We have a big jobs report on Friday.

As we discussed in my last note, the result of the Fed’s very restrictive policy rate has been damage to the labor market.

That damage has been revealed in the rate-of-change at which the unemployment rate is rising.  It’s at a speed that is consistent with the past four recessions.

And with that, the weak jobs data that was reported early last month (Aug. 2) was the signal to markets that the Fed had arrogantly held rates too high, for too long — and that perhaps aggressive rate cuts were coming, as the Fed finds itself cleaning up another policy mistake.

What else was revealed that day?

The Fed’s stubbornly hawkish policy over the past two-and-a-half years has created a vulnerability in global markets.

It was the persistent telegraphing by the Fed of high and stable relative interest rates in the U.S., that attracted capital from around the world, particularly from Japan (where investors borrowed yen cheaply, and invested in higher yielding and high return U.S. assets … i.e. “the carry trade”).

With that, we looked at this chart heading into that jobs report last month (from my July 25 note) and talked about the prospects of that trade reversing …

In this chart, you can see the dollar/yen exchange rate in purple, and the Nasdaq in orange. 

As you can also see the two have, no coincidence, tracked closely. 

The story of this chart above is 1) borrowing yen for (effectively) free, 2) converting that yen to dollars (dollar/yen goes up), and 3) investing those dollars in the highest quality dollar-denominated assets (U.S. Treasuries and the big tech oligopoly stocks).

As we know, the weak labor market picture early last month did indeed trigger a sharp unwind of this trade.  

And here is the update of this chart …

While stocks have made a full V-shaped recovery since that sharp unwind, USDJPY has not.

And with another check-up on the health of the job market coming down the pike this week, this divergence (within the white box in the chart above) looks likely to close in the direction of the purple line (i.e. stocks lower). 

Tomorrow, we get the July PCE report (personal consumption expenditures).

This is the inflation measure the Fed cares most about.  It’s the basis of their 2% inflation target (headline PCE).

The consensus view for the July report is a continuation of what the Fed perceives to be “a stall” at around 2.5%.

For perspective, if we take a step back and look at a longer term view of PCE, inflation running above the Fed’s target hasn’t historically resulted in the type of obsessive Fed response we’ve seen over the past year.   

As you can see in the chart below, PCE has spent plenty of time above 2%.  In fact, the average PCE dating back to 1990 is 2.22% (i.e. above target). 

As we know, this stall in PCE, around 2.5%, has led the Fed to continue holding the policy rate at historically tight levels.  

How tight? 

If we subtract 2.5% (PCE) from 5.33% (Fed Funds Effective Rate), we get a real interest rate of 2.83%. What was the average real rate over the period on this chart above?  It was 0.6%.  The decade prior to the global financial crisis was just 1.73%.

So clearly the current real interest rate is historically very restrictive policy.  

And with that, the result has been damage to the labor market.  As we’ve discussed, while the unemployment rate remains low, the speed of change in the unemployment rate puts it in unique company of the past four recessions. 

So tomorrow’s inflation report should be an uneventful one.  The big event will be next Friday’s unemployment report. 

Today we heard earnings from Nvidia, the most important company in the world.

The state of the new industrial revolution is well intact. 

But we already knew that.  We heard last month from all of the tech giants that are working on the frontier of generative AI (Microsoft, Amazon, Tesla, Meta, Alphabet).

And they told us, 1) the price to build generative AI computing capacity continues to go up … 2) they will spend whatever it takes on the infrastructure … 3) the AI model intelligence continues to rapidly advance, and … 4) the stage of the technology revolution is still very “early.“

So, given that they are all buying as many GPUs from Nvidia (the gold standard) as the company can produce, it was fair to expect another good report from Nvidia. 

With that, for Q2, Nvidia reported this afternoon.  And it was the fifth consecutive quarter of triple-digit year-over-year revenue growth.

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