Pro Perspectives 4/19/22

April 19, 2022

The Spring meetings of the IMF and World Bank governors are in Washington this week.  These meetings include central bankers, minsters of finance, private sector executives and academics.
 
It’s a busy week for the central planners.  These are the people that have determined that our global economy will be transformed, in coordination, to meet their vision of what is “sustainable” environmental, social and governance (ESG). 
 
And now they are reporting on the problems they have created, and are meeting to collaborate on how to solve them.
 
On the former, the IMF released its annual world economic outlook report this morning.  It includes growth downgrades.  And inflation upgrades.
 
They see war-related supply shortages amplifying existing inflationary pressures, raising prices of food, energy and metals.  They see risks of social unrest, and “serious risk of global economic fragmentation.”
 
This all sounds pretty bad. 
 
But if there’s one thing we’ve learned through the Global Financial Crisis (GFC) and the Global Health Crisis (GHC), it’s that markets like global coordination. The turning point for markets and global confidence during the GFC, was the G20 meeting in April of 2009, when the G20 pledged to work together to resolve “a global crisis with a global solution.”  Markets turned well before there was any visibility on a favorable outcome for the global financial system.  On March 16th, 2020 the G7 leaders held a video conference to discuss a coordinated response.”  Stocks bottomed five days later. 
 
So, these dismal headlines from the IMF hit this morning at 9:00 est.  At the 9:30 open, stocks went straight up (not down).  With all of this said, it’s probably a good time to get global finance leaders together as we head into the French election this weekend.  A Le Pen win (an anti-globalist and anti-euro candidate), would be highly destabilizing for the global transformation agenda.  The first spot that would need globally coordinated central bank attention would be the European sovereign debt market (the bonds of the fiscally weaker euro zone countries would become very vulnerable).   
 
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Pro Perspectives 4/18/22

April 18, 2022

We are a couple of weeks away from the Fed’s May meeting. 
 
At this meeting, they have telegraphed a 50 basis point rate hike.  And they have telegraphed the beginning of quantitative tightening. 
 
As we’ve discussed the past couple of weeks: 1) a 50 basis points hike still puts them way behind the curve on the inflation fight.  At 775 basis points behind, in the fight, every day that passes they are only adding fuel to the hottest inflation we’ve seen in four decades, … and 2)  we don’t have an historical reference point of a successful exit of QE.  For the reference points we do have, we find that unknown consequences arise in the quantitative tightening (QT) process, and central banks respond with … more quantitative easing.
 
The question is, will the Fed even get the opportunity, this time, to start the process of “normalizing” the Fed balance sheet (i.e. quantitative tightening)?
 
Remember, when they tried in 2017-2019, they broke the overnight interbank lending market.  And by 2019, they were forced to restart QE.
 
This time around, while the Fed has yet to start QT, the interest rate market is already sending some warning signals. 
 
Last week, the 10-year yield did a round trip between 2.84% to 2.64% in 48 hours — on no news.  Meanwhile, the 30-year mortgage rate is trading at the widest spread to the 10-year yield, since the March 2020 pandemic-induced economic shutdown.  Prior to that, the last time we had seen this wide of a spread was when IndyMac failed in July of 2008 (and the subsequent global financial crisis).
 
I’m not predicting failures of mortgage institutions, but I’m saying there is a strong likelihood of more intervention coming from the Fed (and other global central banks), rather than less.   
 
Consider this:  With the 30-year mortgage now above 5%, we may have (by month-end) one of only four months in the past 50-years, where the month-to-month change in mortgage rates was 1% or greater.
 
This move in mortgage rates highlights the adjustment that market rates are making, to catch up with inflation.  Meanwhile the Fed-determined-interest-rate (the Fed Funds rate) is lagging well behind (and moving at a crawling pace away from zero-interest-rate-policy). 
 
This creates a problem for banks, as they pay interest based on the Fed Funds rate.  The average interest rate paid on checking accounts right now is 0.3%.  Depositors will start looking for better alternatives (i.e. moving money). 
 
