Pro Perspectives 8/30/23

 

 

 

 

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August 30, 2023

We'll see the latest reading on the Fed's favored inflation gauge tomorrow. 
 
It's likely to tick up, but remain in the low 4s (year-over-year percent change). 
 
Importantly, as you can see in the chart below, the Fed's target rate is well above inflation. 
 
 
As we've discussed many times, this dynamic of getting the Fed Funds rate (short term rates) above the rate of inflation has historically been the formula for putting downward pressure on inflation.  And the Fed has built in plenty of cushion, to the tune of over 100 basis points.
 
So the Fed has its foot on the brake. 
 
Moreover, the market is pricing in about a coin flips chance for another quarter point hike by the end of the year.  And that expectation has been set by a combination of the Fed's formal rate projections, along with the persistent jawboning we hear from Fed officials about "keeping at it" until they get inflation down to 2%.
 
That manipulation of expectations serves as more foot pressure on the brake (by design).
 
That said, the Fed is supposed to be "watching the data" for their guide on next steps.  And much of the data has been falling into their comfort zone. 
 
So, what gives? 
 
Remember, loads of government spending is still yet to be deployed. With rates well above inflation at the moment, and a hawkish posture, the Fed has built in some "insurance."

Pro Perspectives 8/29/23

 

 

 

 

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August 29, 2023

We had some July jobs data this morning.  We'll see July core PCE on Thursday, the Fed's favored inflation gauge.  And then on Friday we get the August jobs report. 
 
Remember, the Fed told us the data will determine whether or not they've finished the job on inflation.  And this line-up of data should go a long way toward determining that objective.
 
This morning's jobs data might be the most important.  
 
Remember, from the very beginning of the tightening campaign, Powell has targeted jobs.  More specifically, he targeted the mismatch between the number of job openings and the number of job seekers. 
 
That ratio was over 2, when this tightening cycle started (2 openings for every 1 job seeker).  With that leverage for employees, people were quitting jobs at the highest rate on record. 
 
It's job switching that drives the highest wage growth.  And the Fed was concerned an upward spiral in wages would fuel a self-reinforcing cycle of higher prices. 
 
This morning's report on job openings showed the openings-to-seekers ratio fell to 1.4.  That's the lowest in almost two years.  In March of last year, there were 12 million job openings.  Today there are 8.8 million.  And the quit rate is now back to pre-pandemic levels. 
 
Yields fell 15 basis points on the number this morning.  Stocks had a big day.  Commodities perked up.    
 
Why did markets respond so positively to the evaporation of three million job openings over the past seventeen months?  
 
Destroying three million job openings was wringing out excessive exuberance in the economy.  Undoubtedly some (if not many) of those job openings weren't real jobs, but were creating leverage for employees to command higher wages from employers.  In the Fed's view, this morning's number is success.

Pro Perspectives 8/28/23

 

 

 

 

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August 28, 2023

In my Friday note we talked about the commentary out of Jackson Hole.  We heard from Jerome Powell (Fed) and Christine Lagarde (ECB).
 
Then on Saturday, the head of the Bank of Japan (Ueda) contributed to a panel discussion.
 
Here's my takeaway:  Powell told us they will keep throttling the economy by maintaining high rates.  Lagarde told us that they will keep intervening to fix whatever they break in the financial system, resulting from high rates. 
 
And Ueda told us that they will continue to be the backstop.  They will continue ultra-easy policy, printing yen, and manipulating/suppressing global market interest rates so that the tightening policies of its G7 counterparts don't blow up their own respective government bond markets (i.e. they don't trigger a cascade of global sovereign debt defaults).
 
That's the script they've been following for the past year, and it hasn't changed.  To be sure, the "normalization of rates" in the U.S. and Europe only works with the assistance of the Bank of Japan.
 
Japan's benefit?  As we've said, the world gives Japan the greenlight to devalue the yen, inflate away the world's largest debt load, and increase export competitiveness (through a weaker currency).  It continues to happen.
 
