Pro Perspectives 5/18/22

May 18, 2022

The technical relief rally in stocks was short-lived. 
 
As we've discussed, this continues to look like the Fed is using stocks as a tool to bring down demand (to bring down inflation).  Just as they explicitly influenced stocks higher in the low inflation, low demand post-Global Financial Crisis era … they are now using that strategy in reverse, by talking tough and telegraphing tighter financial conditions, which is a headwind for stocks. 
 
Arguably, they have achieved their goal, already.  The animal spirits of just months ago has been knocked down.  The conversation has flipped from boom to recession.  That will slow the rate of price change (i.e. inflation).  
 
What won't change is the level of prices.  Higher prices are hear to stay. 
 
The offset to that, is higher wages.  That's a new paradigm for corporate America, and though they talk a good game, they don't want to reset the wage scale.  We are seeing that translate into lower margins at Target and Walmart (where the low end of the pay scale was adjusted sharply higher, to get people back to work, and to comply with the social agenda pressures).
 
On a related note, the Fed is now attacking (verbally) wage growth.  They begged for wage growth for fourteen years (when inflation was low).  Now they are attacking it (when inflation is high). 
 
That means, we should be prepared for a slow adjustment in wages across the rest of the pay scale.  It will be over time, to close the gap with what was a swift jump in prices (the consequence of the massive pandemic response, and the additional $3.1 trillion opportunistically poured on top, to fund the Biden agenda).
 
This slow closing of the wage/price gap will mean lower of standard of living/lower quality of life.  This was telegraphed all along the way.  Higher prices, but not higher value. 

Pro Perspectives 5/17/22

May 17, 2022

On Friday we looked at a couple of key technical levels for stocks, that looked like a valid spot for a relief rally. 
 
We hit a 50% retracement in the Nasdaq, from the pandemic lows to the post-pandemic highs, on Thursday (hit it on the nose). It bounced, and we’ve since had three days of higher highs for a near 8% bounce. 

We also fully retraced to pre-pandemic levels on the Russell 2000 (small caps).   That too, has bounced for 8%. 
Is it the greenlight for the broad stock market?
 
Very unlikely. 
 
Remember, as we discussed yesterday, the Fed appears to be using stocks as a tool to “bring demand down.”  And they are doing it through tough talk, or as they call it, “forward guidance.”
 
For fourteen years, the Fed (and global central banks) used this tool of promises and threats to manipulate stocks higher, to induce confidence, paper net worth, and therefore, demand. 
 
Now, it looks like we’re seeing this strategy in reverse. 
 
With that, today, in the face of a nice three day rally for stocks, (Fed Chair) Jay Powell was interviewed as part of a Wall Street Journal event, where he hammered home this message … 
Again, those are the words we're hearing, but they aren't even projecting to end the rate cycle above what would be considered historically "normal" levels (which is around 3%) — much less anything near the current rate of inflation (above 8%). 
 
Still, this continues to be framed by the Fed and the media as an "aggressive" posture by the Fed. 
 
Contrast this, with what former Fed Chair, Ben Bernanke, said during the depths of the financial crisis.  When 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 would be an aggressive offense against inflation.

Pro Perspectives 5/16/22

May 16, 2022

We entered the year with record high net worth for both consumers and corporate America.
 
And near record low debt service. 
 
And with inflation running at forty-year highs.
 
We knew, coming into the year, that the Fed had finally acknowledged the inflation problem, and was ready to take action — albeit in very conservative baby steps. 
 
Even after seeing it's first 8%+ inflation number, the Fed still was projecting a shallow rate hiking cycle, to end around 3% on the Fed Funds rate.  That's about historically neutral (not accommodative, not restrictive to economic activity).
 
As we've discussed, if we look back at the inflation fight of the early '80s, beating inflation required the Fed taking the Fed Funds rate above the rate of inflation.  The Fed Chair at the time, Paul Volcker, beat double-digit inflation with short-term interest rates that approached 20% — and in doing so, he took the economy into recession. 
 
But he also, in stabilizing prices, set the stage for a long and very good period of development for the U.S. economy.    
 
The current Fed still has given us no indication that they have the appetite to take such a path with rates.
 
That said, what they have done is promised to "bring demand down." 
 
And the sacrificial lamb, as the Fed has explicitly framed it, is the job market. 
 
So, yes, we have a Fed that suddenly trying to manipulate to the goal of less jobs.
 
