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.

While the issuance halt initially triggered outsize moves for VXX -- including a 45% jump then reversal in a single session -- the ETN has been calmer as volatility across U.S. stocks retreated, helping prevent a potentially vicious short squeeze in the product. 

All the same, since new cash can’t be added to either note the distortions can be significant. VXX closed at a record 24% premium on Friday, according to data compiled by Bloomberg. OIL has swung between a premium and discount amid major moves in the crude market in the past two weeks. It closed Friday at a 1.1% discount to assets.  

VXX gained 2.4% in early trading as of 9:02 a.m. in New York. OIL was 3.2% lower.

“This is a rare case of an exchange-traded product issuer dropping the ball and mismanaging their products,” said Todd Rosenbluth, head of research at ETF Trends. “Although it is no more likely to occur again this is another red flag for trading ETNs and not ETFs.”

ETNs were created to offer exposure to portions of the market that are difficult for ETFs to access. This comes with additional counterparty risk. The times when ETN products go awry is generally when there is significant credit market volatility like we have seen recently.

The near-term forward spread measures the difference between bets on where the three-month rate will be in 18 months’ time and that same rate today. That curve, along with the more traditional three-month, 10-year spread, has steepened to multi-year highs, spurred by expectations that a hawkish Fed may frontload interest-rate increases, taking the federal funds rate to about 2.8% at the end of 2023. 

A 2018 Fed research paper highlighted that the shorter-term yield curve eliminates complicating factors like the so-called term premium, and thus gives a cleaner read on market expectations for future monetary policy. In effect, the gauge would only invert when a large cohort of investors expected rate cuts on the basis of slowing growth. Previous Fed research has found it has a better predictive power than other parts of the curve -- a conclusion the chair endorsed Monday. 

History has shown that when the force of a Fed tightening cycle causes a yield-curve inversion, it foreshadows a pending recession as consumer spending and business activity increasingly buckles under the weight of policy tightening.

Campbell Harvey was one of the first to historically show the link, with his work on the three-month, 10-year spread -- which has inverted before each of the past eight U.S. recessions. These days, the professor at Duke University’s Fuqua School of Business is concerned about growing threats to the U.S. recovery, even though his beloved spread is not yet flashing “code red.”

High inflation and “geopolitical risk -- which we haven’t even felt the economic outcome of yet, besides at the gas pump -- is all acting like a tax,” Harvey said. “It all indicates slower economic growth.”

Cherry picking the one part of the yield curve that is not at danger of inverting seems to be intellectually dishonest to this observer. Instead, we should be attempting to answer the question why 3-month yields are so depressed.

Market-based expectations for how the Fed moves its target fed funds rate have also broken out. The shift in expectations has come with breathtaking swiftness. The following chart shows implicit expectations for rates after each of the next seven meetings as they stood on Dec. 31, where they had moved by the day the tanks entered Ukraine, and where they are now:

Bear in mind that as the year began, CPI had already topped 7% for the first time in four decades. It’s remarkable both how long it took for investors to come around to expecting a sharp monetary tightening, and how swiftly that realization has now taken root.

What does this imply for asset allocation? Higher bond yields tend to be bad news for stocks if they are part of a Fed tightening, and make high stock valuations harder to justify. However, expectations of a more aggressive Fed are even worse for bonds. The mathematics of the bond market on this point is
inexorable. If rates and yields are going up, then bond prices have to come down.

And, indeed, just as those who’ve been saying There Is No Alternative (to stocks) would have predicted, this news has been far worse for bonds than stocks, meaning that the returns for those who are long in stocks relative to bonds have surged to yet another new high:
 

There is a significant anomaly developing in the bond markets. 2-year and 10-year yields are ramping higher on the expectation of future inflation and much higher rates. 3-month bills are also rising but at a much more sedate pace. The rate is currently at 0.5% which approximates the Fed Funds rate. That’s an oddity because investors are increasingly convinced a 50-basis point in May is a certainty.

From CNBC: Oil giant BP reports highest profit in 8 years on soaring commodity prices

From Reuters: Cereal maker Kellogg Co. forecast full-year profit growth above market expectations on Thursday, riding on higher product prices that helped overcome labor strike disruptions and soaring input costs in the fourth quarter.

From The New York Times: Procter & Gamble’s sales jump as consumers brush off rising prices.

From The Ticker: McDonald’s to raise prices despite record revenue

From Yahoo Finance: Amazon stock soars 15% after earnings, will hike Prime membership fee

US Senator Elizabeth Warren put the pieces together when Fed chair Jerome Powell appeared last month before the Senate Banking, Housing, and Urban Affairs Committee. Offering a lesson in what she referred to as “Econ 101,” the senator from Massachusetts led Powell through a series of questions related to inflation.

Bond prices continue to accelerate lower with 10-year Treasury yields jumping nearly 15 basis points today. Stock markets remain reasonably steady in what is a clear role reversal. Usually, bonds do well in times of economic stress and the stocks decline. Right now, inflationary pressures are weighing heavily on bonds, but stocks are steadier because companies have successfully raised prices.

“The American economy is very strong and well positioned to handle tighter monetary policy,” Powell told a press conference Wednesday following a meeting of the Federal Open Market Committee. “We are attentive to the risks of further upward pressure on inflation and inflation expectations.” He also said that officials could move faster on policy tightening if needed.

The hike is likely the first of several to come this year, as the Fed said it “anticipates that ongoing increases in the target range will be appropriate,” and Powell repeated his pledge to be “nimble.”

“I saw a committee that is acutely aware of the need to return the economy to price stability,” he told reporters, characterizing the mood around the table as policy makers debated the outlook. “It is determined to use its tools to do so.”

In the Fed’s so-called dot plot, officials’ median projection was for the benchmark rate to end 2022 at about 1.9% -- in line with traders’ bets but higher than previously anticipated -- and then rise to about 2.8% in 2023. They estimated a 2.8% rate in 2024, the final year of the forecasts, which are subject to even more uncertainty than usual given Russia’s invasion of Ukraine and new Covid-19 lockdowns in China are buffeting the global economy.

The market took the first hike in this cycle in its stride and not least because it has been fully priced in over the last four months. Remaining nimble is going to be essential. Uncertainties abound, not the least of which is China’s problem with containing the omicron variant is only just beginning. Predicting 1.9% by the end of the year implies at least a 25-basis point hike at every meeting. That seems ambitious in the extreme. 

I and probably many others will be intrigued in your contrarian view that the Fed will hike once and be "done". Whereas as per enclose Bloomberg article others expect seven rate hikes this year.

If only one rate hike does that mean USA stock markets will revert to their bull run?

12-month yields are at 1.19% and climbing. That implies four hikes within the year. The Fed will hike this week, so that implies three additional hikes. I have been of the opinion the Fed will have an extraordinarily difficult time raising rates. If the Fed raises 7 times a recession is inevitable. With three more hikes the chances of a recession are better than even. One and done sounds about right to me. 
 

But for some investors, “it’s opportunistic investing,” said Chris Gaffney, president of world markets at TIAA Bank. “Maybe it’s an opportunity to rebalance and buy some of these big-name, good companies that have been in this correction and the prices are cheaper.”

The S&P 500 is on pace to notch its second consecutive week lower, but retail traders haven’t been deterred by the volatility. They’ve become a reliable support pillar for the market, plowing cash toward stocks for nine straight weeks.

Partly, it’s a habit developed during the Covid-19 crash -- and one that’s proving stickier than many expected. Back then, buying during the March lows proved very profitable, including
for ARKK enthusiasts. 

Gaffney says there’s a swath of investors who are wary of missing out on any other potential big run-ups in prices. “You always get some people who feel like, ‘I missed out on the last big run, and I’m not going to miss that again, so I’m going to get in now when prices are cheap.’”
 

In a secular bull market buying the dip always works. It becomes engrained as the go-to strategy for investors to get a position at a discount. As interest returns, the assets leading the secular trend break higher, the decision is vindicated and buying the next dip becomes an even easier decision. One way to know that a bull market is over, is the buy-the-dip trade fails.

