Tag Archives: #Volcker

Trumpian Thunder

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No respite was found yesterday
With risk assets given away
Now traders all wonder
If Trumpian thunder
Will ever, a rally, convey
 
But from the cheap seats what seems clear
Is Trump, for right now, will adhere
To efforts to trim
The grift and the skim
A prospect his enemies fear

 

The only discussion in markets today is about yesterday’s sharp declines in equity markets.  Questions about how long this can continue or how long President Trump can withstand the pain that accompanies these declines are rampant.  However, thus far the indications are that he and his administration are aware of the risks but also committed to achieving his goals of more domestic manufacturing activity and a perceived fairness or leveling of the international commerce playing field.

We have heard from Trump, Bessent and Commerce Secretary Lutnick, that there is going to be some pain, but they believe it will be short-lived in nature.  And ask yourself this, given how overextended both market valuations and debt metrics had become, was there any way to address these issues (assuming you believed they were issues) without some pain?  Of course not.  I have long maintained that what needs to happen in the US economy is for markets to be allowed to clear, all markets, whether housing or financial, and that we have not seen that happen for more than 50 years.  

While perhaps the case can be made that the housing market came close to clearing in the wake of the GFC, consider what has happened since then with the implementation of waves of QE and ZIRP.  The chart below from the St Louis Fed’s FRED database shows their housing index over time.  Ask yourself if you think the housing market really cleared?  And more importantly, look at the acceleration since then.  President Trump has made clear his focus is on Main Street, not Wall Street, and it is easy to argue that a key driver of this massive rise in house prices has been the Fed and their efforts to prop up Wall Street.  Reversing that is going to be painful.  Hell, simply stopping that move will be painful.

As to equity markets, the only clearing event that we have seen was the crash of the NASDAQ after the tech bubble burst in 2000.  But again, the Fed was there cutting rates and easing policy to support things.  The best evidence that equity markets are at unsustainable levels comes from the valuation metrics, with things like the Shiller CAPE ratio pushed to levels only ever seen in that tech bubble, and clearly significantly above long-term mean (17.21) and median (16.03) levels with today’s current reading of 35.34.

Source: multpl.com

All of this is my way of saying that I do not believe we are anywhere near the end of this process.  While many of you don’t remember President Reagan, at the beginning of his first term, he stood by Fed Chairman Volcker in his efforts to squelch inflation, when Volcker raised Fed funds to 22.0% (see below) and the economy suffered two quick recessions in 1980 and 1982.  

However, that was the medicine that was needed to break inflation’s back and begin a 40-year run of stability and growth in the US amid low inflation.  It is not hard to believe that we are going to need to see another cleansing bout of austerity to once again reset the economy.  And remember, Trump is not running again, so is not worried about reelection.  If we do have a recession soon, it will likely be over and the recovery under way as we head into the next elections, a perfect political outcome for his party.

Ok, let’s see how other markets responded to yesterday’s US declines.  In Asian equity markets, Tokyo (-0.6%) slid, but nowhere near the declines seen in the US.  China (+0.3%) and Hong Kong (0.0%) basically ignored the situation, but the rest of Asia saw a lot more red on the screen with large losses seen in Korea, Taiwan, Australia, Malaysia, Singapore and the Philippines.  In Europe, though, the price action is mixed with some gainers (DAX +0.4%, CAC +0.2%) and laggards (IBEX -0.2%, FTSE 100 -0.15%) as it appears funds continue to flow from the US markets to Europe on the back of the mooted defense buildup.  US futures at this hour (7:10), are very modestly higher, 0.15% across the board, but my take is there is further pain to come.

In the bond market, yesterday saw a flight to safety with Treasury yields sliding 10bps and although we did not see similar moves in European sovereigns.  This morning, Treasury yields are unchanged from the close while European bonds are showing modestly higher yields, between 1bp and 3bps.  JGB’s though, saw yields follow Treasuries lower, dropping -6bps last night as not only did US yields fall, but Japanese Q4 GDP data was released at a weaker than preliminarily reported 2.2%.  Although that was higher than Q3, and represents solid growth, it is not quite what was in the market.

In the commodity market, oil (+0.9%) while higher this morning continues to hold its downtrend as per the below chart.  With further Russia/Ukraine peace talks starting up in Saudi Arabia, the prospects of Russian oil coming back to the market seem to be growing.

