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November 7, 2022

Ahead of tomorrow’s midterm elections, the odds continue to heavily favor a power shift in Congress, with a 70% chance of a Republican sweep of the House and Senate (according to the betting markets at PredictIt).

The notable market mover in the past two sessions has been the dollar, lower.

Let’s take a look at the dollar chart …

The dollar was down 1.9% on Friday. It was down another half a percent today.

As you can see in the chart, Friday has some interesting recent comparables — both big central bank intervention days.

If we zoom out five years, we find that Friday was the biggest down day in the dollar on this chart.

This five-year look at daily change in the dollar index includes the massive fiscal and monetary response to covid lockdowns. And it includes the very contentious U.S./China trade war.

So what could trigger a bigger dollar decline on Friday, than all of the events mentioned above?

Was it anticipation of gridlock in U.S. Congress and therefore an end to the excessive fiscal spending, which softens the inflation and rate outlook?

Was it the Friday's jobs report, which showed some weakness, and could give the Fed reasons to slowdown or pause on rates in December?

Was it Xi's speech at the China International Import Expo on Friday, where he said China remained committed to opening up to the outside world? It's global supply positive (helps with supply related inflation pressures). And it's global growth positive, which could reverse some of the flight to safety that has been driving the dollar higher.

Maybe all of the above have contributed to this move in the dollar, which looks like maybe early stages of a trend change (to lower dollar).

Pro Perspectives 11/4/22

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November 4, 2022

Stocks had a good day. Commodities had a big day (aligning with a big move lower in the dollar).

And the U.S. yield curve steepened, which is generally associated with a more optimistic view on the economy.

What happened?

My view: Part China. Part mid-term elections looming.

China: President Xi is now a couple of weeks into his unprecedented third term. And overnight, at China's International Import Expo, his opening ceremony address was entitled: "Working Together for a Bright Future of Openness and Prosperity."

He said, China remains committed to "opening up to the outside world." This is big news (near term), especially if it implies that Xi will begin prioritizing economic growth over covid prevention.

The speech was full of language suggesting China wanted to play nice in the world for "mutual benefit," working with "all countries" to share the opportunities from "deepened cooperation."

It's global growth positive. And as a signal, Xi (the PBOC) strengthened the yuan on the day (which they control).

A stronger yuan is counter to their economic interest (and policy), where they like to manipulate a weak currency to drive exports. So, again, a stronger yuan on the day was intended to signal alignment to with Xi's speech.

U.S. Midterms: Remember, post-midterm elections, regardless of the outcome, are historically good for stocks.

Bancorp did a study on this: Looking back to 1962, stocks (S&P 500) in the 12-months following a midterm election had an average return of 16%. That's double the long-term average return. And over these fifteen data points observed (over 60 years), ALL had positive stock market performance for the twelve-month period following the midterm election.

Pro Perspectives 11/3/22

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November 3, 2022

Following yesterday's Fed meeting, the 10-year yield is trading well above 4% again.

Rising U.S. yields, on the expectations of higher Fed rates, strengthens the dollar, and drags global interest rates higher — both of which create strains in global sovereign debt markets.

As you can see in the chart, this area for U.S. yields has, in recent history, resulted in damage, and (related) central bank intervention.

Now, with this, and with a very high stakes election coming next week, let's talk about what has taken the world's most influential interest rate market to this damaging 4%+ level.

Remember, it was only three months ago that the Fed raised the short term rate to 2.5%, and in the post-meeting press conference, Jerome Powell called that level "neutral" (i.e. not accommodative nor restrictive of economic activity). And he said they would no longer "guide" on policy, but take things meeting by meeting, dependent on the data.

That was the stopping point for rates.

What happened? Before the day ended, the Democrat-controlled government demonstrated that getting their agenda done was a higher priority than securing economic stability (much less prosperity).

They countered the Fed's inflation fight, by pouring more fuel on the inflation fire. They went on a $1.5+ trillion spending binge over the following month. That forced the Fed back on the offensive.

Again, among many other reasons, the opportunity to de-seat Democrat power in Congress makes this election very high stakes. With a flip in the House and the Senate (both of which are projected), the Republican-led Congress can go to work dismantling some of this spending. That would cool the inflation outlook, and take pressure off of the Fed.

Pro Perspectives 11/2/22

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November 2, 2022

In the September Fed meeting, the expectations were set for another 125-150 basis points of rate hikes by year end.

The Fed followed that meeting with a very active media campaign, where they told us, on a daily basis, that they would do whatever it takes to slay inflation.

So, coming into today's Fed decision, the expectations were set for another 75 basis point hike. The Fed delivered on that.

And coming into today's Fed decision, the interest rate market was pricing in about a coin flip chance of another 75 basis point chance in December.

By the end of today, markets are pricing in a better chance at 50 bps for December. That's somewhat less severe.

If we were looking for positives from the Fed commentary today:

1) The Fed statement acknowledged the, yet to be felt, cumulative effect of 375 basis points of tightening on economic activity and prices (i.e. the rate hikes have a lagging effect).

2) They acknowledged that financial conditions are tighter, due to their policy actions.

