When they pump the world with liquidity, as the central banks and governments have, we will see excesses.

Financial markets are ground zero for risk taking, so it's not surprising that we see early excesses bubbling up there. 

The news of the day has been another hedge fund blowup.  We had a short seller called Melvin Capital blow up last month, on the wrong side of GameStop.  They were bailed out.  And in recent days, we've had the unwinding of a long and overleveraged hedge fund called Archegos.  The big losers here (in addition to the fund) appear to be Nomura (a Japanese bank) and Credit Suisse (Swiss bank).

 

It has historically been dangerous to call events like these contained.  But this one seems contained.  Still, if it were a systemic risk, we know (with certainty, in this era) how central banks would respond.  They would bail-out and backstop – quickly.

Now, in these cases of forced liquidation, investors tend to sell what they can, not what they want to.  With that, there was selling today in what has been working and/or favored inflation trades …

Small caps have been leading the way in stocks this year.  Today, down 2.8%. 

We talked yesterday about the new added risk to the inflation picture — the supply disruption in the Suez Canal.

A reader asked:  What's your solution for this inflation drama you keep going on about (my paraphrase)?     

Answer: You want to be long "inflation assets."

On that note, let's take a look at an interesting chart from Bank of America, and the way they define these asset groupings for these two different price regimes (inflation and deflation) … 

Adding to the risk of a hot run in inflation, we now have a massive container blocking the Suez Canal.

This comes just as the Fed has spent two weeks telling us inflation will be under control. 

This Suez Canal disruption adds a potential third element to what's already a double-whammy recipe for inflation.  As billionaire Ray Dalio said in a recent interview, we have two types of inflation:  1) supply/demand driven, and 2) monetary inflation.  And we're getting both. 

We have monetary inflation, to the tune of 28% growth in money supply from the same period a year ago.

And on the supply/demand side, not only are we getting a supply crunch from the global economic disruption of the past year, the scarcity of supply is being met with pent-up demand, as global vaccinations begin to people back to some semblance of a normal life.  

Now, adding to the supply issues, we have one of the most important seaborne trade arteries blocked.  The Suez Canal handles 9% of global oil products, and 12% of global trade.

The speculation on when it may be resolved spans from days to weeks. 

The longer the delay, the more pressure on prices.  Remember, contrary to what the Fed is telling us, the price pressures are clear in the business world.  In the February ISM Manufacturing report, the "prices paid" component came in at one of the hottest readings in 20 years.  It was the ninth consecutive month of price growth, and it came from hotter demand AND "scarcity of supply chain goods." 
 

With the global politicians organizing this week to discuss the coordinated climate action game plan, it's beginning to look like we might be in the "buy the rumor, sell the fact" period for the clean energy trade.

The one clear proxy-stock for the likelihood of a multi-trillion dollar clean energy movement, has been Tesla.

This is what happened to Tesla shares when the global pandemic flipped the probability of a Trump second-term.  

The broad risk environment is "off" today.  It was led by a 6% decline in oil prices.  Stocks followed oil lower after Jay Powell and Janet Yellen both said asset prices are “high” or "elevated." 

Are they talking down asset prices?  It sounds like it, for the moment. 

Both the interest rate market and the oil market have been putting pressure on Fed policies, implying if not feeding into inflation and inflation expectations.

Today's moves in markets have given the Fed some room to breath.   The 10-year yield is off 13 basis points from the highs of last week.  And oil prices have broken the uptrend from the election-eve lows (as you can see in the chart below). 

Last week was all about inflation and interest rates, as the Fed led a line up of central bank meetings.  Despite the massive $1.9 trillion fiscal spend that began working its way through the U.S. economy last week, the Fed did its best to promote a subdued outlook for inflation.

That subdued inflation narrative sets the table for the next multi-trillion dollar spending blow-out from the Biden administration:  the clean energy deal.  This is being packaged as "infrastructure," but make no mistake, this is all about the climate action agenda (i.e. transforming the economy from fossil fuels to what they promote as more environmentally friendly). 