Explore a U.S. Central Bank Digital Currency (CBDC) by placing urgency on research and development of a potential United States CBDC, should issuance be deemed in the national interest. The Order directs the U.S. Government to assess the technological infrastructure and capacity needs for a potential U.S. CBDC in a manner that protects Americans’ interests. The Order also encourages the Federal Reserve to continue its research, development, and assessment efforts for a U.S. CBDC, including development of a plan for broader U.S. Government action in support of their work. This effort prioritizes U.S. participation in multi-country experimentation, and ensures U.S. leadership internationally to promote CBDC development that is consistent with U.S. priorities and democratic values.

This announcement does not propose anything new. The Federal Reserve has been investigating the merit of a central bank digital currency for years already. The reason the crypto sector responded favourably to this announcement is because of its enthusiasm about the future of digital assets. 

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

When Wall Street indices were breaking out to new highs in 2012/13 the world looked to be on the cusp of a golden era of globalisation, co-operation, and the inevitable rise of the middle class. Higher living standards would breed a more tolerant society with greater respect for the environment and for our fellow global citizens.

In predicting a secular bull market, we were correct about the market call. Wall Street and the FANGMANT stocks have outperformed global indices by a wide margin over the last decade. It was also correct to expect oil to underperform because of the bounty arising from shale oil and gas. Predicting a decade ago that the USA would become energy independent was seen as maverick. Today it’s a fact.

The social upheaval that began with the monetary and regulatory response to the credit crisis represents a significant threat to the utopian ideal of the everyman. Exporting job security in return for cheap products has hollowed out the middle class in most developed countries. The evolution of the subscription business model has also reduced individuals to cash flows; where ownership of hard assets is marketed as an outdated concept. This has contributed to significant social upheaval and the response to the coronavirus pandemic amplified it.  

At the same time, the trend of geopolitical tension continues to rise. The concentration of wealth in the hands of a small number of people, companies and countries is creating greater competition. China is much more active in staking its claim to global trade than in the past and Russia’s current invasion of Ukraine is reflective of a desperate need for both security and relevance in a world that is actively working to use less of its primary export; oil.

Russia said it would press forward with its invasion of Ukraine until its goals are met, as troops were seen moving in a large convoy toward the capital, Kyiv. In the country’s second-largest city, Kharkiv, the mayor said residential areas were being bombed in what he called “a war to destroy the Ukrainian people.”

Hitting the TV tower is aimed at attempting to put Ukraine’s ability to appeal directly to Russia’s population out of commission. The impassioned broadcasts from Ukraine’s president must be particularly annoying for the Russian aggressors. Unfortunately, the success of the initial resistance means Russia is doubling down on the bombardment.

Leveraged funds’ net short positioning in the yen has increased in seven out of the last nine weeks and sits at its most bearish since November, according to Commodity Futures Trading Commission data released Friday. Net positioning in the Swiss franc, another preferred haven asset for currency traders, has been short since September, though it did grow less bearish in last week’s CFTC data. 

The pullback from havens was evident in the spot market on Tuesday, when the Japanese and Swiss currencies retreated while other major counterparts gained against the U.S. dollar. The moves signal that the market is comfortable with where the Russia situation is going, Brad Bechtel, a strategist at Jefferies LLC in New York, said in a Tuesday note. 

“No real downside momentum in the JPY crosses on any of these recent Russia headlines the past few weeks,” he wrote. 

“Even now, as we are on the brink of the conflict, we still do not see JPY perform. Same with the USD and CHF,” he wrote, referring to the Swiss franc.

The news flow from Ukraine is exciting but the trajectory of interest rates is much more important for markets. The defining characteristic of this earnings season was companies reporting better than expected figures for Q4 but disappointing on guidance. Home Depot was the latest example today. Markets are looking at slower growth and higher rates first and the wider geopolitical tension is a secondary concern.

External financing is increasingly intermediated outside traditional channels. Banks and other institutions active in public capital markets, such as equity and corporate bond mutual funds, remain key financing sources for large and mature corporates. That said, “alternative asset managers” (AAMs) have become pivotal for smaller firms globally, including in emerging market economies (EMEs). Many AAMs were established as private equity firms that later expanded into credit, thus turning themselves into one-stop capital providers for firms less able or willing to access traditional sources.

Private markets have three features that distinguish them from public markets. First, there is limited liquidity transformation because investors commit capital for extended periods. Second, these investors tend to be large and sophisticated entities such as pension funds, whose focus on long-term returns enables target companies to confront significant earnings volatility. Third, the regulation of private market investment vehicles is relatively light, partly reflecting the lesser degree of liquidity mismatches and also the limited presence of retail investors.

The lack of regulation in the private markets is seen by many investors as a positive aspect. The challenge for the future is large pension funds are highly active in the sector. They might have long-term liabilities but they also have a long-term need for yield. The private sector has been particularly attractive because they have gained both portfolio diversification and higher returns. 

Mounting inflationary pressures are likely to make central banks more sensitive about weakness in their currencies, which could add fuel to the global tightening cycle, Goldman Sachs strategists George Cole and Michael Cahill wrote in a client note Monday.

This scenario is a regime shift from the competitive depreciation seen over the past decade as central banks acted to protect the appeal of their export markets
To offset a single percentage point weakening in the currency, G-10 policy rates would need to rise 10bps on average, Goldman analysis using a financial-conditions framework showed

Implication is higher G-10 policy rates as each central bank pressures the others, as well as “higher rate volatility relative to FX volatility”

NOTE: Rates volatility reflected in the ICE BofA MOVE Index is the highest since March 2020, while currency vol on JPMorgan’s benchmark index is the highest since late December

Japan’s policy “bears watching” as the central bank’s tolerance of yen weakness has been a key anchor for global yields, Goldman said

Amid rising energy and commodity prices, a weak currency becomes a liability for importers. One of the few tools they have is to allow their currencies to appreciate versus the Dollar.

The Dollar Index is currently appreciating because the general consensus is the Fed will raise rates quicker than either the ECB or BoJ. Since both of those central banks experienced a great deal of difficulty in getting off the zero bound ahead of the pandemic, they are likely to have similar difficulty now. That’s true even if Germany is experienced surging inflation.

Heading into the credit crisis, the TED spread and the OIS spread took on almost legendary status as predictors of future troubles in the financial sector.

The Ted spread is the difference between 3-month LIBOR and 3-month Treasury yields. Since LIBOR is a measure of what rate banks are willing to lend to one another, when the spread widens it is viewed as a measure of perceived risk in the sector.

The LIBOR-OIS spread is the difference between 3-month LIBOR and 3-month Overnight Index Swap. It’s another measure of health in the financial system.

Both spreads jumped higher in 2007 and spiked in 2008. Two things are worthy of consideration at present.

“We’re seeing right now the highest death rates we’ve ever seen in the history of this business,” said Scott Davison, the CEO of OneAmerica, a $100 billion life insurance and retirement company headquartered in Indianapolis.

“The data is consistent across every player in the business.”

Davison said death rates among working age people – those 18 to 64-years-old – are up 40 percent in the third and fourth quarter of 2021 over pre-pandemic levels.

“Just to give you an idea of how bad that is, a three sigma or 200-year catastrophe would be a 10 percent increase over pre-pandemic levels,” Davison said. “So, 40 percent is just unheard of.”

He said the data shows COVID deaths are greatly understated among working age Americans.

Davison says OneAmerica expects to pay out more than $100 million in short- and long-term disability claims due to the pandemic.

“Whether it’s long COVID or whether it’s because people haven’t been able to get the health care they need because the hospitals are overrun, we’re seeing those claims start to tick up as well,” he said.

Because of this, insurance companies are beginning to add premium increases on employers in counties with low vaccination rates to cover the benefit payouts.

Middle aged people have been dying at an increasing rate in the USA over the last decade. Poor lifestyle habits, suicide, and an opioid epidemic contributed to that condition. Now the pandemic has resulted in an acceleration of the trend.

The data reinforce the Fed’s intentions to begin raising rates next month to combat broad-based inflationary pressures and could lead markets to expect even more aggressive action from the central bank. The steady run-up in prices has eroded recent wage gains and diminished American families’ purchasing power, sucking much of the air out of what has been an exceptional bounceback in the U.S. economy.

Leading up to the Fed’s March 15-16 meeting, policy makers will also have the February CPI and employment reports in hand.

Investors boosted their expectations for a a half-point increase in the federal funds target rate in March following the report. While most economists expect a more gradual approach to liftoff -- as has been telegraphed by several Fed officials -- the acceleration of inflation on the heels of rapid wage gains will keep the possibility of a half-point hike on the table.