At the moment, there are two open jobs for every one job seeker.  Not only has Fed Chair, Jay Powell, told us that they intend to bring the ratio of job openings/job seekers to one-to-one, but Ben Bernanke (the Fed Chair that presided over the Great Financial Crisis), echoed that game plan this morning (bring the job seekers ratio to one-to-one). 
 
The question is:  How do they do it? 
 
Raise rates, aggressively?  Higher rates equals tighter credit.  Tighter credit equals less business spending and investment.  And less business spending and investment tends to equate to less hiring.
 
But, again, the Fed is not projecting an aggressive, inflation chasing rate hiking campaign.  
 
With $6 trillion of new money floating around (thanks to all of the post-pandemic fiscal spending largesse), the level of demand is being reflected in an inflation rate of over 8%.  Yet the Fed's projected interest path, ending around 3%, gets them no where near the inflation rate. 
 
As it stands, executing on the Fed's projected rate path would still fuel demand (and therefore inflation).
 
So how to they intend to get their desired effect?
 
It may be that they intend (hope to) talk it into existence. 
 
What the Fed and other central banks learned through the global financial crisis fight, was that once they crossed the line and backstopped nearly everything, the markets would respect their threats/promises. 
 
This became a new tool, added to the central bank toolbox.  They called it "forward guidance." 
 
Throughout the financial crisis, the Fed used forward guidance to manipulate behaviors of consumers and businesses by telling us that rates would remain low for "an extended time."
 
The European Central Bank adopted it in 2012, by promising to defend the solvency of the collapsing European sovereign bond market, by saying they would be a buyer of unlimited sovereign debt (they would be the buyer of last resort).  Just by saying it, interest rates of the weak countries of Europe fell sharply, and the risk of major defaults subsided — without the ECB having to buy a single bond.  The threat, alone, worked.  And that was something that Mario Draghi (the ECB President, at the time) bragged about.
 
So, perhaps the Fed's threat to "bring down demand" is just "forward guidance," intended to influence behaviors (weaker demand).  Just talk. 
 
If so, it's working – so far. 
 
Stocks are behaving as if the Fed will take some recession-inducing action.  The (roughly) a 20% haircut in the stock market lowers the net worth of consumers, from record levels, which will soften demand.  That (stock market decline) alone, is good enough to put a dent in job creation, as companies start reining-in risk (from "uncertainty").  

 
Meanwhile, market interest rates (determined by the market) are at just 2.88% (having done an about face after trading as high as 3.2%).
 
A ten-year yield at 2.88 (at today's close) is not pricing in an aggressive, inflation chasing, rate hiking cycle.  If the bond market is indeed "smarter" than the stock market, perhaps the bond market knows the Fed is just playing the "forward guidance" game — talking, with no intention on big policy action.  
 
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Pro Perspectives 5/13/22

May 13, 2022

As we head into the weekend, stocks had a nice technical relief rally.  
 
Let's look at a few charts.
 
Here's the Russell 2000 (small caps)…

As you can see, the small cap index has fully retraced to pre-pandemic levels (and has bounced). 
 
What else has fallen back to pre-pandemic levels?  Japanese stocks did, in March.  And German stocks are back to pre-pandemic levels. 
Above is a look at the Nasdaq (the center of the tech bubble universe).  As you can see, this has bounced from the 50% retracement of the move from the pandemic lows.  Pre-pandemic levels for the Nasdaq would still be 20% lower. 
 
So, has the tech bubble deflated – or more to come?
 
Bubbles tend to end with panic.  What does seem to be on path for panic is the bubble in crypto currencies. 
 
As we've discussed this past week, the stablecoin cryptocurrencies have been exposed as vulnerable this week (with the failure of the stablecoin Terra).  
 
I suspect more is to come.  And with that, brings risks to the financial system.  Coincidently, the G7 finance ministers are scheduled to meet next week in Germany.  If there are any shock waves from crypto, a coordinated response from global central banks to restore stability would likely be quick. 
 
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Pro Perspectives 5/12/22

May 12, 2022

We talked yesterday about the crypto currency bubble.  Bitcoin has more than halved, which is not unusual for its history.  But the bigger issue is the stablecoin universe.  
 
Again, this is a couple of hundred billion dollars that were traded for private digital currencies, with the promise of remaining pegged to a currency (like the dollar) or asset (like gold). 
 