That brings us back to the discussion we’ve had on yield curve control.  This is a lever the Fed may pull (following the lead of Japan).  They could keep market interest rates from running away. 
 
But as we’ve discussed, market interest rates are a market mechanism.  If explicitly suppressed in an already hot inflationary environment, inflation could run wild. 
 
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Pro Perspectives 4/14/22

April 14, 2022

As we head into the long holiday weekend, we can see where the pain is for the market.   
 
What does that mean? 
 
We see plenty of the daily ebb and flow for markets, driven by news, distractions and sometimes outright sentiment manipulation (by the Fed, by the government, by corporate leaders, by Wall Street).  With the noise of the day, markets will go up/ markets will go down. 
 
But the overwhelming fundamental themes rise to the top when investors have to contemplate going home into a long weekend with positions they don’t have confidence in.
 
With do they do?  If they are positioned against the broad fundamental theme, they course correct.  With that, we close the week with lower stocks (led lower by high-valuation tech stocks) … higher crude oil … and higher yields.
 
This is course correcting for what seems like a market that has been offsides: wishing for the bounce back in big tech, believing that oil prices are only up for event reasons (Ukraine/Russia), and convinced that the Fed will be able to beat inflation with just a shallow path of interest rate hikes (stopping at under 3%).
 
That’s a dangerous market view.  As such, we see the course correcting activity today, that demonstrates the respect for the big themes:  1) the globally coordinated disinvestment in fossil fuels, and 2) rising interest rate environment forced by inflation.   
 
These fundamental realities for oil and interest rates are entrenched, and won’t change without the passage of time and “repricings.”  So, we should expect much higher yields, much higher crude oil (still) and the continued rotation out of growth stocks and into value stocks (still).  
 
My view:  It’s early days for all three. 
 
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Pro Perspectives 4/13/22

April 13, 2022

JP Morgan kicked off Q1 earnings season this morning.
 
It’s the biggest bank in the country.  No entity is closer to the pulse of the consumer, business and government than JP Morgan.
 
So this should give us a clue on what the coming weeks of earnings reports will look like, right? 
 
On that note, here’s what the headlines looked like coming into the market open this morning …   

Slowdown.  Profit drop.  Bad news.  Dislocations.
 
Sounds pretty bad.
 
Let’s take a look …
 
First, this is a bank that returned $4.7 billion to shareholders in the quarter.  Things can’t be too bad. 
 
At $30.7 billion, JP Morgan posted it’s third highest quarterly revenue on record.  This revenue number was only topped by Q1 of last year and Q2 of 2020 — both of which were quarters where the government was handing out stimulus checks!
 
What about earnings?  Well, in Q1 JPM broke a seven quarter streak of earnings beats.  Worse, as Reuters says, they had a 42% profit drop. Are they getting squeezed by higher costs?
 
Not really.  Before we get into the details, let’s take a look back at an excerpt from my note heading into Q2 2020 earnings (this is the quarter of the initial lockdown and the massive initial policy response). 
 
From July 13, 2020 Pro Perspectives:  “We should expect all of corporate America to take this opportunity, in their Q2 earnings reports, to put all of the bad news they can muster on the table. 
 
In a widespread economic crisis, this is their chance to write down the value of anything they can justify, take loss provisions on as much as they can, and set the bar as low as they can, so that in the quarters ahead, they can outperform expectations.“ 
 
They did just that.  In the case of JP Morgan, in the first two quarters of the pandemic, they diverted $16 billion from the bottom line, and directed that money into “loan loss reserves.”  They spent the past six quarters (prior to this morning’s release), moving these “loan loss” reserves back to the bottom line, at their discretion.   
 
With that, by the third quarter of 2020 (still in the thick of the global health crisis) they were blowing away earnings estimates and posting record earnings (an embarrassment of riches, thanks to the credit backstop supplied by the Fed and the revenue tailwinds supplied by fiscal stimulus).   
 
Same playbook is happening now (the earnings management game).
 
This morning’s “hit to earnings” came from voluntary “credit costs.”  Again, this is taking the opportunity to set the bar low, so that in the quarters ahead, they can manage earnings to outperform expectations. 
 