 
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Pro Perspectives 8/25/23

 

 

 

 

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August 25, 2023

The Kansas City Fed is hosting its annual economic symposium at Jackson Hole.
 
As we've discussed, this annual event is well attended by the world's most powerful central bankers and finance officials.  And historically it has served as a platform for central bankers to communicate important signals regarding policy adjustments.
 
Did we get one of these important signals today?
 
The Fed Chairman, Jerome Powell, spoke this morning.  He said a lot, but nothing new.  The Fed has rates in restrictive territory, currently putting "downward pressure on inflation."  And from here, they will watch the data, to see if they need to tighten further, or hold where they are.
 
It turns out the keynote speaker of the event wasn't a Fed official, but the head of the European Central Bank.  It was Christine Lagarde that addressed the symposium topic of this year, "Structural Shifts in the Global Economy."
 
So what did she say?
 
Let's start with her conclusion:  "There is no pre-existing playbook for the situation we are facing today – and so our task is to draw up a new one."
 
That's quite a statement.  She says that the (supply-oriented) changes in labor, energy and trade, are structural — and blames the pandemic.
 
With that, in the post-pandemic world, she says we should expect more shocks emanating from supply, which will result in more price shocks.
 
So, just as everyone has been hoping the central bankers would step away from manipulating the economy and markets, Lagarde says we need even more "robust policymaking in an age of shifts and breaks."
 
If we're paying attention, "robust policymaking" in this post-pandemic era, seems to translate into raising rates to the point of breaking things in the financial system, and then simultaneously intervening in markets to fix what they break (as the ECB did with its sovereign bond market, as the UK did with its sovereign bond market, and as the Fed did with its banking system).
 
As I've said many times here in my daily notes, we are in the era of no-rules central banking.  The world's central banks crossed the line in the sand (i.e. ripped up the rule books) at the depths of the Global Financial Crisis, and unsurprisingly, haven't turned back.  It is now standard operating procedure to fix and manipulate.
 
Related, rather than let markets determine the viability of the coordinated policy agenda of governments (namely, the climate agenda), the central banks continue to position to accomodate the agenda, muting the shocks, if not canceling the negative signals.  

Pro Perspectives 8/24/23

 

 

 

 

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August 24, 2023

We talked yesterday about the Nvidia earnings.
 
For the second consecutive quarter, they delivered shockingly big numbers, and CEO Jensen Huang delivered an education to the analyst community on the global transition to "a new era of computing," and the related trillion-dollar retooling of the world's data centers (from CPUs to GPUs).
 
That said, the stock gave up all of the post-earnings gains by the close today.  Concerning?  For perspective, Nvidia is a trillion-dollar company now, but growing at a better than 100% annual rate, with 80% share of a new trillion-dollar market opportunity.  If we look at Amazon, they developed the (new) cloud business (AWS) over the past decade, growing it at a 50% annualized rate, and the stock went up nine-fold.
 
As we've discussed over the past quarter, this (gen AI) technological revolution is productivity enhancing for the economy.  It's a formula to grow the economic pie (and the size of the stock market).
 
With that, productivity gains create the opportunity for much needed wage gains (to restore quality of life, which has been eroded by inflation).  We're beginning to see both (productivity and wage gains).
 
We averaged just 1% productivity growth for the decade prior to the pandemic, and negative 0.7% since the fourth quarter of 2020.  The most recent productivity growth report came in at 3.7%.
 
That's huge.  Because wages have been (relatively) hot, as you can see in the far right of the chart below.  
 
 
And this wage pressure is precisely why the Fed has focused on jobs in this inflation fighting cycle. Powell has talked endlessly about the mismatch between the number of job seekers and the number of job openings.
 
The concern?  With leverage in the job market, job seekers and employees can command higher wages.  With that, the Fed has feared an upward spiral in wages, where wages feed into higher prices (inflation), which feeds into higher wages … and so the self-reinforcing cycle goes.
 
