Pro Perspectives 4/8/22

April 8, 2022

We talked yesterday about the path to perpetual quantitative easing. After all, we’ve yet to see an example of a successful exit.

Already, just as the European Central Bank (ECB) is projecting rate hikes later this year, and is ending its emergency pandemic bond buying program, there was news from Bloomberg today that the ECB is, at the same time, formulating a plan to prevent a spike in sovereign bond yields in the weaker spots of Europe — with what is likely, more QE!

Let’s talk about why?

Back in 2012, yields on Spanish and Italian sovereign debt had skyrocketed to unsustainable levels, which put two of the biggest countries in the eurozone on default watch, which threatened the dominoes to fall in Europe (a cascade of sovereign debt defaults), and a collapse of the euro (the monetary system).  It was an ominous moment, threatening the disintegration of the euro and euro zone.

But ECB chief (at the time), Mario Draghi, made the threat to do ‘whatever it takes.’ He threatened to buy unlimited Italian and Spanish debt.

Draghi’s threat put in the top for yields, without the ECB having to buy a single bond.  Within two years, yields on Spanish debt fell from almost 8% to 1%.  A European collapse was averted.

Fast forward to today:  the ECB is exiting its pandemic-induced QE program, and scaling down a QE program they’ve been running since 2014.  But there is trouble brewing.

The French election polls show Marine Le Pen closing in on Macron.   Le Pen is a nationalist, and is anti-euro (the single currency).  A Le Pen win would set back into motion (again) the threat of a disintegration of the euro.  And again, crisis policies would be back.  Not just for the European Central Bank, but global central banks.

Again, this leads us back to the conversation of more control and intervention by central banks over markets – to plug new leaks in the global economic system.

QE is Hotel California.  And it highlights the eventuality of a reset of global debt, and a new monetary system.  It’s coming, and it’s coming soon.

On that note, as we’ve discussed, the central bankers and politicians have been telegraphing a monetary system that includes a move to a digital dollar (“central bank digital currencies,” in global coordination).

We had another shot across the bow this week.  Janet Yellen (Treasury Secretary) gave another prepared speech on “digital assets.”

This gets the crypto-enthusiasts excited, as they assume this means the government is taking steps toward accepting and legitimizing private cryptocurrency.  It’s precisely the opposite.  As Yellen said, “sovereign money is at the core of a well-functioning financial system.”

She went on to say how the history of money in the United States was littered with attempts at different forms of private money.  She says, it didn’t work, and they regulated it away.

She went on to say: “monetary sovereignty and uniform currency have brought the clear benefits for economic growth and stability.  Our approach to digital assets must be guided by the appreciation of those benefits.”

So, we have another clear warning for the private crypto market.  The government will regulate it away, and strengthen their monopoly on money through a “central bank digital currency.”

 

Pro Perspectives 4/7/22

April 7, 2022

Yesterday we talked about the history of the Fed's last quantitative tightening. 
 
After spending eighteen months shrinking the balance sheet (2017-2019), the Fed quietly started reversing course in late 2019.  By the time Jay Powell acknowledged it, in a prepared speech (in October of '19), they had already bought $200 billion worth of assets.
 
As we discussed yesterday, this was a response to what they called "strains in the money market."  Things started breaking.  And interestingly, the Fed refused to call the resumption of balance sheet expansion "QE."
 
That said, this stealth QE continued until the covid crisis hit, and then the Fed and all global central banks responded with:  more QE. 
 
What's the point?
 
We do not have a record of a successful exit of QE.  
 
And we don't have to look too far for evidence that QE may be the Hotel California of monetary policy.  "You can check out, but you can never leave."  The Bank of Japan, has been in some form of quantitative easing for the better part of the past twenty years.  What does it lead to?  The ballooning of debt.  Debt in Japan has ballooned to 260% of GDP.
 
So, if we consider that, is it even possible for interest rates in the U.S. to rise?  What do higher interest rates do?  They make government debt a lot more expensive to repay.  That means more borrowing (higher deficits) to service the debt.  And who ends up buying the debt?  The central bank. 
 