For Q1, if we add back the money set aside as the provision for loan losses, JP Morgan would have beat earnings estimates this morning, and would have posted a net income of over $9 billion.  That’s very close to record earnings, when adjusting all of the earnings of the past six quarters for either the credit reserve build or releases.
 
Bottom line:  The activity at the country’s biggest bank is quite healthy.    
 
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Pro Perspectives 4/12/22

April 12, 2022

Inflation for March came in at 8.5% (compared to March of last year). 

That’s a hot number, above expectations, but not the double-digit number I was expecting.  In fact, when I saw it, I thought immediately about the very strange trend in payroll data we’ve seen over the past year. 

For eleven consecutive months, the labor department has undershot the final payroll number, every single month, by an average of 158k jobs.  This, as the administration was pushing hard last year to justify another (massive) fiscal spend (the “Build Back Better” plan).  The initially “disappointing” jobs numbers were quietly revised much higher in the months that followed, with little attention.   

Is the government playing games with the headline inflation data? 

If we look at the monthly inflation, it’s an eye-popper:  up 1.2% from February to March (one month). 

That number, annualized, is 15.3%!  And that magnitude of monthly price jump has only happened four other times on record: 2005, 1980, 1974 and 1973.  Each time, higher inflation has followed. 

That said, the media was out in full force today running headlines suggesting that inflation has peaked.

This looks like the media carrying the water, trying to manage “inflation expectations.”

As we’ve discussed, the Fed is far more concerned about inflation expectations, than they are about inflation.  If they lose control of expectations, people start pulling forward purchases, in anticipation of higher prices, creating a self-fulfilling upward spiral in prices.

As for prices, the only offset to the genie they (the government) knowingly unleashed in March of 2020 (through direct payments to businesses and consumers), is a wage reset (i.e. a broad-based shift in the wage scale, up). 

That’s due to this chart …

Since the initial pandemic response, the money supply has grown at more than four-times the long-term annualized rate.  The genie doesn’t go back in the bottle.  With that, we’re getting a rise in prices (the CPI index) that’s running better than four-times the pre-pandemic trend rate.  

Pro Perspectives 4/11/22

April 11, 2022

We start the week with a lot of noise for markets to digest (China lockdowns, Elon Musk/Twitter, Russia/Ukraine, upcoming Q1 bank earnings).  But nothing is bigger than tomorrow’s inflation data. 

We can see it reflected in the market behavior today.  Stocks were down.  Interest rates were up.  The dollar was up.  Gold was up. 

This is about inflation and rates.   

We’ve been talking about the importance of Tuesday’s report for almost a month now. This data we’ll get tomorrow is the first inflation reading that will include the spike in oil prices from $94 to as much as $130 a barrel — which has sent gas prices well north of $4.  

This should give us the first double-digit inflation number since 1981. The market is looking for 8.4% — a number with some shock value, but that will likely turn out to be conservative. 

This sets up for a big negative surprise.  We will see.

How would the Fed handle a double-digit inflation print? 

Call it transitory?  Maybe.  With oil now back in the $90s, there is cover to say that the influence on CPI from the spike in gas prices will fade, now that the government has released oil from the strategic petroleum reserves.

But they will have a hard time in the coming months explaining away bigger inflation numbers – driven by more factors than just a spike in oil prices.  With that, a runaway interest rate market (a rational response from bond investors) would present a dangerous situation for the Fed and Treasury.  This is where we may see the Fed go to “yield curve control.”   

As we discussed last week, “this would keep market interest rates from running away. But market interest rates are a market mechanism.  If explicitly suppressed in an already hot inflationary environment, inflation could run wild.

With all of this, we can see the path for global governments to justify a new monetary system (central bank-backed digital currencies).

A consortium of 63 global central banks has already promoted CBDCs as the ‘future of the monetary system.'”

 

Pro Perspectives 4/8/22

April 8, 2022

We talked yesterday about the path to perpetual quantitative easing. After all, we’ve yet to see an example of a successful exit.

