As we discussed last week, the annual economic symposium in Jackson Hole has historically served as a platform for central bankers to communicate important signals regarding policy adjustments.

With that in mind, last Friday Jerome Powell finally made it clear that the “time has come for policy to adjust.”

So, the Fed will be cutting in September.  It’s a matter of how aggressive.

How aggressive will be determined, in part, by the job market.

As we’ve discussed, by holding rates too high for too long, the Fed has traded one problem (inflation) for another (unemployment).  And now they acknowledge it, particularly the rate-of-change in the unemployment rate.  That makes the September 6th jobs report a bigger input into the Fed’s calculus (on size of cuts), than the inflation data.

But the Fed Chair also reiterated that the current (high) level of the policy rate gives them “ample room to respond to any risks.”

Perhaps like the risk that bubbled up earlier this month when the yen carry trade started reversing?

But what does Powell’s clear signal on rate cuts do to the yen carry trade?

It telegraphs a narrowing interest rate differential between U.S. and Japanese rates, which fuels a bigger reversal of the carry trade (i.e. more unwinding).

And remember, the first whiff of this rate and policy differential (between the U.S. and Japan) gave us this chart below — the sharp spiral down in global stocks in early August (the red line).

The sharp reversal (the green line) only came from the verbal (and likely actual) intervention by the Bank of Japan.   And it came with a policy about-face in Japan.

So, while Fed rate cuts will remove a burden on some areas of the U.S. economy (growth positive), the reversal of the carry trade leads to tighter global liquidity (growth negative).

With that, we may find that global easing of interest rates in the Western world will also come with a required return of QE.

If we needed a clue that the central banks can’t successfully exit QE, we can find it in the price of gold (on record highs and persistently climbing).

On that note, let’s revisit another important Jackson Hole speech — this one from 2023 (a year ago).  It wasn’t by the Fed Chair, but by the head of the European Central Bank.

ECB President Lagarde’s speech was titled, “Structural Shifts in the Global Economy.”

In it, she said “there is no pre-existing playbook for the situation we are facing today – and so our task is to draw up a new one.”

Just as everyone had hoped the central bankers would step away from manipulating the economy and markets, Lagarde said we need even more “robust policymaking in an age of shifts and breaks.”

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.

As we discussed yesterday, when Jerome Powell speaks in Jackson Hole on Friday, markets will be looking for a signal that the Fed will begin the easing cycle in September.

Remember, the Fed has told us they are watching the job market “carefully” for “cracks” as a condition to start the easing cycle.

With that, we’ve talked about the rapid rate-of-change in the unemployment rate, which should constitute a clear “crack.”

The unemployment rate is up 9/10ths of a point above the cycle low (3.4%) of just 15 months ago.  The speed of this change in joblessness puts in in the unique company of the past four recessions (which came with, in each case, reactionary Fed rate cuts).

Add to this, over the past forty-eight hours there have been reports suggesting the Bureau of Labor Statistics (BLS) will make a big downward revision in the monthly job creation data tomorrow morning.

In this scheduled annual “benchmark revision” by the BLS (i.e. a one-off annual adjustment), Goldman Sachs thinks they could subtract as many as a million jobs from the job creation picture.

This is a big deal.

As we’ve discussed over the past three years, the Biden BLS already has a record of making large revisions in the jobs data which have led to very consequential misreads on the health of the economy by policymakers.

Let’s revisit some analysis from my January 5th note earlier this year, where we stepped through the big revisions made in 2021 and in 2023.

Here’s a look at 2021 …

In my June 28th note, of 2023, we talked about this picture…

This was a central banking forum in Portugal hosted by the European Central Bank.  On this stage was the four most powerful central bankers in the world (from Japan, the U.S., Eurozone and UK).   And they fielded questions spanning from the inflation outlook and rate path, to geopolitical concerns (Russia and China), fiscal policy, digital currencies, and AI.

As we discussed in that note, the guy on the left is the Governor of the Bank of Japan (BOJ), Kazuo Ueda.  And he was the most important person in the room that day.

He was the only one in the room trying to get inflation UP to 2%, and therefore was the only one in the room with negative interest rates, and printing yen each month and buying both domestic and global assets with that freshly printed yen (with no limits).

This BOJ policy not only suppressed Japanese government bond yields, and promoted inflation and economic growth in Japan, it also suppressed the U.S. benchmark government bond yield (the 10-year yield), and served as a liquidity offset (to a degree) to the Fed’s (and Western world) tightening.

The Western world’s inflation fight (via the tool of “normalization” interest rates) only worked with assistance of the Bank of Japan.

And it was clearly well coordinated.  Japan continued ultra-easy policy, printing yen, and manipulating/suppressing global market interest rates so that the tightening policies of its G7 counterparts didn’t blow up their own respective government bond markets (and trigger a cascade of global sovereign debt defaults).

With this context, there’s probably a good reason that Ueda said, while on that stage with his global central banking counterparts, that rates would go up by a large margin in Japan, “IF they GET to normalize policy.”

Let me repeat that:  He said, IF they GET to normalize policy.

He made that comment more than a year ago.

Fast forward a year, and Ueda just tried (on July 31) to initiate the second step toward normalizing policy in Japan — announcing a plan to taper the asset purchase program that has pumped liquidity into the world.

And instead of providing some offset to Japan’s actions, the Fed, almost simultaneously, chose to hold rates at historically tight levels (the highs of the tightening cycle).

It didn’t go well.

This policy combination created a crisis-like shock across key global markets.

And within days the Bank of Japan was verbally walking back on their policy path.  And from the behavior of markets over the past few trading days, it looks like they may be directly intervening (buying assets) to stabilize the Nikkei and the yen, and as a by-product the most liquid, widely-held U.S. stocks.