The former head of the central bank in India wrote a piece on this last August.  He estimates that every percentage point increase in interest rates will translate into a 1.25 percentage point in the fiscal deficit (as percent of GDP).
 
That brings me back to my note from last month, on what will likely be the next move by the Fed:  "Yield curve control" (managing market interest rates to stated target levels).
 
The Bank of Japan started it back in 2016, intervening in the interest rate market to manufacture their desired longer term interest rates. 
 
The Vice Chair of the Fed, Lael Brainard has been an advocate for yield curve control.  This would keep market interest rates from running away. But market interest rates are a market mechanism.  If explicitly suppressed in an already hot inflationary environment, inflation could run wild.
 
With all of this, we can see the path for global governments to justify a new monetary system (central bank-backed digital currencies).
A consortium of 63 global central banks has already promoted CBDCs as the "future of the monetary system." 

Pro Perspectives 4/6/22

April 6, 2022

The minutes from the March Fed meeting were released today, laying out  a plan for reducing the Fed's balance sheet.  Translation:  there will be less liquidity in the economy (tighter money).
 
Let's take a look at how we got here.

You can see above, the global financial crisis response included three iterations of QE, and resulted in the Fed adding $3.5 trillion in assets to the balance sheet.  And they were left with an economy that could barely muster 2% economic growth.  
 
Still, they tried to normalize rates and shrink the balance sheet (i.e. quantitative tightening or "QT").  From 2017 to 2019, they allowed about $800 billion of assets to mature.  You can see that framed in the box in the chart above. 
 
Guess what? 
 
By the end of 2019, the Fed was forced to restart QE.  Why?  Because the overnight lending market did this …
Here's how the Fed explained what happened (my emphasis) …
 
"Strains in money market in September occurred against a backdrop of a declining level of reserves, due to the Fed's balance sheet normalization and heavy issuance of Treasury securities."
 
So, the Fed was forced to rescue the overnight lending market (between the biggest banks in the country) because of an unforeseen consequence of balance sheet normalization.
 
With this in mind, the minutes today spelled out a plan to start allowing about 1% of the Fed's balance sheet to start "rolling off" (maturing, which equates to reducing the size of the balance sheet).  But they will gradually get to that size over a few months, "over a period of three months or modestly longer." 
 
That statement is telling.  Many are expecting some aggressive quantitative tightening.   But the Fed, surely, has very clear memories of the 2019 shakeup. 
 
It's important to understand that reversing the Fed balance sheet is an experiment, with outcomes unknown. 
 

Pro Perspectives 4/5/22

April 5, 2022

On January 5th, the minutes from the December Fed meeting spelled out exactly what Jay Powell had told us just weeks earlier in his (December) post-meeting press conference. 
 
What was the message? 
 
The Fed had set the table for a March liftoff in rates.  And they had contemplated a strategy for shrinking the balance sheet (i.e. quantitative tightening!).  
 
In this chart below of the S&P 500, you can see where stocks were, when this news hit. 
 
This reality that the Fed was going to become inflation fighters set off a broad sell-off.  It was largely led by the high valuation/ high growth stocks and the high growth/no eps stocks.  
 
Valuations began to reset for a world where a higher discount rate would be plugged into Wall Street models.  With that, the broad market forward P/E has since fallen from around 22x to 18x (still a bit above the long-term average P/E of 16x).   

Now, with all of that said, we have Fed minutes tomorrow. 
 
The minutes will be from the March meeting.  And we will learn what was said in the meeting that kicked off the inflation fight (i.e. the first post-pandemic rate hike).
 
On that note, we got some clues today from Lael Brainard. 
 
Brainard, who just months ago was up for the Fed Chair position (and has since been appointed Vice Chair), gave a well-scheduled prepared speech this morning.
 
What were the takeaways?   
 
On policy, she said "it's of paramount importance to get inflation down."  She said they will continue to tighten "methodically" through rate hikes.  And she said they will shrink the balance sheet "more rapidly" than they did in the previous recovery. 
 
