liquidity shock, and returned to easing.
 
So, the Fed has a 300 basis points of restrictive cushion, should inflation remain sticky at current levels.  But the longer the duration of restrictive policy, the more likely the employment situation deteriorates, which triggers Fed action.
 
This is looking like the return of the Fed put.    

Pro Perspectives 3/21/24

 

 

 

 

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March 21, 2024

The Bank of Japan's move on Tuesday was the beginning of the end of its role as the global liquidity backstop/support to Western world economies.  And with that, as we discussed, global central banks may now have less leeway to hold rates too high, for too long. 
 
That said, although the Fed didn't budge on policy yesterday, Jerome Powell did say (twice) that an "unexpected weakening in employment would warrant a policy response."  And he did discuss the strategy to end quantitative tightening, and the related risks of liquidity problems — and he voluntarily brought up the 2019 cash crunch, where the Fed's first ever attempt at quantitative tightening induced a liquidity shock.
 
So, if there was any doubt going into the Fed meeting about whether or not the Fed was entertaining the idea of another rate hike, there should be no doubt now. 
 
And if there were doubt on whether or not this easing cycle would materialize, there shouldn't be now.  Why?  Because the easing cycle was kicked off this morning in Switzerland.  In a surprise move (for markets) the Swiss National Bank cut rates by a quarter point. 
 
As we've discussed here in my daily notes, the major central banks of the world have 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 now all (exception Japan) have interest rates set ABOVE the rate of inflation (restrictive territory).
 
And they will 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).

Pro Perspectives 3/20/24

 

 

 

 

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March 20, 2024

Earlier this month, we talked about the takeaways from Jerome Powell's semi-annual testimony on Capitol Hill, and from the surrounding media-tour chatter from Powell's colleagues.  
 
The Fed seemed comfortable not messing with an economy that was doing well, despite a Fed Funds rate north of 5%.
 
After today's Fed meeting, that seems to remain the case. 
 
Interestingly, they made some tweaks to their December Summary of Economic Projections.  After undershooting on growth all of the last year, by a lot, they dialed UP growth estimates (through 2026).
 
They see employment remaining strong, and inflation getting to target ("over time"). 
 
Take a look at this highlighted area …
 
  
These projections suggest the economy will be stronger, without stoking inflation, all while the Fed will be tighter than they thought just three months ago.  As you can see, they've revised up the Fed Funds rate for 2025, 2026 AND in the longer run. 
 
What would explain this?  Maybe the productivity boom that is underway yet continues to be a topic the Fed is bizarrely quiet about.
 
As we've discussed, generative AI might be the productivity enhancing technological advancement of our lifetime.  Hot productivity gains promote wage growth (which we're seeing), which is needed to reset wages to the increased level of prices (which restores quality of life). 
 
It can do so without stoking inflation, and that formula is playing out.
 
As for economic growth, Jerome Powell himself, presented back in 2016, on productivity growth as a driver of the long-term potential growth rate of the economy.
 
Let's take a look at some charts …  
 
 
Heading into this Fed decision stocks have continued to hug this trendline, which originated from October, when Jerome Powell verbally signaled the end of the tightening cycle (similar line for Nasdaq) — and we finish on new record highs (again).
 
This "end of the tightening cycle," has been just that, to this point — no easing.  But today, Jerome Powell introduced the coming taper of quantitative tightening.  
 
What does that mean?  They will slow the reversal of the Fed's balance sheet.  And they will slow it "fairly soon" he says, making steps toward stopping/ending QT. 
 
This first step will slow the decline of the line in the chart below, slowing the extraction of liquidity from the economy.
 
      
As we discussed yesterday, the Bank of Japan has played the critical role of global liquidity provider the past two years (the liquidity offset to the Western world's liquidity extraction/tightening policies).  And they just made the first step toward exiting this role. 
 
With that, it is perhaps no coincidence that the Fed is ready to wind down the liquidity extraction.  Jerome Powell has the scars of 2019.  After the Fed spent nearly two years draining liquidity from the financial system (quantitative tightening), they created a cash crunch (a scramble for dollars in the interbank lending market). 
 
The pendulum swung from too much liquidity, to too little. 
 
And the Fed was forced to pump liquidity back into the financial system, and at a record rate (i.e. a return to QE).
 
With that in mind, the notable charts of the day were the dollar, which put in a bearish technical reversal signal … 
 
 
And commodities, led by gold, which may make new record highs tonight … 
 
 
 

Pro Perspectives 3/19/24

 

 

 

 

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March 19, 2024

Overnight, the Bank of Japan declared victory over three decades of deflationary pressures.
 
They think they will achieve "price stability" (two percent inflation target) toward the end of the year.
 
With that, they raised rates, ending negative interest rates in Japan. 
 
They ended yield curve control, a seven-year old policy that gave the BOJ a license to do unlimited asset purchases whenever the 10-year government bond yield traded to the high of its stated ceiling. 
 
And they ended ETF purchases (exiting the BOJ's explicit involvement in, not just Japanese equity markets but global equity markets — via ETFs).
 
These are big and bold moves for a central bank that has been the (important) global liquidity provider of the past two years. 
 
Remember, the BOJ continuing ultra-easy policy (including QE), as the rest of the world was tightening, was the only way the major central banks around the world were able to raise rates to combat inflation, without losing control of their respective government bond markets (i.e. runaway yields).  And runaway government bond yields, at record government debt levels, are a recipe for global debt defaults.    
 
So, the Bank of Japan was (had to be) pumping liquidity, as Western central banks were extracting liquidity.
 
With that, this scrapping of emergency policies by the BOJ comes with risks.
 
We will see how it plays out.  For now, the Japanese 10-year yield went down, not up — the yen went down, not up. 
 
They stopped buying stocks, and yet Japanese equities went up, not down.
 
As you can see from this long-term chart of inflation in Japan, the visits to the target 2% area have been brief over the past thirty years.  Despite the wage increases in Japan, which they think will underpin inflation, disinflation has been the global trend since the middle of last year.  And high productivity rates (at least in the U.S.) have been successfully enabling wage growth, without inflation pressure.
 
So, a sustainable escape from deflation in Japan is highly questionable.       

 
 
As we know, the global rate hiking cycle is over for the rest of the world.  Global inflation is falling, and most central banks are in restrictive territory, and rate cuts are next.
 
With the BOJ's move, global central banks (led by the Fed) may now have less leeway to hold rates too high, for too long.   With global government debt at record levels, they need to ensure that government bond yields (borrowing rates) continue the path lower.