These pegs have broken.
 
A once $15 billion stablecoin called Terra now trades for 42 cents on the dollar.  The biggest stablecoin is Tether ("tethered" to the U.S. dollar).  It too, has broken the peg, trading as low as 95 cents on the dollar.
 
Interestingly, on Monday (May 9) the Fed released its annual report on Financial Stability.  That same day, Terra broke the peg.  And on Tuesday, Janet Yellen (the Treasury Secretary) testified before the Senate Banking 
Committee.  Tether broke the peg on Tuesday.
 
In the Fed report, among the vulnerability to the financial system that were cited:  "the vunerability to runs" in the "rapidly growing stablecoin sector." 
 
Guess what that triggered?  Runs on stablecoins (i.e. mass simultaneous investor withdrawals/redemptions).
 
So, is this a threat to the financial system?  Will there be contagion?  
 
In the case of Tether, it doesn't hold its $80+ billion of liabilities in U.S. dollars in a bank.  In fact, below is the breakdown of how the Tether liabilities ("reserves") are invested, based on their end of year 2021 independent accounting report. 

They have about $40 billion of investments (including commercial paper, money market funds, secured loans and other digital currencies).
 
This is like a shadow bank. 
 
It seems very likely, that the company will have a difficult time recovering principal from these investments to return to Tether holders – if they see mass Tether redemptions.  But the bigger problem is what a mass exodus of Tether's investments (all of that commercial paper, money market funds, etc.) might mean to the financial system.  
 
Remember, it was a run on a money market fund back in 2008 that set off more similar runs across the money market universe, requiring the Fed to step in.  They halted redemptions, and guaranteed the principal of money market funds.
 
This risk seems to be what is adding significant weight on markets.
 
With all of the above in mind:  
 
>The Japanese yen tends to behave like a safe haven in times of global uncertainty and economic/financial stress.  Today it was up 1%. 
 
>Treasuries have bounced sharply the past three days (THE place for global capital flight when risk is elevated). 
 
>And the dollar made new 20-year highs today (the other hiding place for global capital in "risk-off" environments).
 
As we've discussed, when the Fed announced it's quantitative tightening plans, history tells us that unforeseen consequences will follow (something will break in the financial system).  This may be it, in the making.  
 
The good news:  History also tells us that the Fed will respond (in such a case).  With backstops, guarantees, more QE.  Whatever it takes.  
 
The easiest, first step for the Fed to take, to curtail any flare up in the financial system, might be to signal to markets that they will hold off on QT — take a wait and see approach.     
 
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Pro Perspectives 5/11/22

May 11, 2022

The inflation report came in hotter than expected this morning.  Yet, both the monthly and twelve-month change came in lower than the March report's blow out numbers.
 
So, has inflation indeed peaked, as the media, the administration and the Fed have suggested throughout the past month?  
 
Unlikely.  The 8.3% twelve-month change in prices for April (in this morning's report), was indeed cooler (slightly) than the 8.5% inflation in the March report.  But oil had a lot to do with the cooler number. 
 
If we look at the change in price of crude from Feb to March, it was 18%.  From March to April, crude prices were down 6%.  Not so coincidently, Biden announced a record release of oil from the U.S. Strategic Petroleum Reserve (SPR), on March 31.  Oil prices were manipulated lower.  But now, prices have returned to pre-SPR announcement levels.
 
Bottom line:  This oil price driver of inflation isn't going anywhere.  And with the strong ex-food-and-energy inflation number this morning, we should expect higher inflation prints from here (i.e. we haven't seen "peak").
 
With all of this, yesterday we talked about the dynamic between bitcoin and gold.  With the bursting of the tech bubble, bitcoin has technically broken down, and we suspected that a hot inflation number today might reveal a return of the real inflation hedge (i.e. gold).
 
We might be seeing it.  As I write, bitcoin is down 10% on the day.  Gold is up better than half a percent.  
 
These are the two charts we looked at yesterday.  One is bouncing (gold), technically, the other has broken down (bitcoin)…   

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. 
 
Those "no eps" tech companies, that have relied on endless streams of capital to burn have been exposed as uninvestable (without easy money terms).  
 
The stablecoin universe is beginning to break.  This is a couple of hundred billion dollars that were traded for private digital currencies, with the promise of remaining pegged to a currency (like the dollar) or asset (like gold).  These pegs started to break over the weekend (i.e. those initial dollars invested will not be returned).  
 