Source: tradingeconomics.com

As to the metals markets, gold (+1.0%) is the laggard this morning with both silver (+1.6%) and copper (+1.9%) leading the space higher.  If US equities are responding to a growing probability of a US recession, then I would have expected the industrial metals to soften.  However, after several down days, this could well be just a reflexive trading bounce.  We will need to see further movement to get a better sense of things.

Finally, the dollar remains under pressure generally with the euro (+0.5%) once again gaining ground and touching the 1.09 level for the first time since the US presidential election.  Not surprisingly, that has dragged the CE4 currencies higher as well, but the dollar’s weakness is seen vs. CNY (+0.4%), KRW (+0.5%), SEK (+0.45%), NOK (+0.8%) and even CAD (+0.25%).  Again, the big picture here is that the current policy aims for the US have begun to alter the concept of US exceptionalism with regards to the stock market.  As funds flow elsewhere, the dollar is quite likely to continue to decline.  This will be reinforced if we continue to see 10-year Treasury yields decline.

On the data front, while today is not very exciting, we do see CPI and PPI this week.

TodayJOLTS Job Openings7.75M
WednesdayCPI0.3% (2.9% Y/Y)
 Ex food & energy0.3% (3.2% Y/Y)
ThursdayInitial Claims225K
 Continuing Claims1910K
 PPI0.3% (3.3% Y/Y)
 Ex food & energy0.3% (3.6% Y/Y)
FridayMichigan Sentiment66.3

Source: tradingeconomics.com

We are now in the Fed’s quiet period so there are no Fed speakers until their meeting next Wednesday, but as I have been saying, nobody is really paying much attention to them anyway.  I think we have seen some major changes evolve and that means that equities are likely to remain under pressure along with the dollar, while bonds should hold their own.

Good luck

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Real Savoir Faire

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There once was an aging Fed Chair

With poise and some real savoir faire

He claimed the foundation

Of rising inflation

Were objects that, right now, were rare

But soon when supply chains are mended

And joblessness falls as intended

Inflation will sink

To levels we think

Are fine, and the world will be splendid

Remember when the FOMC Statement and following press conference were seen as hawkish?  That was sooo last week!  There was talk of rate hikes in only TWO YEARS!  There was talk about talk about tapering the purchase of assets as monetary policy started to ‘normalize’.  (Not for nothing but given we have had the same monetary policy for effectively the past 13 years, ZIRP and QE might be considered normal now, not positive real rates and a stable balance sheet.)  Well, apparently the market reaction was not seen as appropriate by Chairman Jay and his cadre of central bankers, so we have heard a definitive retreat on those concepts in the ensuing six days.  

Just since Monday, we have heard from six different FOMC members and every one of them has essentially said, “just kidding!”  Yesterday, Chairman Powell testified to a House Subcommittee on Covid and was forced to explain, yet again, that policy changes were still a long way down the road and that inflation remains transitory.  It was not, however, just Powell delivering that message.  It was also Cleveland’s Loretta Mester, SF’s Mary Daly and NY’s John Williams amongst others.  Current policy settings are appropriate, inflation is transitory and there is still a long way to go before that elusive substantial further progress toward the Fed’s dual mandates will have been achieved.

History has shown that the Fed’s effective reaction function, at least since Alan Greenspan was Chair, is defined by an equity market decline of a certain amount.  This is especially true if the decline happens quickly whereupon they will jump in and ease policy.  It appears that the amount of market angst necessary to get the Fed to change their tune regarding infinite liquidity and monetary support continues to shrink.  It used to take a decline on the order of 15%-20% to get the Fed nervous.  This time, the S&P 500 fell less than 2% before virtually the entire committee was on the tape walking back their tough talk.  And yet, they would have you believe that when inflation is roaring higher for the rest of the year, they have the intestinal fortitude to fight it effectively by raising interest rates or reducing QE.  As actions speak louder than words, my money is on the Fed being completely unable to address rising inflation.  Be prepared.

