Russia’s President Vladimir Putin said any energy infrastructure in the world is at risk after the explosions on the Nord Stream gas pipelines.

The attacks were an act of terror that set “the most dangerous precedent,” the Russian president told a Moscow energy forum on Wednesday. “It shows that any critically important object of transport, energy or utilities infrastructure is under threat” irrespective of where it is located or by whom it is managed, he said.

Putin blamed the sabotage on the US, Ukraine and Poland, calling them “beneficiaries” of the blasts that caused major gas leaks in the Baltic Sea. The US and its allies have rejected those allegations and suggest Russia may have been behind the underwater blasts.

The attacks on two strings of Nord Stream and one string of Nord Stream 2 at the end of September have raised concerns over the future of Europe’s gas supplies. Other critical infrastructure in the region has also suffered damage in recent weeks. 

Earlier this month, an act of sabotage halted train services across northern Germany and the government has said it can’t rule out foreign involvement. A pipeline that carries Russian oil through Poland was found to be leaking on Tuesday. Investigations continue, and Poland’s top official in charge of strategic energy infrastructure said he assumed it was an accident.

This is a none too subtle threat to expect escalation of attacks on energy infrastructure for as long as the EU is supporting Ukraine’s resistance efforts. The sabotage of Germany’s rail network with specialized interruptions conducted simultaneously at locations 200km apart is a display of Russia’s extraterritorial ability to sow disruption.

It will be interesting to see whether the higher gilt yields (and turbulent stock markets) lead to an increased demand for fixed pension annuities and thus a new demand for gilts

Thank you for this email which may be of interest. Annuity sales in the USA set a record in the 2nd quarter of this year at $79.4 billion. With so much volatility in stock markets there has been significant demand for guaranteed returns and particularly now since bonds pay a modest yield. 

Should Social Security beneficiaries see an 8.7% increase in their monthly checks next year, it would mark the steepest annual adjustment since 1981, when recipients saw an 11.2% bump. An increase of that magnitude would raise the average retiree benefit of $1,656 by about $144 per month or roughly $1,729 annually, the group said.

"A COLA of 8.7% is extremely rare and would be the highest ever received by most Social Security beneficiaries alive today," Mary Johnson, a policy analyst at the Senior Citizens League who conducted the research, said. "There were only three other times since the start of automatic adjustments that it was higher."

However, the decades-high benefit increase is not always good news for recipients, according to Johnson.

Higher Social Security payments are a bit of a Catch-22. They can reduce eligibility for low-income safety net programs, like food stamps, and can push people into higher tax brackets, meaning retirees will pay more taxes on a bigger share of their monthly payments.

There is a lot of complication in the US tax code but one thing is certain, if you make more you pay more. That both increases compliance costs and ticks people off when they believe they should not have to pay taxes. It’s likely to become a political factor in coming elections.

Thank you so much for a superb and invaluable service. I’ve been a subscriber since the ‘80s. I’ve just recently renewed my subscription again after a short break of a couple of years. Just so enjoying hearing your thoughts and steady guidance through these volatile times, thank you. I’d really enjoy your thoughts re this recent article from Reuters ‘Pension fund blowup faces brutal second act’ which may also be of interest to the collective

Thank you for your kind words and this question which I’m sure others have an interest in. The short answer is the blowup of pension funds in the liability-driven investing (LBI) sector is likely to have a long tail. Pensions are now going to be much more wary about taking on leverage so they are forced sellers of illiquid assets. 

Investors counting on a Federal Reserve pivot any time soon are bound to get burned again, according to PGIM Fixed Income.

“We’ve seen this movie time and time again,” said Greg Peters, co-chief investment officer at the Newark-based firm, in an interview. “The market gets hyped up on different narratives between inflation releases. I’ve been surprised by it, and we’ve been using it as an opportunity to sell into.”

The firm, which manages assets of $790 billion, sold US Treasuries after a rally earlier this week sparked by speculation the Fed was about to turn more dovish. The market move proved short lived, backing its view that there’s still not enough evidence to suggest policy makers will rein in aggressive interest-rate hikes.

The speculation -- fueled by a smaller-than-expected rate hike in Australia -- drove action across global markets in the first two days of this week, driving down two-year Treasury yields by nearly 30 basis points at one point to below 4%.

Neel Kashkari, who has historically been viewed as a dove, was quoted today as saying "more work to do" on bringing down inflation, and is "quite a ways away" from being able to pause its aggressive interest-rate hikes.

Such maneuvers had been a decade in the making. Easy money after the global financial crisis made debt investors hungry to buy loans and bonds that provided higher yields. Funds began to agree to weaker protections in their creditor agreements. Loan and bond documents riddled with loopholes and imprecise language gave borrowers more flexibility in times of stress.

The documents didn’t explicitly allow future creditors to grab collateral. But they left just enough ambiguity, sometimes called “trap doors,” for lawyers with a bit of ingenuity and a lot of motivation to move assets to new entities and give dying companies some fresh capital. Because of these often-overlooked provisions, some creditors were surprised to discover they’d been left with almost worthless loans and bonds after struggling companies restructured.

“Loose documents have become the norm rather than the exception,” says Damian Schaible, co-head of restructuring at Davis Polk & Wardwell. “If we go into a real recession, we are going to see more and more borrowers and sponsors seeking to exploit document loopholes to create leverage against and among their creditors.”

Covenant light debt issuance has dominated the post Global Financial Crisis bond markets. That hasn’t mattered until now. Default rates were low, successive waves of new money ensured rates stayed low, and credit remained abundant. 

Upgrade from Cautious to Attractive: No one knows exactly when this downturn will end and we find it difficult to get ahead of macro events, but we see signals that suggest we should no longer be overly pessimistic: (1) the cyclical sell-off has already been punitive in an historical context; (2) the magnitude of the valuation correction (YoY) is approaching extremes relative to the last two decades; (3) earnings risks are now well understood and it is surprises that will drive stocks from here; (4) green shoots are emerging while some consumer parts of tech are close to bottoming; (5) we are upgrading our top down EM strategy view on IT, Korea, and Taiwan; these are set-up for a reversal in returns in the coming weeks. What is not understood is cycle turns and the market's willingness to increasingly look through this late stage of the downturn and, hence, our focus on the other side of the cycle.

An inflection is near and we see reasons to be constructive on a 2H23 recovery. (1) Macro headwinds are fading with the bulk of the Fed’s heavy lifting likely to be done by year-end and benefits from China’s reopening; (2) demand elasticity and replacement cycles will be driven by the sharp fall in pricing, especially consumer products; and (3) supply adjustment is accelerating via significant production and capex cuts that are underway. We have clearly worked through the slowdown in the consumer and are most positive on 'first-in, first out' exposure in LCD panels bottoming now, followed by memory in 4Q22, while the trough for foundry, auto and semicap should come with a lag in 1H23.

As the fourth quarter begins and investors position for how they hope to salvage returns for 2022, questions are already arising about the prospects for 2023. There is no doubt, steep declines in asset prices, particularly within the tech sector, have improved valuations. In normal circumstances that would be sufficient to create attractive entry points. Therefore, the question is whether this is a normal correction following the excesses of the pandemic or the end of the cycle. 

Dear Eoin, In the 1960s and 1970s subscribers to the David Fuller Chart Service received a booklet containing hundreds of charts each week or each month. I used to come into the office at 6a.m. and complete the point and figure charts each day. Thanks to this work, I gained a reputation among my colleagues for being the first one to spot changes in the long-term trends of both overall markets, sectors and individual shares. As of this morning, I am getting up one hour earlier and I will start by looking at all the daily charts of the Autonomies in the Chart Library. Let's hope that this will produce the same result. This morning's work show very small blue upward marks in almost every chart. These are tiny upward movements in the year-long major decline in all these share prices. This "summer's swallow" has not yet started chirping. Regards,

Thank you for this account. David was still having chartbooks printed in 2003, when we began working together. By that stage they were a very niche product that had become obsolete with the development of charting software. Nevertheless, the practice of looking at lots of charts is as useful today as it has ever been.

In following your program of activity, I would suggest taking one day to look at point and figure charts. They will give you clear confirmation of a change of trend.

Even if new buyers step into purchase these bonds, they’re likely to demand a higher yield for doing so — potentially adding to government deficits and mortgage rates at a time when they’re already soaring.

“All this points to a somewhat higher resting level for the mortgage/Treasury basis—and potentially for other related assets like IG corporates, which finally caught up with some of the mortgage widening over the past few days,” the analysts conclude.

2-year yields at over 4% are sufficient incentive to drag cash into the sovereign markets. When the alternative is to lose double digits in the stock market and see cash eroded by inflation, the allure of a guaranteed 4% is reason enough to invest.

The price of deeper out-of-the-money insurance in equities is falling, implying lower demand for
crash insurance. This suggests the market believes the Fed put is getting closer.

A conundrum all year has the been the relatively low level of the VIX despite equity markets being in a bear market. The VIX has been low relative to implied volatility, relative to longer-term volatility, and remains low compared to cross-asset volatility. Most notably, though, the VIX has been low -- and
continues to fall -- versus at-the-money volatility.
 
This is due to the price of further out-of-the-money put options falling by more than options that are less out of the money. We can see this by looking the difference in volatility between 80% and 90% out-of-the­-money put options and see it has been falling.

As the VIX is a weighted average of all S&P options with approximately 1-month to expiry and that have a non-zero bid, the lower price of these deeper out-of-the-money options is keeping the VIX lower relative to at-the-money volatility than it otherwise would be.

Puts have still been in demand though. The put/call volume ratio has been rising, showing that investors are buying more puts relative to calls. But the put/call price ratio has been falling, showing that investors have been paying relatively less for those puts.

Investors have therefore not been paying up as much for crash insurance, and buying puts that are less out of the money. The Fed is now well into its hiking cycle, and the market is inferring it believes the Fed put is getting nearer.

Certainly, current oversold conditions suggest a short-term bounce is at hand. But while excess liquidity remains depressed, it will be hard for the market to make new highs. The Fed put may be closer, but that does not mean the bear market is over.

No two crises are the same and yet the temptation to think “this time is different” has been proved wrong on so many occasions that the term is a cautionary tale. The Bank of England intervened to support the domestic pension system this week. Several schemes required £100 million in additional capital each and others were looking at closing. The central bank had no choice but to wade in and provide some stability. The ramifications of this move raise more questions than answers.

I've spent some long days and nights this week on this very subject (work as an investment actuary in DB [Ed. Defined Benefit] pension fund space)...

Fiscal policy context: mini-budget, with expected energy price cap but surprise revenue cuts (tax, NI, duty, etc.); cost of the latter might be in the vicinity of c£40bn pa (without OBR numbers its hard to say though).

Monetary policy context: TBC regarding rate hikes from November MPC meeting; QT expected to be of the order of c£80bn over next 12months, in an effort to combat inflation. So we have fiscal loosening amid a longer term aim from the BoE to tighten.

As above, the surprise cuts cost, and the DMO has therefore had increase it's expected gilt issuance significantly. This huge increase in supply led to an increase in gilt yields, which move inversely vs price and hence inversely vs relative demand. But, that was only the start...

DB pension schemes facing substantial deficits post-GFC typically have portfolio divided into two parts:

one part seeks excess return in order to make good the deficit
the other part "hedges" the liabilities, which behave like typically long duration bonds (insomuch as they have interest and inflation sensitivities) - their long duration makes them susceptible to quite large changes in value (e.g. 20y duration with a 1% increase in rates at that duration would lead to a 20% fall) - it's therefore a good idea to minimise risk, but you need to minimise risk relative to your specific liabilities (i.e. jurisdiction, duration, realness, etc.)

But, if you're trying to hedge 100% of your liabilities (or even something less) with <100% of your assets (in practice this number is often in the 25-50% range), then you need to use leverage. Two (not exhaustive) ways of gaining exposure to interest rates and inflation using leverage are: 

To enter into swaps whereby I agree with you that I'll pay you x% each period and you'll pay me whatever a floating interest rate or inflation is. I haven't actually bought anything in doing so and therefore haven't actually used any money = leveraged exposure

Another option is that we use a "repo". I sell you my gilt on the understanding that I'll buy it back on a known future date at a specified future (higher) price. In other words, I am paying to borrow over the period whilst still exposed to the price move of the asset repo'd. With that borrowing I can go and buy another gilt. I've therefore effectively doubled my exposure to gilt price moves = leveraged exposure.

In practice, to ensure that these synthetic hedges don't pose excessive credit risk either way, you are usually required to maintain a pool of collateral (the gilt in the repo, or a pool of assets backing a swap portfolio).

With both these techniques, if rates rise/fall, then the value of my liabilities falls/rises. So too do my assets. If I had used these synthetic techniques to ensure my asset sensitivity = liability sensitivity then the move will be similar on both sides, so my deficit won't have changed.

So, what's the problem? As yields rise, the value of my gilts fall. So, when I close out the positions on a repo for example: I make a loss on the second gilt; I then can't repay the lender in the repo arrangement. You can see how this ends if I hadn't repo'd once, but more...

That means then that when yields rise people are forced to close out positions and you end up with a load of gilts sold. Those additional sales push the price down further (DB funds are massive players in the gilt markets - less so in other risk asset markets - so move prices materially). This forces those next up the chain to close out, pushing the price down further. Repeat. You end up in a spiral that collapses pretty spectacularly and pretty quickly.

The only way to avoid having to close out in such situations is to keep posting more collateral. But, that means selling those assets you're using to seek excess returns. Can you do that quickly enough, allowing for settlement times and the necessary transfer of cash over to your leveraged gilt portfolio? Normally yes when markets are moving gradually, but not in the last week and certainly not in a fully fledged spiral sell-off.

So far, it's not a pension fund solvency issue - just a liquidity one - they have the cash/liquid assets but can't put them to work in time. But, you really don't want to be the last one out in these spirals as you come out at the worst price without much ability to get back in for the ride back down (in yields/up in prices). You either want to be out from the start or in all the way and still in at the top. If you do end up closed out in the spiral, then you most likely will struggle to buy back in before yields fall. And that is where the long term damage is done: when yields fall back down, the value of your liabilities is going back up, but you no longer have the hedging assets to match that rise, so your scheme funding worsens.