So, what are the clues that Japan went back into emergency policy mode, filling the cracks that emerged in the global financial system (and in communication/coordination with its global central bank counterparts)?

The first clue is that the Fed speakers we’ve heard from over the past week have been mostly apathetic to the recent market shock.

They haven’t tried to assuage markets by signaling any greater appetite to cut rates — no acknowledgement of a policy mistake.  And keep in mind, the U.S. 2-year yield had the type of extreme decline only associated with major market crisis events (each of which were followed by a Fed response).

The second clue:  Gold.

If this extreme market reaction is further evidence that the global economy can only be held together with central bank life support, then quantitative easing is a permanent feature.

Printing money means the purchasing power of the money in your pocket goes down.  Gold goes up, relative to the value of fiat currencies.

Indeed, gold closed today testing record highs, yet again.

With that, we’ve often looked at this longer term chart of gold over the years, since it was trading in the $1,600s in March of 2020.  Spot gold is now closing in on $2,500.

And this classic C-wave (from Elliott Wave theory) projects a move up to $2,700ish. 

I’ll be away the remainder of the week, so you will not receive a Pro Perspectives note from me.

In the meantime, I’d like to invite you to join my premium services, The Billionaire’s Portfolio and the AI-Innovation Portfolio.   You can find more information here and here.

Best,

Bryan 

In the past couple of weeks, we’ve been looking at this chart of the Nikkei (Japanese stocks) and the Japanese yen.

As we discussed, with the Bank of Japan recently announcing plans to exit its role as the global liquidity provider while the Fed simultaneously holding interest rates in the most important global economy at historically tight levels, it raises the risk of a liquidity shock for global markets.

The first stage is a reversal of the “carry trade” — where global investors borrowed yen for (effectively) free, converting that yen to dollars (USDJPY goes up), and investing those dollars in the highest quality dollar-denominated assets (U.S. Treasuries and the big tech oligopoly stocks).

That unwind is being represented in the chart above, and the chart below …

And as you can see, it has resulted in trend breaks in major global stock markets.  Bond markets, too.  And the severity of these market moves are historically extreme.

If we look at the three day loss in the Nikkei (Japanese stocks), it’s comparable to only three other dates over the past thirty years.

Clearly these are not friendly comparables.  In fact, in each case a central bank response (i.e. QE) shortly followed.

That leads us the second stage of the carry trade unwind.

With the occurrence of rare/low probability market moves, the possibility of margin calls and forced liquidations rises in the financial sector.   And that can quickly spread, and lead to a liquidity shock and global financial instability.

With that, is the recent pressure on markets over?  Unlikely.

To this point, surprisingly, the Fed has yet to even signal that the policy outlook has materially changed, despite the recent weak labor data and despite the market activity of the past two days.

That said, remember Jerome Powell admitted last week that they have “a lot of room to respond” to a shock or weakness in the economy (i.e. plenty of rate cut ammunition, given the high level of the policy rate) — and the Fed and other central banks have made it explicitly clear, over the past several years, that the balance sheet is now a tool used to fix “financial dislocations.”

They break it.  And they fix it.

In fact, Fed member Austan Goolsbee said it today: “If the economy deteriorates, the Fed will fix it.”

On that note, as we’ve discussed many times here in my daily notes, we’ve yet to see an example of a successful exit of QE.  It’s Hotel California — “you can check out, but you can never leave.”

This is the chart of the dollar/yen exchange rate in purple.  And the Nasdaq is in orange. 

As you can see the two have tracked closely, and it’s no coincidence. 

This reflects the “carry trade” — the borrowing of yen for (effectively) free, converting that yen to dollars (dollar/yen goes up), and investing those dollars in the highest quality dollar-denominated assets (U.S. Treasuries and the big tech oligopoly stocks).

So, in the chart above, the rise in dollar/yen and rise in stocks are products of abundant global liquidity promoted by Bank of Japan monetary policy. 

On that note, let’s revisit an excerpt from my note last week: 

“With the Bank of Japan telegraphing the beginning-of-the-end of QE (a plan to taper global liquidity), the (carry) trade is reversing, as you can see within the white frame in the chart above.

And with that, the risk rises of global liquidity swinging in the direction of too tight (i.e. a liquidity shock).  The question is, will the Fed surprise markets next week with a move, or will the market have to force the Fed’s hand?”   

Fast forward to yesterday: The Bank of Japan did indeed lay out the plan to reduce the size of the program that has supported the Japanese government bond market, and other key asset markets around the world (including U.S. Treasuries) for the past decade-plus.  They also raise rates, and signaled more to come. 

And the Fed did not surprise markets with a move (a counter-punch) but rather chose to hold rates unchanged (at historically high real rates) for the twelfth consecutive month.

With that dynamic at work, here is an updated look at this Nasdaq vs. dollar/yen chart …

As you can see to the far right of the chart, the reversal of the carry trade continues in dollar/yen and that suggests it will continue in the Nasdaq (in stocks).

That would mean a break of this big trendline we’ve been watching in the Nasdaq (and a similar line in the S&P futures).

As we discussed earlier this week, this big trendline represents the trend from the October lows, which was marked by Fed signaling that the tightening cycle was over.

The trajectory of the trendline represents the view that financial conditions will be easing.  But, again, the policy expectations that induced the trendline have not materialized.

So, back to the question in last week’s note:  Will the market have to force the Fed’s hand?

It appears so.

If we get a weak jobs report tomorrow, and if stocks break down, expect the Fed to line up the media tour for committee members to communicate certainty on a September cut.

Moreover, they should float the possibility of cutting by 50 basis points.  Notably, in five of the past six rate cut series the Fed started with a half point cut.