That said, we need wages to reset (higher) to the (higher) level of prices, not the other way around.  A fall in prices to restore buying power would lead to a deflationary bust (low or contracting economic activity and falling prices).  That scenario is far worse than high inflation.
 
A deflationary bust is vulnerable to a self-reinforcing spiral, and very difficult to escape (ask Japan).  And it's far more dangerous, given that we've already exhausted two deflation-fighting tools:  government spending, and expansion of the Fed balance sheet.
 
With all of the above in mind, while wages have indeed been on the move, we are already getting an offset from productivity gains.
 
The cost per unit of output last quarter was just 1.6%.  That's lower than the average unit labor cost of the 20-year period prior to the Global Financial Crisis.
 
The Fed should be very happy with the prospect of a productivity boom.
 
We'll see if that factors into the messaging tomorrow at the big St. Louis Fed economic symposium at Jackson Hole.  As I've said, this event has a history of signaling policy adjustments.  

Pro Perspectives 8/23/23

 

 

 

 

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August 23, 2023

We had a big move in the interest rate market today.  It started yesterday with a sharp drop in the vulnerable spots of the European sovereign debt market.
 
Both Spanish and Italian 10-year yields dropped significantly, even as the U.S. 10-year yield (the global anchor interest rate) traded to new 16-year highs.
 
It's important to note that the European Central Bank was forced to step in, again, and backstop these government bond markets back in June of last year, when Italian yields were trading at 4.28%.  Yesterday, the yield was 4.41%. 
 
Spanish yields were 3.21% (back in June).  Yesterday:  3.75%.
 
Today, the relief valve in the global interest rate market was pulled.  
 
European government bond yields have all reversed around 25 basis points in about 24 hours.  
 
And the U.S. 10-year yield has done this …
 
 
Is it driven by soft manufacturing data from Europe this morning?  Was it driven by the sharp slowdown in U.S. housing turnover in yesterday's data?  Does it have anything to do with what ECB President Lagarde might say at Jackson Hole on Friday afternoon?
 
Or, did the ECB simply do what they've told us they would do if yields reached levels that created (solvency or liquidity) risk to the euro zone (particularly, the weak spots)?  
 
Probably the latter.  Nonetheless, the pressure in the interest rate market may be abating.  We will see. 
 
Let's talk about Nvidia …
 
In my Monday note, we talked about the significance of this Nvidia earnings report for markets, as "even more important than Friday's Fed event."
 
Remember, it was three months ago that Nvidia's CEO shocked the world, declaring "the beginning of a major technology era."  He told us there was a "rebirth of the computer industry" underway, where "AI has reinvented computing from the ground up."
 
And he told us there was a "retooling" going on across the economy, the beginning of a 10-year transition of the world's $1 trillion data center, to accelerated computing.
 
And he had the numbers to back it up.  They grew revenues by 19% in Q1 compared to the prior quarter, and they guided to 52% growth for Q2 (shockingly huge).  From the "steep" data center demand, they expected revenues to jump from $7.2 billion to $11 billion in just one quarter.  
 
That brings us to today.  So how did they do in Q2?
 
It was another jaw-dropper.  They did $13.5 billion in revenue for the second quarter.  It was driven by the data center (which more than doubled from Q1).  Moreover, they guided revenue of $16 trillion for Q3.  
 
As I said after the May earnings report, it's a "big wake-up call on the massive technological transformation underway (and just in the early stages)."
 
For those that weren't awakened last quarter, this report should do the trick.
 
As you can see in the graphic below, the explosive growth is indeed coming from this data center "retooling."
 
  
And keep in mind, Huang has continually been asked how long this demand might last, and he continues to reference this trillion-dollar transition from traditional to accelerated computing. 
 
Nvidia has 80% of the market on the GPU chips that power this "retooling."  So, even at a $10 billion quarter (in data center revenue), the numbers will get much, much bigger. 
 
It's very early.
 