In this week's episode, we eventually saw the BoE step in. Probably a day late and after much pressure, but understandable given to calm things they are committing to buying gilts to whatever extent is necessary - effectively QE, and the opposite of what they are trying to do medium term to curb inflation. But, their purchase has calmed things substantially, so that's good. It's just unfortunate that there will have been some casualties on the way - we'll find out over the coming days. There will be large variation: those that were "underhedged" a month ago will have won big time; those that were forced sellers immediately before the BoE statement will be big losers; others will be somewhere between.

Here's the 20y nominal gilt yield. You can very clearly see when the budget was and when the BoE stepped in around 11am this morning. Worth also flicking to "all" to see quite how sharp this is in historical context. 

When people talk about how central banks have distorted the fixed income markets this is a perfect example. Pensions need reliable returns to meet their obligations. That’s especially true of defined benefit programs which occupied 45% of the UK market in 2019. The alternative to goosing returns with leverage or moving further out the risk curve into private assets.

The price of refusing to take these risks would be to demand much higher contributions to cover the shortfall and nobody wants to do that. Faced with the possibility of angry retirees, at the prospect of not receiving their dues, or relying on the central bank to bail them out, the answer is always going to be the latter.  Quantitative easing introduced significant moral hazard and yesterday Bank of England action, while necessary, compounded it

Let's do a little rule of three.
Debt service is now at about three percent of GDP per year and the ECB can no longer manipulate Italy's rates downward, to keep Italy's head above water, since the US is raising its rates.
On today's growth figures (which will fall), and with interest rates rising over the next five years, debt servicing will rise to six percent of GDP, which means that the standard of living of every individual will fall by at least three percent, which is impossible.
And there is no solution as long as Italy remains in the Euro, and everyone in Italy knows this.              
And Italy can easily get out because it has a primary budget surplus and a trade surplus. It does not need the financial markets to make ends meet, unlike France.
In any case, make no mistake: the Italian elections are about one thing and one thing only: the euro. "Always think about it, never talk about it" seems to be the watchword in Italy.
And so, the more "right-wingers" are elected, the higher the probability that Italy will abandon the euro.

Yield curve control is the topic of the moment. The UK has just introduced it, so the logical question is which jurisdiction will deploy it next. In this regard, Japan’s refusal to abandon its program looks particularly inspired. Another way to frame this question is what will Germany do to ensure everyone continues to use the Euro? So far, the answer has been whatever is necessary.

Congrats on your opinion on a larger correction and acting on it with put purchases.

Last week Double Line presentation  had a chart that showed the performance of equity and the different credit subclasses, Ags., EM, HY, ClOs and so forth. Showed  the large move by equities compare to credit over the same time period. It made me wonder how much further the equity correction can go.

You often follow interesting companies, you mention EQNR from Norway. have you ever looked a Freyr. It is also Norwegian and is involved in batteries. During  the last days because of a report on its possible growth it had a huge move , but during this correction it may be a good opportunity, let me have your thoughts. Based on your comments  how much the market has already priced in the EVs maybe it is not a good idea.

The move on copper is not a good signal  

Trust all is well for you  and your family

Thank you for these well wishes and questions which may be of interest to the Collective. Of my nine different long-dated put positions, the only one not in profit is Tesla and yet that is the one I have the greatest hopes for. They all have maturities in 2024, but I expect the point of maximum pessimism will arrive while they still have some time value.

Brookfield is looking to multiply its current 4 GW renewable portfolio by 3 to four times in India within the next decade in generation as well as help corporates make the transition to decarbonise and invest in building large scale supply chain in the country, said a top executive.

The renewables current assets under management is approximately $1 billion.

Earlier this year, Brookfield Asset Management announced that it raised a record $15 billion for its inaugural Global Transition Fund. This marks the world's largest private fund dedicated to the net zero transition, signaling that investors are still committed to establishing cleaner portfolios. Brookfield is the single largest sponsor of the fund having deployed $2 billion itself.

Brookfield deals with state utilities but sees incremental green power demand coming from corporates who are increasingly becoming bulk consumers. For example, as part of its road map to achieve 100 per cent dependence on renewable energy by 2025. Amazon on Wednesday announced its first utility-scale projects in India — three solar farms located in Rajasthan. These include a 210-megawatt (Mw) project to be developed by India-based developer ReNew Power, a 100 Mw project to be developed by local  developer Amp Energy India, and a 110 Mw project to be developed by Brookfield Renewable Partners.

Brookfield is the name that comes up in almost every conversation I have with investors. The name is treated reverentially because the team so artfully plotted a route through the Global Financial Crisis and the subsequent boom.

on today's video you highlighted the virtues of the NOBL Dividend Aristocrat index, but on closer inspection the yield on this is just 2%. A year ago, that was 4x the yield on short term treasuries in the US, but with 1 and 2- year treasuries yielding 4% now, double that of NOBL, there seems to be far less support from those seeking out yield.
The TINA approach is fast coming to an end. With that in mind, and with the Sterling continuing to take strain, what investment vehicles are available to us in the UK to invest in 3M, 1Y an 2Y US Treasury paper?

Thank you for this question which may be of interest to the Collective. There is of course a big difference between capturing a high yield now and buying with the expectation of dividend increases in future. It is essentially the difference between current yield and yield to cost.

I have been thinking a lot about the aspects of the market we all tend to take for granted. The types of conclusions we have been conditioned to draw, because that is always how markets work. It strikes me as a big question because we should be asking if these market norms are the result of the decades-long process of disinflation or are they rules that transfer between big secular themes.

The basic working hypothesis of the markets is the Fed will rescue its stock market. The EU will rescue its bond market and China will rescue its property market. The rationale for all three is the same. That’s what they have always done because those are the biggest asset classes owned by consumers in all three jurisdictions.

In the Big Picture Roundup, you shared this wonderful chart.

The problem is that the way that you shared it, means that we could not see the date axis.

It would be great if you could share a better version of this chart e.g., on Comment of the Day

Thank you in advance

Thank you for pointing this out. The aspect ratio between my monitor and the recording software is not always one to one. Here is the chart you were asking about.

What I like about this chart is it starts in 2000. It graphically illustrates that some property markets completely sidestepped the housing crash associated with the global financial crisis in 2008. These same markets, notably Australia, Canada, New Zealand and Sweden are expensive on a price/income and price/rent basis.

The global economy may face a recession next year caused by an aggressive wave of policy tightening that could yet prove inadequate to temper inflation, the World Bank said in a new report.

Policy makers around the world are rolling back monetary and fiscal support at a degree of synchronization not seen in half a century, according to the study released in Washington on Thursday. That sets off larger-than-envisioned impacts in sapping financial conditions and deepening the global growth slowdown, it said.

Investors expect central banks to raise global monetary policy rates to almost 4% next year, double the average in 2021, just to keep core inflation at the 5% level. Rates could go as high as 6% if central banks look to wrangle inflation within their target bands, according to the report’s model.

When quantitative easing was first introduced there was a lot of handwringing at the thought of moral hazard. The Federal Reserve waded into public markets to buy sovereign bonds with the stated aim of back stopping government spending and encouraging speculation. It was viewed as a very risky endeavour that would send the wrong signal to speculators; that they can’t lose. In 2012/13 the EU went in the opposite direction and withdrew liquidity for fear that debtor nations would not mend their ways if assistance was too generous. 

Dear Eoin, I may not be the only Europe-based investor who is currently facing the following dilemma. My income and expenditure are both in Euros. I have protected and increased my wealth and income by investing in USA stocks which have given me both capital appreciation and currency increase. Now the USA dollar looks over-valued and all equity options appear to be unfavourable. In addition, inflation is high and so holding liquidity means losing real spending power. What are the alternatives on offer?

Thank you for this question which touches on a topic everyone has an interest in at present. Inflation has been described as the thief which comes in the night, but lately it feels like bandits are roaming around the house in broad daylight.

I think it looks like interest rates will have to rise a lot (toward the higher end of the 4.5 to 6 percent range) and a significant fall in private credit that will curtail spending. This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.

Now, we can estimate what that rise in rates will mean for market prices and economic growth. The rise in interest rates will have two types of negative effects on asset prices: 1) the present value discount rate and 2) the decline in incomes produced by assets because of the weaker economy. We have to look at both. What are your estimates for these? I estimate that a rise in rates from where they are to about 4.5 percent will produce about a 20 percent negative impact on equity prices (on average, though greater for longer duration assets and less for shorter duration ones) based on the present value discount effect and about a 10 percent negative impact from declining incomes.

Now we can estimate what the fall in markets will mean for the economy i.e., the "wealth effect." When people lose money, they become cautious, and lenders are more cautious in lending to them, so they spend less. My guesstimate that a significant economic contraction will be required, but it will take a while to happen because cash levels and wealth levels are now relatively high, so they can be used to support spending until they are drawn down. We are now seeing that happen. For example, while we are seeing a significant weakening in the interest rate and debt dependent sectors like housing, we are still seeing relatively strong consumption spending and employment.

The upshot is that it looks likely to me that the inflation rate will stay significantly above what people and the Fed want it to be (while the year-over-year inflation rate will fall), that interest rates will go up, that other markets will go down, and that the economy will be weaker than expected, and that is without consideration given to the worsening trends in internal and external conflicts and their effects. 

US rail workers are about to go on strike. By now the pattern is familiar. The companies they work for are making record profits and the wages have not kept up with inflation. This will also again highlight the disparity between the benefits of union workers versus less well represented groups. This is exactly the kind of evidence of a wage price spiral the Fed is seeking to avoid by hiking rates aggressively.

US consumer prices were resurgent last month, dashing hopes of a nascent slowdown and likely assuring another historically large interest-rate hike from the Federal Reserve.

The consumer price index increased 0.1% from July, after no change in the prior month, Labor Department data showed Tuesday. From a year earlier, prices climbed 8.3%, a slight deceleration, largely due to recent declines in gasoline prices.

So-called core CPI, which strips out the more volatile food and energy components, advanced 0.6% from July and 6.3% from a year ago, the first acceleration in six months on an annual basis. All measures came in above forecasts. Shelter, food and medical care were among the largest contributors to price growth.

The acceleration in inflation points to a stubbornly high cost of living for Americans, despite some relief at the gas pump. Price pressures are still historically elevated and widespread, pointing to a long road ahead toward the Fed’s inflation target.

Inflation probably has peaked but that is not a commentary on how quickly it comes back down. The bullish narrative for inflation is that the pandemic was an anomaly. The surge in inflation was created by supply shocks and liquidity-fuelled asset price appreciation. With the end of the pandemic and less money supply, inflation will fall back as quickly as it rose, so buy the dip.

After the discussion around earnings trajectory for the S&P 500, the focus then typically turned to how to trade it. Here, we have some sympathy for the view that markets may potentially hold up very tactically until the EPS cuts actually happen. As already noted, conference season is upon us and investors are ready for some bad news at least with regard to how 3Q is progressing. However, the degree of that deterioration is more debated now given the recently announced $500 billion student debt forgiveness and extended moratorium on loan payments until December, combined with the energy subsidy announced this past week in the UK to help consumers through the winter. Both of these are rather large fiscal stimulus packages that could keep the "tone" of company commentary less bearish than feared, and potentially delay the eventual cuts. Nonetheless, we have high conviction that EPS cuts will play out in earnest over the next 2-3 months, and as a reminder from our note last week, mid-September through October is a particularly challenging seasonal period for EPS revisions.

The yield curve (10-year – 2-year) inverted for a week in April and has been persistently inverted since June. The classic version of the yield curve (10-year – 3-month) is not yet inverted but it is still trending lower. This spread collapsed from an artificially elevated level in May. It tends to be much more volatile than the longer-dated version because short-term interest rates can whip around a lot.  

Actually, it all started moments before the ECB released its policy statement. The euro dropped like a stone by around 40 pips in a move that got me wondering whether there had been a leak. Most likely, it’s one of those trades that was going to be very directional, but it’s telling that the move was bearish the euro when most expected a jumbo hike and shows that investors expect the euro to remain under pressure, with high conviction on the trade.

Then came the unprecedented interest rate increase. And for everyone that expected some lively action, it seemed that screens were frozen. Little reaction from the common currency, same picture with the bond monitors. Was it down to some great communication by the ECB that there was little reaction? Or did the market just wait for more info before trading in size? The answer came a few minutes later when euro area bond yields felt some pressure as the decision by the Governing Council was unanimous.

It became totally evident when short-end yields led a double-digit advance across the curve and the euro didn’t budge. The current narrative goes that there’s little the ECB can do to support the euro given the energy crisis. And especially if inflation remains supply-driven in the euro area, higher rates won’t do the trick. Not as much as they can do for a demand-driven inflation, like the one in the US, as Lagarde said. After all, there’s been a deep breakdown of the correlation between the common currency and bond yields since mid-August, and yesterday just highlighted this divergence. Given natural gas prices fell to the lowest in almost a month as politicians draw plans to intervene in regional markets, it could be that the euro manages to set a medium-term bottom soon.

The ECB only has one mandate which is to control inflation. It has taken on a wide range of additional responsibilities over the last twenty years but the central mandate to target a 2% rate has not changed. 

Of course, they never accounted for the possibility of mass hysteria among the ruling class during a pandemic and a war on the border of the EU shortly afterwards. 

Thanks for another very informative comment of the day. do you expect the SP500 to test the lows of 2020? I would very much like to hear your views on this. Thanks in advance. Best rgds.

Thank you for this topical question. As a repeat delegate at the Chart Seminar, you will remember that targets are more a reflection of personal bias than an accurate predictor of where prices are likely to trade. Since I am short the Nasdaq-100 I am keenly aware of the influence that has on my personal psychology and that is likely to affect how I view downside potential. Let’s look at the chart facts.

According to a Bloomberg News report, Truss has drafted plans to cap annual electricity and gas bills for a typical household at or below the current level of £1,971 ($2,300). That would have a significant impact on inflation, which our baseline scenario forecasts will reach 15% in January. Mechanically inputting the cap freeze into our forecast shows inflation peaking in July (at 10.1%) and then falling back at a faster pace -- approaching 2% within a year.

