Pro Perspectives 9/26/24

 

 

 

 

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September 26, 2024

We've talked about the outlook for a weaker dollar, driven by the recent Fed rate cut and the likelihood of a dramatic decline in U.S. real rates over the next year.
 
And as we've also discussed, a weak dollar tends to be fuel for commodities prices. 
 
Pretty much every important commodity in the world (food, energy, metals) is priced in U.S. dollars.  As such, the value of the dollar tends to have an inverse relationship with the price of commodities.  That inverse correlation gives stability to global buying power.
 
And remember, this comes as the bull cycle for commodities is young, and commodities prices still remain at historically extreme cheap levels relative to stocks.
 
Add to this, commodities have gotten another tailwind this week out of China.
 
On Monday, the Chinese central bank unveiled the most aggressive monetary stimulus since the pandemic.  It included rate cuts, support for the real estate market and direct support for the stock market. 
 
And then last night, the Chinese government followed that with a comprehensive plan to boost the Chinese economy.  It includes about a quarter of a trillion-dollars in fiscal stimulus.
So, this is clear big and bold action by the Chinese government to boost the economy, reverse deflationary pressures and appeal to foreign capital.
 
In a world where most major global stock markets are sitting on record highs, China becomes a "value with a catalyst" alternative.  And that catalyst, is the Chinese government explicitly supporting the stock market.
 
   
And this is liquidity that will spill over into global markets, and stimulate global growth. 
 
What commodity is the proxy on global growth?  Copper.  
 
What's the biggest mover on the week in global markets?  Copper.
 
As for commodities more broadly, China has a history of stockpiling commodities during periods of fiscal stimulus. 

Pro Perspectives 9/25/24

 

 

 

 

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September 25, 2024

We talked about both the technical and fundamental case for a weaker dollar yesterday.  
 
The outlook for lower real interest rates is clearly dollar negative.  And it plays into the long-term dollar cycles, which are in the early stages of a bear cycle.
 
That said, the dollar ripped higher today at 10am (EST).  
 
And it was driven by the safe-haven feature of the dollar. 
 
And this was the catalyst …
 
 
Zelensky took the stage at the UN and said Russia was planning attacks on Ukraine nuclear plants.
 
Forty-five minutes later, it was reported that the head of the Israeli army said they were preparing for a ground offensive in Lebanon.   
 
And hours later, Putin was on the wires announcing that Russia is expanding "the category of states and military alliances subject to nuclear deterrence."  If they get reliable information of an attack, aided by nuclear powers (Western world military alliance), he says they reserve the right to use nuclear weapons.
 
With the above in mind, we also talked about gold prices in my note yesterday.
 
It printed another new all-time high today.  And even at record highs, the reasons to own gold continue to build:  Falling real interest rates, fiscal and monetary policy profligacy, and now the dialing up of war rhetoric, which fuels safe have demand for gold. 
 

Pro Perspectives 9/24/24

 

 
 

 

 

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September 24, 2024

Let’s take a look at the dollar.

As we said last week, following the Fed action, the bigger 50 basis point cut was clearly dollar negative.  While the first move was up, the direction has since been down.

And as you can see in the chart, it looks like it’s breaking down technically …

And as we’ve discussed, the Fed has kept real interest rates (Fed Funds Rates minus the inflation rate) at historically high levels, and now that real rate is coming down, and has a lot of room to continue coming down before the Fed gets rates to what they consider “neutral” (neither restrictive nor stimulative to economic activity).

And the dollar tends to follow the direction of real rates.

For more perspective, let’s revisit the long-term dollar cycles, which we’ve kept an eye on throughout the history of my daily note.

Since the failure of the Bretton-Woods system through the onset of the Global Financial Crisis, the dollar traded in five distinct cycles – spanning 7.4 years on average.  And the average change in the value of the dollar (in those five cycles), from extreme to extreme was greater than 50%.

As you can see, the era of quantitative easing (QE) has seemingly distorted this last bull cycle.

The top was in late 2022, just after the Fed started QT (quantitative tightening/reversing QE). 

And now we’re in a dollar bear cycle.  And that aligns with the outlook for the bull market in commodity prices (lower dollar, higher commodities prices).  

With that, we’ve seen it reflected in gold.

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 this $2,700 level that we’ve been projecting from the technical analysis (Elliott Wave Theory).   