With that, today, even after an 8% move in the stock on earnings, Nvidia became cheaper than it was prior to the report, and cheaper than it was prior to the Q1 report, on a multiple of revenue (price/sales).
 
As I said going into that May Nvidia earnings report:

The automobile is to mobility, as AI is to productivity.

 

A productivity boom is coming, and it is well needed.

 

Productivity growth is the key to improving living standards.  As ChatGPT says, "sustained productivity growth of around 2% per year has historically been associated with positive economic outcomes and improvements in living standards." 

 

We averaged just 1% for the decade prior to the pandemic, and negative 0.7% since the fourth quarter of 2020.

 

Just as the 1920s were defined by innovation (the automobile and widespread access to electricity), we have the formula here for another "roaring 20s." 

Huang said today that he expects companies to realize trillions of dollars of productivity gains, from generative AI.  

Pro Perspectives 8/22/23

 

 

 

 

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August 22, 2023

Nvidia will report earnings after the close tomorrow.
 
As we've discussed here in my daily notes, Nvidia will need to deliver on what was a huge promise made in its Q1 earnings event.  That set the expectation for an $11 billion revenue quarter in Q2.  And that's a better than 50% jump from Q1.  
 
What if they miss? 
 
If they miss, the AI-heavy Nasdaq would probably trade into this technical support (the yellow line in the chart below) over the following days.  This is the trendline from the year's low – about 4% lower than current levels. 
 
But it would be a buying opportunity, likely even considered a gift for those that haven't participated in this AI revolution, to get involved.
 
 
Regardless of the numbers tomorrow, we should expect Jensen Huang, CEO of Nvidia, to reveal the rapid innovation in the industry, of just the past quarter.  That includes the deal they announced today with VMWare, where they will be working together to deliver generative AI applications for companies, enabling these companies to deploy large language models (like a ChatGPT) using their own proprietary data (keeping that data private and protected).
 
Speaking of "rapid innovation," billionaire activist investor, Dan Loeb, recently said this about the generative AI opportunity in his investment letter:  "We believe generative and other forms of AI could compare to the Industrial Revolution but compressed into a period of months and years, rather than decades."
 
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Pro Perspectives 8/18/23

 

 

 

 

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August 18, 2023

We revisited the chart of U.S. 10-year yields yesterday, and the episodes of stress to the global financial system, over the past twelve months, when yields spent some time above 4%.
 
If we look back to the beginning of the Fed's tightening cycle, we are now in the longest stretch without a stress event (five months), and with yields now sitting near the highest levels since the inception of zero interest and QE policies of the past fifteen years.
 
That said, the major central banks of the world have been able to successfully exit zero interest rates (and QE) with an historically fast normalization of rates, all in the face of one of the most complicated global financial, economic and political environments in history — and without losing control of the bond markets.
 
And if history (of the past 15 years) is our guide, we have no reason to believe they will lose control this time either.
 
Remember, it's a "managed" normalization.  As we've discussed often in my daily notes, in the post-GFC era of no-rules central banking, they are in the practice of "fixing and manipulating."  And as long as it's done in cooperation (very important) with their global central bank counterparts, there are no penalties (not to the currency, not to the bond market, not to equity markets, not to foreign investment).
 
With that in mind, we should expect more rate sensitive vulnerabilities to be revealed in markets and/or the global economy.  But we should also expect central banks to continue to do "whatever it takes" to maintain stability.
 
Now, let's take a look at stocks …
 
This looks like a modest correction.  We're down 5% since Fitch came in after the close of the market on August 1st with a downgrade of U.S. debt.
 
 
After a 45% run from the January lows, a 10% correction for the Nasdaq is just two percentage points away (at the trendline).
 
On that note, we have the big Nvidia earnings next Wednesday, where they will need to hit the very big guidance upgrade from last quarter.  If we look across recent earnings reports from the AI infrastructure stocks, we should expect Nvidia to deliver.  
 
The 10-year yield was under 4% before the Fitch downgrade.  It has traded up to 4.32% since.  And part of the case for the downgrade was their expectation that the Fed will go another 25 basis points in September.
 