The cost of implementing that measure would be a whopping £130 billion over the next 18 months, according to Bloomberg News. If we then add fresh support to businesses, which may total £40 billion based on draft government plans, the full size of the package could reach 7% of GDP. That’s a massive fiscal boost, close to the level of government support seen during the pandemic.

But it’s early days. There’s a high probability that the reported plans will face significant push-back from the Treasury or from within the Conservative Party -- especially as these measures would be poorly targeted. A key question will be how the energy cap is funded. It could be clawed back from households later, keeping energy prices higher for longer, or purely financed by government borrowing. The latter option would create a significant hole in the government’s finances -- even if the cap delivers around £30 billion of savings from lower inflation-linked debt payments in 2023-24.

Another possibility is the government intervening in wholesale energy markets. That could dampen the impact on the public finances, because it would open up the possibility of reducing bumper profits from some electricity producers. The snag here is it would be akin to a windfall tax, which Truss has previously said she would not pursue.

7% of GDP is a lot of money to spend on standing still. The fact the £170 billion price tag coincides almost identically with the excess profits for energy companies quoted last week. It suggests the government is aware of what sector can be targeted should financing this stimulus become an issue.  

Aside from fanning inflation, the biggest energy crisis in decades is sucking up capital to guarantee trades amid wild price swings. That’s pushing European Union officials to intervene to prevent energy markets from stalling, while governments across the region are stepping in to backstop struggling utilities. Finland has warned of a “Lehman Brothers” moment, with power companies facing sudden cash shortages. 

“Liquidity support is going to be needed,” Helge Haugane, Equinor’s senior vice president for gas and power, said in an interview. The issue is focused on derivatives trading, while the physical market is functioning, he said, adding that the energy company’s estimate for $1.5 trillion to prop up so-called paper trading is “conservative.”

Many companies are finding it increasingly difficult to manage margin calls, an exchange requirement for extra collateral to guarantee trading positions when prices rise. That’s forcing utilities to secure multi-billion euro credit lines, while rising interest rates add to costs.

“This is just capital that is dead and tied up in margin calls,” Haugane said in an interview at the Gastech conference in Milan. “If the companies need to put up that much money, that means liquidity in the market dries up and this is not good for this part of the gas markets.”  

The ECB is looking primed to begin hiking rates while at the same time it will also be prevailed upon to provide significant additional liquidity. This is akin to taking with one hand and giving with the other. Even that’s a stretch.

Thanks for joining us as we took you through the results of the Conservative leadership race. Liz Truss will take office Tuesday and give a speech outside her new home -- No. 10 Downing Street. In the meantime, these are the key takeaways so far:

Liz Truss won the race to be the UK’s next prime minister, but achieved a smaller-than-expected margin of victory over Rishi Sunak, with 57.3% of Tory members’ votes.
She vowed to cut taxes, grow the economy, and address the crises in energy and the National Health Service.
Truss will visit Queen Elizabeth II in her Scottish castle to be formally appointed on Tuesday, after which she will make a speech to the nation and appoint members of her cabinet.
She inherits a forbidding in-tray: surging inflation, predictions of a recession and a record squeeze on living standards spurred by soaring energy prices.
Truss has promised to announce how she would help Britons through the cost-of-living crisis in her first week -- reports suggest she could freeze energy bills and offer targeted financial help to low-income households and pensioners.

The Pound and Gilts have sold off aggressively over the last month as traders priced in the rising potential Liz Truss would succeed Boris Johnson. The most urgent issue is the massive impending jump in electricity costs. No prime minister can survive through that kind of living standard decline, so price caps are inevitable.

My theory is that the breaking of these superbubbles takes multiple stages. First, the bubble forms; second, a setback occurs, as it just did in the first half of this year, when some wrinkle in the economic or political environment causes investors to realize that perfection will, after all, not last forever, and valuations take a half-step back. Then there is what we have just seen – the bear market rally. Fourth and finally, fundamentals deteriorate and the market declines to a low.

Let’s return to where we are in this process today. Bear market rallies in superbubbles are easier and faster than any other rallies. Investors surmise, this stock sold for $100 6 months ago, so now at $50, or $60, or $70, it must be cheap. Outside of the late stage of a superbubble, new highs are slow and nervous as investors realize that no one has ever bought this stock at this price before: so it is four steps forward, three steps back, gingerly exploring terra incognita. Bear market rallies are the opposite: it sold at $100 before, maybe it could sell at $100 again.

The proof of the pudding is the speed and scale of these bear market rallies.
1. From the November low in 1929 to the April 1930 high, the market rallied 46% – a 55% recovery of the loss from the peak.
2. In 1973, the summer rally after the initial decline recovered 59% of the S&P 500's total loss from the high.
3. In 2000, the NASDAQ (which had been the main event of the tech bubble) recovered 60% of its initial losses in just 2 months.
4. In 2022, at the intraday peak on August 16th, the S&P had made back 58% of its losses since its June low. Thus we could say the current event, so far, is looking eerily similar to these other historic superbubbles.

Have we seen the secular peak in this market? That’s the only real question investors need to concern themselves with. The above statistics are certainly compelling, but the size of the rebounds should also be considered relative to the size of the initial declines from the peaks. Let’s round out that data.

1. The Dow Jones Industrials Average accelerated to the peak on September 3rd 1929. It fell 47.87% to the initial low on November 13th
2. The peak in 1973 was a failed upside break from a range that had been forming since 1966; with the Dow failing at the psychological 1000 on several occasions. That failed upside break resulted in a deeper pullback than any (25% & 36%) posted during the ranging phase. The failed downside break in 1974 resulted in a 75% rebound. It was another six years before a breakout to new highs was sustained.
3. Between March 10th and May 26th 2000 the Nasdaq Composite fell 40.72%.
4. Between January 7th and the low on June 17th the S&P500 declined 24.52%.

With regard to increasing the pace of QT, the past attempts were undertaken during periods of much lower inflation. With inflation currently much higher, dare I say it, might this time be different?

Thank you for this question which is highly relevant since the Federal Reserve will be doubling the pace of balance sheet run-off to $95 billion a month within weeks. We only have two examples of significant balance sheet contraction by central banks. That was the ECB between 2012 and 2014 and the Fed between 2018 and 2019.

Deutsche Bank estimates that subtracting the rebate will reduce the Retail Prices Index, which determines payments on UK inflation-linked debt, by about 2.7 percentage points. That would lower the debt interest bill by around £14 billion this year, according to Bloomberg calculations based on Office for Budget Responsibility data. RPI is also tied to some consumer products, such as mobile phone tariffs.

Such savings would be welcomed by the government, which is under intense pressure to spend even more in response to the surge in energy costs. A similar reduction in the Consumer Prices Index, and a potentially lower path for interest rates as a result, could also save the government billions.

Based on CPI, UK inflation is already above 10%. The Bank of England forecasts that it will top out just above 13%, although a surge in gas prices in recent weeks mean officials will almost certainly have to increase that forecast. That means the ONS decision may impact the peak rate this winter, but not change the direction of the outlook for prices. 

Persistent inflation has a long tail. The longer it lasts, the greater the effects for government finances in future. Index-linked pensions, tariffs and utilities all push higher with a lag from a current bout of inflation. That’s both a near-term headache and medium-term challenge for most governments. That greatly increases potential for government intervention. It is starting with subsidies and will quickly transition to price caps if prices fail to decline.  

The price of Germany’s electricity over the next year has climbed over $1000pb in Brent oil energy equivalent terms. This is far from normal. It’s a crisis that stems not only from restrained energy supply from Russia but a series of unfortunate issues elsewhere too. In addition to energy restraints, the euro area is facing the full brunt of climate change with flash floods and record droughts, combined with slowing trade with China and US recession risks. However, we think the bigger challenge Europe will face this winter is not inflation, but stagflation. Altogether it’s why we expect EUR/USD to fall to 0.90 this winter, inflation to climb further to multi-decade highs before peaking, GDP to decline over the coming year and the ECB to first raise rates in response to higher inflation, and then cut next year as the energy-induced recession continues. Will Germany run out of gas? Probably not. That's due to LNG supply, but even more due to falling industrial demand. High prices and falling demand of an essential such as energy is not good for growth, but it gives hope that blackouts in Germany won't be the story of early 2023.

This report shares the downbeat consensus view that Europe is going to endure a profound winter of discount. There is no doubt the challenges are immense but so have been the efforts to overcome them. For example, the EU has reached its November target for natural gas reserves. That suggests some slowdown in demand following indiscriminate buying over the last few months.

Officials attending the Federal Reserve’s Jackson Hole gathering signaled the ECB is prepared to at least repeat the 50 basis-point hike enacted in July, with some not excluding an even larger increase. Executive Board member Isabel Schnabel urged “strong determination to bring inflation back to target quickly.”

While Lane didn’t spell out whether he’d oppose a 75 basis-point step, his comments suggest officials would need to see the need for a higher “terminal rate,” or high point of the current hiking cycle, for him to support such a move.

The Irish official said a “multi-step adjustment path towards the terminal rate also makes it easier to undertake mid-course corrections if circumstances change.” If new data called for a lower terminal rate, “this would be easier to handle under a step-by-step approach,” he said. 

Among the more cautious voices on the Governing Council is Executive Board member Fabio Panetta, who said last week that policy maker must tread carefully as a significant economic slowdown would ease inflationary pressure. 

The ECB has one of the most out of control inflation problems in the world. The pressure being exerted on the region from Russia’s energy war is not about to disappear. However, the successful filling of gas storage facilities ahead of schedule will moderate the risk of shortages this winter.  

With just 10 days to go until Boris Johnson’s successor as premier and Conservative Party leader is announced, neither candidate has detailed how much assistance they’ll provide to families and businesses who face soaring energy costs, despite Chancellor of the Exchequer Nadhim Zahawi conceding that the current support package is “not enough.”

Whichever candidate wins the Tory leadership contest, addressing the impact of rocketing energy bills will be at the top of their in-tray after Ofgem said on Friday that a price cap on average annual energy bills would rise to £3,549 ($4,206) in six weeks’ time. That’s 178% higher than last winter and 80% more than at present. 

The only questions considered are how much support to provide. Fiscal discipline is out of favour at present. With inflation and energy prices hitting living standards so aggressively, the UK government is under extraordinary pressure to ease the pain.

Any sign from this week’s Jackson Hole symposium of more aggressive rate hikes to come will whack credit markets, which have already started to give back summer gains. Misplaced optimism about the US inflation and economic outlook squeezed spreads to unsustainably tight levels, leaving debt vulnerable to a fall that will be exacerbated by dwindling liquidity.

US high-grade bonds got overbought as fund inflows chased better returns, despite a barrage of issuance which will likely resume in September. The high-duration debt stands to lose most from a more hawkish Fed.

Spreads have almost 25 bps to go before hitting the July wide at 160 bps, but investors are keeping powder dry for a move back to May 2020 levels above 180 bps. That would be a fairly extreme move for a market that tends to move in 1-2 bps daily increments, but pre-Labor Day lack of liquidity provides scope to gap out.

Junk’s summer gains were led by the riskiest bonds, which would be battered most by a higher rates/lower growth environment. Some are waiting for a pummeling to 800 bps -- from 432 bps currently -- before buying in.

The biggest factor in the underperformance of portfolios from the beginning of the year had been the strong correlation between bonds and equities. They both fell at the same time and played havoc with the 60/40 portfolio set up. That relationship stopped working from early this month. Treasury prices resumed falling but stock prices rebounded.

We have a large number of people who are estranged from our economy. In 1960, 5% of men were not working between the ages of 25 and 54. Today it’s more like 15%. If 15% of men are not working at any point in time, then a quarter of the people will have been out of work for a year or more over a four or five-year period. That’s destructive to the economy's productive potential. It’s destructive to their families. It’s destructive to the areas in which they live. It’s destructive to the moral fabric of our national life.

I recently finished reading Coming Apart by Charles Murray. It’s a harrowing account of how the polarization in the economy is manifested in a growing rift between the privileged, insulated upper class and a benefits-dependent underclass.  

That’s a key finding from a survey released Thursday by consultant PwC, which last month polled more than 700 US executives and board members across a range of industries. Half of respondents said they’re reducing headcount or plan to, and 52% have implemented hiring freezes. More than four in ten are rescinding job offers, and a similar amount are reducing or eliminating the sign-on bonuses that had become common to attract talent in a tight job market. 

At the same time, though, about two-thirds of firms are boosting pay or expanding mental-health benefits. The most common move: making remote work permanent for more people.

The primary argument being used to say a recession has not already begun is the Purchasing Manager’s Index and the low unemployment rate. It is reasonable to say a recession is not underway if companies are buying more on a month over month basis and unemployment is close to a record low.

“UK CPI inflation surged in July amid rising food prices that helped lift the rate above market expectations. The peak is still likely come in October, when energy prices are due to be increased again -- we see annual CPI moving to a little below 13% at that point. With inflation now more than five-times the Bank of England’s target, the question isn’t whether the central bank will tighten, it’s by how much? Today’s reading makes it more likely than not that the BOE lift rates by 50 basis points in September -- our baseline ahead of the data release was for a 25-bp move.”

Economists are growing increasingly pessimistic about the UK, with the risk of a recession now seen as far more likely than not due to rising cost pressures. The BOE expects a recession to start in the fourth quarter, lasting into the early part of 2024.

The central bank expects inflation to surpass 13% later this year when regulators allow energy bills to rise again. That would mark the worst reading since September 1980, when Margaret Thatcher’s government struggled to bring a wage-price spiral under control.

 

In the normal course of events UK inflation should have peaked already. Money supply growth peaked on a year over year basis 18 months ago and on a month over month basis is now negative. At the same time the Bank of England has been raising rates, albeit modestly, for the last eight months and is now also talking about reducing the size of its balance sheet.

Q: Are we in a bear or a bull?

