August 27, 2021

As we've discussed, the Fed spends a lot of time manipulating the expectations of consumers and businesses, as part of their policy making.

They talk a lot, in attempt to manufacture stability in markets, and the path they would like to see, for the economy and for interest rates.  

Sometimes it works.  Last year, at the peak of pandemic and economic uncertainty, they managed to stabilize the treasury market by vowing to backstop the troubled corporate bond market.  Within months of the announcement, even crippled airline companies were able to sell billions of dollars of bonds.  All told, the Fed only had to buy $14 billion worth of corporate bonds – a tiny fraction of the total market.  It was the threat, that they would do "whatever it takes" that returned stability, not just to the corporate bond market, but to the treasury market and to all global markets (stocks, bonds, commodities … everything).  

Now they are trying to navigate the end of emergency policies.  And they are, once again, talking a lot.  As we know, the Fed chair had a highly anticipated prepared speech this morning, where he was due to telegraph a beginning of the end of QE.

He did, but with a healthy dose of expectation manipulation.  First, before Powell gave his speech, they rolled out Fed President after Fed President for interviews with financial media.  Their job was to confirm the market expectation that the Fed sees the economy in good shape, inflation as possibly a higher risk than the previously projected, and, indeed, that it was time to start winding down the QE program.  Perfect. 

So what did the most important Fed official say, the Chair?  He reigned it all back in.  He gave us five reasons that inflation wasn't going to run hot.  

With that, the interest rate market finished lower on the day.  And that was a victory for Powell and company.  After all, they want to remove accommodation on their schedule.  They don't want to see a run up in market interest rates, which would put them in a position where they would be forced to unwind emergency policies faster, and begin lift-off of the Fed Funds rate earlier.

August 26, 2021

Jay Powell will make a prepared speech tomorrow at the annual Kansas City Fed global economic symposium.  This event, typically hosted in Jackson Hole (but online this year), has a history of gathering the world's most powerful central bankers.  And there is a history of major policy signalling.  

In 2010, Bernanke telegraphed QE2 in his Jackson Hole Speech.  Two years later, he telegraphed QE3 at the event.  In 2014, Mario Draghi (head of the European Central Bank) telegraphed aggressive action from the ECB to battle deflationary pressures — a bond buying program was formally announced just days later. 

Interestingly, the Kansas City Fed moved the event to Jackson Hole, back in 1982, in effort to convince Paul Volcker to attend – the Fed Chair and a fly fishing enthusiast.  Volcker was, at the time, aggressively battling high inflation with very aggressive interest rate hikes. 

Of course, we enter this Jackson Hole meeting with the most dangerous inflation we've seen since the Volcker era

And remember, just last week Powell talked specifically about Volcker in a town hall meeting.  He admiringly called him "the most distinguished public servant, in economies, in [Powell's] lifetime."  And he admires him because of his courage to take on the unpopular, but necessary path of beating what Powell calls The Great Inflation.

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 set the stage for a long and very good period of development for the U.S. economy. 

Now, we already know the Fed has pivoted, over the past month, in acknowledgement of the aggressive inflation already baked into the economy.  On that note, I suspect we'll see Powell, once again, bring up the Volcker era in his prepared speech on Friday.  If he does, the markets may have to recalibrate for a Fed that is beginning to see a higher risk (than previously) that they may have to become inflation fighters in the near future. 

August 25, 2021

Sticking with the theme we've discussed the past two days, rates continue to rise on optimism about the economic recovery.  And that's being fueled by optimism about the pandemic outlook (with the expectation of widespread global vaccine mandates, following the FDA's approval of Pfizer's vaccine).

So, U.S. 10 year yields are now 10 basis points higher than prior to the FDA announcement on Tuesday.  And as we discussed on Tuesday, we should expect the world to follow the lead of the FDA, with regulator approvals and subsequent widespread vaccine mandates.  With that, yields globally are on the move. 

Today, German yields had the biggest one day move since March.  Italian yields (one of the weak spots in Europe) jumped by nine basis points, the biggest move since late February.  What's in common now, with that late February – early March period?  Congress was about to put a stamp of approval on the $1.9 trillion Biden spending package.  Today, they are about to put a stamp of approval on another $4.5 trillion in government spending.  

In anticipation of the $1.9 trillion, the U.S. ten year yield rose from 1% to 1.75% in forty days, earlier this year.  The difference then:  The Fed was not only concerned about rising rates, there were reports that they might consider taking additional action to force down longer-term market interest rates (through another iteration of "operation twist"). 

This time around, the Fed is actually talking UP rates.  

August 24, 2021

We talked yesterday about the FDA vaccine approval as another November 9th, 2020-like moment,  where markets interpret it as new hope that the pandemic will end. 

And that — combined with even more extravagant government spending coming down the pike, and a Fed that has prepared markets for an end of emergency policies — is a recipe for the beginning of the end of ultra-low rates.  And it all is reflective of a sustained economic recovery. 

Indeed, rates were on the move today, trading up to 1.30%.  And no surprise, when we look across the stock market, small cap and value stocks have been the outperformers the past two days on this formula of "pandemic escape" and sustained economic recovery. 