We should get a good view on that next Friday morning, when Jerome Powell speaks at Jackson Hole.  Contrary to the Fitch view, Powell may signal the end of the tightening cycle.  We will see. 

Pro Perspectives 8/17/23

 

 

 

 

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August 17, 2023

The U.S. 10-year yield traded up to 4.32% today.  Let's revisit the events that have occurred over the past year, when the 10-year has traded above 4%.  
 
We've stepped through each of these events many times in my notes.  Suffice to say that this level of the U.S. 10-year yield, the world's most important interest rate (the anchor for global rates), has revealed vulnerabilities in the global financial system — vulnerabilities that were created from the zero interest rate and QE world (of much of the past 15 years).
 
For perspective, the last time the 10-year yield traded above 4.30% was last October — on the day the Bank of Japan intervened to both defend the yen, and relieve the pressure in global interest rate markets.
 
The time before that was 2007. 
 
At that time, the U.S. government debt load was 62% of GDP.  Today is more than double that burden.  And the Fed's balance sheet was $800 billion.  Today it's over $8 trillion.
 
Clearly, we're in uncharted territory.  Will China's highly-indebted property developers be next?  It's looking more likely.  What has been a slow moving crisis (over years), stemmed by Chinese government intervention along the way, has accelerated over the past week.  The dominos appear to be lining up.  
 

Pro Perspectives 8/16/23

 

 

 

 

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August 16, 2023

We had the Fed minutes today.
 
If left to the headline summary on the newswires, one would get a hawkish impression.  The markets responded as such (lower stocks, higher yields).
 
Remember, the Fed told us after the July meeting that they would be completely "data dependent" in determining the path forward for monetary policy.
 
With that in mind, today's headlines from the meeting minutes pointed to two areas they saw as "necessary" to "restore economic balance":  1) below trend growth, and 2) a softer labor market.
 
Well, as we discussed yesterday, the Atlanta Fed model, thus far, is projecting a 5% annualized growth economy in the third quarter (well above trend).
 
So, condition number one is far from being met.  Another headline said participants said the labor market is still "very tight."  That sounds like a vote against condition number two.
 
Moreover, another headline that stuck out:  Most participants saw continued "significant" upside inflation risks.
 
Sounds like a Fed hell-bent on delivering more rate hikes, no?
 
More likely, we've just seen another example of Fed public perception manipulation (or as they call it, "guidance").
 
Remember, the Fed doesn't want to signal "mission accomplished" to consumers, businesses and investors.  It would be the equivalent of pressing the gas pedal on the economy.
 
So, to be sure, those few headlines on the wires today were carefully curated by the Fed.
 
With a little context, the same paragraph within the minutes that said "most" participants saw "significant" upside risks to inflation, also said that "some" participants saw downside risks, from the lag effects of policy.  And "a number" saw the risks as two-sided.
 
This doesn't sound like the unanimity we've seen on the rate decisions.
 
And remember, the July hike was indeed a unanimous decision (among the 11 voting members), despite a headline inflation rate that had fallen to 3% — a full percentage point lower than the inflation data available to them the month prior, within which they chose to hold rates steady (unanimously).
 
With that in mind, it appears, from reading the minutes, that there was indeed some dissension.
 
"Almost" all participants agreed raising rates at the July meeting.  "A couple" favored leaving rates unchanged. Clearly these dissenters were among the six non-voting Fed district presidents.
 
But it's probably a good proxy on where the Fed really is — far less hawkish than they present themselves to be.
 
With that, we're a little more than a week away from the Kansas City Fed's economic symposium in Jackson Hole.
 
This annual event is well attended by the world's most powerful central bankers and finance officials, and has a history of signaling policy adjustments.  As we discussed last week, perhaps this will be an "end of the tightening cycle" theme.
 
Deflation in China, and a technical correction in stocks (perhaps underway) would give them the cover to do so.