With this chart above in mind, gold tends to trade inversely to real interest rates.  And as we discussed above real rates are just beginning to decline and have a ways to continue lower.  And it happens to be as gold is already on record highs, driven by the U.S. fiscal profligacy of the past few years, global money printing, seizure of Russian assets and geopolitical risks.

So gold still has room to run. And the commodities bull cycle in general is young.  Broad commodities prices remain at historically extreme cheap levels relative to stocks.

 

 

Pro Perspectives 9/23/24

 

 

 

 

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September 23, 2024

Remember, Jerome Powell told us last week precisely what signal he wants the market to take from the Fed's rate cut. 
 
He said, they don't think they are behind the curve, and that the Fed's "strong move" should be taken "as a sign of [their] commitment not to get behind the curve."
 
Shortly thereafter the governor of the Bank of Japan said the uncertainty around the U.S. economy is the reason for unstable markets.  And he said while soft landing in the U.S. economy remains the base case, "the data since early August has been weak, so risks have heightened somewhat."
 
Keep this all in mind as we consider the comments made by a lineup of Fed speakers since last week's meeting.
 
On Friday, Fed Governor Waller said he would support "big rate cuts" if needed.  If the labor market worsens or inflation data softens quicker, he said he's fine moving in 50s to get to "where they want to go." 
 
"Where they want to go," would be the neutral rate, which is much, much lower. 
 
So, that makes "soft inflation" a condition for him.  And not so coincidentally, he added that he sees inflation coming in soft for August, based on the inputs from the recent PPI and CPI. 
 
Atlanta Fed President Bostic had commentary focused on the labor market.  He says, "if the labor market deteriorates that is a reason for a faster pace to neutral."
 
Chicago Fed President Goolsbee said this:  "Keeping rates at decade-high does not make sense when you want things to stay where they are." 
 
That implies they want things to stay here (2%ish growth, 4.2% unemployment, and very near target on inflation).  If that's the case, the "neutral rate" is where you want to be, to neither stimulate nor restrict economic activity.  And he added, "we are 100s of basis points above the neutral rate." 
 
So, from this commentary (including the Bank of Japan) we can deduce that both the unemployment rate and the (soft) inflation rate sit on thresholds that, if breached, would prompt an aggressive reaction from the Fed. 
 
This all sounds like a Fed that knows they are behind the curve.  They held rates for too high, for too long, which has put the economy in a vulnerable position — though they don't want to admit it publicly.
 
And if we take Powell's guide on this Friday's PCE report, it should come in at 2.2%.  That would be a drop from the July reading of 2.5%.  And that means, by holding rates steady in July (for the twelfth consecutive month), the Fed actually got 30 basis points tighter (more restrictive) in the month of August (i.e. as inflation falls and the Fed Funds rate stays steady, the "real interest rate" moves higher/policy gets tighter).
 
With that, they only accomplished maybe 20 basis points of actual easing out of their policy decision last week.
 
What we do know from all of this is that the Fed wants us to believe, unequivocally, that they are on high alert to protect the economy.
 
That should serve as a perceived safety net for hiring and investing. 
 

Pro Perspectives 9/19/24

 

 
 

 

 

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September 19, 2024

Earlier this year we talked about the parallels between the current environment and the late 90s boom. 

A technology revolution was underway in the late 90s, with the rapid adoption of the internet.  Productivity was high.  Growth was hot.  Inflation was low. And the Fed juiced it with rate cuts, starting in 1995.

The economy went on to average 4.5% quarterly annualized growth through the end of the 90s.  And stocks did this ...

  

 

Also like the current environment, the Fed had real rates (Fed Funds rate minus inflation) at historically high levels heading into the first cut. 

Greenspan cut a quarter point in July of 95, again in December, and then January.  Despite more rate tinkering throughout the period the real rate remained relatively high, as you can see in the chart below .

And as you can see in the far right of the chart, the real rate prior to yesterday’s 50 basis point cut was in the zone of that late 90s boom (i.e. at historically high levels). 

The question:  After yesterday’s move, could the Fed hold real rates here and still get a 90s-type boom-time economy, this time driven by the technology revolution of generative AI?

Growth solves a lot of problems.  But the U.S. debt/gdp has doubled since the late 90s.  And while the debt service/gbp is comparable to the late 90s period at the moment, it won’t be as they continue to refinance at high nominal rates. 

This debt service situation argues that the Powell Fed will have to make deeper cuts than Greenspan did in the mid-90s. 

 

Pro Perspectives 9/18/24

 

 

 

 

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September 18, 2024

The Fed cut rates by half a point today.
 