Thank you for voicing the question I believe everyone is asking. The short answer is yes, the long answer is more nuanced. Let’s frame this discussion in terms of the yield curve spread. The 10-year – 2-year is sharply negative. The 10-year – 3-month and the 10-year – Fed Funds Rate have both accelerated lower but are not yet negative. All three point toward significant monetary tightening. That is before the impending acceleration in the contraction of the Fed’s balance sheet is 

Strategists at Citigroup Inc., using a mix of spot and forward curves to help construct a predictive model, now say that there’s a greater than 50% chance of a recession over the next year. 

“It’s a perfect storm now with both sides of the curve causing the inversion, and making it likely to continue,” said Jason Williams, a strategist at the New York-based bank. “Given the strength of the labor market and still high inflation, there’s no reason for the Fed to slow down it’s hiking.”

Investors have been conditioned to expect the “Fed put” because they have underwritten the stock market following every significant decline since the 1987 crash. The challenge today is inflation is way above the Fed Funds rate and also outstripping wage growth. Providing the normal liquidity surge into that environment is counterproductive to ensuring stable prices.

I know you have consistently highlighted the challenges that UK households will experience in relation to their energy bills, and just today they are saying that "typical" households could be paying nearly £600 in January, money that most just can't find. Already consumers are a collective £1.3 billion in arrears on their bills, with an expected 86% hike in the energy cap expected on 1 October.

But far less is said of the impact on businesses, and on this I can shed some very specific light. I own a small business, an indoor children's play centre. On 1 December last year I renewed my energy supply contract, and faced with an increase then from 15p/kwH to 20p/KwH I opted to take just a 1 year renewal, with gas prices fairly stagnant until then as you know.

I have been informed today that when I come to renew once more on 1 December, I am going to staring at a tariff of anywhere between 50p/kwh to as much as 89p/kwh. I was also told in no uncertain terms by the 'sales' person at my current supplier, that they are trying to migrate away from small and medium business in this environment, and are deliberately pricing us away. the daily fixed standing charge will move from £83 per month, to potentially as much as £1,000.

For context, my own energy bill is going to shift from £20k per year to closer to 60k-£70k. This is going to be catastrophic for U.K. businesses, as many will be left in dire straits, unable to keep the lights on, and customers cool (in summer) or sufficiently warm in the winter. So many businesses in the hospitality sector especially are saddled with the burden of Covid "bounce back loans", delayed VAT repayments, and of course huge inflation on input costs with a consumer at breaking point. Business closures = higher unemployment...it is looking particularly dire here in the U.K.

Thank you for sharing this visceral experience of price increases business owners are experiencing. The challenges are significant and options to raise prices are inhibited so many businesses will close. The strike action in the UK which has been building for months and will escalate further. They are a symptom of how much living standards are being impacted by the rising cost of living.

“This is a necessary print for the Fed, but it’s not sufficient,” Pond said. “We need to see a lot more. You can think about this print as sort of like the weather -- it’s better today than it has been over the past few days. But it’s still summer. There’s still a lot of humidity out there. It’s not great. So it’s in the right direction. But we’re certainly not there yet.” 

For Diane Swonk, the chief economist at KPMG LLP, the Fed is now hedging against risk of future supply shocks as well as combating current inflation and will likely favor a 75 basis-point increase.

“The Fed is no longer willing to rest on their laurels on a one-month move,” she said. “The greater risk for the Fed is to stop too soon than stop too late. It will take a lot more cooling than this for the Fed to shift its decision rule, although in this economy, September seems an eternity away.”

The big question for investors is whether the Federal Reserve will focus on core or non-core items in how much they decide to raise rates in September. Commodity price inflation is less urgent today than earlier this year. Lumber prices have made a full round trip. Wheat has fully unwound the Ukraine invasion surge. Palm Oil is steadying in the region of the 2008, but the price has almost halved from the peak level. 

Bond investors in New Zealand are not as sanguine. Yields on two-year debt are just two basis points below 10-year rates, the narrowest gap since 2015 when the curve last inverted. The difference between Australia’s 10- and three-year bond futures stands around 17 basis points.

Much of the fears in Australia and New Zealand are centered on concerns about the housing market, which experienced a post-pandemic boom when borrowers piled in to take advantage of record-low interest rates. The two central banks have indicated that borrowing costs will continue to rise.

“The Australian economy is already showing some cracks -- weak consumer sentiment, falling dwelling prices, cooling consumer spending -- and New Zealand’s economy is showing more,” said Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. in Sydney. “Australia will slide into recession in the second quarter of next year under the weight of recent and prospective RBA rate hikes, which will expose Australia’s Achilles’ heel, an extended housing market and highly leveraged consumers.”

Australian consumer confidence dropped for a ninth straight month in August to reach a two-year low, according to a report released Tuesday by Westpac Banking Corp.

The yield curve spread (10-year – 2-year) is a reliable lead indicator for US recessions. It does not have nearly the same strong record of predicting recessions for other countries. That is probably because other countries do not rely so heavily on their banks for credit creation. 

Lawmakers appear close to passing into law the Inflation Reduction Act of 2022. The legislation is born out of the Build Back Better agenda that President Biden proposed more than a year ago. It raises nearly $750 billion over the next decade through higher taxes on large corporations and wealthy individuals and lower Medicare prescription drug costs, to pay for nearly $450 billion in tax breaks and additional government spending to address climate change and pay for lower health insurance premiums for Americans benefiting from the Affordable Care Act (see Table 1). The remaining more than $300 billion goes to reducing the federal government’s future budget deficits (see Chart 1). Broadly, the legislation will nudge the economy and inflation in the right direction, while meaningfully addressing climate change and reducing the government’s budget deficits.

The renewable energy sector rebounded emphatically on the prospect of additional subsidies last week. Removing the limitation on EV rebates so every buyer gets a $7500 discount and reinstating the 30% tax credit for solar installations are both stimulative for their respective sectors.

Gold inched higher as Treasury yields pared their recent surge, with traders temporarily looking beyond the Federal Reserve’s aggressive interest-rate hike path. 

Bullion rose as much as 0.8%, rebounding from the worst daily loss in two weeks in the previous session. On Friday, a stronger-than-expected US jobs report added to the case for more Fed monetary tightening, pushing up the dollar and bond yields while crushing gold since it pays no interest and is priced in the greenback. 

Still, a bigger rate hike isn’t a done deal, and investors are now waiting for a US inflation report later this week to gauge how hawkish the Fed may be at its September meeting. That allowed a pause for Treasury yields and the dollar, lifting gold prices on Monday.

A hike of 75 basis points at next month’s Fed policy meeting “is far from locked in,” TD Securities commodity strategists led by Bart Melek said in a note. For now, “the yellow metal has been able to hold firm.”

The precious metal has rallied for the last three weeks, as concerns over a global recession and heightened US-China tensions boosted demand for the haven asset.

Holdings of bullion in exchange-traded funds have remained under pressure, however, falling for an eighth straight week.

Spot gold rose 0.7% to $1,788.34 an ounce as of 10:49 a.m. in New York. The Bloomberg Dollar Spot Index and the 10-year Treasury yield edged lower. Silver, palladium and platinum all advanced. 

I spent a lot of time thinking about gold over the weekend. I’m not happy with how my trading of the metal has gone over the last year. Despite significantly offsetting my loss with success in other trades, I still feel the pang of failure in gold more acutely than with other instruments. This is the 2nd time in four years I have sold at the wrong time, so I am resolved to do better in future.

Yields on two-year Treasuries surged in response to the jobs report, a reflection of the expected Fed rates over that period. Market pricing indicated a 75 basis-point increase to the Fed’s key rate is now seen as a more likely outcome in at the central bank’s September meeting than 50 basis points.

Powell has described the labor market as “tight to an unhealthy level,” and has been seeking a moderation to help bring demand for products and services more in line with supplies that have been constrained by Covid-19 disruptions. He and other Fed leaders are worried about the potential for a wage-price spiral, with higher wages feeding into inflation in a cycle that is hard to break.

“This number is so comprehensively strong with a pretty significant uptick in wages,” said Mark Spindel, chief investment officer at MBB Capital Partners LLC in Chicago. “Companies are paying up for labor. Income matters most. When you look at the breadth of the employment report, and the earnings, this is an enormous tailwind for income.” 

It has been widely reported that the USA has missed out on 2 million immigrants following the isolationist policies adopted by President Trump’s administration. At least 1 million of those would have been highly educated/skilled individuals.

The Bank of England is reminding the world what a politically independent central bank can and should do: act as a “trusted adviser,” willing to share analytically honest views that other more politically sensitive institutions are either unable or unwilling to do.

Of course, this is not a risk-free approach. Such honesty — rather than catalyzing appropriate responses from policy-making agencies that lead to better economic and social outcomes — can provoke household and corporate behaviors that accelerate the bad outcomes. Yet the risks involved are worth taking, especially when the alternative is a central bank that loses institutional credibility, sees the effectiveness of its forward policy guidance erode and becomes even more vulnerable to political interference.

It should also be noted that the UK’s situation differs in some important way from those of other countries. The country’s economic challenges are complicated not only by the energy price catch-up but also by the political transition and the changing nature of the country’s relations with its trading partners.

In the last six weeks gilt yields have pulled back aggressively from 2.75% to test the region of the trend mean around 1.75%. This is the first area of potential resistance and is the point at which traders will begin to question how likely a long-term low interest rate environment is.  

The drumbeat of recession grew louder after the US economy shrank for a second straight quarter, as decades-high inflation undercut consumer spending and Federal Reserve interest-rate hikes stymied businesses and housing.

Gross domestic product fell at a 0.9% annualized rate after a 1.6% decline in the first three months of the year, the Commerce Department’s preliminary estimate showed Thursday. Personal consumption, the biggest part of the economy, rose at a 1% pace, a deceleration from the prior period.

“The more important point is that the economy has quickly lost steam in the face of four-decade high inflation, rapidly rising borrowing costs, and a general tightening in financial conditions,” Sal Guatieri, senior economist at BMO Capital Markets, said in a note. “The economy is highly vulnerable to slipping into a recession.”

It is always dangerous to say this time is different in markets. However, on this occasion there really is some justification that claim. Two consecutive quarters of negative growth meets the technical definition of a recession. However, there are some important mitigating circumstances. For one, unemployment has not risen significantly. There has also never been a recession when the PMI was among 50. That suggests muddier perspective than we might be accustomed to.

For Slimmon, the beat-down in consumer sentiment has gone far enough to warrant betting on a turnaround.

“There’s a very low expectations in those stocks right now. What if the direction of change is actually higher for consumer sentiment?” he said. He views the risk-reward as attractive.

“Those stocks might recover dramatically because they’re down so much.” He plans to snap up shares “well into the weakness” in August, which is among historically the worst months for equities as volumes are thin and workers are on vacation.  

Stock market moves during this period are usually dominated by macro events. “The macro story this year is not very good,” he said, citing a global geopolitical crisis and the lack of an August meeting among Fed officials.

“The focus of the market shifts from what ultimately long-term drives stocks, which is earnings. And when the shift goes to other things like macro events that creates volatility.”

As for those areas he will likely stay away from, he offered two sectors. “If you think about what’s worked year-to-date on a relative performance basis, there are two groups that have really done well: energy and defensives,” he said. “It’s a little late to be selling the energy stocks. They’ve been so creamed. I wouldn’t be aggressively buying those stocks.”
 

Many investors are anticipating the Jackson Hole conference in August will be a time for central bankers to declare the peak for inflation is in. The most risk tolerant traders are initiating long positions today to ensure they have the cushion of rebound ahead of that event. There is clear scope it will be a buy the rumour and sell the news event if central bankers fail to deliver.

While Morgan Stanley strategists say it’s too early to expect the Fed to stop tightening its policy even as fears of a recession grow -- suggesting stocks have more room to fall before finding a bottom, JPMorgan Chase & Co. strategists say bets that inflation has peaked will lead to a Fed pivot and improve the picture for equities in the second half.

Sticky inflation is what will keep the Fed hawkish for longer this time around, according to Morgan Stanley’s Michael J. Wilson. While during the past four cycles the US central bank had stopped tightening its policy before the start of an economic contraction, triggering a bullish signal for stocks, current historic levels of inflation mean the Fed will likely still be tightening when a recession arrives, Wilson wrote in a note.

Equity markets “may be trying to get ahead of the eventual pause by the Fed that is always a bullish signal,” Wilson said. “The problem this time is that the pause is likely to come too late.”

Over at JPMorgan, Mislav Matejka said in a note on Monday that challenging activity momentum and softer labor markets could open doors to a more balanced Fed policy, leading to a peak in the US dollar and inflation.

Inflation may well have peaked or be close to a peak because the consensus is that it is entrenched. What we do not know is how quickly inflationary figures will come down and where they will subsequently stabilise.

The publication of the June bond figures by China Central Depository & Clearing Co. took place about a week later than in previous months. Interbank-bond-market figures released by the central bank’s Shanghai head office on Friday were also delayed, as they are typically sent out in the first half of each month. In May, China’s bond-trading platform for foreign investors quietly stopped providing data on its transactions.

Foreign investors still held 2.32 trillion yuan of Chinese debt at the end of June, well above the 221 billion yuan they owned in 2014. The opening up of China’s capital markets and the inclusion of the nation’s debt in more global bond indexes has attracted central banks and global investors eager to tap its higher yields.

“The bulk of the remaining foreign holdings of Chinese fixed-income assets reflects reserve manager, sovereign wealth fund and index tracking demand,” said Lemon Zhang, a strategist at Barclays Plc in Singapore. Looking ahead, large inflows are unlikely as investors aren’t optimistic on duration or China’s currency, while higher global yields provide alternatives, she said.

Demand for Chinese bonds has waned in recent months as US 10-year yields surged above 3%, while similar-maturity yields in China remained stuck in a range of 2.7% to 2.85% due to the People’s Bank of China’s accommodative monetary policy.

There has been a popular belief among institutional investors that China was for bonds and the US was for equities. The logic is that China is a creditor nation with vast reserves, strong growth and low debt/GDP ratios while the US is encumbered with massive debts and seems incapable of correcting the gaping deficit.