This topic continues to be the primary narrative in markets around the world, with many other countries now grappling with the transitory inflation story as well.  Nothing else really matters, and rightly so.  If inflation is building a head of steam and will be rising around the world, central banks are going to be forced to respond.  Some will respond more forcefully and more quickly than others, and it is those currencies which are likely to outperform going forward.  Investors today are generally unfamiliar with investing in an inflationary environment.  The 1970’s were the last time we really saw inflation of substance and even I was still in college (and I am almost certainly much older than you) when that was the situation, with many, if not most, of the current investment community not yet even born.

A quick look at the chart of the Dollar Index (DXY) from that time shows that from the autumn of 1971, right after President Nixon closed the gold window and ended Breton Woods, through the end of 1979, right after Paul Volcker was named Fed Chair and had just started his inflation fight, the dollar declined about 28% (roughly 4% per annum).  Of course, once Volcker got going and US interest rates were raised dramatically to kill off inflation, the dollar rose more than 75% in the following four years.

The point is that while we may disparage the Fed’s actions as being wrong-headed, their policies matter immensely.  Jay Powell may wind up with his reputation in tatters akin to Arthur Burns and G. William Miller, the Fed Chairs who oversaw the sharp rises in inflation in the 1970’s preceding Mr Volcker.  It seems unlikely this outcome is his goal, however, his insistence on toeing the political line rather than hewing to sound money policies bodes ill for the future.

Anyway, while US equity markets have essentially retraced all their post FOMC losses, the rest of the world has seen a more mixed outcome.  In Asia last night, the Nikkei (0.0%) was essentially flat although there were gains in the Hang Seng (+1.8%) and Shanghai (+0.25%).  Europe, on the other hand, is under some pressure this morning with both the DAX (-0.5%) and CAC (-0.4%) feeling some pain based on softer than expected, though still strong, Flash PMI data.  The UK, however, is seeing a much better performance (FTSE 100 +0.35%) as not only was the PMI data stronger than expected, but there apparently is a breakthrough on the lingering Brexit issues of treating goods in Northern Ireland.  Meanwhile, US futures are essentially unchanged this morning, perhaps waiting for some more encouragement from today’s roster of Fed speakers.

Bond markets, after a very choppy few days, have calmed down greatly with Treasuries (+1.2bps) softening a bit while European sovereigns (Bunds -1.4bps, OATs -1.4bps) are seeing some demand.  UK Gilts are little changed as the market there awaits tomorrow’s BOE meeting, where some believe there is a chance for a more hawkish tilt.

Commodity prices are definitely firmer this morning led by oil (+0.7%) but also seeing strength in precious metals (Au +0.25%, Ag +0.7%), base metals (Cu +0.7%, Fe +1.4%, Sn +0.2%) and agricultural products (Soybeans +0.5%, Wheat +1.2%, Corn +0.4%).  Clearly the commodity markets see inflation in the future.

Finally, the dollar is mixed this morning but, in truth, the relatively small movements indicate a lack of interest.  Commodity currencies like NOK (+0.1%), AUD (+0.2%) and NZD (+0.2%) are the leading G10 gainers while JPY (-0.35%) continues to come under pressure, arguably suffering from the fact that Japan imports virtually all its commodities.

In the EMG space, the picture is also mixed with HUF (+0.7%) the leading gainer after the central bank raised its benchmark rate to 0.9% yesterday a 0.3% increase that was expected.  But the idea that they are joining the several other EMG central banks in tightening mode (Brazil, Russia, Ukraine) has investors buying up the forint.  Away from that, ZAR (+0.4%) is clearly benefitting from higher commodity prices as are RUB (+0.2%) and MXN (+0.1%) although the latter two are quite modest.  On the downside, KRW (-0.5%) saw the sharpest declines as a combination of equity outflows as well as a sharp rise in Covid infections was seen quite negatively.  But in truth, most APAC currencies were under some pressure overnight, albeit not to the extent seen in Seoul.

Today’s data brings the Flash PMI (exp 61.5 Mfg, 70.0 Services) as well as New Home Sales (865K).  But more importantly, we have three more Fed speakers set to reiterate the message that policy is not going to change for a while yet, so no need for investors to panic in any market.  The dollar responded logically to the idea that the Fed was going to tighten policy, but now that they have gone out of their way to walk that idea back, I expect the dollar is more likely to drift lower for now.  Perhaps when it becomes clearer that the Fed is actually going to move, we could see some strength again.  But that is likely still a few weeks or months away.  Trade the range for now.

Good luck and stay safe

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