Tag Archives: #keynes

Misconstrue

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Ahead of today’s CPI
The markets continue to fly
Though prices keep rising
The pace is surprising-
Ly slower than pundits decry
 
Perhaps now it’s time to review
How old models all misconstrue
The world of today
As their results stray
From outcomes we’re all living through

 

Let’s start with this morning’s CPI data where expectations are for M/M rises of 0.3% for both headline and core readings which translate to 2.7% and 3.0% for the annual numbers.  In both cases, that would be the highest reading since February and will put a crimp in the inflation slowing trend as both the 3-month and 6-month trend data will stop declining.  I assure you that the immediate culprit will be defined as the tariffs, although it is probably still too early to make an accurate reading on that.  Nonetheless, you can be sure that, especially if the bond market sells off, the cacophony will be extreme as to President Trump’s policies are destroying the nation.

Personally, I would disagree with that take.  In fact, something I theorized last week was that a likely impact of the tariffs was that corporate margins would be hit, not necessarily that prices would rise.  Apparently, somebody much smarter than me agrees with that view, a well-respected analyst, @super_macro on X, who made that point this morning.  But all we can do is wait and see the data and response.

Yesterday, as well, I touched on how bond yields around the world were rising which remarkably seems to be a theme in the mainstream media this morning.  I wonder if they’re secretly reading fxpoetry?

Ok, but let’s move on.  I have consistently expressed my view that the current macroeconomic models in use, which are almost entirely Keynesian based, are simply no longer relevant to the world as it currently exists.  I made the point about economic statecraft, as defined by Michael Every (@TheMichaelEvery), the Rabobank analyst who has been far more accurate in his forecasts of likely political outcomes.  Well, in the financial space, another Michael, Green (@profplum99), is also ahead of the pack in my view.  He was on a podcastlast week that is well worth the hour (40 minutes if you listen at 1.5X speed).  

The essence of his work is that the rise in passive investing has had major consequences for equity markets, and by extension other financial markets.  When John Bogle founded Vanguard with the goal of popularizing passive index investing, it represented a tiny fraction of the market and so, its low fees made it an excellent source of capturing market beta unobtrusively.  However, in the ensuing 50 years, and especially in the last 20 when 401K plans were flipped from opt-in to opt-out by government regulation, things have changed dramatically.

This is the most recent chart I can find showing how passive investments (e.g., index funds and target date funds) have grown dramatically in size relative to the overall market (notice the inflection in 2006 when the opt-in regs changed).  In fact, they currently represent about 50% of equity market assets.

The reason this matters is because the term passive is no longer very descriptive of what these funds do.  As Mr Green explains, they work on the following algorithm, if funds flow in, they buy more stocks and if funds flow out they sell them.  Since they are following cap weighted indices, they basically reflect that since funds flow from every 401K into the market throughout every day, they continue to buy the largest stocks (Mag7) out there regardless of any concept of value.  If you think this through, the main factor in the markets is no longer how a company performs, but how many people have jobs where they have some portion of their incomes allocated to 401K plans.  So, as long as people have jobs, and if employment is growing, equity prices have a price-insensitive base of support.  The upshot is equity markets are no longer forward-looking systems, as has been the belief since early financial market theories, but rather they are indicators of the employment situation.  And it is key to remember that the unemployment rate is a lagging macroeconomic indicator

This matters because the Fed, and frankly most major financial institutions and analysts, continue to model the economy with an input from equity markets.  Consider the Index of Leading Economic Indicators, which has the S&P 500 explicitly in the calculation as an example.  Now, if the Fed is looking at models which discount changes in the equity market, clearly a part of their process, it means they are looking in the rear-view mirror.  This is a very cogent explanation as to why the Fed’s models have grown so out of touch with reality, which if you consider how important they are to monetary policy, and by extension the economy as a whole, is quite concerning.  

Concluding, Mr Green has eloquently explained what I have observed over the past months and years, the Fed’s (and most of Wall Street’s) models are simply no longer fit for purpose.  Add to this the concept of fiscal dominance, where government spending overwhelms monetary policy as has been the case for the past several years, and we all can see why the Fed is flying blind.  

