Pro Perspectives 11/21/22

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November 21, 2022
 
We spend a lot of time talking about the inflation picture here in my daily notes, and for good reasons. 
 
Among the reasons:  We had record money supply growth, driven by the monetary and fiscal response to the pandemic, and related lockdowns.  When the money supply grows faster than the economy’s ability to produce goods and services, you get inflation (too much money, chasing too few goods).  It’s that simple. 
 
With that very simple formula, in plain sight, it’s hard to believe that Fed officials, in unanimity, could call the inflation of last year “transitory.” 
 
Equally as hard to believe, they unanimously flip-flopped late last year, becoming tough-talking inflation fighters, yet they started their inflation fight (against a forty-year high inflation rate of 8.5%), by raising interest rates a whopping 25 basis points — that’s from zero interest rates.  Meanwhile, they continued with their inflationary bond buying program (i.e. QE).  
 
They’ve since, in unanimity, outright threatened to crush demand and jobs, and have promoted a draconian interest rate outlook.  In doing so, they’ve crushed the stock market.  They’ve crushed economic growth.  And they’ve produced an inverted yield curve (which has a history of preceding recession). 
 
And now, as we discussed in my Friday note, inside of one year, the pendulum has swung.  A year ago, they were executing inflationary policy in a hot inflationary environment.  Today, instead of just slowing inflation, they are now executing deflationary policy into an environment of declining prices.
 
It all looks like mismanagement at every step.  And, again, the policy path has been unanimously supported and promoted by the Fed Governors and Fed Presidents … until today. 
 
Finally, we may have a dissenting voice from the Fed (though not from a voting member) — introducing some sanity.  San Francisco Fed President, Mary Daly, in a prepared speech today, said that the “markets are acting like [the Fed Funds rate] is around 6%.” 
 
She’s saying that financial conditions are much tighter than the 3.75%-4% Fed Funds rate.  And her 6% “proxy rate” (as she called it) happens to be right in line with the core inflation rate.  It’s an important dissent in what has been an unexplainably agreeable Fed. 
 

Pro Perspectives 11/18/22

November 18, 2022

Let’s continue our discussion from yesterday on the difference between a deceleration in rate-of-change in prices, and outright price declines(i.e. deflation).

The Fed’s stated goal is to slow the rate-of-change in prices to their inflation target of 2%.   However, they are inducing a decline in prices/deflation, rather than just a slow down in inflation.

Is it by design?

That brings me to a very important statement made by the Fed Chair in the last post-FOMC press conference.  In response to a question about the lag effect between policy and prices, Jerome Powell said “we do need to see inflation coming down decisively, and good evidence of that would be a series of down monthly readings.”

“Down monthly readings” means, negative change in prices.  He wants to see deflation (at least for a period of time).  And that suggests the Fed wants to move the level of prices lower, not just the rate of change.

Well, he’s getting it.

They nearly returned stocks to pre-pandemic levels this summer …

Gold, the historic inflation hedge has fully retraced to pre-pandemic levels …

Energy?  Crude oil prices are not too far off from pre-pandemic levels …

Here’s a look at global food prices … falling, but still 35% above pre-pandemic levels …

What about housing?Housing prices have rolled over.

A return to pre-pandemic prices in housing would inflict major pain.

 

 

 

 

Pro Perspectives 11/17/22

November 17, 2022

We may have hit peak Fed lunacy today, with voting Fed member, Jim Bullard, suggesting that the Fed Funds rate could need to go as high as 7%, in order to beat inflation.

Keep in mind, the nonpartisan Committee for a Responsible Federal Budget projects for every 100 basis point rise in the U.S. 10-year yield, the U.S. government adds $285 billion annually in interest costs.  This adds, materially, to a record, and already unsustainable government debt load.

Of course, we don’t have the money.  We will borrow it.  From whom?  Mostly, it will be the Fed that will have to be the buyer of last resort.

When we’re financing our own deficit, and therefore expanding our government debt bomb (via the Fed), you get more inflation, not less, as traditional holders and buyers exit, and/or just reject it as an investment.

Don’t worry, as we’ve already seen, well before that level (of 7%) would be reached, the global financial system would implode (sovereign debt defaults, currency devaluations and other vulnerabilities within the system would be revealed).

And we don’t need to pontificate about outcomes, it’s already happened — at just half of the level on the Fed Funds rate that Bullard theorized today.

Conversely, what looks far more likely than a 7% Fed Funds rate?  A swing from record inflation, back to deflationary pressures.

By early December, when we see the November inflation report, I suspect we will see a negative monthly inflation number (i.e. a price decline in the month).