3) Powell acknowledged that inflation expectations are still well anchored. Of course, this is what the Fed cares most about, as losing control of inflation expectations can quickly result in consumers pulling purchases forward, with the idea that prices will be higher tomorrow. And thus, a price spiral. But inflation expectations have been tame, mostly attributed to the Fed's threats to economic activity and to financial market health.

So, these three points are all quite positive, especially given that the monthly inflation readings over the past three months have come in tame.

There is a clear case for "mission accomplished." Sit and watch.

Still, the Fed continues to err on the side of overtightening, and they want us to know it.

On the negative side for stocks and the economy today, Powell intentionally wanted to hammer home four points:

1) They have more "ground to cover" on rates.

2) They think they will get to a higher level on the Fed Funds rate now, than they forecast just two months ago.

3) Powell made an effort to include in his "off-script" Q&A session that he thinks "it's very premature to think about pausing (on rate hikes)." Emphasis, very.

4) And, he says they are committed to bringing inflation down (erring on the side of overtightening).

Now, with all of the above in mind, remember the Fed, largely, set these expectations back in September.

And as we've discussed, more important, at this stage, is what happens next Tuesday.

The betting markets continue to price in a better than 70% chance of a Republican sweep of Congress.

In that scenario, the spigot on any additional fiscal spending would be closed. Moreover, the inflationary policies that have already been approved (including Build Back Better/IRA) would be challenged. If that plays out, the Fed would find themselves in a position where they have overtightened, already.

Pro Perspectives 11/1/22

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November 1, 2022

We the Fed decision tomorrow, let's take a look at the most recent inflation data, which they are supposed to be "dependent" upon for making policy decisions.

Here's a chart of the consumer price index. This is the "headline" number, including food and energy. And it's from this index that the big 8%+ number is calculated (current, compared to the same period a year ago).

Notice the consumer price index has flattened since June (i.e. very little inflation). Also notice the levels from a year ago, which the current CPI reading is being measured against.

The takeaway: Even if inflation flat-lined from here, it would be many months before the year-over-year inflation number dropped materially. In fact, if CPI flat-lined, it would be February before the headline number would drop below 5%.

But if the Fed is executing policy to slow the rate-of-change in prices, the Fed should be concerned about the recent rate-of-change, not the change relative to last year's price. The recent data should give them information on whether or not their policies are working.

With that, if we look at the monthly change in prices, over the past three months, it has been tame. July was 0%. August was 0.1%. And September was 0.4%. That's a three-month average of 0.2%.

If you woke the Fed up today, and told them inflation was running at a 0.2% three-month average (annualized at less than 2.5%), they would be doing nothing with interest rates.

Pro Perspectives 10/31/22

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October 31, 2022

It’s Fed week.

We’ll hear from Jay Powell and company on Wednesday.

The market has priced in a 75 basis point hike. That would bring the effective Fed Funds rate to just above 3.75%.

From there, the interest rate market is pricing in a coin flip chance between 50 bps and 75 bps at the December meeting.

That could get the Fed Funds rate to 4.5%.

Remember, it was their last meeting, in September, where they created the expectations for this, and did so through their “survey of economic projections” (SEP). These are forecasts made on the economy, by each board member and each regional Fed President (total of 19 forecasts).

Here’s a look at how these Fed officials presented the outlook in the September meeting…

Let’s focus on the Fed Funds rate projection (circled in yellow). This was revised UP a full percentage point.

That projected an additional 125 and 150 basis points of tightening by year end. It’s that aggressive posturing by the Fed that sent the interest rate markets in an upward spiral (not just domestic markets, but global).

They went a step too far with the tough talk/ restrictive forward guidance.

And with that, we found the uncle point for the global financial system.

The UK government bond market broke, and required a rescue from the Bank of England. Stocks made new lows on the year. The dollar made new highs on the year, and then the Bank of Japan was forced to intervene, to defend the value of the yen against a strong dollar (which is driven by the U.S. rate outlook).

With all of this going on, both the Australian and Canadian central banks responded with smaller than expected rate hikes in their respective October meetings. They balked.

So, back to the Fed. Given the exposed fragility in the global financial system to the current level of market interest rates, will the Fed pull the trigger on another 75 basis points this week? Probably, but the treasury market has that rate increase more than priced-in (and consumer and mortgage rates do too, as they are based on treasury rates).

The big questions: Will the Fed acknowledge: 1) the rate sensitivity that has been exposed in the financial system, 2) the cooling inflation picture, and 3) the likelihood of a (less inflationary) fiscally conservative change in Congress coming? Let’s hope so. If so, the market will dial down (maybe dramatically) the rate outlook for December. Rates will go lower, the dollar will go lower, stocks will go higher, the stability will improve.

For perspective on just how “aggressive” the Fed talk is, versus what they really expect, let’s take a look at what the Fed’s long-run forecast for rates looks like now (in these Fed projections), relative to the past 10 years.

Notice that in the very low inflation environment of the past decade, where deflation remained a bigger risk than inflation, the Fed’s projection for the long-run level of the Fed Funds rate was not only higher, but much higher than the current long-run projection (which is just 2.5%).

Does this reveal the Fed’s true view, that after ballooning of government debt (globally) there is a very low ceiling on where rates can go (given debt servicing and financial system risk)?