The latter is not news. Jay Powell told us in December that they would be more aggressive in reducing the balance sheet in this hot economic recovery, with hot inflation (relative to the weak recovery, and weak inflation of 2017-2019… the previous period of quantitative tightening). 
 
What is surprising is that Brainard used the word "methodically."  Setting the expectation for autopilot like rate hikes doesn't do much to curtail inflation expectations.  
 
When Ben Bernanke was asked about the inflationary risks of QE, back in 2010, he said dealing with inflation is no problem.  "We could raise rates in 15 minutes." 
 
That kind of intermeeting large adjustment in rates would go a long way toward resetting the inflation trajectory — quickly.  So far, it doesn't appear that the Fed has given any consideration to it. 

Pro Perspectives 4/4/22

April 4, 2022

The banks will kick off earnings season next week.  They will be reporting on a quarter that slowed to an annualized growth rate of somewhere between 1.5% and 2%.
 
Let’s take a look at the trajectory of the growth projections over the past quarter.

We’ve heard a lot of “slowing economic growth” chatter.  You can see it in the chart.  If we look at the consensus from the economist community (the blue line), what started as an expectation for a little better than 3.5% growth, is now coming in closer to 2%.  
 
That looks anemic against the nearly 7% annualized growth in Q4.  But that was the book-end of the fastest growth since 1984.
 
For more perspective, if the Q1 growth comes in around where the Atlanta Fed and economists are projecting, it would be about in line with the trend levels of the decade that preceded the pandemic. 
 
That said, it doesn’t feel like a slowing economy.  This is not a weak demand economy.  This is an inflation thief economy.  Inflation is crushing “real” growth.  Conversely, we may very well have double-digit nominal growth this year.  As we’ve discussed, this is the “sprint on a treadmill” economy, where the economy is hot, yet it’s increasingly harder to maintain a standard of living.
 
Reference point?  If we look back to the inflation spikes of the early 70s and early 80s, nominal GDP grew by an annual rate of better than 10% during those periods. 
 
With that magnitude of inflated growth, our economy (nominal GDP) could balloon to $30 trillion economy within the next few years.
 
This is precisely what we talked about shortly after the government and the Fed fired the monetary and fiscal bazookas, to respond to the initial covid shut-down (back in March 2020).  They went unimaginably big, and with the intent of inflating growth, devaluing money and inflating away debt.  That initial response was probably enough to accomplish the mission.  But then the new administration had an agenda to execute, and continued to fire more fiscal bullets, in the name of “crisis.”  And they may not be done. 

 
We shouldn’t be surprised if we get another fiscal spend — the “Build Back Better” plan, packaged as a wartime response.
 
With that, nominal GDP would continue to float higher. 
 
As I said, this strategy of inflating growth and inflating away debt was always intentional/by design.  You can see that starting to reflect in this chart (to the far right). 

Pro Perspectives 4/1/22

April 1, 2022

We end the week, and open a new month and quarter, with the jobs report.
 
Not surprisingly, the data this morning showed a very hot labor market, and hot economy. 
 
Unemployment is 3.6%.  That's just a tenth of a percentage point away from pre-pandemic levels, which were 50-year lows.
 
The economy added 431k jobs.  That number will be revised higher by this time next month, as it has for eleven consecutive months. In fact, last year the labor department undershot the final payroll number, every single month, by an average of 158k jobs. 
 
Bottom line:  While unemployment is near record levels, the job growth every month is running just about as hot as it was last year, during the biggest "back to work" phase.
 
What about wage growth?   
 
Year-over-year wage growth was 5.6%.  That's a big number, and a big deal.  For much of the decade that followed the depths of the post-financial crisis, wage growth was stagnant, below 3%. 
 
Guess who wanted 3%+ wage growth as a driver for inflation, to assist in escaping the burdensome and dangerous deflationary forces? 
 
The Fed.
 
Now they have wage growth (a lot of it), and (still) 11 million unfilled jobs, with employers in a position of strength to continue commanding higher wages.  And they have every incentive to do so, as the cost of living has outpaced their wage gains.  
 