After all, coming out of recessionsmall caps tend to follow the path of interest rates (climbing rates, suggests more optimism about the outlook).  With that, as interest rates (the 10-year yield) rose from as low as 31 basis points, last year, to as high as 1.78% this year, small cap value stocks soared.  Conversely, as you can see in the chart below, as we've seen a decline back to 1.13% on the ten-year over the past few months, small caps have fallen, diverging from the performance of larger cap growth stocks (and the broader market).

So, with the above in mind, with a fresh catalyst for a move in rates (higher), we should expect small cap value to roar back into the end of the year.  

The Russell 2000 is now up 13% year-to-date.  That is underperforming the broader market, which is up 19%.  Again, history tells us we should expect the opposite coming out of recession.  Be long small–caps!

August 23, 2021

Stocks trade to new record highs today.  The dollar is lower.  And commodities are up.

While the Fed has another highly anticipated speech for markets to parse this week, the driver for global markets today (higher) was an FDA approval of the Pfizer vaccine. 

Just as CDC guidelines have become the standard for corporate and government decision-making, under the assumption that any legal judgement will defer to the guidelines of the governmental agency.  This FDA approval will trigger, and very likely set a standard for U.S. mandates – and global mandates will follow the lead of the U.S.

This comes as downward revisions have been coming in for Q3 GDP, in the wake of a resurgence in COVID cases over the past two months, and related softening economic data.  The FDA vaccine approval should reverse that tide, especially combined with the $4.5 trillion of new government spending that the House is "evaluating" this week. 

I'm reminded of the well placed November 9th (2020) announcement from Pfizer, of vaccine efficacy.  It sparked hope of the end of the pandemic, and that came alongside an election that was telegraphing massive fiscal spending. 

From that date, stocks soared, rallying 28%, and at a near perfect 45-degree angle.  Crude oil never looked back, following a similar path to that of stocks (up and to the right on the chart) — from $37 to as high as $77.  And yields never looked back, trading from 0.80% to as high as 1.78%.

This FDA approval could provide a similar catalyst for hope on the pandemic outlook, and for markets. 

Given the recent pull back in crude oil and bond yields, these two markets look like a big bounce is in store, following this FDA catalyst.

Crude oil put in a technical reversal signal today (a bullish outside day)…

And 10-year yields trade more than 1/2 percentage point lower than the highs of just March, despite a Fed talking about exiting emergency policies  …

August 20, 2021

Despite the health crisis and geopolitical noise surrounding stocks, the S&P 500 finishes the week less than 1% off of record highs.

The tailwinds continue to overwhelm the risks.  

Tailwind #1 for stocks:  Second quarter earnings season is winding down, and haven't disappointed.  We were expecting big earnings beats.  We got it.  About nine out of ten companies beat estimates, with earnings growth of better than 90% (compared to the same period last year).

Tailwind #2 for stocks:  The House will return to Capitol Hill next week, to rubber stamp $4.5 trillion of government spending (spending intended to stimulate and transform the American economy).

Tailwind #3 for stocks: The Fed, while setting the table for an exit of emergency policies, will continue to promote ultra-easy financial conditions for at least the better part of the next year.  They've pivoted from the "easy forever" stance, but they are far from slowing down the train of 6%-7% growth, at this point.  Market interest rates close the week at just 1.25%. 

Tailwind #4 for stocks:  What was a headwind a month ago, has now become a relative tailwind.  Oil prices are 19% lower than a month ago. That underpins consumption and, if anything, softens the inflation picture – at least for the moment.  

With the above in mind, the dips in stocks have been shallow thus far, in 2021.  We’ve had a 6% decline, and a couple of 5% declines.

 

While a correction may be due for stocks, remember, the corrections in the post-financial crisis era have tended to be fast.  Risk enters quickly, and the slides can be sharp.  But it has paid to buy the dip.  The recoveries have been very quick and lucrative, along the way over the past 12 years – mainly because the Fed has continued to position itself to backstop stability and confidence — and stocks play a key role in those goals

August 19, 2021

Amazon is said to be planning large retail stores, "akin to department stores."

This is what is widely thought to be one of the most innovative companies in the world, reverse engineering itself into traditional brick and mortar retail — but only after they've destroyed the retail industry. 

This is precisely why we have anti-trust laws.  So that anti-competitive predators can't destroy industries, to achieve monopolistic power. Sadly, our lawmakers have not only allowed this to happen, most have invested in it. 

For far too long, Amazon was allowed to underprice the competion and subsidize its losses in the online retail and delivery/logistics business with the massive profits it gathered from its dominant cloud computing business.

Now that Amazon has crushed the competition and destroyed the value of malls and department store real estate across the country, they will swoop in and pick up retail real estate for pennies on the dollar, and become the new brick and mortar retailer on the block.  

But guess what happens when competition is crushed by predatory pricing, and a monopoly rises?  Prices go up, and up, and up. 

Uber is a good example of how this turns out.  Uber was able to skirt typical cab regulations by hiring David Plouffe, a senior advisor to President Obama (hired explicitly to fight regulation).  From there, they were able to step in crush the entrenched and highly regulated cab industry, by undercutting them on price.  Losses were subsidized by venture capital firms. 