This may be (likely is) the beginning of the end of private crypto currencies.  At the very least, it's a major shakeout.  We should expect this reckoning in crypto to create continued selling in the tech sector (tech stocks).  And a bursting of the crypto bubble will likely create some waves in the financial system.  We will see.   
 
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Pro Perspectives 5/10/22

May 10, 2022

The big April inflation report comes in tomorrow morning.
 
Let's talk about what to expect …
 
First, it was the inflation report from last month that finally got the market stirring.  The 8.5% headline change in prices, from the year prior, was the hottest since 1981. 
 
But it was the monthly change that was even more stunning, at 1.2%.  That number, compounded monthly, would give us around 16% annual inflation.  And that would actually sound more like the reality of prices consumers are seeing in every day life.
 
Still, following that report last month, the media, the administration and the Fed immediately responded by promoting the idea that (somehow) inflation had peaked. 
 
We will see tomorrow. 
 
The market is expecting a 0.2% change from April to March.  That would be a dramatic softening from the March report.   And the year-over-year expectation is for 8.1%.
 
If we focus on the monthly number, this sets up for a negative surprise (i.e. a hotter than expected number).  
 
This comes as the historic inflation hedge, gold, sits on this big technical trendline/ support.  

Meanwhile, what has been considered the "modern day gold," and new inflation hedge, Bitcoin, has already technically broken down — in sympathy with the bursting of the tech bubble.   
If we get a hot inflation number tomorrow, and moreover, if inflation has yet to peak, I suspect we will get to see if gold recovers its role as the favored inflation hedge. 
 
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Pro Perspectives 5/9/22

May 9, 2022

We've talked a lot about the historical track record of QE exits. 
 
The record is not good.  We know that in each case (globally and domestically), the "quantitative tightening" experiments ended with … more QE. 
 
With that, in my note last month, I posed the question of whether the Fed will even get the opportunity, this time, to start the process of "normalizing" the Fed balance sheet (i.e. quantitative tightening)?
 
We know the Fed formally announced their intentions in its meeting last week.  But with the start date set for June 1, and the air quickly coming out of the QE sponsored tech-stock and crypto bubbles, they may be back to damage control by June 1.
 
But it won't be because of stocks.  It will likely be because of the side-effects of QT (the unwind of the tech bubble, related).    
 
Without question, all along the path of the post-financial crisis, the Fed has wanted and needed stocks higher (and they behaved accordingly).  Higher stocks drove the wealth effect, and confidence, and that underpinned demand, in a world of weak demand (following the very long, slow recovery from the debt-induced financial crisis). 
 
This time, the Fed is explicitly trying to slow demand, to align with supply disruption (though much of it is by the design of bad government policy-making).
 
With that motivation (slowing demand), they are probably quite satisfied with the quick haircut in the stock market — particularly, the high flying, high valuation, high speculation tech sector.  It will slow the animal spirits, and therefore the 'rate of change' in prices (inflation).
 
But, as we've discussed, putting the QE genie back in the bottle doesn't have a good record.    
 
Unforeseen consequences tend to arise.      
 
Remember, 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.  
 
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."
 
Nevertheless, here's how stocks responded to the stealth QE of late 2019 … up 15% in a near perfect 45 degree angle (… then covid lockdowns, and the response:  more QE). 

 

As we discussed last month, as much as the Fed might like to move on from QE, from what we know of it, QE is "Hotel California." 
 
"You can check out, but you can never leave."
 
Again, it highlights the eventuality of a reset of global debt, and a new monetary system. 
 
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Pro Perspectives 5/6/22

May 6, 2022

As we end the week, let’s take a look at a few charts.
 
First, here’s a look at the performance of global asset prices over the past week.

You’ll notice, despite all of the financial media hand wringing over stocks, related to the Fed meeting, the S&P 500 (the proxy for global stability and risk appetite) was only down less than 1/2 percent on the week. 
 
Other notables:  The VIX (also known as the market’s ‘fear gauge’) was down on the week, not up. 
 
And crude oil was up more than 5% on the week — not exactly a signal of economic slowdown, but then again, crude is now trading on a supply shortage, brought to us by the design of global (and domestic) policymakers. 
 
On that front, it’s important to remember how we started the week.  On Monday morning, it was reported that the European Union was ready to propose a Russian oil embargo, and Germany was now on board. 
 