Again, what does the Fed tell us wage growth does?  It feeds into inflation.  This is known as a feedback loop.  More wage growth > more inflation > more wage growth … 
 
This should haunt the Fed.
 
Note for Billionaire's Portfolio members:  Our portfolio continues to perform very well (up 8.5% ytd, versus an S&P 500 that's down 5%). I'm still working through a portfolio update, with focus on how we are invested to take advantage of the increasingly important role of cyber security.  Please keep an eye out for that note in the next few days.
 
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Pro Perspectives 3/31/22

March 31, 2022

For the second time in four months, the President has announced a release of oil from the Strategic Petroleum Reserve (SPR).  
 
In this case, it's a big promise.  A million barrels a day for six months, or roughly 180 million barrels.  That's about a third of the U.S. SPR. 
 
Will it bring down oil prices?
 
Back in September, China released oil from its strategic reserve for the first time ever.  Oil prices went up, not down. 
 
Two months later, Biden issued an order to release 50 million barrels from the U.S. SPR.  The price of oil did very little that day.  But the next day, on the evening of Thanksgiving, the news of the Omicron variant hit the wires, and the price of oil (and most markets) fell sharply. 
 
Within six weeks, oil prices were higher.
 
What should we expect from this big oil supply injection from the Biden administration? 
 
Higher prices.  
 
Why?  Not only have we, and much of the world, committed to defunding new oil exploration, and regulating down domestic supplies, we are now (voluntarily) drawing down our reserves.  
 
This SPR release only weakens our position, from an already weak position.  OPEC countries will be even happier to sell us all the oil we will need (until we are all driving Teslas), just at higher and higher prices.  And so will the domestic producers that have survived this planned supply destruction of the fossil fuels industry.
 
 

Pro Perspectives 3/30/22

March 30, 2022

As March ends, all eyes will turn to inflation data.  And it's going to be a wrecking ball for central bankers that are trying to manage inflation expectations.
 
As we've discussed, the Fed is far more concerned about inflation expectations, than they are about inflation.  If they lose control of expectations, people start pulling forward purchases, in anticipation of higher prices, creating a self-fulfilling upward spiral in prices.
 
With this, you have to wonder what the first double-digit print in inflation will do to consumer psychology.  
 
I suspect we will find out on April 12, when we get CPI numbers for March. 
 
Keep in mind, for February, the data came in hot, with prices close to 8% from the same period a year prior.   And that did NOT yet account for the sharp spike in the price of oil.  Add in a 30% spike in oil prices, and a double-digit March inflation number seems like a done deal. 
 
We had some clues from the German inflation data this morning.   This was a preliminary reading for the month of March.  It was a huge negative surprise.  The 7.3% year-over-year increase in prices was more than two percentage points higher than the consensus estimate.
 
The consensus view for March U.S. inflation (thus far) is 8.2%.
 
Where would a negative sentiment shift in the inflation outlook most quickly tend to manifest?  The bond market.  Yields (market interest rates) would go on a tear.  Not only could that signal exacerbate inflation fears, but it could also trigger global capital flight, which could lead to a currency and debt crisis.    
 
This brings us back to my note from yesterday, where we discussed the prospects of global central bankers following the Bank of Japan's lead, by setting market interest rates (i.e. yield curve control).
 
So, just as the Fed has exited QE, they may be forced to return to the QE game very quickly (buying treasuries to maintain an orderly rise in market interest rates).    

Pro Perspectives 3/29/22

March 29, 2022

Stocks rallied today (again).  Oil and gold traded lower today (again).  This has the appearance of a relief in the risk environment. 
 
Is there reduced risk on the war front?  Is there energy supply relief coming from the Iran negotiations?  Are Covid lockdowns in China, foreshadowing another round of global pandemic restrictions?  
 
We talked about the latter yesterday.  But it now appears that none of the above are dictating the recent market activity.
 
With the behavior of the bond market the past two days, it does appear that the bond market is telling us something. 
 