What you were saying about the huge migration to Texas makes me wonder if this isn't the right time to buy home builders who are active in that area? Or REITs?  What about NXRT, an old favourite of mine which has now come right done (fortunately I got out)? It specialises in refurbishing multi-family properties in the sunbelt. Is it too early to buy again do you think?

Thank for this question which may be of interest to the Collective. A realtor friend of mine shared his rationale. If a buyer is worried about interest rates rising, then buy now before they go higher. If they are worried about rates falling buy now because that will inflate prices and you can always refinance. I think it is safe to say a realtor will always have a convincing rationale to buy

Former Treasury Secretary Lawrence Summers issued one of his harshest criticisms yet of the Federal Reserve’s slowness in moving to raise interest rates, and warned that policy makers are still presenting forecasts that are unrealistic.

“In 2021, our central bank let us down quite badly,” hurting policy makers’ credibility, Summers said on Bloomberg Television’s “Wall Street Week.” “It made mistakes in the core functioning of a central bank,” including in its failure to lean in against fiscal stimulus last year, he said.

Among the errors has been a “repeated poor forecasting record -- and I have to say that it’s not something that’s been fully fixed,” Summers said. The June median Fed official predictions showed inflation coming back toward the 2% target but unemployment only reaching a high of 4.1% by 2024 -- a “highly implausible” result, he said.

“Frankly I think in 2021 our central bank lost its way. It was talking about the environment, talking about social justice in a range of things,” Summers, a Harvard University professor and paid contributor to Bloomberg TV, said. “It was confidently dismissing concerns about inflation as transitory.”

Turning to Japan, which has seen its currency tumble to the weakest since 1998 as the Bank of Japan declines to join its peers in tightening policy, Summers said it’s likely to be a challenge to exit the current zero-yield targeting regime.

Dollar’s Impact
“Sooner or later they’re going to leave the yield curve control strategy and I’m not entirely sure what’s going to happen when they do,” Summers said. “In the meantime, the pressures are likely to build,” with the potential for “an even weaker yen,” he said.

While some emerging markets are also suffering from a strengthening dollar, Summers said that he didn’t see a “systemic” crisis along the lines of 1998. Still, countries with “particularly unsound policies” including Turkey and Argentina are a concern, he said.

The world as it is, the reactions of traders to evolving stimuli, and the world as we would like it to be, are three very different places.

The reality of massive money supply growth in 2020/21, and the subsequent decline in supply growth represent the background for market. The absence of clear sources of new liquidity suggest it is unproductive to expect sharp rebounds on par with those seen in 2021.

Historically, gold prices have often come under pressure in the early stages of a slowdown as central bank policy is still tightening or is tight and real interest rates are rising. Of course, this dynamic reverses when policy rates are cut. We expect a further lift to real interest rates this year, particularly as inflationary risk fades in 2H22. As such, additional liquidation of exchange-traded funds can be expected. We advise protecting the downside to longer-term holdings in the yellow metal into year-end. However, we see opportunities to be more positive though 2023 as the Federal Reserve pivots to an easier stance and the US dollar weakens.  

Gold is often regarded a perpetual zero coupon bond. It therefore thrives in an increasingly negative real interest rate environment and struggles when a rates trend towards positive real rates.

You are sending out comprehensive information that I am not finding anywhere else, addressing multiple markets, which is quite helpful for me as an investor. So that brings up two questions: First, I wonder if you agree that the Fed has already reduced its balance sheet by about $1 trillion dollars? (As I heard recently from one analyst, which, given the rise in the dollar could explain the decline in values of multiple assets...) And, second, given the drop in so many assets: Bitcoin, gold, stocks, uranium recently, metals on the LME, to name a few, are we already actually in a recession, even though not officially labeled by the powers that be, is this, in fact a recessionary event we are proceeding through regardless on any official labeling, in your opinion?

Thank you for this question which may be of interest to the Collective. The Fed only began reducing the size of its balance sheet in July. They are starting at a pace of -$47.5 billion and plan to double that to $95 billion in the autumn. The bulk of global quantitative tightening so far has been achieved through the strength of the Dollar.

Your daily talks, now focusing on the probability of a recession, are as always full of interest. I never miss them, or if I have to, I at least read the Comments of the Day.

I've been struggling to decide on some "investments" that could profit from the recession scenario, and which could remain there for the medium term, without my having to watch them every day for sudden reversals. Any suggestions? Shorting a commodity ETF?  Shorting the US banking sector? I'm sure you have other ideas.

Thank you for this long-term patronage and this question which may be of interest the other subscribers. The phrases “buy and forget” and “shorting” don’t normally go together. Shorting necessarily means leverage. You can’t walk away from a leveraged position because they can go against you in a hurry.

New chancellor Nadhim Zahawi has urged unity after his predecessor, the health secretary, and several junior ministers walked out.

But the prime minister has been hit by six further resignations, taking the total to 16 in the past day.

It comes as he prepares for PMQs later and a grilling by senior MPs.

Mr Johnson's premiership has been plunged into crisis following the dramatic resignations of Chancellor Rishi Sunak and Health Secretary Sajid Javid.

They quit within minutes of each other on Tuesday following a row over Mr Johnson's decision to appoint Chris Pincher deputy chief whip earlier this year.

Their departures triggered a wave of resignations from more junior roles that has continued on Wednesday.

In six further departures ahead of PMQs, education ministers Will Quince and Robin Walker, Justice Minister Victoria Atkins, Treasury minister John Glen, and ministerial aides Laura Trott and Felicity Buchan have all walked out.

Boris Johnson is a proven vote winner, but it was widely reported when he became Prime Minister that he is not well liked by his party colleagues. That later point is now becoming relevant as demand for solutions to unfolding economic issues are in high demand. Regardless of efforts to remove him, the range of possible options to mounting economic, inflationary and energy challenges will be the same.

“The 10-year yield may have been depressed for a large part of the past 15 years or so because global central banks have increased their balance sheets substantially and have reduced the term premium at the long end of the curve. And so you can get around these possible distortions by focusing more closely on how the market is pricing central bank policy.”

“What you will see is, three to six months from now, most if not all of these recession-probability metrics that we get from the yield curve will begin to start flashing at least orange, if not red.”

No Sense
“The Fed is telling us that they want to go to 3.8% sometime in early 2023; the two-year yield is over 100 basis points below that level right now,” noted Jim Caron, chief fixed-income strategist at Morgan Stanley Investment Management.

“This doesn’t make any sense whatsoever -- unless one of two things: one, the market just doesn’t believe that the Fed is actually going to be able to hike in the way that they’re saying they will, or, something’s going to happen along the way.”

More broadly, “the markets are right now are surrendering to the fact that we’re likely to have a hard landing or a recession,” he said.

 Long-dated yields have generally tended to rise during periods of quantitative easing because the Fed crowds out other investors and reduces the risk in other asset classes. Therefore, there is less inclination to hoard bonds and more incentive to buy risk assets; both public and private. That suggests the argument QE depresses long-dated yields is wrong. 

“It is hard to find much positive to say about the EUR,” said Dominic Bunning, the head of European FX Research at HSBC. “With ECB sticking to its line that we will only see a 25bp hike in July – at a time when others are hiking much faster – and waiting for September to deliver a faster tightening, there is also little support coming from higher yields.” 

Money-market traders are betting ECB will deliver around 140 basis points this year, down from more than 190 basis points almost three weeks ago. The repricing gathered pace after a string of weak economic data last week, with traders trimming bets again on Tuesday after French services PMI was revised lower. 

Investors have also been more cautious on the euro due to the risk of so-called fragmentation, when economically weaker nations see unwarranted spikes in borrowing costs as financial conditions tighten. The ECB is expected to deliver further details of a new tool to backstop more vulnerable countries’ debt at their policy meeting later this month.

The losses Tuesday were compounded by poor liquidity and selling in euro-Swiss franc, according to three Europe-based traders. The euro fell as much as 0.9% against the Swiss franc to 0.99251, the lowest level since 2015. 

“The FX market is not back up to full liquidity given the US holiday,” said Mizuho’s Jones. “Any given size of trade is likely to have a greater impact on market movement.”

Russia’s calculus is simple enough. They are betting the economic pain European countries are enduring because of their support for Ukraine will be so great they will be willing to make a deal sooner rather than later.

The latest leg of the bond-market rally came after Fed Chair Jerome Powell said on Wednesday that the risk of harm to the economy from higher rates was less important than restoring price stability. Traders continue to expect another 75-basis-point rate increase in July, and swaps referencing Fed policy
meeting dates price in a peak rate near 3.5% in March 2023, followed by a drop to about 3% by year-end.

“The market is digesting increasing odds of recession,” said Janet Rilling, senior portfolio manager at Allspring Global Investments, which manages $541bn in assets. And it’s likely that “inflation will stay pretty elevated. So the Fed will continue to be aggressive” raising rates. 

In turn, she said the extent of the recent drop in Treasury yields means shifting to a more defensive posture. “Watching today’s movement, this could be presenting an opportunity here
to reduce duration.”

The market added to gains, amassed before the US trading day began as European bond markets rallied, after the release of personal income and spending data for May. Spending rose 0.2%, half the expected increase. The price index for purchases rose 0.6% versus an expected 0.7%, supporting the view that an
inflation peak is being established. 

I’ve seen a lot of commentary in the financial media about where R-star might reside. It’s a valuable discussion. Afterall, we all want to know what the real inflation-adjusted neutral rate of interest is. However, the discussion must be grounded in accepting that it is impossible to prove until after the fact.

Money supply doubled in the month to April 2020 and remained at an elevated month-over-month level for a year. That quantity of money printing has resulted in a significant inflation scare. It overstimulated demand at a time when supply was constrained from responding as quickly. The volume of outstanding debt is higher today than during any previous cycle, so investors are understandably troubled.  

Could you please explain how the Fed US Treasury H15 Constant Maturity 10 Yr Real Yield (H15X10YR Index) is calculated?

Thank you for this question which others may have an interest in. A lot of the answer can be found by comparing the chart of the constant maturity real yield with the TIPS chart.


The only difference I can see is that the constant maturity imputes an accurate bond yield with exactly 10-years to mature even when there is no bond that matches that exact maturity. I am growing progressively more distrustful of these kinds of measures which rely on TIPS. It's a very small market and the Federal Reserve is very active in it so it is unlikely to give an accurate depiction of what the real yield in fact is.

There was one necessary condition underlying the bond market’s ability to shrug off the worst inflation numbers in a generation after only a week; nobody is really sure if they believe the Fed. Credibility is vital to central banks, and I argued for Businessweek on Thursday that it is indeed as important an anchor to the monetary system as gold used to be. A round trip like this showed extreme hesitance to accept the Fed’s guidance; arguably, the currency of its forward guidance has been adulterated.

That said, the Fed can’t have lost all credibility. The rebound in bond yields started Thursday morning as Jerome Powell began taking his second day of questions from Congress. Unlike on Wednesday, he said that his commitment to get inflation back down to 2% was “unconditional.” That, like many central banking pronouncements in the past, had an effect. But it's still concerning that the Fed needs to be more shrill to get its message across; it does look as the coinage of forward guidance is being debased:

Meanwhile, a telling indicator of how far sentiment has swung back toward bracing for a (disinflationary) recession comes from inflation breakevens. German inflation expectations have receded after a dramatic surge over the last 12 months, although they still remain higher than they were at the beginning of the year. The same is not true of US breakevens for average inflation over the next 10 years, and for the five years starting five years hence. Both are now lower than they were in May last year — an extraordinary fact given the extent of the inflationary shock since then, and the new geopolitical drivers for inflation that have arisen this year. If you’re convinced that much higher rates of inflation are on the way, along with higher interest rates to combat them, then the market is still making it very cheap for you to bet on that outcome

There is talk of the ECB raising rates in July, but Europe is already in a recession and Germany is fearful Russia will stop natural gas exports through the original Nordstream pipeline altogether. Against that background the ensuing economic contraction would make the case for interest rate hikes moot.

The European Central Bank’s Isabel Schnabel started it. In February she flashed a chart showing how much the euro had weakened against the US dollar. Two months later, the Bank of Canada’s Tiff Macklem bemoaned the decline of the Canadian dollar. Swiss National Bank President Thomas Jordan suggested he’d like to see a stronger franc. The US dollar had been soaring—now up 7% for the year—as the Federal Reserve prepared to aggressively combat inflation.

And so one by one, central bankers elsewhere, just as desperate to tame the relentless march of inflation in their own backyards, began sending not-so-subtle signals that they would for once welcome a stronger currency—which helps reduce the cost of imports by boosting buying power abroad. It’s a form of intervention so rare that their jawboning alone moved markets.

On June 16, two of them upped the ante: Switzerland surprised traders with the first rate increase since 2007, sending the franc soaring to its highest level in seven years. Hours later, the Bank of England announced its own rate increase and signaled bigger hikes to come

Competitive currency appreciation a viable defense against inflation. A stronger currency makes imports less expensive but also depresses the competitiveness of domestic export-oriented businesses. In the last week Norway raised by 0.5%, the Czech Republic by 1.25%, UK by 0.25%, Switzerland by 0.5%, USA by 0.75% and Brazil by 0.5%. The ECB appears likely to raised by 0.25% in July. Here is a link to global-rates.com which carries a useful monitor for short-term rate movements. 

Federal Reserve Chair Jerome Powell gave his most explicit acknowledgment to date that steep rate hikes could tip the US economy into recession, saying one is possible and calling a soft landing “very challenging.”

“The other risk, though, is that we would not manage to restore price stability and that we would allow this high inflation to get entrenched in the economy,” Powell told lawmakers on Wednesday. “We can’t fail on that task. We have to get back to 2% inflation.”

The Fed chair was testifying before the Senate Banking Committee during the first of two days of congressional hearings. In his opening remarks, Powell said that officials “anticipate that ongoing rate increases will be appropriate,” to cool the hottest price pressures in 40 years. 

“Inflation has obviously surprised to the upside over the past year, and further surprises could be in store. We therefore will need to be nimble in responding to incoming data and the evolving outlook,” he said.