And they project another half point cut by year end.
 
And it has everything to do with the employment situation. 
 
We've talked for months about the clear "cracks" in the labor market.  And the Fed told us back in March that unexpected weakness in the labor market was a condition for a policy response.
 
And yet they did nothing while watching the unemployment rate rise at a rate-of-change consistent with the past four recessions, and (in each case) consistent with a Fed easing cycle.
 
So they come in today, not with just a cut, but a large cut, and projecting another 50 by year end, and another 100 basis points by the end of next year.
 
What signal should the market take from this?
 
We don't have to guess.  Jerome Powell told us what signal he wants the market to take from this.  He said, they don't think they are behind the curve, and that this "strong move" should be taken "as a sign of our commitment not to get behind the curve."
 
Translation: If the job market deteriorates further, he says "we have the ability to react to that by cutting faster." 
 
So, how did markets respond?
 
It should have been stocks up, yields down, commodities up, dollar down.
 
What happened?  
 
Stocks:  Up first, then down. 
 
Yields: Down first, then up. 
 
Commodities:  Up first, then down. 
 
The dollar:  Down first, then up.  
 
This outcome for markets, by end of day, was the opposite of what you might expect for a Fed move that lightened the brake pressure on the economy, and with plenty of promises that they will do what it takes — that they are "committed to a good outcome" (i.e. stabilizing the labor market and averting an economic downturn).
 
This odd market behavior brings us back to my July 31 note, just following the Fed's last meeting. 
 
Given the Fed's reluctance to move in that July meeting, despite the obvious drag that rates were having on the economy, and the clear weakness that had developed in the labor market, I asked:  Are they not moving because they are worried about the dollar (i.e. preserving global capital flows to protect the dollar)? 
 
As we now know, the sharp unwind of the carry trade accelerated the next day, leading to a sharp drop in the dollar.  It was only stabilized by verbal (and likely actual) intervention from the Bank of Japan.
 
Today's Fed news was clearly dollar bearish. Yet, the dollar went up.
 
Are the Fed and the Bank of Japan coordinating to maintain stable markets?  Likely.    

Pro Perspectives 9/17/24

 

 
 

 

 

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September 17, 2024

With the Fed due to officially kick off an easing cycle tomorrow they will do so well behind the curve, with the Fed Funds rate sitting 283 basis points ABOVE the rate of inflation (PCE).

But the interest rate market has already determined where rates should be.

Since Jerome Powell signaled the end of the tightening cycle in October of last year, the 10-year yield (the market determined interest rate) has fallen by 140 basis points.

Moreover, with the even sharper plunge in the 2-year yield (down 166 basis points since last October) the yield curve has returned to a positive slope, after two years of inversion.

And as we’ve discussed here in my daily notes, yield curve inversions are historically predictors of recession.

And when the curve turns positive again, it tends to indicate an economy has either entered or is about to enter recession.

That said, while market interest rates have adjusted, consumer interest rates have been slow to follow.

The average 30-year fixed mortgage rate is now at 6.2%.  If we look back at the historical spread between mortgages and the 10-year yield, it should be closer to 5.4% (or lower). 

 

Average credit cards rates are 17 percentage points above the 10-year yield.  It’s historically closer to a spread of 10. 

Auto rates?  Those are running about 300 basis points above the long run average spread to the 10-year.

Maybe these spreads will finally start narrowing when the Fed proves tomorrow that it will indeed kick off the easing cycle, after a lot of talk.  

 

Pro Perspectives 9/16/24

 

 

 

 

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September 16, 2024

The Fed will cut rates on Wednesday.
By how much, probably has more to do with preserving global financial stability than preserving labor market stability (at least for the moment).
 
On the latter, this first rate cut will come in reaction to "cracks" in the labor market that have developed as a result of the Fed holding real rates (the Fed Funds Rate minus the inflation rate) too high, for too long.  
 
So, the Fed wants to stabilize the employment situation.
 
And it has a lot of room to cut/ to stimulate. 
 
In fact, as you can see in the chart below, they could cut by more than 200 basis points to get to the level they deem to be "neutral" (not stimulative nor restrictive).   
 
 
Of course, a huge slash of rates won't happen.   
 
Why? 
 
As the Fed (and the world) discovered early last month, the prospect of rates moving lower in the U.S., while rates are simultaneously moving higher in Japan (as Japan is exiting its emergency level policies that have supported global markets the past two years), presents a shock risk to global liquidity and global financial stability. 
 