We talked about the prospects of a yield curve inversion earlier this month, and we looked at this chart below …

As a reminder, this is the spread between the 10-year and 2-year Treasury yields.  This had declined to 23 basis points when we looked at it on March 8th. Today it's just 2 basis points (the 10-year yield is at 2.39%, and the 2-year yield is at 2.37%).   Why does this matter?  Each of the six recessions, dating back to 1955, were preceded by a yield curve inversion.  Recession followed between 6 and 24 months.
 
Now, with that in mind, you would not be going out on a limb to call for a Fed-induced recession to come in the next 24 months (regardless of what this chart above tells you).   After all, as we've discussed, the last time the Fed had to deal with an inflation problem like we're seeing now, they had to ramp rates ABOVE the rate of inflation, to bring inflation under control.  That would be applying a heavy foot on the brakes of the economy. 
 
But within this outlook, we should expect such a yield curve inversion to happen at much higher levels of interest rates.  It would be reasonable to expect the inversion to take place because the 2-year yield is aggressively moving higher (along with the Fed Funds rate), not because the 10-year yield is stagnating at historically low levels, and then aggressively moving lower.  That doesn't project a hot economy, where the Fed is just starting a tightening campaign (from emergency level rates). 
 
So, what's happening to push the 10-year yield aggressively lower the past two days?  It may have everything to do with Japan.  
 
The Bank of Japan intervened twice yesterday in the Japanese government bond market — buying JGBs in "unlimited amounts" to put a lid on rising bond yields (at just 25 basis points on the 10-year).  
 
This "yield curve control" is, and has been, explicitly part of the BOJ's game plan to promote economic activity in Japan.  But what is becoming clear, is that policy change in the U.S. is pulling all global interest rates higher.  It's unwelcome.  The 10-year yield in Germany has swung from negative 10 basis points, to positive 74 basis points, just this month!   The 10-year yield in Japan is at six year highs, the highest levels since they adopted the plan to outright suppress Japanese yields back in 2016.
 
With this in mind, and the actions by the Bank of Japan this week, the move in the U.S. 10-year yield today may be a signal that "yield curve control" could be coming to a central bank near you.
 
Remember, as we discussed last week, if we consider a 2% spread between mortgages and the (U.S.) 10-year … and a spread of about 2% between the 10-year and the Fed Funds rate … then we should expect the 10-year yield to be in the mid-4% area by year end (if the Fed gets back to neutral).  And we should expect mortgage rates to be over 6%.  But in anticipation, it's not crazy to think the 10-year yield (and therefore consumer rates, like mortgages, auto loans and credit cards) could reset to those levels very quickly (like a spike in rates).  
 
An aggressive spike in market interest rates would be bad news for the major central banks of the world.  How would they protect against that scenario?  Yield curve control — to (attempt to) carefully manufacture a stable path to higher interest rates. 

Pro Perspectives 3/28/22

March 28, 2022

Markets kick off the week digesting the inflammatory words from Biden over the weekend, about removing Putin.

And to add to the sentiment headwind, Biden was out pushing his 2023 budget today, which includes higher taxes and disincentives for investment (by taxing UNrealized gains!!).

I suspect it’s clear to anyone, an aspiration from the West for regime change in Russia would trigger a long, messy global war. Therefore, oil prices would go UP significantly, as the supply/demand imbalance would be compounded. And gold would go UP significantly, as global capital would move to relative safety.

That said, both (oil and gold) went down significantly today.

Meanwhile, tech stocks led the way, up — from very early in the day.

Neither Biden’s reckless foreign policy actions, nor his threats to curtail wealth at the top, could keep stocks down. Perhaps the White House policy news was overwhelmed by another factor: the return to lockdowns in China.

In fact, if we can read anything into the market behavior of today, it’s that the market considers the political appetite for more lockdowns to be greater, than the political appetite for global war.

These stocks that thrive in a lockdown were big performers on the day …

Amazon was up 2.5%. Zoom was up 3%. Roku was up almost 4%. Docusign was up 4%. Doordash was up 9%.