Used car prices peaked earlier this year.  Food prices, globally peaked in February.  The median house price peaked in May.  Rents have fallen for two straight months.  Oil prices peaked in June.

These prices have all been consistently falling since peak levels.

There’s a difference between deceleration in the rise of prices (i.e. cooling inflation), and a decline in prices (deflation).

The Fed is inducing deflation.

With this in mind, let’s take a look at this chart of “six-month change” in money supply…

 

Money supply is declining, and at the fastest rate on records going back over 60 years of history.  Moreover, as you can see in the chart, a negative six-month change in money supply is highly unusual. It’s only happened twice prior to this recent episode (’92 and ’93).

Deflation is typically associated with a contraction in the supply of money and credit (the former is happening, the latter not yet).

 

Pro Perspectives 11/15/22

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November 15, 2022
 
G20 leaders are meeting in Indonesia, and we have another World War III flashpoint.  This is becoming a theme. 
 
Remember, back in June, it was the week of the G7 meetings, when a litany of war provocations came … from the Western world. 
 
>The U.S. and G7 allies banned imports of gold from Russia.  
 
>Russian defaulted on its debt, forced by the asset freeze and banking sanctions (transactional restrictions) placed on Russia from the Western world. 
 
>NATO announced plans to increase “troops on high-readiness” from 40,000 to 300,000.
 
> The G7 included in its communique that they would phase out Russian oil, and in the meantime, threatened price caps on Russian oil imports.   
 
>Finland and Sweden signed an agreement paving the way to join NATO, Putin had already said that he would respond (in kind) if NATO were to deploy military and infrastructure in these bordering countries (Finnish land border, and Swedish maritime border).
 
> And then, Biden announced the U.S. would ramp military presence in Europe by opening a permanent army base in the Poland (formerly controlled by Russia and a flashpoint of WW2).
 
Fast forward to today, and as G20 leaders are meeting, we get news that Russia has fired a missile into Poland, with two resulting casualties.
 
So the literal line has been crossed.  Has the figurative line been crossed, to trigger Poland’s NATO allies into action?
 
If we look to markets for clues, the dollar, Treasuries and gold would be soaring.  That hasn’t happened. 

Pro Perspectives 11/14/22

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November 14, 2022
 
Conveniently, just days after the election, a court struck down the Biden administration’s plan to cancel student debt (as unlawful).
 
This (student debt cancellation) was an issue young voters were said to back at double the rate of older voters (twice as likely to vote in favor of).  And voter turnout for the young demographic was the second highest on record for a midterm.
 
Fair to say, it was an executive order that never had a chance, but served as bait to voters.  Again, interesting timing on the court decision.      
 
If we think about the inflation picture, this (student debt “relief”) was a considerable influence on the inflation outlook.  Remember, on July 27th, after 225 basis points of rate hikes (a Fed Funds rate of 2.25-2.5%), Jerome Powell told us they had reached the “neutral level” for rates (no longer accommodative, but also not restrictive).
 
It was an unsolicited message to markets, that appeared to imply they were ready to sit and watch (perhaps they had done enough).
 
Stocks roared higher.  Stocks soared 9% over the next fifteen trading days. 
 
What also happened that day in July?  Congress passed the $280 billion Chips Act.  The Fed was well aware that was coming.
 
And by the end of the day, July 27th, the key holdout in Congress from getting the clean energy agenda done, flipped.  Manchin was ready to make a deal.  And unexpectedly, Congress was ready to add another $500 billion in deficit spending (that’s the amount of spending and tax breaks estimated by the consulting firm McKinsey).  
 
Now, how inflationary will these programs be?  We don’t know.  Objectively, both are long-term government spending programs. 
 
If we look back at the 2009 “American Recovery and Reinvestment Act,” that was the biggest fiscal stimulus spend on record, but did little-to-nothing to reverse the deflationary pressures in the economy (i.e. it wasn’t inflationary).  The heavy lifting to fight-off deflation (at the time) was done by the Fed over many years.
 
Now, it was about a month after the very important events of July 27th that the Fed went back on the offensive against inflation.  Jerome Powell revived the rhetoric about doing ‘whatever it takes’ to slay inflation, at his keynote speech at the big global economic symposium in Jackson Hole.  
 
That was on August 26th.  What happened two days prior?  Biden announced his plan to cancel student debt. 
 
With this in mind, what has been the most direct driver of inflation within the trillions of dollars in fiscal stimulus over the past two-plus years?  Putting money directly into the hands of consumers.  What does cancelling a long-term debt burden do for consumers?  It redirects debt service into consumption.  It’s wildly inflationary — and to the tune of half a trillion dollars worth of debt cancellation. 
 