The Federal Reserve has already signalled what their plans are. They aim to end purchases next month and simultaneously begin to raise rates. The market is well on its way to pricing in a 50-basis point hike. Reducing the size of the balance sheet is expected to begin sometime later this year. That’s where the big differences between this tightening cycle and last begin.

The process of running off debt is expected to take a different trajectory from the last time around. Jay Powell signalled they will be focusing on reducing mortgage debt holdings. The Fed is probably worried about the spiralling cost of shelter. By reducing their holdings of mortgage bonds, they are potentially aiming at property prices.

You have put a chart of the TGA balance and projections in the comment of the day. I am sure I am not alone in wondering where this information comes from. Is it speculation by the Daily Shot or has the Treasury announced that this is their intention? How certain can we be that the projection is reasonably accurate? Have such projections been made before and, if so, have they held true? I am confused as I have never heard of such projections before. Best regards and keep up the good work.

Thank you for this question which may be of interest to the Collective. The Treasury General Account (TGA) at the Federal Reserve was irrelevant until before the global financial crisis. Since then, it has been growing as the role of government spending in the economy increases.

A bad back currently prevents me golfing, walking the dog, or driving the car and, in my opinion justifiably, I am feeling a grumpy.

So here are a few gripes for you:

First gold:
For several years you taught us that the gold price follows an approximate 35-year cycle between highs, although the gold price could outpace stock indexes for short periods in between those highs. We’ve not heard too much about the 35-year cycle for a while, the message now being that it is not unusual for gold to trade in a boring range for up to 18 months or so before breaking out conclusively up or down. You believe it will break to the upside taking out previous highs (which runs contrary to your 35-year cycle theory). I hold a fair chunk of gold and silver miners in ETFs but regard the holding as a hedge rather than representing a belief that gold will imminently break to the upside. It might and it would be nice if it did but I doubt it. As David said, investment options are similar to a beauty parade and for the foreseeable future, many options are likely to look superior to gold.

Second India v China:
You are very hard on China and its political system. Having lived most of my life in Asia I take a less severe view. Like most observers I was disappointed to see that XI, the reformer, had no intention of political reform but on reflection, I think he’s probably right to opt for political stability at a time when China is still struggling to bring modernity to all its people and regions; when lightening-speed technological change is taking place across the globe and when it finds itself in an inevitable struggle to assert what it regards as its rightful influence on global institutions and practices. On a smaller scale in Singapore Lee Kuan Yew did much the same thing and while there is now a little more political tolerance in Singapore than there was, the Government – and most of its people – believe that full-throated democracy would lead to economic and societal break-down. That would be Xi’s worst nightmare.

My grouse is not so much with your view on China but with your uncritical view of India. I agree with you that India should do well given its demographic advantage and talents of its people. However, I think the Modi government is quite repugnant in its covert – and not so covert – support of extremist Hindu nationalism represented by terrorisation of the Muslim and Christian communities, and by its appalling failure to do much about the abuse of women, also fuelled by Hindu extremists. In the medium term, I fear this, together with over-dependence on coal, will limit India’s investment appeal and therefore its economic potential.

To declare my investment positions, I have reduced my exposure to India and wait for an opportunity to reinvest in China. My favourite Asian market currently is Vietnam.

Third, the purpose of your ‘service’:
Under David’s direction, Fuller Money provided objective macro oversights together with some trading suggestions/recommendations and some investment suggestions/recommendations. He often put his money where his mouth was and invested in his recommendations. Towards the end of his career, he stopped publishing his investment portfolio which I regarded as a pity. Under your direction, Fuller-Treacy Money continues to provide objective (if sometimes convoluted and long-winded) macro oversights, but I find it difficult to work out whether beyond that you are offering trading hints or investment hints. I use the word ‘hints’ rather than ‘suggestions’ because in this aspect you are far more non-committal on specifics than was David. The details you provide of your own investment activities suggest that you are a trader with long(ish) term investments in gold bullion, gold miners and Rolls Royce. I made several profitable purchases based on David’s recommendations but so far have identified none under your watch.

Fourth Daily Audio and Video:
From emails you have referred to from other subscribers, I am confident that I am not alone in being irritated by several of your constant refrains. Three which particularly annoy me are ‘The big question is ….’ (to which we never get an answer); ‘[Gold (for example) has a lot of work to do’ (which is a nonsense, better to identify factors which might influence buying/selling decisions) and; ‘I can’t talk and chew gum at the same time’ (which sounds quite catchy heard for the first time, but grates increasingly after many repetitions).

So, getting that off my chest makes me feel slightly less out of sorts. I shall be renewing my subscription in March. It’s been part of my routine for too long.

Thank you for this detailed email, your long-term support and I hope you back feels better soon. If it is muscular, rather than a herniation, I strongly recommend Yunnan Baiyao. I’ve pulled muscles in my lower back on several occasions either playing tennis or lifting. If it is taken quickly after injury, it provides a powerful, quick solution with no side effects I have experienced. 

I began questioning the wisdom of relying on the Dow/Gold ratio during the early stages of the pandemic. Here is a link to Comment of the Day on April 24th 2020. It includes a large number of long-term ratios and concluded that the Dow Jones Industrials Average is no longer the best way to look at the long-term ratio, confirmed concentration of attention in the growth sector, predicted the recovery in oil prices, higher wages, and the return of inflation.

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

The biggest trend in the world isn’t bitcoin or the FANGMAN stocks. It’s bonds. Yields peaked in 1980 and the cost of borrowing has done nothing but decline since.

That’s enabled the steady rise of leverage, debt accumulation, asset price appreciation, speculation in all manner of public and private assets and every other bull market too.

The exact mix of where the debts have accumulated most is different in each country. For the USA, fiscal excess and unfunded liabilities are the biggest debt issue. The large number of companies surviving with no profits is the second biggest debt issue.

In Australia, Canada and the UK, consumer debt ratios, household debt and property debt are the pain points. The Reserve Bank of Australia’s reluctance to raise rates, despite inflation, is a symptom of the economy’s reliance on property prices.

For China, the accumulation of debt in the property sector has been epic. The sector represents 30% of GDP. At least in Japan, the massive quantity of debt is held domestically but it is a significant hurdle to raising rates.

European Central Bank policy makers can envisage recalibrating their outlined policy path in March, according to officials familiar with their thinking.

The Governing Council agreed on Thursday that it’s sensible not to exclude the possibility of an interest-rate hike this year, said the people, who asked not to be identified because their discussions are private. 

An end of bond-buying under the ECB’s regular program, the APP, is possible as early as the third quarter, the officials said. No decisions have been taken. 

An ECB spokesman declined to comment. ECB President Christine Lagarde refused to repeat at her press conference that a rate increase was very unlikely this year, highlighting more persistent-than-expected inflation pressures in the 19-nation bloc. Investors brought forward bets on a liftoff while she spoke.

This graphic from the Nordea highlights the fact that European inflation is all about energy. Raising interest rates doesn’t do much more to curtail demand than high prices are doing already so the ECB is understandably reluctant to rush into action.

Alphabet Inc.’s brisk rally on Wall Street on Wednesday is giving a boost to the Nasdaq 100 Index, still reeling from last month’s selloff in tech stocks. Shares in the Google parent are surging after it announced a stock split and posted quarterly sales and profit that topped analysts’ projections, signaling the resilience of its advertising business. The gains in Alphabet shares -- the third biggest stock on the Nasdaq 100 with a weighting of 7.4% -- account for most of the rise on the index on the day.

Apple warned about its ability to fulfill orders before Christmas and subsequently was able to beat that projection. The share jumped on the news but guidance was for slower growth in Q2.

Euro-area inflation unexpectedly accelerated to a record, overshooting expectations by the most in at least two decades and heaping pressure on the European Central Bank to pare back pandemic stimulus more quickly, like its counterparts in the U.S. and the U.K.

Consumer prices jumped 5.1% from a year ago in January, up from 5% in December. The median estimate in a Bloomberg poll of 44 economists saw a reading of only 4.4% and none predicted inflation gaining pace.

The euro climbed 0.3% against the dollar to $1.1305 while German bonds pared gains to leave the 10-year yield one basis point lower at 0.03%.