With that cheery thought, let’s see how markets are behaving.  Yesterday’s modest US rally was followed by some strength in Asia (Nikkei +0.55%, Hang Seng +1.6%) although mainland shares were unchanged.  Chinese data overnight surprised on the upside regarding GDP, with an annualized outcome of 5.2%, and it saw IP rise 6.8% Y/Y, also better than expected but Retail Sales (4.8%) and Fixed Asset Investment, which is housing driving (2.8%) both disappointed.  The upshot is that domestic demand continues to flag although they have been working hard to export lots of stuff.  The rest of the region saw a very positive day with almost all markets gaining.  In Europe, the picture is more mixed as tariff concerns continue to weigh on nations there with today’s price action a mix of small gains (CAC, DAX) and losses (IBEX, FTSE 100) and nothing more than 0.3%.  US futures, though, are pointing higher at this hour (7:20) by 0.5% or so.

In the bond market, yesterday’s modest rise in yields is seeing a reversal with Treasury yields slipping -1bp, but European sovereigns having a good day with yields down between -5bps and -6bps.  Inflation data from Spain confirmed that the overall inflation situation there is ebbing, and market participants are now pricing one more rate cut by the end of this year which would take the ECB rate down to 1.75%.  As it happens, JGB yields were unchanged overnight, but there is still growing angst over their recent rise.

In the commodity arena, oil (-0.5%) reversed course yesterday and sold off more than $2/bbl as per the below chart.

Source: tradingeconomics.com

This makes more sense to me given the apparent growth in supply, but there seems to be an awful lot of calendar and crack spread activity in the market, most of which I do not understand well enough to describe, but which can impact pricing of the front futures contract.  I would suggest looking on substack at market vibesfor a real education.  I keep trying to learn.  However, from a macro view, I continue to believe that prices have further to decline than rise from current levels.  As to the metals markets, gold (+0.5%) and silver (+0.4%) continue to find consistent support and I see no reason for them to reverse course anytime soon.

Finally, the dollar continues to do very little overall.  For now, the more aggressive downtrend appears to have been halted, as per the chart of the DXY below, but it is hard to get too excited about a significant rebound based on the macro data and interest rate outlook.  The one thing working in the favor of a dollar rebound is the extreme short dollar positions that exist in the hedge fund and CTA communities.

Source: tradingeconomics.com

In addition to the CPI data, we will see the Empire State Manufacturing Index (exp -9.0) and we will hear from four Fed speakers today (Bowman, Barr, Collins and Logan).  Absent a major shock in the CPI data, it strikes me that there is limited reason for any of these speakers to change their personal tune.  So, Bowman is calling for cuts, while the other three have not done so, at least not yet.  In fact, if we start to hear a more dovish take from any of them, that would be news.

And that’s it for this morning.  Market activity is pretty dull overall, and trends remain in place.  Remember, the trend is your friend.

Good luck

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Confusion Reigns

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Investors and traders are caught
Twixt data which shows that they ought
Be uber concerned
Although they have learned
That fighting momentum is fraught

And so, it’s confusion that reigns
Reminding us of Maynard Keynes
Though logic dictates
We’re in dire straits
That doesn’t prevent further gains

One of the remarkable things about the current situation across markets and macroeconomics is that every piece of new information seems to add to the confusion rather than any sense of clarity.  As such, both the bulls and the bears, or perhaps the hawks and the doves, have constant reinforcements for their views.  As John Maynard Keynes famously told us all in 1920, “the market can stay irrational longer than you can stay solvent,” and right now, there are many who are flummoxed by the seeming irrationality of the markets.

 

Data continues to print demonstrating economic weakness, with this morning’s German IFO results simply the latest.  Expectations fell sharply to 83.6, a level whose depths had only been plumbed in the past during the GFC, at the beginning of Covid and when Russia invaded Ukraine.  Too, the Business Climate fell to 88.5, mirroring the Expectations index in futility.  In other words, this is an indication that businesses in Germany are not merely in a recession currently but see no escape soon.  And why would they?  After all, Madame Lagarde promised another rate hike next month and there is talk of further hikes later.  So, it appears there will be no short-term relief for the citizens there.   And yet, despite a very modest amount of equity market selling at the end of last week, most equity markets remain solidly higher halfway through 2023.