Already, just as the European Central Bank (ECB) is projecting rate hikes later this year, and is ending its emergency pandemic bond buying program, there was news from Bloomberg today that the ECB is, at the same time, formulating a plan to prevent a spike in sovereign bond yields in the weaker spots of Europe — with what is likely, more QE!

Let’s talk about why?

Back in 2012, yields on Spanish and Italian sovereign debt had skyrocketed to unsustainable levels, which put two of the biggest countries in the eurozone on default watch, which threatened the dominoes to fall in Europe (a cascade of sovereign debt defaults), and a collapse of the euro (the monetary system).  It was an ominous moment, threatening the disintegration of the euro and euro zone.

But ECB chief (at the time), Mario Draghi, made the threat to do ‘whatever it takes.’ He threatened to buy unlimited Italian and Spanish debt.

Draghi’s threat put in the top for yields, without the ECB having to buy a single bond.  Within two years, yields on Spanish debt fell from almost 8% to 1%.  A European collapse was averted.

Fast forward to today:  the ECB is exiting its pandemic-induced QE program, and scaling down a QE program they’ve been running since 2014.  But there is trouble brewing.

The French election polls show Marine Le Pen closing in on Macron.   Le Pen is a nationalist, and is anti-euro (the single currency).  A Le Pen win would set back into motion (again) the threat of a disintegration of the euro.  And again, crisis policies would be back.  Not just for the European Central Bank, but global central banks.

Again, this leads us back to the conversation of more control and intervention by central banks over markets – to plug new leaks in the global economic system.

QE is Hotel California.  And it highlights the eventuality of a reset of global debt, and a new monetary system.  It’s coming, and it’s coming soon.

On that note, as we’ve discussed, the central bankers and politicians have been telegraphing a monetary system that includes a move to a digital dollar (“central bank digital currencies,” in global coordination).

We had another shot across the bow this week.  Janet Yellen (Treasury Secretary) gave another prepared speech on “digital assets.”

This gets the crypto-enthusiasts excited, as they assume this means the government is taking steps toward accepting and legitimizing private cryptocurrency.  It’s precisely the opposite.  As Yellen said, “sovereign money is at the core of a well-functioning financial system.”

She went on to say how the history of money in the United States was littered with attempts at different forms of private money.  She says, it didn’t work, and they regulated it away.

She went on to say: “monetary sovereignty and uniform currency have brought the clear benefits for economic growth and stability.  Our approach to digital assets must be guided by the appreciation of those benefits.”

So, we have another clear warning for the private crypto market.  The government will regulate it away, and strengthen their monopoly on money through a “central bank digital currency.”

 

Pro Perspectives 4/7/22

April 7, 2022

Yesterday we talked about the history of the Fed's last quantitative tightening. 
 
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.
 
As we discussed yesterday, 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."
 
That said, this stealth QE continued until the covid crisis hit, and then the Fed and all global central banks responded with:  more QE. 
 
What's the point?
 
We do not have a record of a successful exit of QE.  
 
And we don't have to look too far for evidence that QE may be the Hotel California of monetary policy.  "You can check out, but you can never leave."  The Bank of Japan, has been in some form of quantitative easing for the better part of the past twenty years.  What does it lead to?  The ballooning of debt.  Debt in Japan has ballooned to 260% of GDP.
 
So, if we consider that, is it even possible for interest rates in the U.S. to rise?  What do higher interest rates do?  They make government debt a lot more expensive to repay.  That means more borrowing (higher deficits) to service the debt.  And who ends up buying the debt?  The central bank. 
 
The former head of the central bank in India wrote a piece on this last August.  He estimates that every percentage point increase in interest rates will translate into a 1.25 percentage point in the fiscal deficit (as percent of GDP).
 
That brings me back to my note from last month, on what will likely be the next move by the Fed:  "Yield curve control" (managing market interest rates to stated target levels).
 
The Bank of Japan started it back in 2016, intervening in the interest rate market to manufacture their desired longer term interest rates. 
 