While slowing in Germany and France, the euro zone’s two biggest economies, the spike in energy costs pulled price growth higher across the 19-member currency bloc as a whole. It was more than a percentage point higher than analysts predicted in Italy, where it accelerated to 5.3%.

Stripping out energy and other volatile components like food, core inflation was 2.3%, down from last month’s 2.6% reading.

Energy prices are a multiple of where they were a year ago. That’s hitting everyone’s wallet. The issue is particularly worrisome in Europe where natural gas inventories are extremely low and consumption taxes are high. An even bigger crisis has been avoided only by virtue of winter weather being relatively warm of late.

Thanks for the great service pulling the noise out of market trends for us. We especially enjoy what my wife affectionately calls the “Big Picture Long-Winded” Friday recordings. Regarding the possible rotation into the renewable/green economy do you have any ideas on Industries/companies that could benefit from the build out? Or would the safer play be directly in the commodities needed for the grid, vehicles, batteries, and such? Hoping to get to another Chart Seminar before too long.

Thank you for your kind words. A former delegate at The Chart Seminar once described my sense of humour as “impish” and I can’t argue with that. Your better half’s turn of phrase certainly tickled me. The Friday broadcasts are often a delicate balance between trying to be pithy and attempting to cover the relevant arguments. I’m looking at a late May/early June date for a London seminar and I hope to see you there.

The question of the future of the zero carbon/green revolution/energy transition is a big one. On one hand we have high minded projections of a utopian future where the air is pristine and no economy is dependent on carbon emissions for growth. Promises of hundreds of trillions being spent to achieve that goal were a major feature of international conferences in 2021.

“The Fed’s latest update is net negative for risk assets, as it seems to show that the Fed has a lower strike put than we thought - in other words Powell would be comfortable to allow further market weakness and volatility without intervening,” said Altaf Kassam, EMEA head of investment strategy and research at State Street Global Advisors.

“Investors should continue to avoid developed markets government bonds as there is only downside there. We are rotating into defensive equities, long-dated U.S. Treasuries, commodities and VIX futures - Volatility will be here for a while.”

The Fed is talking about raising rates faster than any other developed market central bank. That represents a strong tailwind for the Dollar Index and it broke upwards to new recovery highs today. This has been a consistent rebound from the lower side of the range and nothing has yet happened to question potential for a run back towards the psychological 100 level.

Most global finance firms are planning to establish or expand operations in the U.K. in 2022, according to a survey of 40 key decision-makers in the industry.

Around 87% of global financial services investors expect to invest in the U.K. next year, EY’s latest poll found. That’s the highest since the professional services firm started tracking sentiment toward the country in 2016, the year of the Brexit vote, and compares to 50% in early 2021 and a low of 11% in 2019. 

The data is a boost for the City of London, whose credentials as an international finance center are being questioned since the U.K. left the European Union. Meanwhile, 90% of respondents said the U.K. offers the right conditions to invest in assets with environmental, social and governance attributes.

“This is testament to the stability and resilience of the mature U.K. market which continues to ably withstand the material challenges and uncertainty of both the pandemic and Brexit,” said Anna Anthony, EY’s financial services managing partner for the U.K.

There was a lot of fear that Brexit would result in London being denuded of financial firms. The reality is the Eurozone represents only a portion of the business done in one of the world’s great financial centres.

Billionaire investor Mike Novogratz has said cryptocurrencies will struggle to pull out of their sell-off if stocks keep falling, as he urged investors not to buy the dip.

Prices for bitcoin, ether and other digital currencies have fallen sharply across the board as they track Wall Street's rout in tech stocks, driven by pressure from rising bond yields.

"Crypto will have a hard time rallying until stocks find a base," Novogratz, CEO of investment company Galaxy Digital, tweeted late Thursday.

Novogratz pointed to the sharp fall in the Russell index, which is down almost 10% year to date, saying there are 1.2 trillion bad equity longs above the market.

"This is now a bear market," he said, adding: "Sell rallies.  Don't buy dips."

Doubts about whether bitcoin is a risk asset or a safe haven have been dispelled over night as bitcoin followed the stock market to new lows. That’s an important distinction because the primary comparison between bitcoin and gold over the last couple of years is they are both long-term stores of value. Recent action suggests that belief is wrong.

The swift run-up in government bond yields is curtailing risk appetite. More importantly it reintroduces the discount rate in the calculation of fundamental value. When money is both free and available in vast quantities, the discount rate on future cashflows goes to infinity. At that point, the most fanciful valuations are accepted as realisable because the time allowed to fulfill the goal is infinite. Higher rates reintroduce a time value of money argument and forces valuations down. That has resulted in a significant correct for many liquidity-dependent sectors.  

Many people have remarked on the wonders of compounding. For example, Albert Einstein reportedly called compound interest “the eighth wonder of the world.” If $1 could be invested today at the historic compound return of 10.5% per year, it would grow to $147 in 50 years. One might argue that economic growth will be slower in the years ahead than it was in the past, or that bargain stocks were easier to find in previous periods than they are today. Nevertheless, even if it compounds at just 7%, $1 invested today will grow to over $29 in 50 years. Thus, someone entering adulthood today is practically guaranteed to be well fixed by the time they retire if they merely start investing promptly and avoid tampering with the process by trading.

I like the way Bill Miller, one of the great investors of our time, put it in his 3Q 2021 Market Letter:

In the post-war period the US stock market has gone up in around 70% of the years . . . Odds much less favorable than that have made casino owners very rich, yet most investors try to guess the 30% of the time stocks decline, or even worse spend time trying to surf, to no avail, the quarterly up and down waves in the market. Most of the returns in stocks are concentrated in sharp bursts beginning in periods of great pessimism or fear, as we saw most recently in the 2020 pandemic decline. We believe time, not timing, is the key to building wealth in the stock market. (October 18, 2021. Emphasis added)

What are the “sharp bursts” Miller talks about? On April 11, 2019, The Motley Fool cited data from JP Morgan Asset Management’s 2019 Retirement Guide showing that in the 20-year period between 1999 and 2018, the annual return on the S&P 500 was 5.6%, but your return would only have been 2.0% if you had sat out the 10 best days (or roughly 0.4% of the trading days), and you wouldn’t have made any money at all if you had missed the 20 best days. In the past, returns have often been similarly concentrated in a small number of days. Nevertheless, overactive investors continue to jump in and out of the market, incurring transactions costs and capital gains taxes and running the risk of missing those “sharp bursts.”

As mentioned earlier, investors often engage in selling because they believe a decline is imminent and they have the ability to avoid it. The truth, however, is that buying or holding – even at elevated prices – and experiencing a decline is in itself far from fatal. Usually, every market high is followed by a higher one and, after all, only the long-term return matters. Reducing market exposure through ill-conceived selling – and thus failing to participate fully in the markets’ positive long-term trend – is a cardinal sin in investing. That’s even more true of selling without reason things that have fallen, turning negative fluctuations into permanent losses and missing out on the miracle of long-term compounding.

The arguments against selling become progressively more compelling the longer prices move up and to the right. It would have been a mistake to sell everything in January 2020 when news of the coronavirus was breaking unless you were equally committed to buying it all back at the first sign of bottoming in March. That visceral experience has acted as a learning experience for many investors who will have resolved never to sell. That is most particularly evident in the crypto markets where faith in the bullish hypothesis has been rewarded time and again.

“Consumption remains the weakest link in China’s growth story at the moment and that will by and large continue for much of this year,” said Louis Kuijs, head of Asia economics at Oxford Economics. “We think Beijing has a bottom line of around 5%. As is the case at the moment, if growth is weaker than that, they’d feel strongly motivated to pursue more policy easing.”

Economists expect more policy action from the PBOC in coming months. Goldman Sachs Group Inc. said there’s a possibility the central bank will allow banks to lower the five-year loan prime rate, a reference for mortgages, on Thursday. The one-year rate was already cut in December. Economists at Australia & New Zealand Banking Group and BNP Paribas see the likelihood of further reductions in the reserve requirement ratio for banks.   

The big question for liquidity dependent stocks is where the next big source of liquidity is going to come from. The US government is struggling to get additional spending measures passed. The Fed expects to be done with QE tapering in a couple of months and both Europe and Japan are not significantly increasing their programs. The potential for China to do more to support flagging growth is one of the few realistic possibilities for ample additional liquidity in the near term.