 

“Very challenging” is likely a gross understatement. I was surprised to hear him say the economy is very strong and capable of withstanding additional interest rate hikes. Instead, I suspect we are going to see an abrupt fall off in the volume of goods traded as the cumulative effects of inflation cut into disposable income.

As China’s property slump persists, one developer is trying to entice farmers to buy homes by accepting their crops as payment. 

Central China Real Estate Ltd. is offering to pay farmers as much as 160,000 yuan ($24,000) for their wheat to offset down payments for homes in its River Mansion residential project in Shangqiu, a city in Henan province, according to a Monday marketing post. Weeks ago, it offered to accept garlic from growers looking to buy homes in another project in Kaifeng city.

The move reflects how far some developers are willing to go to attract wary homebuyers as the economy slows and the industry endures a crippling cash crunch. Central China, the country’s 37th-largest builder, recently sought state support when its parent company agreed to sell a stake to the provincial government. 

Its perk to farmers appears aggressive. Central China was offering to buy wheat at 4 yuan a kilogram, higher than the record 3-3.1 yuan that China’s state stockpiling company was purchasing the grain for earlier this month. 

Landlocked Henan is China’s largest wheat-producing area. The country just had another bumper harvest of winter-sown wheat. 

Similarly for garlic, Central China offered to pay 10 yuan a kilogram last month. That’s higher than the 6.92 yuan wholesale price as of June 10, according to weekly data released by the commerce ministry. 

Property manias tend to start in prime areas and move progressively further into the hinterland. During a crash it is usually the third tier cities and far flung suburbs that see the most aggressive selling pressure. Eventually, even the prime areas take a hit. China’s tier 3 cities have seen an epic bull market in housing as capital fled the exorbitant prices in the tier 1 cities. It is a measure of how desperate the company is to make sales that it is now willing to accept volatile commodities rather than insist on cash.

The Greens party minister also said the country will rely more on coal-fired power plants to produce electricity. A bill providing the legal basis is making its way though parliament and should take effect quickly after discussions in the upper house on July 8. 

Using more coal to generate power is “bitter, but it’s simply necessary in this situation to reduce gas consumption,” he said. “We must and we will do everything we can to store as much gas as possible in the summer and fall.” 

Siegfried Russwurm, president of the German industry lobby group BDI, said the country should “stop gas-fired power generation now and get coal-fired power plants out of reserve immediately,” in an interview with Funke Mediengruppe published Saturday. Importing electricity from neighboring countries has its limits, he said.

Savings will also have to be made by the industry. An auction model will begin this summer to encourage industrial gas consumers to save fuel, which can then be put into storage, Habeck said, adding that the government is ready to take further measures if needed.

There is a lot of discussion in the financial media about the possibility the Eurozone will break up. I don’t see that as a realistic possibility. Europeans understand they are in a better position to oppose foreign adventurism together than apart. Putting cherished climate goals on the long finger is an example of the lengths they are willing to go to protect national interests.

“One of the factors affecting prices is this: nine major shipping companies consolidated into three alliances controlling the vast majority, mostly shipping in the world,” Biden said.

“And each of these nine is foreign-owned. During the pandemic, these carriers increased their prices by as much as 1,000%.”

Attempts to “demonize ocean carriers” are not only inaccurate but dangerous because they undermine the ability to understand the root of US supply-chain problems, the World Shipping Council said in a statement.

“As long as America’s ports, rail yards and warehouses remain overloaded and unable to cope with the increased trade levels, vessels will remain stuck outside ports to the detriment of importers as well as exporters,” the WSC said. “Ocean carriers continue to move record volumes of cargo for our country and have invested heavily in new capacity – America needs to make the same commitment and invest in its land-side logistics infrastructure.”

Price controls are a lot easier to impose when the targets are overseas companies. The challenge is that insisting ships need to leave with full cargoes ignores the reality of a trade imbalance. China does not import the same quantity of goods from the USA that it exports. It’s impossible to send every ship back full, at a minimum loading empty containers is time consuming and additional layers of compliance raise costs and slow down turn around. Of course, there is also the possibility these measures could shift supply of ships away from the USA if the burden of regulation becomes too onerous.

In a sign of deepening turmoil in the crypto community, Babel Finance became the second major digital-asset lender this week to freeze withdrawals, telling clients it is facing “unusual liquidity pressures” as it contends with recent market declines.

“The crypto market has seen major fluctuations, and some institutions in the industry have experienced conductive risk events,” the Asia-based lender and asset manager said in a notice on its website to explain the temporary measure.

Another day, another crypto exchange declines to allow withdrawals. Cryptocurrencies are pure liquidity plays so they are unlikely to recover until there is clear visibility on where the next outsized round of new money is going to come from.

Federal Reserve officials raised their main interest rate by three-quarters of a percentage point -- the biggest increase since 1994 -- and signaled they will keep hiking aggressively this year, resorting to drastic measures to restrain the rampant inflation they failed to forecast.

Slammed by critics for not anticipating the fastest price gains in four decades and then for being too slow to respond to it, Chairman Jerome Powell and colleagues on Wednesday intensified their effort to cool prices by lifting the target range for the federal funds rate to 1.5% to 1.75%.

They projected raising it to 3.4% by year-end, implying another 175 basis points of tightening this year.

The median official saw a peak rate of 3.8% in 2023, and five officials forecast a federal funds rate above 4%; the median projection in March was for 1.9% this year and 2.8% next. Traders in futures markets were betting on a peak rate of about 4% ahead of the release.

The Fed reiterated it will shrink its massive balance sheet by $47.5 billion a month -- a move that took effect June 1 -- stepping up to $95 billion in September.

The Fed expects to raise rates above 3% by the end of the year. That’s a higher high. The only time the Fed Funds rate posted a higher high in the past was in 1999 and it was quickly reversed. This time around, the big question is how long that level will be sustained and where the next low will be.

JPMorgan Chase & Co. jumped by the most in 18 months as upbeat comments from Chief Executive Officer Jamie Dimon on the US economy and improved guidance helped drive bank shares higher.

Shares of the JPMorgan rose as much as 7.1% on Monday, the most since November 2020, after the start of the company’s investor day, when it boosted its annual forecast for net interest income excluding its markets business and maintained its expense outlook. The KBW Bank Index climbed as much as 4.4%, with Citigroup Inc., Bank of America Corp. and Wells Fargo & Co. all gaining more than 5%.

Wells Fargo banking analyst Mike Mayo said in a note to clients that the biggest takeaway from JPMorgan’s gathering so far is that it shows there’s “no recession imminent.” JPMorgan’s presentation was bullish for the company and “even more so for the industry,” he added.

Bank shares have been under extensive pressure this year as worries that an aggressive series of interest rate hikes by the Federal Reserve could plunge the US economy into a recession. The KBW Bank Index has fallen 25% since hitting a record high in early January.

JPMorgan has been the worst hit among the biggest banking stocks. While Monday’s surge has helped erase some of the decline this year, the lender is still down nearly 22%, making it the worst performing big bank stock. Still, analysts have not given up on the company, with the average 12-month price target forecasting a 23% gain, near the highest it’s been since the pandemic began.

Rising interest rates are generally considered positive for banks because they get to charge more for their services. The challenge today is the spread they rely on to profit has evaporated as the yield curve has flattened. The absolute rate on mortgages also means refinancing income has disappeared on mortgages. That implies banks will probably do better when the yield curve steepens and yields contract.

As inflation has continued to surprise on the upside, countries all over the world are accelerating their efforts to raise rates. Brazil’s Selic Target rate is now 12.7% and the EU is beginning to talk about moving deposit rates out of negative territory.

We tend to think of interest rates as barometers of efforts by central banks to control domestic factors. However, there is also the additional point that if interest rates are rising everywhere, the availability of cheap cash is declining and competition for what is available becomes more fervent.  

Russia has started the process of paying holders of two foreign-currency bonds before a key carveout in restrictions expires next week.

The money isn’t due for another week, but the settlement date for both payments is two days after a temporary exemption for US bondholders to receive Russian bond funds is set to end. 

That loophole has allowed the government to get payments through the plumbing of the international financial system to US investors, staving off a foreign default. But Treasury Secretary Janet Yellen characterized the carve-out as “time-limited” last week.

Payments of $71.25 million on a note maturing 2026, and 26.5 million euros ($28 million) on debt due 2036, were transferred to the National Settlement Depository, or NSD, Russia’s Finance Ministry said Friday. It added that its obligations on the debt have been met “in full.” 

Previous fund transfers have been delayed or blocked by financial institutions amid the sweeping international sanctions imposed on Russia since its invasion of Ukraine. About $650 million of payments were made just days before a grace period was due to expire earlier this month.

Russia Dodges Default for Now as Investors Get Dollar Funds

From the NSD, the payments go to international clearinghouses, which distribute the funds to the various custodian banks where foreign bondholders have their accounts.

If that all goes smoothly, attention will turn to almost $400 million of coupons due toward the end of June. 

Without the Treasury loophole for US investors, and no alternative options arranged, the question will be whether bondholders elsewhere can still receive the funds. 

The first two coupons due June 23 have clauses that allow payment in euros, pounds sterling or Swiss francs. Their terms also stipulate that the funds will land with the local paying agent, the NSD.  

One day later, $159 million comes due that can only be paid in dollars, via a unit of JPMorgan as foreign paying agent.     

Engineering a Russian debt default is obviously part of the economic warfare the West has launched in response to the invasion of Ukraine. The impact of those measures is significantly reduced by the fact Russia has one of the lowest debt to GDP ratios in the world.

The increase is more than double the pace of basic wage growth, squeezing consumer spending power at the sharpest pace on record. The pain is set to intensify, with the Bank of England predicting double-digit inflation by October when energy bills are almost certain to jump again. 

There was evidence of more generalized inflation, with a 6.7% jump in food and non-alcoholic drink prices. The cost of recreation and culture rose 5.9%, the largest increase since at least 2006, and restaurant and hotel prices were up 8%. Part of that was due to value added tax reverting to the normal rate after the pandemic. Furniture and household equipment rose 10.7%.

The cost-of-living crisis already has amplified the political debate about how to handle a series of shocks hitting the UK. Prime Minister Boris Johnson’s Conservatives government has targeted relief at those with jobs, while the Labour opposition is calling for an emergency budget to help pensioners and people on benefits. 

“Countries around the world are dealing with rising inflation,” Chancellor of the Exchequer Rishi Sunak said in a statement. “We cannot protect people completely from these global challenges but are providing significant support where we can, and stand ready to take further action.”

The Pound came close to reversing yesterday’s rebound on global de-risking following Jerome Powell’s comments on persisting with policy tightening. Even though the price of oil was down $3 today, the weakness of the Pound has exacerbated the impact of the advance for European consumers. Brent crude in Pounds is still consolidating above the 2008 and 2012 peak. A sustained move back below £70 will be required to confirm a change of trend.

The violent selloff has forced many systematic macro strategies, including trend followers and volatility-targeted funds, to slash equity holdings. Last week, their exposure fell to the bottom of a five-year range that even if stocks resume selling, their unwinding would be relatively subdued, according to Morgan Stanley. 

For instance, should the S&P 500 drop 5% in one day, the cohort would need to offload less than $20 billion of stocks in the follow week, analysts including Christopher Metli estimated. That’s down from an expected disposal of over $100 billion at the start of the year.

Goldman’s long/short hedge fund clients saw their gross leverage falling 12 percentage points during the week through Wednesday, the largest reduction over comparable periods sine at least 2016, according to data compiled by analysts including Vincent Lin. 

Light positioning by hedge funds and quants is among indicators watched by Goldman’s Scott Rubner to determine whether investors have capitulated. With cash holdings elevated in mutual funds and day traders retreating, one missing ingredient to call the all-clear is a reduction of stocks in US household holdings and retirement accounts, he says.

“Tracking this cohort is my single and most important focus from the lows here,” he wrote in a note last week. “We have not capitulated, it is very slow on the way out.” 

There is still a great deal of uncertainty about the trajectory of monetary policy and the continuing impact of the war in Ukraine. The challenge for investors is to determine if this has been adequately priced in by the pullback to date.

As I see it, the risk of recession, whether it is real or merely implied by an inversion of the yield curve, won’t deter the Fed from hiking rates higher faster or from injecting more volatility to build up negative wealth effects, and signs of a recession might not mean immediate rate cuts to ramp demand back up …

…cuts may have to wait until the Fed is certain that inflation is surely dead.

Back to the level of the stock market under the Fed call.

According to President Daly’s comments, the recent stock market correction and the rise in mortgage rates is “great”, but not enough (“want to see more”). Chair Powell also noted in his press conference that he wants to see further tightening in financial conditions still. At face value, that implies that the Fed won’t stop shaping expectations until we see more damage to stocks and bonds.

Rallies could beget more forceful pushback from the Fed – the new game…

A link to the full report is posted in the Subscriber's Area.

This is a welcome elucidation of the “chicken and egg” argument I have been talking about the audio/video commentary.
 
If the stock market and other financial assets sell off, the Fed will believe their policies are working which reduces the need for further tightening. However, if investors believe tightening is less likely they will buy the dip which will convince the Fed their policies are not sufficiently tight.

Coinbase Global Inc., like the rest of the cryptocurrency market, is having a really tough week. Not filing-for-bankruptcy bad, but the biggest US crypto exchange did just mention the B-word in a regulatory filing, giving its customers a painful reminder of how bad things could get for them if Coinbase ever does get seriously distressed.

In its quarterly report, Coinbase added a risk disclosure: if the company were to file for bankruptcy, the court might treat customer assets that the exchange is custodian for -- their Bitcoin, Dogecoin or whatever -- as Coinbase’s assets. And they’d be at the back of the line for repayment, forcing normal people, unaccustomed to the ins and outs of federal bankruptcy court, to claw back their money along with everybody else owed money by the exchange.

It’s a huge amount at stake. Coinbase was custodian for $256 billion of customer money on March 31, according to the filing.

Chief Executive Officer Brian Armstrong quickly took to Twitter to elaborate, saying the company is not at risk of going bankrupt and that users’ funds are safe.