The Vice Chair of the Fed, Lael Brainard has been an advocate for yield curve control.  This would keep market interest rates from running away. But market interest rates are a market mechanism.  If explicitly suppressed in an already hot inflationary environment, inflation could run wild.
 
With all of this, we can see the path for global governments to justify a new monetary system (central bank-backed digital currencies).
A consortium of 63 global central banks has already promoted CBDCs as the "future of the monetary system." 

Pro Perspectives 4/6/22

April 6, 2022

The minutes from the March Fed meeting were released today, laying out  a plan for reducing the Fed's balance sheet.  Translation:  there will be less liquidity in the economy (tighter money).
 
Let's take a look at how we got here.

You can see above, the global financial crisis response included three iterations of QE, and resulted in the Fed adding $3.5 trillion in assets to the balance sheet.  And they were left with an economy that could barely muster 2% economic growth.  
 
Still, they tried to normalize rates and shrink the balance sheet (i.e. quantitative tightening or "QT").  From 2017 to 2019, they allowed about $800 billion of assets to mature.  You can see that framed in the box in the chart above. 
 
Guess what? 
 
By the end of 2019, the Fed was forced to restart QE.  Why?  Because the overnight lending market did this …
Here's how the Fed explained what happened (my emphasis) …
 
"Strains in money market in September occurred against a backdrop of a declining level of reserves, due to the Fed's balance sheet normalization and heavy issuance of Treasury securities."
 
So, the Fed was forced to rescue the overnight lending market (between the biggest banks in the country) because of an unforeseen consequence of balance sheet normalization.
 
With this in mind, the minutes today spelled out a plan to start allowing about 1% of the Fed's balance sheet to start "rolling off" (maturing, which equates to reducing the size of the balance sheet).  But they will gradually get to that size over a few months, "over a period of three months or modestly longer." 
 
That statement is telling.  Many are expecting some aggressive quantitative tightening.   But the Fed, surely, has very clear memories of the 2019 shakeup. 
 
It's important to understand that reversing the Fed balance sheet is an experiment, with outcomes unknown. 
 

Pro Perspectives 4/5/22

April 5, 2022

On January 5th, the minutes from the December Fed meeting spelled out exactly what Jay Powell had told us just weeks earlier in his (December) post-meeting press conference. 
 
What was the message? 
 
The Fed had set the table for a March liftoff in rates.  And they had contemplated a strategy for shrinking the balance sheet (i.e. quantitative tightening!).  
 
In this chart below of the S&P 500, you can see where stocks were, when this news hit. 
 
This reality that the Fed was going to become inflation fighters set off a broad sell-off.  It was largely led by the high valuation/ high growth stocks and the high growth/no eps stocks.  
 
Valuations began to reset for a world where a higher discount rate would be plugged into Wall Street models.  With that, the broad market forward P/E has since fallen from around 22x to 18x (still a bit above the long-term average P/E of 16x).   

Now, with all of that said, we have Fed minutes tomorrow. 
 
The minutes will be from the March meeting.  And we will learn what was said in the meeting that kicked off the inflation fight (i.e. the first post-pandemic rate hike).
 
On that note, we got some clues today from Lael Brainard. 
 
Brainard, who just months ago was up for the Fed Chair position (and has since been appointed Vice Chair), gave a well-scheduled prepared speech this morning.
 
What were the takeaways?   
 
On policy, she said "it's of paramount importance to get inflation down."  She said they will continue to tighten "methodically" through rate hikes.  And she said they will shrink the balance sheet "more rapidly" than they did in the previous recovery. 
 
The latter is not news. Jay Powell told us in December that they would be more aggressive in reducing the balance sheet in this hot economic recovery, with hot inflation (relative to the weak recovery, and weak inflation of 2017-2019… the previous period of quantitative tightening). 
 
What is surprising is that Brainard used the word "methodically."  Setting the expectation for autopilot like rate hikes doesn't do much to curtail inflation expectations.  
 
When Ben Bernanke was 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 kind of intermeeting large adjustment in rates would go a long way toward resetting the inflation trajectory — quickly.  So far, it doesn't appear that the Fed has given any consideration to it.