This will be the dominant theme for markets, beginning this week.  There's already talk today that the White House is preparing a bill for the House, in the amount of (another) $3 trillion.

Add to that, the U.S. is set to meet with officials from the EU, China and Canada this week on the global climate change initiative.  And the European Central Bank Chief is presenting a speech this week to high level European officials, titled "Investing in Climate Action — a make or break decade." 

As we discussed heading into the U.S. election, the global climate action initiative has been clear and globally coordinated, involving the most powerful governments and companies in the world.  And the financial backing is nearly unlimited. 

Remember, a group called Climate Action 100+, composed of the most powerful investors in the world (representing $32 trillion in assets under management), has dictated how major energy companies are deploying capital on new projects since, at least, 2017 – forcing the pivot to climate responsible initiatives.  And every major global government entity/cooperative behind the activist movement has been feeding the effort with cash and subsidies.

Trump was an existential threat to this global initiative. No surprise, there were powerful forces at work to remove him. 

So we are two months into the new administration, and with an aligned Congress, the Climate Action agenda is (and will be) fully executed, with full extravagance. 

We've talked about inflation and interest rates all week, and the build up to, and aftermath of, the Wednesday Fed meeting.

Indeed, this dynamic has become the primary focus for markets, as we end the week.

The market is beginning to price in inflation, maybe hot inflation.  The Fed continues to stand its ground, telling us they don't see it. 

Even some of the most partisan economists (on the left) are concerned about inflation, following the massive $1.9 trillion stimulus.  Larry Summers, former Treasury Secretary, flatly said, putting this $1.9 trillion on top of the $900 billion (from December) "will set the economy on fire."

He sees one of three outcomes:  1) inflation will run hot, the Fed will stay behind the curve (inflation-rife country), 2) the Fed will kill the economy with rate hikes and create recession, or 3) the Fed will perfectly thread the needle, taming a period of very rapid growth back to reasonable growth. 

Bottom line, he says "very substantial risks on the path we are on."

He thinks we may be reliving the policies of the 1960s "on steroids." He says, like the 60s, policymakers have grown complacent about a period of low inflation, and "political leaders think we have needs that are pressing and they want to push through" (taking advantage of what they believe is structurally low inflation). 

A clear loser (as we've discussed) in the likely outcome here, the dollar.  Summers agrees.

The Fed held the line today, sticking with its well advertised position: “pedal to the metal” monetary policy, pumping money into the economy alongside an unimaginably huge fiscal spend, all while pretending they have no concern about troubling inflation coming down the pike.So, the Fed sees 6.5% growth this year, with 4.5% unemployment. That would be three-times 2019 growth.  And that would be what the Fed considers to be full employment.

And yet, they see inflation at a very tame 2.4%.  That’s quite a bit lower than the average long run inflation rate (of 3.1%).   Sounds great, magical.

But the Fed isn’t telling us that we are in a Goldilocks growth economy.  They are just refusing to give any indication to markets that they will take the punch bowl away.

With that, the response from markets:  risk assets go up.  Stocks hit new record highs.

But gold went up, and the dollar went down.  This is a signal that markets see through the Fed’s messaging.

Expect this direction in gold (up) and the dollar (down) to continue, as the posturing by Powell and company continues to put the Fed at risk of getting a negative surprise on inflation, and getting a late start on fighting it (i.e. behind the curve).

After today, I suspect the bond vigilantes will go to work, selling Treasuries, pushing market interest rates higher – testing the Fed.  That will tighten financial conditions, threaten a slowdown of the economy, and force the Fed to act — likely with the “Operation Twist” program we’ve been discussing.

As we discussed yesterday, this type of response from the Fed would keep the fire under growth (still fueling asset prices), but it would also mean even hotter inflation to lurking around the corner.