That triggered a 3% decline in the S&P 500 over just a few hours (on Monday).
 
And crude finished up nearly 10% from the Monday morning levels.
 
Here’s how crude looks heading into the weekend — a bullish technical breakout.  
 

Finally, let’s take a look at money supply.  Remember, the policies surrounding the pandemic response, ballooned the money supply by over $6 trillion.  
Now that the Fed has started quantitative tightening (i.e. reversing QE), some are expecting the money supply to shrink. 
 
While money may be extracted from bank reserves (by changing a digital number to a smaller number with a keystroke), it didn't show the desired effect on actual money supply during the Fed's 2017-2019 QT program.  As you can see in the chart above, money supply grew during the period (by a trillion dollars). 
 
What's the point?  The rate of change in prices should subside.  But the level of prices, caused by this tidal wave of new money, isn't going anywhere. 
 
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Pro Perspectives 5/5/22

May 4, 2022

The Fed raised rates yesterday, and announced its quantitative tightening plan to begin on June 1.
 
As we discussed yesterday, markets responded well. 
 
Today, that was not the case.
 
What’s going on? 
 
My view:  Mostly this …

This is the chart of the yield on the 10-year Treasury.  This is the benchmark market-determined interest rate, which is the basis for setting many consumer rates. 
 
It spiked today, 16 basis points (a big move), and above 3%.  Mortgage rates went to 5.27%, the highest level since 2009.  
 
So, is 3% a dangerous level for rates, given that the Fed has just taken the Fed Funds rate up to 75 basis points?  No.
 
The fear is, that this move (in rates) today is just the beginning of a fast repricing of the interest rate market. 
 
After all, the Fed told us yesterday that they intend to "expeditiously" take the Fed Funds rate to what they deem to be the "neutral" level (maybe this year).  As we discussed yesterday, that's believed to be somewhere between 2 and 3%. 
 
If we consider a 2% spread between mortgages and the 10–year … and a spread of about 2% between the 10–year and the Fed Funds rate … then the right yield for the 10–year should be in the mid-4% area.  That would take mortgage rates to be over 6%.
 
This begs the question:  Why hasn't the bond market already priced this "neutral" Fed rate in?  Why isn't the 10-year yield at 4.5% right now? 
 
Moreover, if the bond market really is the "smart money," why hasn't the 10-year yield adjusted according to an 8.5% inflation economy (i.e. much, much higher yields)?
 
Why?  Because the government bond markets have been highly manipulated by central banks, globally.  
 
The Fed has been explicitly manipulating the bond market, to suppress interest rates, for the better part of the past fourteen years.  But now, they are out of that business (allegedly).
 
So, it's logical to think, now that the Fed is out, that the interest rate market could quickly reset to the reality of the inflation environment.  
 
That would put the economy at risk of a runaway interest rate market.  And that would make the Fed's job of price stability and full employment exponentially more difficult.
 
I suspect that is what created fear in markets today.   
 
But as we discussed over the past few weeks, don't underestimate the appetite of global central banks to coordinate (with the Fed), to keep market U.S. interest rates in check (making the Fed's job to manage inflation expectations and the monetary policy "normalization" easier – and, therefore, the global economic and interest rate environment more stable).  
 
Remember, not only is the Bank of Japan (BOJ) still in the QE business, but they are in the unlimited QE business (buyers of unlimited Japanese Government Bonds as part of their yield curve control program).  They have a stated policy to buy as much as they see fit.  And in Japan, that also means buying stocks, real estate, corporate bonds – it's all fair game.
 
From my April 28 note: How do you prevent a global economic shock that may (likely) come from reversing the mass liquidity deluge of the past two years (if not 14 years, post Global Financial Crisis)? 

 

You keep the liquidity pumping from a part of the world that has a long-term structural deflation problem, and that has the biggest government debt load in the world (exception, only Venezuela). Japan.

 

The Bank of Japan, in this position, can be buyers of foreign government debt (namely the U.S.) to keep our market rates in check (keeps the world relatively stable), which gives the Fed breathing room on the rate hiking path.  

 

And Japan's benefit?  The world gives Japan the greenlight to devalue the yen, inflate away debt and increase export competitiveness (through a weaker currency).  They hit the reset button on an unsustainable, debt-laden economy.  We will see.

 
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