 

This morning’s data begs the question, can the global economy, or really any industrialized nation’s economy, avoid a recession if the manufacturing sector is declining.  We are all aware that most of the G10 economies are services oriented, while we see much larger proportions of GDP driven by manufacturing in larger emerging markets.  The following table, with data from the World Bank shows what these proportions as percentages of GDP were in 2021 (latest data available):

 

Australia

6

Brazil

10

Canada

10

China

27

Germany

19

India

14

Ireland

35

Japan

20

Korea

25

Mexico

18

South Africa

12

Spain

12

Sweden

13

UK

9

US

11

 

It should be no surprise that China, given their mercantilist policies, are at 27%, nor that South Korea (25%) and Mexico (18%) have relatively large manufacturing sectors.  But both Germany (19%) and Japan (20%) are also quite manufacturing focused.  As such, it should not be that surprising they both had run large trade and current account surpluses given that’s what mercantilist policies generate.  The point is, if manufacturing is heading into a slump, or perhaps already in one, can the broader economy maintain overall growth? 

 

Arguably, there is a significant portion of the services economy that is highly dependent on manufacturing as well.  Consider things like financial services for those companies, transportation of manufactured goods as well as raw materials to factories and food and janitorial services at factories.  Those are not part of the equation, but if factories close down in ‘service oriented’ economies, all those services will shrink as well.  The point is even in the US, where manufacturing technically represents only 11% of GDP, a slump in that sector will have wide ranging impacts.   And what we have seen just this month is a litany of lousy data on the manufacturing side.  ISM Manufacturing (46.9), Kansas City Fed (-12), Philly Fed (-13.7), Dallas Fed (-29.1) and Chicago PMI (40.4) all point to severe weakness in the US manufacturing sector.  Can the US economy really grow strongly with a key sector under such pressure?  Can any economy?  Germany is already in a recession, and we know that their manufacturing sector is sliding.  China, too, has shown weaker data consistently and the government there is trying to figure out how to support the economy to prevent a severe slowdown.  These are the arguments for why an official recession is coming to the US and all of Europe and probably the world. 

 

And yet, equity market bullishness remains intact.  At least based on the major indices.  Despite the fastest set of interest rate hikes in history by the Fed, ECB and BOE amongst others, equity indices are higher throughout the G10 this year, led by the NASDAQ’s remarkable 29% rally.  In addition, as we approach month/quarter end this week investment managers who have not been willing to close their eyes and buy are finding themselves forced into that situation.  Meanwhile, inflation data, while slowing from its peak seen 6mo-9mo ago remains well above central bank targets indicating that there is further monetary policy tightening to come.

 

So, who do you believe?  The data that shows key sectors of the global economy are slowing?  Or the data that shows ongoing strong employment means overall economic activity is continuing to rise?  It is easy to understand why so many analysts are forecasting a recession.  It is also easy to understand why investors don’t respond that way as they watch market performance.  And this, of course, is why Keynes’ words were so prescient, right now, markets do not seem rational, but they are what they are.

 

Arguably the one thing that is not frequently discussed but has been shown to be true over time is that G10 governments do not like to see recessions at all and will do anything they can and spend any amount, to prevent one from occurring.  As long as central banks continue to monetize the debt required to do so, this structure can continue.  But at some point, the debt will overwhelm the system and a correction will occur.  It is anybody’s guess as to when that might happen, but it certainly feels like that day is slowly coming into view.  At some point, investors will ignore what the central banks say and there will be a very significant correction.  But there’s nothing to say it can’t wait five more years.  As I said, confusion reigns.

 

Turning to the market activity overnight, After Friday’s down session in the US, Asia continued that trend with Chinese equity markets the weakest of the bunch, but screens red across the region.  Europe, which had been uniformly negative earlier in the session has now seen a very modest bounce back to basically unchanged although US futures remain slightly in the red.

 

That risk-off feeling is being seen in bond markets with yields lower across the board this morning as both Treasuries and European sovereigns find themselves with yields sitting between 3bps and 4bps softer than Friday’s closing levels.  The 2yr-10yr yield curve inversion remains -102bps, certainly not a positive economic sign, and we are seeing European curves invert as well.  Even JGB yields are a touch lower this morning.