Why such angst? There’s a lot in the minutes, with much useful information for students of the economy and monetary policy. You can find the full version here. For those less interested in such studies, the passage of three sentences that accounted for more or less all of the market reaction read as follows:

it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated. Some participants also noted that it could be appropriate to begin to reduce the size of the Federal Reserve’s balance sheet relatively soon after beginning to raise the federal funds rate. Some participants judged that a less accommodative future stance of policy would likely be warranted and that the Committee should convey a strong commitment to address elevated inflation pressures.

This commits the central bank to nothing, but the notion that there were hawks on the committee who thought that the Fed should reduce the size of its balance sheet (in other words, start to sell off its huge bond holdings in a move that, all else being equal, should raise yields) came as an unpleasant surprise. Those words are there for a reason. The Fed thought it a good idea to plant a reminder of hawkish intent just as markets were ramping up again after the New Year break, and it seems to have worked.

The Fed Minutes were the catalyst for the sell-off in bonds yesterday which contributed to the weakness in the growth sector. I suspect talk of being more aggressive in quantitative tightening than the 2018/19 period was the primary reason investors took fright.

Treasury yields rose a second day, with five-year rates hitting the highest since before the pandemic took hold in the U.S., amid increasing conviction that the Federal Reserve will raise rates at least three times beginning in May.

The five-year Treasury note’s yield climbed as much as 3.8 basis points to 1.392%, the highest since Feb. 20, 2020, while 30-year yields bumped up toward their 200-day moving average.

Yields across the curve are rising for a second straight day, after Monday’s selloff lifted the 10-year note’s yield by nearly 12 basis points in its worst start to a year since 2009. The two-year yield topped 0.80% for the first time since March 2020.

That move rippled through markets from Australia to the U.K., where bond trading resumed after a holiday on Monday. Australian 10-year yields jumped as much as 15 basis points to 1.82%, the highest since Nov. 26. Yields on the same U.K. tenor surged as much as 10 basis points to 1.07%, the highest since Nov. 3.

At 1.38% the 5-year yield has fully unwound the pandemic panic compression of early 2020.  In that time total debt outstanding has increased by $5.7 trillion or 24.6%. That’s an eyewatering figure.  Why the market did not flip out about it is a question which flummoxed investors in 2021.

Equity team co-heads Atul Narayan and Erin Miles on other equity markets catching up with the US: Looking ahead, it feels that things are primed for the equity markets that have lagged the US (China, Japan, the UK, Europe, etc.) to catch up. There are several factors at play. First, COVID has been a material relative support to US equities from all channels—favorable sector tilt, less virus economic impact, more support from falling rates (versus, say, Japan, where yields are pegged), and compressing risk premiums, given safe-haven appeal for US equities, especially the FAANMGs. We would expect the COVID impact to gradually fade in the coming year and this to be a relative support for the markets outside the US.

Second, China is showing early signs of moving toward easing after a year when the structural goals (deleveraging, rebalancing, common prosperity, etc.) were prioritized. This again will be a bigger relative support for economies like Japan, Europe, and EMs that are a lot more exposed to China. Finally, if you look back over the last 100 years, it’s almost always been the case that the winners of a given decade end up being laggards in the next one because of the degree of exuberance (and pessimism) that gets priced in following the winning (and losing) stretch. Given how stretched the relative positioning and pricing is today (for logical reasons), we expect the US versus rest of world diff to finally start to revert after a decade-long off-the-charts performance. The main things we are watching closely are the evolution of COVID globally, China’s policy stance, and the retail flows in the US, which were the biggest support for US equities over the past year and a half.  

Based on valuations alone, there is a strong risk-adjusted argument for favouring ex-US assets. I also find the argument that a recovery for China’s economy would have a more positive effect on the Ex-US basket to be reasonable. However, momentum remains a tailwind for Wall Street which has been supported by the relative strength of the Dollar all year.

So far, 23 members of the House Democratic Caucus have announced they will not seek reelection. While it is common for the party in control to see a series of high-profile retirements ahead of a difficult midterm cycle, the sentiment inside the caucus is that even more departures are likely. A combination of political winds tilting toward Republicans, redistricting boxing some members out of easier races and an overall low morale among House members could lead to even more retirements in the coming months.

"We have got a problem here," retiring Rep. Cheri Bustos said of the general morale inside the House. "There are way too many people serving as members of Congress right now who I not only don't look up to, I have zero respect for. And I'm saddened to have to say that."

Bustos, who was first elected in 2012 and represents western Illinois, announced she was retiring earlier in the year and told CNN that she was looking for "a new chapter in her life." But it's clear that the current standing of Congress loomed over the decision. Bustos said that while she believes some Democrats aren't "team players" -- she did not name names -- the bulk of her concerns are with Republicans, and the prospect of turning over power to the GOP in 2022 is disturbing for all Democrats in Congress.

"When you've only got a three- or four-vote majority and you see people who are in tough districts announcing that they're not running for reelection, yeah, everybody worries about what's ahead," said Bustos, the former chair of House Democrats' campaign arm.

If the party in power can’t get key pieces of legislation across the line, it creates the perception of ineptitude. With mid-term elections less than a year away, the Democratic administration should begin to feel some urgency in January with a view to passing at least part of their ambitious goals.

Turkey halted trades on all listed stocks after sharp declines triggered a market-wide circuit breaker,
with the lira extending declines to a record low.

Trading of equities, equity derivatives and debt repo transactions were automatically halted twice within an hour after the Borsa Istanbul 100 index fell as much as 7%. The index was earlier up more than 5.6% before sinking as a central bank intervention on the currency market failed to stem the lira’s decline. The currency has come under pressure after the central bank cut its benchmark repo rate by a percentage point to 14% on Thursday, despite inflation accelerating to over 21%.

The central bank’s easing cycle since September saw the key rate fall by 5 percentage points, prompting a rush to buy dollars among corporates and retail investors.  President Recep Tayyip Erdogan has advocated for cuts in borrowing costs, arguing that lower rates will eventually free Turkey’s economy from a reliance on short-term foreign inflows. The policy pivot and the ensuing market turmoil prompted complaints from industrialists, who say the current volatility is hurting companies. 

Less than two weeks ago the central bank intervened to support the currency. In normal circumstances that would begin to re-instill confidence. By cutting rates and bowing to political will, the central bank today demonstrated it is not able to do what is necessary to avoid a currency and debt crisis.

“Anytime there’s a risk of easy money being taken away, that will result in some of these very expensive areas of the market to pull back,” said Megan Horneman, director of portfolio strategy at Verdence Capital Advisors.

“The pressure on the Fed to pick up the pace of tightening is only mounting. With higher prices permeating the marketplace, we could see a snowball effect when it comes to inflation challenges as more suppliers justify higher prices and more consumers begin to close their wallets,” said Mike Loewengart, managing director of investment strategy at E*Trade Financial.

“The inflation trajectory remains worrisome. While we believe that price pressures will abate next year, the Fed is doing the prudent thing by tapering faster, so that it is well-positioned to hike rates if needed,” said Win Thin, global head of currency strategy at Brown Brothers Harriman.

Liquidity is the only game in town. With a looming threat that the USA is about to close the momentary spigot, a distinct air of risk-off trading is increasingly evident. That suggests, the risk of a lengthier and deeper process of consolidation is rising.

Tapering is tightening for markets, if not the economy. Due to the much greater than expected rise in inflation, the Fed is pivoting to a more aggressive removal of monetary accommodation. We believe this is warranted and supported by an administration that appears less focused on the stock market as a barometer of its success. Furthermore, tapering is different than in 2014 for 3 reasons: 1) the Fed is exiting QE twice as fast this time,2) asset prices are much richer today and 3) growth is decelerating rather than accelerating. This could be important for the economy, too, given how levered consumers are to stock prices today.

The uptrend over the last 13 years has been liquidity fuelled. That’s been the abiding factor behind every correction and every recovery since the initial lows in late 2008. It is reasonable to expect the end of the latest quantitative easing program will have a similar effect on market prices as every other one.

Gundlach, 62, said the reason why Fed Chair Jerome Powell characterizes the economy as strong, but not strong enough to allow for a rate hike at this point, is that the underlying condition is in fact weak -- artificially propped up by an unprecedented degree of stimulus.