Segregated accounts didn’t save MF Global’s clients in 2019. It took six months to get two thirds of their money back and it’s not clear how successful efforts have been to recover the rest. Since the crypto markets are unregulated and Coinbase is an “exchange” rather than a broker, the funds are not truly segregated. The company might not be in imminent danger of going bust, but that only exacerbates the leverage to the bitcoin price. It’s a very binary bet.

This in turn takes us to an interesting observation by George Saravelos, Deutsche Bank AG’s global head of currency research, who says that “we are perhaps now reaching the tipping point where further financial conditions tightening will start to place more severe headwinds to how much more we can reprice the Fed.” This will result in the dollar becoming less responsive to risk-off due to more dovish implications for the Fed path. And while it’s still early stages, Saravelos argues that “the market is starting to behave as if we may be approaching this tipping point.”

Now, even if inflation does peak this year, that won’t mean central banks will exit their tightening path, but will adjust it accordingly. Just look at the Bank of England’s latest forward guidance and the divide within the voting committee. At the same time, and if we talk stagflation or recession, we should consider that the yen may attract haven flows once again given its low inflationary readings, Japan’s current surplus and so forth.

Today’s month over month CPI figure was 0.3%. Analysts expected 0.2% but the prior reading was 1.2%. That’s still a moderation in near-term inflation, even if it is still rising. Year over year the rate is still 8.3% which is in the middle of what was expected and the last reading.

For some time, the best-looking charts have been the yield charts, almost everywhere but particularly in Europe. They are a pure example of consistency.

Questions: with the trillions of dollars invested in these securities how are the losses going to be reconciled? My personal belief was that rates could not go to where they seem headed because of the losses it would imply. Is there a lower rate case? How does this logic chain play out? The "prisoners" that own these bonds, who are they and how many of them are there? Is the 60/40 cookie cutter approach to managing portfolios getting crushed? Is income the new oil?

Sorry for the multiple questions but intellectually the global losses in bonds has to be discussed in my opinion.

Thank you for these topical questions. I agree being short bonds (long yields) has been the most consistent breakout of any market anywhere this year. As a result there is no doubt bond portfolios have been under extraordinary stress. Reconciling losses in fixed income will mean pension contributions will have to rise, payouts will fall, recipients will need to work longer and/or assets prices will need to recover.

A momentous week has ended with a thud rather than a bang (at least on the data front) as the U.S. employment numbers came out broadly in-line with expectations. To be sure, there were some notable features of the data -- a drop in both household employment and labor participation, though perhaps that was driven by the timing of Good Friday, which fell during the survey week. 

You can cherry-pick whatever you like from the figures to support your pre-existing view, so at this point it’s hard to say that they change much of anything. For now, the growth picture remains strong enough to support the policy trajectory that’s currently priced into rates markets. That, in turn, should continue to apply pressure to equities, regardless of how “cheap” they may seem.

From a macro perspective, the issue to focus on has clearly rotated from inflation to growth. Pretty much everyone understands that base effects will drive y/y CPI and PCE figures lower, but the run-rate of inflation will remain high enough for central banks to keep worrying ... and keep (or start) tightening. That policy trajectory will change when the growth outlook deteriorates significantly enough that demand looks more correctly aligned with supply. So that’s what we’ll be watching for.

While you can point to the 353k drop in household employment as a signal that the economy is weakening, that’s a pretty tenuous hook upon which to hang your hat at this point -- particularly given that household employment growth had comfortably outstripped the establishment survey over the prior six months. Moreover, the drop in the participation rate suggests the household figure may well have been a supply, rather than demand, issue -- which is problematic if the relatively elevated level of wages can still not attract fresh workers.

The pandemic economy is not the new normal. It was an anomaly fueled by money creation on a previously unimaginable scale. It is therefore reasonable to expect that unwinding much of the bonanza will be required to get inflation back under control.

I seem to remember many years ago David saying that the time to be wary of share markets is after the third interest rate rise. Is this accurate and, if so, is it a relevant indicator for us now?

Thank you for this topical question which may be of interest to the Collective. The initial response to a new hiking cycle is generally seen as positive by investors because they prize efforts to control inflation and preserve growth. However, interest rate hikes have a lagged effect on the economy and are cumulative in nature. That means the initial enthusiasm at continued growth gives way to worry about the toll of withdrawing liquidity as the number of hikes builds. 

The Treasury Department said in a statement Wednesday that it will sell $103 billion of long-term securities at auctions next week -- down $7 billion from February. This marks the longest string of quarterly cuts since a 2014-2015 cycle. In a surprise for some dealers, it’s also trimming sales of two-year, three-year and five-year auctions in coming months.

“The issuance plans announced today leave Treasury well positioned” with regard to necessary borrowing, the department said in its statement. However, “additional reductions in future quarters may be necessary depending on future developments in projected borrowing needs.”

The Fed hiked by 50-basis points today as expected and suggested 75 basis point hikes are not being actively considered. The pace of quantitative tightening will initially be slower than initially expected.  It will start on June 1st at $47.5 billion and ramp up to $95 billion over the next quarter instead of starting at $95 billion now.

Against a backdrop of quicker inflation and solid spending, Fed monetary policy is still geared for a half-point rate hike next week. Nonetheless, officials need to balance tighter policy with risks to demand. 

The economy faces other potential headwinds that include knock-on effects from Russia’s war in Ukraine. Growth prospects in Europe are deteriorating, some raw materials are in short supply and the Chinese government’s severe pandemic-related lockdown measures are leaving supply chains in disarray.

The S&P 500 rose and the yield on the 10-year Treasury note remained higher along with the dollar.

“With strong growth of consumer spending, business investment and employment in the first quarter, the U.S. economy was not in a recession at the beginning of the year,” said Bill Adams, chief economist at Comerica Bank. “Growth should resume in the second quarter as the trade deficit and inventories become smaller headwinds.”

Biden blamed the contraction on “technical factors,” saying in a statement that employment, consumer spending and investment all remain strong.

When you feel pressured by inventory shortages and rising prices, the natural response is to accelerate purchases. Orders also tend to be front loaded to forestall the trouble of having to worry about inventory in future.

“All the big mining companies coming down 20-25 pct in 4 to 5 days. pretty scary to me. what am I missing? Beside talk about the Fed raising interest rates in May with 0,5 pct and a growth scare or the lockdowns in China? Any other reasons? Should we now buy the miners again with the positive future ahead? Gold and copper also look attractive now. your opinion please”

Thank you for this question which may be of interest to the Collective. Ultimately, the question can be distilled down to whether we believe the rest of the world is going to invest in enough infrastructure to outpace a significant economic slowdown in China. The answer is not necessarily binary. We probably get one first, then the other.  

Thanks for this commentary Eoin, which I found very good. I think we can have an intermediate correction in commodities and equities. The equity correction might be longer lasting and deeper in my opinion given valuations, interest rates, and massive positioning but I agree totally that the Fed will loosen policy when the going gets tough. That's what the Fed did during the 1970s several times if my memory is correct. I think the Germans did the same during the 1920s with much worse results, but their position was much worse.

One thing regarding the yield curve. If the Fed raises rates 250 or 300 bps, the curve will invert mathematically if bond yields are unchanged or fall. However, once the market sees the Fed raising rates, long rates could increase depending on inflation and the economy

Thank you for this insightful email. I don’t want to put limits on how long or how deep a correction can be. We can only deal with the reality provided by markets. The one thing we do know is the correction is in response to tightening liquidity conditions, so it is unlikely to end until liquidity conditions ease.

Hurt by plunging tech valuations, SoftBank is walking away from some of its loss-making portfolio firms to comply with stricter investment criteria, said the people, who asked not to be identified because the matter was not public. Many of the two Vision Funds’ portfolio of 300-plus companies are loss-making.

The Japanese investment firm offered to contribute money if Light could find another investor to lead the next fundraising round, one of the people said. But with its biggest backer offering only a token amount, other investors were wary about stepping in, the person said. The Redwood City, California-based startup has hired a consulting firm to explore options, including winding down operations.

“Their purse strings are tight as they have ever been,” the person said.

A Vision Fund spokesman and Light Chief Executive Officer Dave Grannan declined to comment. 

The adoption of prudence at SoftBank’s Vision Fund -- which rewrote the rules of venture capital by deploying billions of dollars from the sovereign wealth funds of Saudi Arabia and Abu Dhabi into startups -- is an about-face from its past freewheeling largess. 

For years, SoftBank’s founder and Chief Executive Officer Masayoshi Son persuaded startup founders to accept Vision Fund money by encouraging them to think bigger and promising continued support to help them expand. He would often invest more money than founders were looking for if they would try to accelerate growth.

Before approving the investment in Light, the billionaire made clear to Grannan that his interest was predicated on the startup’s ability to adapt its depth-sensing imaging technology for self-driving cars -- something Light’s founders never considered before.

Ambitious startups with big ideas and no path to profits are finding the Vision Fund is a fair-weather friend. That only increases the pain they experience as yields rise. The startup sector is most acutely sensitive to tighter liquidity. Some will not survive this correction.

U.S. stocks fell as the selloff in Treasuries resumed, with the rates market hedging the possibility that the Federal Reserve will tighten policy more aggressively. The dollar gained.

The S&P 500 dropped, reversing gains of as much as 1.2%. The tech-heavy Nasdaq 100 extended losses, underperforming major benchmarks, as the jump in yields weighed on growth-related stocks.

Treasury yields rose across the curve, with the policy-sensitive two-year rate climbing 14 basis points 2.72% as traders priced in 50 basis-point rate hikes at each of the next three meetings. The dollar gained against all of its major peers following the surge in yields.

Fed Chair Jerome Powell said he saw merit in the argument for front-loading interest-rate increases and that a half-point hike “will be on the table for the May meeting.”

Tesla’s earning buoyed sentiment this morning but the momentum was short lived. The Federal Reserve wants to kill off demand. They know as well as the rest of us raising rates will do nothing to increase oil supply, clear port congestion or boost crop yields. The tools they have at their disposal all target demand.   

Which firms have monopoly - pricing power?

Thank you for this question which may be of interest to the Collective. David and I pondered this same issue a decade ago. Globalisation was flourishing, the shale revolution promised US energy independence and companies were expanding enthusiastically to capture market share among the new vibrant emerging market middle classes. We also worried about inflation because central bank money printing money was so prolific.

Over the weekend I participated in a sales presentation for solar panel installation. The cost to the consumer has not come down all that much over the last few years, which suggests manufacturing efficiencies are not being passed on to consumers. However, financing for the panels is unusually attractive.

I was offered a 25-year fixed rate loan for $65980 at 1.49%. 20-year yields are at 3.17% and 30-year yields are at 2.99% so it begs the question where are they getting the cash to lend at 1.49%?

As prices continue to rise amid inflation, so too does financial stress, according to new research from Affirm, the payment network that empowers consumers. The research found that 73% of Millennials / Gen Z consumers - and 66% of U.S. consumers overall - are concerned that rising costs will prevent them from being able to pay for the things and experiences they want to achieve this year.

The study asked 1,740 consumers about how inflation is affecting their spending habits and revealed three key trends around how Americans are responding to the pressure on their wallets.

A night out is off the table - instead, consumers are prioritizing the home as their happy place

Purchases for the home are the top category Americans plan to prioritize as costs rise (38%).
Going out to restaurants (53%), entertainment (47%), and beauty (34%) are the top categories consumers plan to deprioritize.

Buy-now-pay-later is the opposite of delayed gratification. The sector has surged in popularity over the last two years as homebound consumers splurged on anything to relieve the tedium of the pandemic. Lifestyle creep is a hard habit to break and is usually forced on people by a sharp reversal of fortunes.

Paraphrasing Herodotus…

…”circumstances rule central banks; central banks do not rule circumstances”.

Inflation is a complex phenomenon, and it has nothing to do with DSGE models. Free-flowing commodities and commodity traders guarantee price stability, not central banks, and deflationary impulses coming from globalization shouldn’t be mistaken for central banks’ communication skills as anchors of price stability.

Luck is luck. Luck isn’t structural…

Luck is running out; central banks were lucky to have price stability as a tailwind when they had to fight crises of FX pegs, par, repo, and the cash-futures basis. Those were the easy crises. The ones you can print your way out of with QE.

But not this time around…

Inflation borne of shortages (commodities [due to Russian sanctions], goods [due to zero-Covid policies], and labor [due to excessive positive wealth effects]) is a whole different ballgame. You can’t QT or hike your way out of it easily…

…and if you can’t, credibility gets damaged, a decline of the U.S. dollar is inevitable, and shorting U.S. rates, the U.S. dollar, and some FX pegs make logical sense.
 

There are a lot of moving parts in the markets today. Everyone is eager to come up with a narrative that cuts through the verbiage and illuminates a path to security and stability of mind and purpose. It’s not easy because there are so many conflicting ambitions. Most people can’t shake the feeling momentous events result in momentous, not necessarily fortuitous, outcomes.

While the U.S. consumer-price index climbed by the most since late 1981, excluding volatile food and energy components, the gauge increased 0.3% from a month earlier and 6.5% from a year ago -- due in part to the biggest drop in used vehicle prices since 1969. The March CPI reading represents what many economists expect to be the peak of the current inflationary period, capturing the impact of Russia’s invasion of Ukraine.

Comments:
“There were some green shoots in the data that suggest March could potentially be the peak for inflation,” said Lindsey Bell, chief markets and money strategist for Ally. “When you couple this with the recent retreat in oil prices, improving shipping costs, a potential reduction in demand from higher prices, and the cycling of higher inflation comparisons, it’s possible that inflation could be topping out.”

“While today’s inflation print hit a four-decade high, there was a sigh of relief as some components of core inflation weakened,” said Charlie Ripley, senior investment strategist for Allianz Investment Management. “Regarding peak inflation, we have been at this juncture before where subtle shifts within the data make it appear that the level of inflation has reached its peak for the cycle only to keep marching higher.”

“It’s a red-hot number, but the market’s reaction for now suggests it’s priced in, especially with the month-over-month core read coming in below expectations,” said Mike Loewengart, managing director of investment strategy at E*Trade from Morgan Stanley.

The above headline was a bit premature as early rises were later reversed.