The point:  While the student debt promise may have influenced the outcome of an election (not good) … looking beyond that, the blocking of it may have a major influence on the inflation outlook, and therefore may give the Fed good reason to believe the peak in the inflation data is in (i.e. less restrictive monetary policy, which would be good news).

Pro Perspectives 11/10/22

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November 10, 2022
 
We had the October inflation report this morning. 

How big of a deal is that? 

 
The past two reports triggered moves in stocks, of a magnitude that has historically only been associated with very significant moments.
 
Remember, we looked at this chart last month, following the September inflation data. 
 
As you can see, these outsized ranges are associated with major market crises, policymaker intervention, policy change (via elections/votes) and market liquidity crises.
 
The two on the far right, however, came as the result of an inflation report.
 
And today will add another data point to this history. 
 
The October inflation report came in this morning cooler than expected.  Stocks (S&P futures) finished the day up 5.4%.
 
Ten-year Treasury yields collapsed.  The dollar was down big. 
 
This looks like a regime change for markets. 
 
While the government’s  (lagging) inflation report wasn’t spectacularly different than the prior few months, we know from real-time inputs (like new and used cars, rents) that prices have been rolling over for months.  Add to this, we are now past the midterms with a very high likelihood that we get at least a split Congress, which should quash any new government spending (less inflationary pressure).
 
As we’ve discussed, the 4%+ area of the benchmark U.S. 10-year Treasury yield (which has been the result of the Fed’s rate hiking campaign and tough talk about the path of rates) has proven to the level that exposes vulnerabilities in the global financial system.  In each stint above 4%, over the past six weeks, we’ve seen fireworks:  the blow up of UK government bonds, an intervention to defend a downward spiraling yen, and now the blow up of a major crypto exchange.
 
With that in mind, this chart below suggests we may have seen the last of that 4% level, at least for a while … 

Pro Perspectives 11/9/22

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November 9, 2022
 
The betting markets had priced in a 70%+ chance of a Republican sweep as we entered the midterm elections yesterday.  That has now become a 70%+ chance of a divided Congress.
 
On its face, that should be good for stability (some needed predictability), as it is assumed that a Republican House would block any new agenda items from the Democrats.
 
Let's talk about cryptocurrencies…
 
There were rumors on Monday that a major cryptocurrency exchange, FTX, was in trouble.  
 
This was the response from the billionaire founder …
Forty-eight hours later, it's insolvent.
 
What could this mean to the remainder of the cryptocurrency universe.  Nothing good.
 
Bitcoin has now lost 75% of its peak value from a year ago. 
 
As Warren Buffett has said, "only when the tide goes out, do you discover who's been swimming naked."  The "tide" in this case, is the easy money, low inflation era. 
 
The tide has gone out, and the mal–investment is being exposed.  That includes high valuation, no earnings tech companies … SPACs … and crypto currencies (to name a few).
 
Pre-financial crisis, this FTX failure would very likely create waves/shocks in the financial system.  After all, FTX has tentacles reaching throughout the crypto universe, major venture capital firms and hedge funds.  But the scale, even of crypto in aggregate, is nothing compared to the trillions of dollars global central banks have lobbed around, over the past fourteen years, in response to the many crises.
 
What this FTX event will do, is give politicians a clear excuse to do what they've already promised:  they will regulate away private money, to maintain their monopoly on money.

Pro Perspectives 11/8/22

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November 8, 2022
 
We've talked about the falling dollar, which began with an outsized decline on Friday.
 
Again, that decline even outpaced the magnitude associated with two major central bank interventions of the past two months (Bank of England and Bank of Japan).
 
Yesterday we talked about some reasons why the dollar could be in the early stages of a trend change (to move lower).
 
The move lower in the dollar has given some life to gold (which typically moves inverse to the dollar). 
 
Let's take a look at the chart …
As you can see, after testing the low $1600s three times, gold failed to break down, and has now broken this big descending trendline (a bullish break).
 
What else is going on with gold?
 
Central banks around the world stockpiled gold in the third quarter, with the highest quarterly demand on records dating back to 2000.  For the year, central banks are on pace to accumulate the most gold since 1967.
 
What does this portend? 
 
Even with the high likelihood of gridlock coming to D.C., which should bring a counterforce to the stag-flationary economic agenda of the White House, the country and the world have an unsustainable sovereign debt burden to overcome.  And the fiat currency system will continue to be in the crosshairs.  As we know, over 60 global central banks (the BIS) are already at some stage of considering a central bank-backed digital currency.
 
With this in mind, when surveyed, central banks say their accumulation of gold, is with the goal of getting to their "historical positioning" in gold as a reserve asset. 

Pro Perspectives 11/7/22

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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.