Here are some other takeaways from Gundlach’s remarks:
He focused heavily on inflation, saying the annual pace of gains in the consumer price index could hit 7% in the next month or two. He ran through numerous inflation measures and pointed out that shelter costs have climbed significantly. He also said it’s possible that the CPI inflation gauge won’t drop below 4% throughout 2022.

Markets could face more volatility now that the Fed has said it might quicken its tapering program.

Gundlach reiterated that he bought European stocks for the first time in 12 years, which he disclosed a few months ago. He still owns some of those and they’ve done just OK until recently. He didn’t own emerging-markets equities, though he envisioned a scenario when they might outperform U.S. firms. “We’re looking for major opportunities” and emerging markets could be one over the next few years, he said.

The dollar has been in structural decline since 1985, he said, reiterating that the twin-deficit problem (that’s the current-account gap and the federal budget deficit) will cause the greenback to fall over time, which bodes well for emerging markets.

I’ve been saying for most of this year that the Dollar is the lynchpin for a migration away from US Dollar assets. Wall Street has outperformed by a wide margin from the perspective of international investors since 2008.

While “not that concerned about omicron as a major risk factor for equities,” the strategists led by Michael Wilson see headwinds building elsewhere, after Federal Reserve Chairman Jerome Powell signaled the possible accelerated tapering of asset purchases. “Tapering is tightening for the markets and it will lead to lower valuations like it always does at this stage of any recovery,” the strategists wrote in a note to clients.

Brian Nick of Nuveen, the investment arm of TIAA, with $1.3 trillion in assets under management, also said Monday that “the major risk to our outlook remains a sudden tightening of financial conditions if central banks are forced to respond to inflation driven by an overly tight labor market.” In contrast, most of the economic and market risks associated with the virus “are behind,” according to Nuveen’s outlook for 2022.

Other strategists, including those at JPMorgan Chase & Co., have also singled out a hawkish turn by central banks, and not Covid-19, as the main risk to their outlook for stocks. But while JPMorgan reiterated on Monday that its base-case scenario is for the equities rally to continue into next year, Morgan Stanley sees the S&P 500 trending lower, and valuations declining.

There is rising enthusiasm that the omicron variant is more transmissible, but less deadly than its predecessors. That lends further credence to the view the COVID virus is following the established pattern of becoming less deadly over time. From an evolutionary perspective, transmissibility is preferrable to killing the host, so this progression makes sense.

That suggests the end point of the pandemic is in sight. In just the same way we have vaccines and early treatment options for the flu, we will have the same for COVID possibly as soon as the next few months. The “bad flu” conclusion will be vindicated even if it depends on evolution to get there. That’s also the view of a group of doctors I had brunch with yesterday morning.

A year ago, I began a series of reviews of longer-term themes which will be updated going forward on the first Monday every month. The last was on October 1st. These reviews can be found via the search bar using the term “Secular Themes Review”.

One of the most basic truisms in the financial markets is it is easier to make money in a bull market. The bull market that began in late 2008 and early 2009 has been liquidity fuelled. That was not obvious to everyone a decade ago but now everyone gets the message. Money printing inflates asset prices. As long as central banks are printing, we will have bull markets and the most speculative assets will perform best.

In today’s Audio you stated that there was an increasing risk of deflation. This is unsurprising because the capitalist system rewards the production of cheaper and better goods, while the continuing industrialization of the under-developed countries maintains downward pressure on wages. Throw in the emergence of crypto currencies and one must ask if gold will ever regain its former status in the economic system. Your views would be appreciated.

Thank you for this question which is particularly topical as we look to the year ahead. This year has been notable for a significant uptick in inflationary pressures. The extraordinarily low base level of 2021 contributed enormously to the year over year change while the tsunami of liquidity ensured readings were above even the most ambitious forecasts. This has resulted in economic statistics hitting headlines for most of the year even though most of what has happened is a product of base effects and liquidity.

Anticipating a spike in inflation this month, ECB officials have redoubled efforts in recent days to reassure citizens that they are facing a once-in-a-generation cost-of-living squeeze that won’t endure, driven by energy and a series of one-time factors.

While President Christine Lagarde is sticking to that script, some colleagues are warning that price pressures might take longer to subside, stoking speculation about the future course of monetary policy. 

At a Dec. 16 gathering, the Governing Council is set to announce the end of its pandemic bond-buying plan and outline how regular purchases and interest rates will develop as the economy continues its recovery.

“While energy costs and statistical effects can explain the bulk of this month’s jump, today’s reading also revealed some stronger than anticipated underlying pressure. That will add to concern over upside risks to the outlook, but the ECB is still likely to see inflation falling below 2% by the end of next year.” - Maeva Cousin, senior euro-area economist. 

The spike in Eurozone inflation was expected even if the headline number was higher than estimates. The ECB believes inflation will drop back towards 2% once the pandemic subsides. At least they are dearly hoping that will be the case.

South Africa announced the identification of a new variant on Nov. 25, saying a few cases had first been identified in neighboring Botswana and then others had followed in Tshwane, the municipal area in which Pretoria is located. The announcement caused a global panic, roiling markets and resulting in travel bans on southern African nations.

Scientists advising South Africa’s government told a media briefing on Monday that while omicron appeared to be more transmissible, cases appeared to be very mild.

Coetzee’s patients have been relatively young. A vaccinated 66-year-old patient did return a positive test on Monday but was only mildly ill, she said.

Everything we have been led to believe over the last couple of years is that cold and flu viruses mostly evolve to be more transmissible because that furthers the urge to replicate all organisms share. Becoming less deadly is often a part of that because it aids in replication. That part of the argument is complicated by the fact that COVID does not kill before it is has ample time to replicate and disperse.

Global central bank interventions at the onset of the pandemic are still flooding the system with reserves while removing collateral from the market. 

In the U.S., much of the excess cash is currently being mopped up by the Fed facility, but that doesn’t solve everything and the government’s attempts to stay under its legislated borrowing cap by reducing bill issuance at the moment are exacerbating imbalances.

In Europe, meanwhile, governments simply haven’t got enough bills on issue, there isn’t a real equivalent to the Fed RRP facility, and the market mismatch has become clearer as banks rush to shrink their balance sheets ahead of year-end.

If the channels in Europe become clogged, then the “collateral shortage spills over into the FX swap market as euro depositors swap into dollars to park their cash in a deeper, more flexible collateral market,” Credit Suisse strategist Zoltan Pozsar wrote in a note to clients last week. 

The remedy, in Pozsar’s view, is for Europe to create its own mechanism that helps convert cash into collateral without using dealers’ balance sheets. That could be a Fed-like overnight RRP facility from the ECB and/or an injection of bills by the central bank, he said.

Absent that kind of fix, though, the risk is that pressures will continue flowing across the Atlantic for now.

Amid all the talk of inflation and the trend towards monetary tapering, it is also worth reminding ourselves that the world is awash in liquidity looking for a home. 3-month European yields are close to -1%. That’s a powerful incentive to find anything else to invest in. With the ECB signalling they have no intention of raising rates or abandoning monetary accommodation anytime soon.

6. How worrisome is this variant?
It’s too early to say. The World Health Organization said there are fewer than 100 whole genomic sequences of the new strain available, which could add to the time it takes to study how it compares to previous strains and its impact on Covid therapies and vaccines. Viruses mutate all the time, with the
changes sometimes making the virus weaker or sometimes making it more adept at evading antibodies and infecting humans. Covid vaccines have shown they are effective against previous variants and pills being developed by Merck & Co. and Pfizer Inc. may also provide new treatments. 

7. What should we look out for next?
In the U.S., which recently lifted a year-long ban on tourism from much of the world, top medical adviser Anthony Fauci said he wants to see more data. The European Centre for Disease Prevention and Control assigned the variant -- first detected in South Africa and Botswana -- the category “Variant of Concern.” BioNTech expects the first data from laboratory tests about how it interacts with its vaccine within two weeks.

This is the most important chart from the above article. It highlights how transmissible this variant it. From the available data, it is much more transmissible than the Delta or Beta variants and is already approaching dominance of South Africa cases. That implies it will spread around the world rapidly and within a month or at most two will be the dominant global strain.