 

Oil prices are a touch higher this morning although WTI remains below $70/bbl and metals prices are also a bit firmer, bouncing off recent lows.  However, that seems more to do with dollar weakness than commodity strength.

 

Which is a bit odd as during a classic risk-off session, the dollar tends to do quite well, yet today it is softer vs. all its G10 counterparts led by NOK (+0.9%) and many EMG currencies.  Forgetting TRY (-2.7%), the other losers are CNY (-0.7%) which is catching up after a few days of Mainland holidays, and TWD (-0.3%).  However, there is a long list of gainers led by ZAR (+0.9%) and HUF (+0.6%).  Arguably, falling Treasury yields are hurting the dollar somewhat, but quite frankly, I’m not convinced that is the driver here.

 

On the data front, as it is the last week of the month, we will get updated GDP and PCE figures as well as an array of things:

 

Today

Dallas Fed

-20.0

Tuesday

Durable Goods

-0.9%

 

-ex transportation

0.0%

 

Case Shiller Home Prices

-2.60%

 

New Home Sales

675K

 

Consumer Confidence

103.8

Thursday

Initial Claims

264K

 

Continuing Claims

1772K

 

Q1 GDP

1.4%

Friday

Personal Income

0.3%

 

Personal Spending

0.2%

 

Core PCE Deflator

0.3% (4.7% Y/Y)

 

Chicago PMI

44.0

 

Michigan Sentiment

63.9

Source: Bloomberg

 

On the speaker front, the ECB has their summer confab in Sintra, Portugal this week with Powell, Lagarde, Ueda and Bailey all speaking on Wednesday and Thursday.  It will certainly be interesting to hear them all together as they try to convince themselves they are in control.

 

I remain skeptical as to the potential for further gains in risk assets, but I have been skeptical for months and been wrong.  As to the dollar, if yields are going to decline, I could see the dollar slide further, but if risk does get jettisoned, I expect the dollar to find a bid.

 

Good luck

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Our Dovish Song

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Said Powell, you all would be wrong,
Til progress moves further along,
On jobs and inflation
To think there’s causation
For us to change our dovish song

I challenge anyone to put forward the name of a central bank board member, from any major central bank, who is anything but dovish.  Once upon a time there was a spectrum of views ranging from neo-Keynesians, who believed it was the central bank’s job to continually support economic activity to the Austrian scholars, who believed that the less central bank activity, the better.  The neo-Keynesians pushed to maintain the lowest interest rates possible to encourage capital investment and by extension further economic growth.  They were far less concerned with price implications and far more concerned with the employment situation.  The Austrians were highly focused on price stability and believed that stable prices allowed people to have the confidence to create products and services demanded by the public, which would drive economic growth.  And there was a great middle with central bankers adhering to some of those views, but willing to be pragmatic.

But that is all ancient history now as there is only one type of central banker left in the world, the uber-dove.  Literally, every comment made by any central banker, whether from the Fed, the ECB, the BOJ, the BOE or anyplace else, describes the need, not only for ongoing easy money, but for massive fiscal stimulus as well.  There isn’t even a lone, voice in the wilderness, arguing the other side anymore.  The financialization of economies, which itself is the result of more than a decade of easy money, has resulted in an evolution of views.  In essence, interest rates, per se, are not the focus, but financial conditions.  And one of the key variables in every central bank measure of financial conditions is the price of the stock market indices.  A higher stock market means easier money, in this model, and so leads to further growth.  I fear they have the causality backwards (easy money leads to a higher stock market), but my views don’t matter.  Even formerly staunch monetary hawks, notably the Bundesbankers, are all-in for more stimulus and see no reason to consider any potential negative consequences of these actions.