 

And now, according to Bloomberg, the market share of New York City taxis has dropped from 100% to 11% in eight years.  Ride hailing apps have gone from zero to 81% of for-hire-transportation in NYC.  And the number of yellow taxis on the New York City streets has been cut in half compared to pre-pandemic.  And now, you guessed it, it costs more to take an Uber than it does a yellow taxi. 

Expect the successful monopoly building by Amazon to have a similar outcome:  higher prices of most things we consume, set and controlled by Amazon.    

August 18, 2021

The minutes from the July Fed meeting hit today. 

It's well known, now, that the Fed has been discussing the reduction of the bond buying program, to begin in the fourth quarter.  The minutes confirm that. Though the tone was far from hawkish.

Conversely, if we listen to Jim Bullard, not a voting member this year, but a vocal rational voice from the Fed, he has been publicly acknowledging the risks that inflation could come in much hotter than the Fed has positioned for.

Probably no coincidence, Bullard had some well timed comments today just before the July Fed minutes were released.    

He warned that the Fed might ultimately be forced into "inflation fighting mode."  He said growth is robust, labor markets are as tight as they ever get, and he said that firms are successfully passing higher input prices along to consumers. 

Remember, yesterday we talked about Fed Chair Jay Powell's admiring commentary on Paul Volcker's battle and defeat of the Great Inflation of the early 80s.   Bullard brought up Volcker today, too, saying that the Fed is already behind the curve on inflation, as compared to Volcker-era actions. 

So, again, given the somewhat dull tone from the Fed minutes (which are nearly a month old now), it's probably no coincidence that Bullard is rolled out to inject something closer to reality for the markets to chew on. 

And looking back at some of Bullard's commentary over the past two months, he's made the point that the Fed doesn't need another housing bubble.  With that, of the $120 billion a month of bond purchases currently being executed by the Fed, $40 billion are mortgage backed securities.  Expect the Fed to exit that market first (in the coming months).  That should put the brakes on the aggressively rising housing market. 

August 17, 2021

Jay Powell spoke today in a virtual Town Hall meeting. 

Given that the Fed has had a change of tune over recent weeks on the monetary policy outlook, it's a good idea to pay attention when the Fed Chair speaks.   

Clearly the Fed has made a intentional pivot since its July FOMC meeting, in an attempt to set the stage for 1) a wind down of QE, and 1) to move forward expectations on raising interest rates.  Of course, this intentional pivot comes as the Fed is confronted with undeniably hot inflation, with trillions of dollars of additional fiscal stimulus about to rain down. 

So what did Powell say today? 

First, he said, very explicitly, that the Fed is in the process of "putting away its tools designed for actual emergencies."  This confirms the recent chatter from Fed officials, that they will begin dialing down asset purchases in the next couple of months. 

Now, maybe the most interesting thing said in today's Town Hall, was this:  When asked what book he recommends, Powell went into a long admiring discussion on Paul Volcker.  He recommended his book, "Keeping At It."  And he called Volcker "the most distinguished public servant, in economics, in my lifetime."

So, as Bernanke was known to be a student of The Great Depression (and happened to be the right guy at the right time to navigate us through what could have been a Great Depression 2.0), Powell seems to have spent a lot of time studying what he calls "The Great Inflation" period.  Like Bernanke, perhaps he may be the right guy, at the right time. 

Volcker was, of course, confronted with double-digit inflation in the early 80s (as high as 14%).  And he combatted it with an aggressive campaign of interest rate hikes.  He took short term rates to as high as 19%.  As Powell said, he took a lot of bashing.  He was very unpopular.  But in the words of Powell, "he did what was best for the country," over the medium and long-term.  He beat inflation.  And it led to, what Powell described as, "a long and very good period for the development of the U.S. economy."

 
For the first time in forty years, we have the very real threat of double-digit inflation.  Will Powell respond as aggressively as Volcker responded? He seems to be prepared.

 

August 16, 2021

The stock market hit another record high today, again proving to be impervious to geopolitical risk.  Why? 

Liquidity.  There is a ton of liquidity in the system.  And if there were any shock event, we know exactly how global central banks would respond:  "more liquidity."

With that, equity prices continue to march higher, with plenty of tailwinds.  

Bonds, on the other hand, look like perhaps there is a geopolitical risk story being acknowledged.  Yields on the ten-year Treasury note traded back down to 1.21% today – from 1.37% just two trading days ago.

The question is:  With the quick collapse of the Afghan government, upon the withdrawal of U.S. troops, does it embolden China to act on Taiwan? 

Chinese state-owned media has already planted the seed to question the resolve of the U.S., to defend Taiwan, if China were to invade Taiwan.  If fact, as you can see in the tweet below, the language suggests when, not if "war breaks out in the Straits." 
 

With this, keep in mind, U.S. assets remain the safest and most liquid place to park capital in the world, and, as such, money will continue to flow into the dollar and our Treasury market as relative safe havens.  What else has had a big bounce back in recent days?  Gold.