The result is likely to boost the Reserve Bank of Australia’s confidence in the economy’s prospects as the board prepares to review the A$4 billion weekly pace of its bond-buying program in February. Su-Lin Ong at Royal Bank of Canada put the odds of quantitative easing ending at that meeting at 30%.

The capex data is “likely to see markets continue to price in multiple hikes over the year ahead,” said Ong, head of Australian economic and fixed-income strategy at RBC. Money markets are wagering the RBA will start its policy tightening cycle with a 15 basis point hike to 0.25% by May 2022.

Today’s report showed the Covid lockdowns weighed on outlays, with total capital expenditure slipping 2.2% in the three months through September from the prior quarter. Spending on equipment, plant and machinery fell 4.1%, suggesting it will detract from economic growth in the period. 

Australian firms are looking around the world and see massive monetary and fiscal stimulus. Much of that spending will be focused on infrastructure and they are in line to benefit from outsized demand for resources. This is the time to invest in new supply before everyone else does.

“The Communist Party is celebrating its 100th year — so is JPMorgan,” the bank’s chief executive officer, Jamie Dimon, said Tuesday at a panel discussion at the Boston College Chief Executives Club. “I’d make a bet we last longer,” reported Bloomberg News. 

And

In China, business dealings often come down to narrative. One day, a foreign bank is welcome, and its presence is seen as helping China improve its financial industry. The next day, the same enterprise could be painted as a predatory vulture. Words matter, and harmless intent or humor can be misconstrued in translation. Jamie Dimon has every right to tell a joke, but it always helps to know your audience.

The longevity and persistence of the Party are not topics of conversation in China. Jamie Dimon may as well have been using cartoons of the Prophet Mohammed in his PowerPoint. That’s the closest parallel for the gaffe committed yesterday. It is reasonable to expect JPMorgan’s prospective Chinese private banking clients to think twice before the starting a relationship. Retribution may not happen immediately but it will come.

Rates shock” in 2022 to follow “inflation shock” of 2021 and “growth shock” of 2020

Financial conditions set to tighten, short rates to rise, QE to end, inverted yield curve a threat, and EPS growth to slow sharply; GDP growth to remain robust with China as outlier

Base case for strategists is low or negative and volatile asset returns in 2022, after “18 months of fat (latterly frothy) returns in crypto, credit and U.S. equities”
2021-2022 investment backdrop is similar to early stagflation of late-60s

Stock market upside could continue if it becomes clear in 1H that Fed is determined to keep real rates deeply negative, “the-mother-of-all bubbles in crypto & tech remains a fat tail”

Biggest downside risk is Fed staying hawkish even if Wall Street corrects, because fears of wage-price spiral grow; more extreme downside risks include a crypto-derivatives crash, geopolitical events related to China and Taiwan, and that a receding liquidity wave exposes credit-events to the detriment of a private or public equity

I have seen a noticeable uptick in talk of a crash over the last couple of weeks. It might be early to think about this is as a consensus view, but it certainly suggests some investors are wary of chasing successive new highs in steep uptrends.

The world’s fish population is in a dire state, with about half of assessed stocks being overfished,
according to a study backed by Australian billionaire Andrew Forrest. 

The rate of depletion is worse than previous estimates of just over a third, Forrest’s Minderoo Foundation said in a report Sunday. A tenth of fish stocks worldwide is now on the brink of collapse, reduced to 10% of their original size, the study shows.

The findings are based on 48% of the total global catch for which there’s sufficient data, according to the report. The other half lacks information to say if they are sustainable or not. More than 1,400 stocks were assessed from 142 countries.

The journey to replenishing fish numbers isn’t easy. The report noted that it could take between three and 30 years for stocks to recover, and in many places that would require a major overhaul. The foundation recommended increased intervention and investment from governments, as well as better auditing and management practices from businesses.

Two important characteristics to the global fishery are worth considering. The first is overfishing which is a current problem and will likely get worse. The second is cyclicality. We have enough back data to conclude the Pacific goes through long warming and cooling cycles. Together with intense fishing, the current time is when we would expect to have lower catches of small pelagics like sardines and anchovy.

Let’s start with a proposition that one can prove with simple (if tedious) arithmetic: every deficit of government (spending in excess of revenue) is matched by a surplus across other sectors – households, corporations, and foreign countries – where their income will exceed their consumption and net investment. The chart below shows what this looks like. I’ve excluded some very small payment items for simplicity, but the basic upshot is simple: every time the government runs a deficit, you’ll see it directly reflected in the sum of three surpluses: personal savings, retained corporate profits, and trade deficits (a surplus from the perspective of foreigners).

Think of it this way. What a government deficit does is to direct goods and services produced by other sectors of the economy toward consumption and investment (including transfer payments to individuals, subsidies to companies, and public infrastructure) that has been approved by Congress. In return, the sectors that produced those goods and services receive income for output that they did not consume. This private surplus takes the form of securities, and in equilibrium, those securities are exactly the same ones (Treasury debt and base money) that the government issued in order to finance the deficit.

The red line in the chart below is essentially the federal deficit as a share of GDP (including amounts spent on transfers to other sectors). The blue line is the sum of personal, corporate, and foreign surpluses. The two lines are mirror images of each other because this sort of equilibrium is just arithmetic.

Already, investors may feel a bit sick here. See, the deficit that the U.S. government ran during the pandemic amounted to nearly 19% of GDP, and that – in equilibrium – is exactly why corporate earnings, personal savings, and trade deficits enjoyed a record surge in recent quarters. Meanwhile, the spending bills currently on the table ($1 trillion for infrastructure and $1.8 trillion for social and climate spending) are 8-10 year spending proposals, partially offset by revenue measures. There’s nothing in current legislation that’s going to replicate the breathtaking federal deficits we’ve seen in the past 18 months. That means – purely by the force of arithmetic – that the sum of those other three surpluses must shrink. The only question is which of the three will take that hit.

The hard fundamentals point to a sharply overvalued market, but bull markets don’t die of old age. They are most often assassinated by central banks. The next most significant cause of recessions is surging oil prices. The reality is bull markets thrive on liquidity and as long as the liquidity keeps flowing, valuations will continue to expand. 

DAOs are not a new idea. Vitalik Buterin, Ethereum’s co-founder and unwitting figurehead, contemplated Decentralized Autonomous Organizations in the original Ethereum Whitepaper in 2013. The DAO, a doomed decentralized venture fund, launched and folded in 2016. DAOs have been on fire this year within the web3 community; becoming a DAO is the de facto long-term fate of any sufficiently serious protocol. 

In October, a16z led a $10 million round in the popular DAO Friends with Benefits. A couple weeks ago, PleasrDAO bought a 1/1 Wu-Tang album for $4 million. Last week, the Ethereum Name Service (ENS) became a DAO and airdropped $2 billion worth of ENS tokens on anyone who’d bought a .eth domain over the past few years. Many people received $10s of thousands just for being an early adopter. 

But despite the early bright spots, most people have never heard of a DAO or bought into web3 yet -- it’s still very early. There’s still a struggle going on between web3’s fans and its skeptics, including many members of the US government. That’s not how it should be. America should be the home of web3, as @punk6529 eloquently laid out here: 

I’m sure those of us with a few grey hairs remember 2008 when securitization was a dirty word that was blamed for crashing the global financial system. The reason it created such a problem was it took groups of cashflows, treated them as a whole, they spliced them up into income streams with varying degrees of risk. Then smart people took that structure, leveraged it, and kept on leveraging it until it broke. Banks went bust all over the world and regulators swore it would never happen again. That’s why banks are less than eager to participate in these new ventures.

Kashkari said the move was “appropriate” and stressed that moving too quickly to remove the Fed’s support could end up hurting the economy more than it helps on the inflation front.

“When we adjust monetary policy it acts with a lag,” he said. “So if we overreact to a short-term price increase, that can set the economy back over the long term.”

Kashkari, who doesn’t vote this year on the policy making Federal Open Market Committee, said he expects heightened demand connected to previous fiscal stimulus and supply constraints caused by the pandemic to slowly ease. 

Asked about President Joe Biden’s pending decision whether to reappoint Fed Chair Jerome Powell to another four-year term, or perhaps choose Fed Governor Lael Brainard to succeed him, Kashkari said both are capable and would be likely to pursue similar monetary policies.