This was made clear once again yesterday by comments from Lagarde, Powell and Bailey, all of whom continue to explain that their respective central bank will do whatever is necessary to support the economy, and, oh by the way, more fiscal stimulus is necessary as they can’t do it all by themselves.  While current central bank messaging tells us rates will remain low until at least 2023, look for that terminal date to continue to get pushed back.  We have already seen this play out for the ECB, where in 2018, they tried to explain that rates would begin to normalize by the end of 2020.  We all know that never happened.  Now they claim when the PPE uses up its authorization in 2022, that will be enough.  But it won’t.  They will simply expand and extend the terms again.  Here at home, we have already heard from numerous Fed speakers that if inflation were to rise to 2.5% or 3.0%, they wouldn’t be concerned.  And Powell, yesterday, was clear that more fiscal stimulus was needed to help the economy, and that the Fed would be adding even more liquidity until “substantial further progress” is made toward their goals.

So, what does this mean for markets?  It means that the inflation of asset price bubbles will continue, and that when looking at foreign exchange, the question will be which nation will maintain the easiest (or tightest) relative policy.  The broad view remains the Fed has more firepower than any other central bank, which is a key reason so many (present company included) believe the dollar will eventually decline.  But it will not be without a fight.  No other country believes they can afford for their own currency to appreciate or they won’t be able to achieve their goals.  Perhaps the real question is, what will be the catalyst to stop the flow of easy money?  And truthfully, I cannot see one on the horizon.  Traditionally, it would have been a rise in inflation, but that would be warmly welcomed by the current central bank heads, so there is really nothing left.

But perhaps, we are seeing a bit of fatigue on investors’ parts, as the trend higher in asset prices seems to have stalled for a time.  Certainly, there has been no decline of note, but it is not racing up like it had previously.  Does this mean the end is near?  I doubt it.  But remember this, when the last black swan appeared, Covid, central banks, notably the Fed, had some monetary policy room to adjust rates and try to address the problem.  When that next rare black avian appears, with rates already at zero or negative throughout the G10, what do they do next?

And on that cheery thought, let’s take a quick tour of what has been a pretty dull overnight session, where the Lunar New Year has begun to be celebrated.  In Asia, only the Hang Seng (+0.45%) was open with Japan closed for Coming of Age day, and Shanghai celebrating New Year’s.  PS, the Chinese celebration lasts for a full week.  In Europe, stocks started off mixed, but have edged higher over the past few hours with the DAX (+0.6%) leading the way followed by the FTSE 100 (+0.1%) and finally the CAC essentially unchanged on the day.  US futures markets are all higher, led by the NASDAQ (+0.5%) with the other two key indices up around 0.3%.

Bond markets, despite the growing positivity in stocks, are pretty healthy today as well.  Perhaps the never-ending promises by central bankers to continue to buy bonds is helping.  So, while Treasury yields are essentially unchanged, in Europe, Bunds, OATs and Gilts have all seen yields decline by about 2.3 basis points, and that price action is consistent across the smaller markets as well.

Oil (-0.7%) is lower today for a true change of pace, as it has rallied for the previous eight consecutive sessions.  Arguably, this is simply a trading pause, as there is no news of note that would drive the market.  Meanwhile, gold is unchanged on the day, although there is strength in the base metals space while ags remain mixed.

As to the dollar, it is under very modest pressure this morning, with AUD (+0.35%) the leading gainer in the G10 after mildly positive comments from the Treasury Secretary there.  But away from this, no other currency has moved even 0.2%, indicating there is nothing happening.  In the emerging markets, LATAM currencies are the leaders (CLP +0.8%, BRL +0.6%, MXN +0.5%) although don’t count out ZAR (+0.75%) either.  The ZAR story is a response to much better than expected mining production data while CLP has seen investor inflows into the bond market increase and Brazil is benefitting from a bill just passed granting autonomy to the central bank.  Be careful on MXN, as Banxico meets today and is expected to cut interest rates again, with a 25bp cut priced into the market, but some looking for more.

On the data front, yesterday’s CPI data was a bit softer than forecast, but didn’t seem to have much impact on the markets, although the dollar did edge lower after the release.  This morning, Initial Claims (exp 760K) and Continuing Claims (4.42M) are all we get and there are no Fed speakers slated.  So, on this snowy day in the northeast, I would look for the dollar to remain rangebound as it seeks its next catalyst.  To my eyes, the correction appears to be over, but we will need something else to get the dollar selling bandwagon rolling again.

Good luck and stay safe
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