Used car prices have an outsized effect on the USA’s official inflation measure because they don’t look at either food or energy. The Index rallied 57.3% between June 2020 and January 2022. It is now declining. Used cars cost about the same as new vehicles with the only difference being you can get a used car today but wait for a new one. The wait is increasingly preferrable to consumers as monetary conditions tighten.

The unmooring of long-term Treasury yields just keeps gaining momentum. Yet there’s a wall of corporate cash lurking on the sidelines, which could curb further bond losses.

Demand from pension funds “should help cap the path of long-end rates ultimately,” Shahid Ladha, head of Group-of-10 rates strategy for the Americas at BNP Paribas SA, told Bloomberg Television Monday. “In terms of their appetite and possible support to U.S. fixed income, we have seen an average of $10 billion a quarter or $40 billion a year.” However, demand this month has been below average -- so it has room to pickup, he added. 

Ten-year U.S. rates climbed through 2.75% Monday for the first time since March 2019, following a wave of rising yields in Europe as traders intensified global bets on aggressive rate hikes from major central banks. While benchmark rates may climb even higher, likely breaking above the 3%, demand for Treasuries will probably resurface, Ladha said.

When there was $17 trillion in negative yielding debt very few investors were worried about the surety of long-term losses. They were too interested in short-term momentum driven gains to give much thought to the long-term.

Frontline Ltd. and Euronav NV are considering an all-stock merger that would produce the world’s biggest tanker fleet, just as Russia’s invasion of Ukraine drives a recovery in the market.

The creation of a tanker behemoth -- capable of carrying the equivalent of about 100 days of German daily oil demand -- would come at an opportune moment. With shippers shunning Russian vessels, demand for other carriers is increasing, boosting a market that’s languished for more than a year.

Shares of both Frontline and Euronav have rallied this year, valuing a combined tanker company at more than $4.2 billion.

“A combination of Frontline and Euronav would establish a market leader in the tanker market and position the combined group for continued shareholder value creation in addition to significant synergies,” John Fredriksen, who owns a 39% stake in Frontline, said in a joint statement on Thursday.

The Baltic Dirty Tanker Index remains on a recovery trajectory since Russia’s fleet is having difficulty moving around. The Index hit a new 14-year high on Friday. Meanwhile Brent crude oil prices are back below $100 and likely to fall further as China’s demand outlook worsens. That begs the question how long the surge in tanker prices will last.  

The ECB’s behind-the-scenes preparations hint at how officials are bracing for the moment when bond markets will need to cope without large-scale interventions for the first time after more than seven years of nearly uninterrupted asset purchases. 

Policy makers stopped emergency bond-buying last month and aim to halt regular quantitative easing in the third quarter.

The creation of a new crisis tool against a relatively benign market backdrop might mark a rare moment of the ECB getting ahead of the game rather than catching up under duress. By contrast, former President Mario Draghi’s OMT measure in 2012 and the Pandemic Emergency Purchase Program in 2020 were unveiled after financial turmoil had engulfed the region. 

Already last year, policy makers discussed a precautionary instrument to prepare for so-called fragmentation risks, with officials from the region’s periphery lobbying for an unconditional purchase backstop, while peers from core countries insisted on some strings attached.

The debate was resolved when the Governing Council deemed in December that extra flexibility in reinvesting bonds maturing from its emergency portfolio would be sufficient. But the imminent end of QE and heightened uncertainty about the implications of Russia’s war in Ukraine has reignited concerns among some policy makers.

Financial repression comes in many shapes and forms. At its simplest it means holding down interest rates, so inflation runs hot and reduces the burden of paying back fixed interest debt. When that is accompanied by lower government spending, it can erode debt relative to GDP quite quickly.

$143.9B Total funding for Q1’22. Global funding to startups reached $143.9B in Q1’22, a 19% drop compared to the record-breaking Q4’21 — the largest percentage fall since Q3'12. However, Q1’22 was still the fourth-largest quarter for funding on record and its total was 7% higher than the same quarter in 2021.

113 New unicorns. Q1'22 saw the birth of 113 new unicorns globally — a 5-quarter low and a slight drop from the 115 unicorns born a year ago in Q1'21. US and Europe accounted for most of the new unicorns, with 67 and 20 unicorn births, respectively. The highest-valued new unicorn was the US-based visual collaboration company Miro, with a valuation of $17.5B.

49% Of all funding goes to the US. US-based startups received 49% of global funding in Q1’22, with a quarterly total of $71.2B. Despite accounting for almost half of all dollars invested, Q1’22 US funding marked a 5-quarter low for the country. US-based startups also drove a significant proportion of the deal activity, accounting for 37% of all deals in Q1’22.

160% Climb in valuations. So far in 2022, companies raising new financing have gained a median valuation increase of 2.6x compared to their prior financing rounds. Median valuations of early and mid-stage deals also trended up, reaching $34M and $343M, respectively. For late-stage deals, however, the median valuation dropped to $1,054M in 2022 YTD — barely above the $1B mark crossed for the first time in 2021.

-45% Drop in public exits. The number of exits via SPACs and IPOs decreased by 45% QoQ in Q1’22, while M&A activity remained elevated with 2,983 deals in total. US-based startups accounted for 40% of all exit activity in the quarter, followed by Europe at 34%.

120 Tiger funded cos. Top investor. Tiger Global Management continued to be the most active investor in Q1’22. The firm invested in 120 companies, up from 107 in Q4’21. The largest investment Tiger participated in was a $1B Series D round to Checkout.com with 12 co-investors.

91 IPOs in Asia, more than any region. Asia led globally in terms of IPOs, which were down for every region this quarter. Asia based companies accounted for 9/10 of the top IPOs in Q1'22, including 8 China-based companies. The largest IPO came from South Korean LG Energy Solutions, which exited at a valuation of $98B.

-30% Decrease in megaround funding. Mega-rounds accounted for less total funding and fewer deals this quarter, consistent with broader VC trends. At $73.6B, total megaround funding represented just over half of all venture dollars invested in Q1'22, down from 59% in Q4'21.

71% Jump in Philadelphia funding. Quarterly funding is down across all major cities and tech hubs in the US, except for Philadelphia, Atlanta, and Dallas. Among them, Philadelphia and Atlanta based startups saw the largest jumps in funding at 71% and 30%, respectively.

20% Of funding goes to fintech. 1 out of every 5 dollars in funding went to fintech in Q1’22, despite investment in the sector shrinking quarter-over-quarter. The retail sector came second, accounting for 17% of all venture funding in Q1'22.

A link to the full report is posted in the Subscriber's Area.

Discount rates don’t matter until they do. SPAC, IPO and every other “innovation” focused asset has experienced a deep pullback over the last six months. That’s entirely due to jumps in yields which reintroduced a discount rate to valuations.

Brookfield Business Partners agreed to buy CDK Global Inc., a provider of software for auto dealerships, in an all-cash deal with an equity value of $6.4 billion.

The investment company said it will pay $54.87 a share for Hoffman Estates, Illinois-based CDK, according to a statement Thursday. The price was 12% higher than CDK’s closing price Wednesday, and 30% above where CDK traded on Feb. 18, just before speculation surfaced regarding a potential sale of the company. CDK shares rose 11% to $54.50 at 9:45 a.m. in New York.

“CDK’s board of directors carefully evaluated a range of strategic and financial alternatives over several months and determined that this transaction is superior to all other available alternatives,” Chief Executive Officer Brian Krzanich said in the statement. 

Brookfield, which has about $690 billion of assets under management, said the CDK transaction is expected to be completed in the third quarter. The deal’s enterprise value is $8.3 billion, according to the statement. 

There are two parts to every private equity company. The first is what they already own and how the valuation for those holdings has been arrived at. The second is availability of fresh capital to make new purchases and the valuation of what they are in the market for acquiring.

If the economy is going to avoid recession this year, consumers will need to dip into savings accumulated during the pandemic. So far, the evidence suggests this hasn’t happened. That’s worrying given the deep cost-of-living crisis facing the country.

It’s well documented that the combination of enforced saving during lockdowns and massive government income protection programs has seen household balance sheets to balloon over the past two years.

The cash, once seen as rocket fuel for the recovery, is now being viewed as a way for households to maintain the volume of goods and services they consume while inflation spirals.

That’s what made the latest credit data from the Bank of England all the more concerning. As yet, consumers have shown no willingness to dip into the 200 billion pound slush fund they have amassed even though inflation continues to run well ahead of income growth.

With inflation set to accelerate further those cash reserves will need to be drawn on if the economy is going to avoid falling off a cliff. In our forecast, we have assumed 10% of the stock of deposits is used over the next year, when the hit to spending power will be at its most intense. Consumption still contracts on a quarterly basis in 2Q and 4Q, but the economy avoids recession. About 25% of the pandemic savings are used over our whole forecast period to 2025.

Of course, it may be that as the squeeze on household budgets intensifies, it forces people to use the cash. It’s also possible that rather than run down assets, households borrow. For low income workers, who weren’t able to bolster their savings during the pandemic, that may be the only option if they want to maintain their spending. With that in mind, it was notable that the same credit data showed a big increase in unsecured net borrowing.

Still, with consumer confidence at levels that are normally associated with recessions, the worry is that caution prevails and the economy takes a far bigger hit than we expect this year.

Economic statistics are good at giving some visibility on aggregate numbers but terrible at displaying divergences in opportunity. £200 billion in excess saving ignores the fact most people do not savings. The reality is higher prices mean many people have to make hard decisions about consumption.

In 2020 I began a series of reviews of longer-term themes which will be updated going forward on the first Friday or Monday of every month. These reviews can be found via the search bar using the term “Secular Themes Review”.

“Play along to get along” has been the default strategy for global peace over the past thirty years. The default proposition was that if we concentrate on commerce, and all grow wealthy together, there was no real need to focus on our political differences. Under that system globalization flourished.

A just in time global supply chain allowed components to be made in a host of different countries, assembled in China and exported to the world. The demise of subsidy regimes allowed commodities, particularly agriculture products, to be produced in the lowest cost regions and exported to the globe. The internet has allowed the dissemination of know-how and services like never before.

In attacking Ukraine, Russia expressed a willingness to risk being cut off from much of the global economy. Regardless, of any other motive, Russia’s invasion of Ukraine is a gamechanger for the global order. With evidence of war crimes emerging, the chances of Russia being welcomed back into the global trading community are growing progressively more distant. We are back in an “Us versus them” global environment.

Barclays Plc’s $600 million structured products blunder has little precedent on Wall Street. But the bank’s past misconduct may have set the stage for the paperwork fail it revealed this week.

A key issue at the heart of the regulatory breach appears to be its loss of the so-called well-known seasoned issuer status in 2017, a right granted by the U.S. Securities and Exchange Commission that allows banks to sell notes in the U.S. with fewer filing requirements. 

Since 2007, Barclays had faced the risk of losing this right at least five times in the aftermath of issues from dark pool disclosures to foreign exchange manipulation, an analysis by Bloomberg News shows. The bank had to repeatedly engage with the SEC over it and apply for waivers, so it didn’t lose this classification.

Barclays isn’t the only bank to have engaged in such back-and-forth with regulators, and the loss of the WKSI approval explains how a limit breach could happen. But the years-long battle to keep that status raises ever more questions over how it could have overlooked one of the most expensive clerical errors ever. 

The oversight is landing the bank with about 450 million pounds ($600 million) in expected expenses from buying back unregistered securities the bank sold, a halt to a booming U.S. business, possible regulatory fines that will deepen the pain, and a delay to a highly anticipated stock buyback.

The raft of additional regulatory hurdles imposed on banks following the credit crisis necessitates having an army of personnel on hand to make sure every “i” is dotted and every “t” crossed. It surprising how few banks have come in for active censure for failing to comply fully with regulations. Barclay’s is certainly being punished for its transgression by investors.

Chinese stocks listed in the U.S. fell Thursday after Securities and Exchange Commission Chair Gary Gensler dialed down prospects of an imminent deal to allow Chinese firms to keep trading on American exchanges.

The Nasdaq Golden Dragon China Index dropped as much as 4.9%, with iQIYI Inc. and Baidu Inc. sinking more than 6% after being added late Wednesday to SEC’s growing delisting watch list. Alibaba Group Holding Ltd. fell 4.6%, while its e-commerce rivals JD.com Inc. and Pinduoduo Inc. slid more than 7%.

U.S.-listed China stocks have steadied in recent trading after authorities signaled support to overseas listings and financial markets, yet investors remain on edge amid a long-standing dispute over whether American regulators can get full access to U.S.-traded Chinese company audits. In response to the SEC chair’s comments, China said talks with the U.S. accounting
watchdog will continue.

Under the Holding Foreign Companies Accountable Act, the SEC started publishing a provisional list of companies identified as running afoul of requirements with the first
release in early March.

“The growing provision list is a reminder that there’s a risk” and a reminder to do a risk check, TH Capital analyst Tian X. Hou said in an interview, noting that as investors become more familiar with the delisting situation, they will realize this is a routine check by the SEC under the new rules.

Even at the best of times, auditors miss signs of trouble in the balance sheets of companies. They are a regulatory burden designed to ensure companies follow the rules and yet whenever a crisis develops, the conflict-of-interest argument arises because auditors missed obvious transgressions.

It is not valid to interpret inverted term spreads as independent measures of impending recession. They largely reflect the expectations of market participants. Among various terms spreads to consider, the 2-10 spread offers a particularly muddled view. Especially in the present circumstances when the 2-10 spread is very much out of step with the near-term forward spread, which offers a much more precise view of market expectations over the next year and a half, it is difficult to concoct a reason to be concerned about the flattening of the 2-10 spread. In contrast, if and when the near-term spread does contract, we know that investors will then be expecting a cessation in monetary policy tightening. While such a shift in expectations could well be precipitated by future concerns about a recession, that need not be the case. A more benign cause would be a marked easing in inflation and inflation expectations that allow for a cessation of policy firming.

The benign outcome is more often referred to as a soft landing. The 10-2 year spread closed at 1 basis point and was inverted for a brief period intraday. The 10-year-3-month is at 189 basis points which is an historically wide diversion.