How did the market react last month?  A massive spike in the VIX and a three-day loss in the Nikkei (Japanese stocks) comparable to only three other periods over the past thirty years:  the darkest days of the Global Financial Crisis, the tsunami and the Covid lockdown.
 
So, both the Fed and Bank of Japan will again determine policy this week.  We should expect the Bank of Japan to hold the line (do nothing to incite a market reaction). 
 
But the Fed will cut. 
 
And whether or not the Fed will trigger a negative reaction across global markets will likely have to do with: 1) how big of cut, and 2) how they manage expectations on the speed and depth of future cuts.
 
With that, the market is now leaning toward 50 basis points.  We've heard a former Fed governor calling for 50.  Elizabeth Warren, the Senator from Massachusetts wrote a letter to the Fed today calling for a 75 basis point cut.  
 
Given the shock risk, my bet is on 25, and a Fed that positions the cuts as just "reducing restriction" and maintaining focus on the inflation fight.
 
In line with that view, the Bank for International Settlements (the "BIS," a consortium of the world's top central banks) published a well-timed report today, urging central bankers not to "squander" the interest rate buffers they have built over the past couple of years by cutting too rapidly.   
 

Pro Perspectives 9/11/24

 

 

 

 

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September 11, 2024

Going into this morning's inflation report, markets looked vulnerable. 
 
As we discussed yesterday, the bond market has been telling us the Fed is way behind the curve — too slow to recognize the deterioration in the job market (and the economy). 
 
Oil prices have been falling, sending a negative signal on the demand outlook.
And this chart below, we've been watching, was projecting more downside for the Nasdaq/big tech stocks. 
 
 
Remember, this is the chart of the dollar/yen exchange rate in purple, and the Nasdaq in orange.
 
The two have tracked closely resulting from the flow of global capital driven by the "yen carry trade" (i.e. borrowing Japanese yen effectively for free, converting that yen to dollars, and investing those dollars in the highest quality dollar-denominated assets).
 
But as we've discussed over the past month, the prospects of rate cuts to come from the Fed, combined with tightening policy in Japan, have triggered a reversal of the yen carry trade — out of dollars and dollar-denominated assets, and back into the yen.  
 
So, the inflation data this morning was the final catalyst heading into what will be the Fed's first rate cut next week.  And with no surprise in the inflation picture, it seemed clear that the continuation of the reversal of the yen carry trade would ensue.
 
Indeed, the morning started with aggressive selling in stocks.  But at 11am EST, it all reversed — stocks, commodities, yields, bitcoin … everything.
 
What happened?  Commentary hit the wires from the founder/CEO of the most important company in the world.  Jensen Huang took the stage at a Goldman Sachs tech conference.  And he said the demand for the new Blackwell chip is "so great … everybody wants to be first, and everybody wants to be most." 
 
Did this turn markets?  Maybe.  But it's nothing new.  
 
If we look back at Nvidia's August earnings, we already know demand is insatiable. 
 
It's the rapid design cadence in accelerated computing and supply constraints that have capped Nvidia's growth capacity (at least at this point) — at a trend of $4 billion of new revenue a quarter.  And if that trend continues, the year-over-year growth rate for Nvidia will be cut in half by this time next year (to something closer to 50%, from triple digits).  

 

Pro Perspectives 9/10/24

 

 
 

 

 

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September 10, 2024

As we discussed last week, the Fed specifically went after jobs as the mechanism to bring down demand, and therefore bring down inflation from multi-decade highs.

The question is, did it come at the expense of an economic recession?

There are signals flashing.

Take a look at the 2-year yield …

 

The 2-year is now down more than 80 basis points from late July.

That’s 175 basis points lower than the Fed Funds rate.  The bond market is telling us the Fed is way behind the curve — too slow to recognize the deterioration in the job market (and the economy).

So, the front end of the yield curve has collapsed, and the yield curve is now positive sloping, after two years of inversion.

Yield curve inversions are historically predictors of recession.

When the curve turns positive again, it tends to indicate an economy has either entered or is about to enter recession.

What else is flashing a warning signal?

Oil.

Oil is down 13% in seven days, trading near the lows of the past three years.  The last time we had a seven-day decline of that magnitude was March of 2023, surrounding the bank shock.

Of course, the bank shock was cleaned up with more central bank intervention.  Similarly, the recent carry trade shock was, at the very least, curbed through verbal intervention (by the Bank of Japan).

So, we have some signals flashing in a world where central banks have made a habit of cancelling market signals.