“Both of them have been instrumental in the new framework that we’ve adopted in terms of not shortcutting the recovery, and I’m confident that either of them as chair would continue to see that through,” he said.

Kashkari is one of the biggest doves at the Fed but he is not short of company considering the trajectory of policy. Regardless of who is in charge, the set of challenges that need to be addressed will not change. The economic recovery is uneven with labour force participation declining while the number of job opens is climbing. That’s not going to be fixed by monetary policy.

Second point I would make is that the usage of fiscal and monetary policy to bridge to the other side of this epidemic has been pretty extraordinary and beyond anything I’ve ever seen, certainly, in the investment universe. I would say generally well-designed, flexible, more than adequate, in order to minimize social and economic disruption. And you think about the backdrop of when you pull monetary and fiscal together, not just in the US, but globally—I mean, you pressed into the system immense amounts of liquidity. But just to put a couple of these numbers in the backdrop into perspective, today versus 20 years ago—20 years ago there was less than $3 trillion of liquidity in the system—in dollar equivalents, 6% of GDP. It’s now $40 trillion or just under 50% of GDP.

So, first thing, from an investment point of view, that liquidity is completely different. And then, how do you invest? And now, you think about you’re probably on the back side of that. And then finally, to wrap up, I’ll pass it to Ray for his better, bigger-picture thoughts than mine, I would throw out: how do you think about global and political tensions on the back side of what I just described? Supply-chain breakages, the dynamics around how do you think about your domestic trade, how do you think about your domestic ecosystem, which I think you’ll see some stress based on, you know, how have you operated internationally over the last few decades? So, big consideration, I think, is going to be how do you think about political tension, and how do you think about sovereign or regional dynamics? Maybe a bit more profound and different than we’ve seen over the last couple of decades. So, with that, I’ll pass it to Ray for his big-picture thoughts on these things.

Capital is both global and mobile, so it flows to the most attractive assets wherever they may reside. With liquidity representing 50% of global GDP there is a clear incentive to invest in capital intensive industries that will bear fruit long into the future.

“We haven’t seen, I’ll say, any more resistance to our price increases than we’ve seen historically.” -- McDonald’s Corp. CFO Kevin Ozan, Oct. 27 earnings call

“Looking at Q4, we expect our selling price actions to continue to gain traction, as we work to mitigate the raw material and logistics inflationary pressures we have experienced throughout the year.” -- 3M Co. CFO Monish Patolawala, Oct. 26 earnings call

“We feel very comfortable that any inflation that is affecting our margin today, we have the ability to offset it.” - Chipotle Mexican Grill Inc. CFO John Hartung, Oct. 21 earnings
call

“We have now announced pricing in nine out of ten categories, so very broad based.” -- Procter & Gamble Co. CFO Andre Schulten, Oct. 19 earnings call

While most CPI categories rose, the cost of airfares declined for a fourth month and apparel prices were unchanged. Wages have strengthened markedly in recent months -- with some measures rising by the most on record -- but higher consumer prices are eroding Americans’ buying power. 

Inflation-adjusted average hourly earnings fell 1.2% in October from a year earlier, separate data showed Wednesday.
 

The ability of companies to pass on inflation is a good reason why the stock market generally does well in the early portion of an inflationary cycle. The big question therefore is not whether they can successfully pass on one price increase but whether they can continue to pass on price increases should inflationary pressures trend higher.

But the White House has raised the possibility with some Senate Banking Committee members that Powell might not be reappointed, according to two people familiar with the matter. Discussing the chairmanship with Brainard could signify that the Biden team is weighing how a break with Powell might
help advance their goals for the central bank. Brainard and Powell work closely together on multiple issues and are viewed as holding similar views on monetary policy, but she’s favored a tougher stance on big banks.

If he chose Brainard, Biden would be nominating someone who would excite Democrats in Congress but put Republicans and large banks on edge -- setting up a tougher confirmation battle in the Senate, where Democrats command only 50 of the 100 seats. Still, Vice President Kamala Harris would be able to cast a tie-breaking vote.

The progressive wing of the Democratic Party was intent on forcing the infrastructure and big social spending bill to be passed together. By breaking from that policy, the Biden administration successfully passed the infrastructure bill over the weekend, but will also have angered the progressives. Courting Lael Brainard for the position of Fed chair and the potential to appoint progressive-friendly people to the Fed board will likely be used as a way of keeping that wing of the party on side.

Gains in Treasuries may be partly driven by short-covering, which appears to have contributed to Thursday’s U.K.-led rally. CME Group Inc.’s preliminary open-interest data for Treasury futures show steep declines, in particular for the two-year note contract. Open interest in two-year note futures fell 2.3%, its biggest drop in three weeks.

Fed officials continue to emphasize that inflation is too high even as they hope to foster labor-market recovery by keeping interest rates low.

Federal Reserve Bank of Kansas City President Esther George Friday said “the risk of a prolonged period of elevated inflation has increased,” and “the argument for patience in the face of these inflation pressures has diminished.”

The declines in 10- and 30-year yields -- which fell as much as 6.5 basis points to 1.899%, the lowest since Sept. 23 -- come despite next week’s auctions of those tenors. The auctions, whose sizes were announced on Nov. 3, are smaller than the previous new-issue auctions in August, however. The reductions were the first since 2016.

The longer-term inflationary trend is being driven by wage demand growth and the upward pressure on the cost of housing and rents. However, it does not all happen at once, and some of the supply inelasticity factors that contributed to inflation over the last year are easing.

For Opendoor, Zillow’s departure represents an opportunity, CEO Eric Wu said in an interview. He expects his company, which pioneered the iBuying model, to be the market leader now that the best-known brand is out.

“We’re going to lead the charge in this transition from offline to online,” he said in an interview.

Wu said Opendoor has invested heavily to build expertise in home pricing and getting renovations done in a timely, cost-efficient manner. Those challenges contributed to Zillow’s iBuying demise.  

On Oct. 17, Bloomberg reported that the Seattle-based company would stop pursuing new acquisitions for its iBuying business, citing shortages of workers and supplies it needed to fix up homes. But Zillow also struggled to get pricing right. The company bought many homes for more than it could sell them for, forcing it to take writedowns of more than $500 million on property inventory. 

Those results convinced Zillow CEO Rich Barton that the iBuying model was too risky for his company.

“Fundamentally, we have been unable to predict future pricing of homes to a level of accuracy that makes this a safe business to be in,” Barton said on the company’s earnings call this week.

Anyone using Zillow’s app to look at houses over the last year will quickly have realised how inaccurate the “Zestimate” score is for gauging a home’s value. It was in no way reflective of the market condition because it was not adjusting quickly to new selling prices for homes. That resulted in differences of over 20% when we were housing hunting in the spring. That would also have forced Zillow’s algorithm to be manually adjusted to cope with the lag of data which obviously created issues.

Frankfurt, Toronto, and Hong Kong top this year’s UBS Global Real Estate Bubble Index, with the three cities warranting the most pronounced bubble risk assessments in housing markets among those analyzed. Risk is also elevated in Munich and Zurich; Vancouver and Stockholm both reentered the bubble risk zone. Amsterdam and Paris round out the cities with bubble risk. All US cities evaluated— Miami (replacing Chicago in the index this year), Los Angeles, San Francisco, Boston, and New York— are in overvalued territory. Housing market imbalances are also high in Tokyo, Sydney, Geneva, London, Moscow, Tel Aviv, and Singapore, while Madrid, Milan, and Warsaw remain fairly valued. Dubai is the only undervalued market and the only one to be classified in a lower category than last year. On average, bubble risk has increased during the last year, as has the potential severity of a price correction in many cities tracked by the index.

Hot but likely short-lived fireworks
House price growth in the cities analyzed accelerated to 6% in inflation-adjusted terms from mid2020 to mid-2021, the highest increase since 2014. All but four cities—Milan, Paris, New York, and San Francisco—saw their house prices increase. And double-digit growth was even recorded in five cities: Moscow; Stockholm; and the cities around the Pacific, Sydney, Tokyo, and Vancouver.

The methodology of taking the price of an apartment in the downtown area of a city is certainly convenient. However, for markets like Los Angeles, it does not fully reflect the dynamics of the market. There is no doubt that the price of apartments has risen significantly in the last decade, it is also true that some of the city’s cheapest pieces of real estate lie within a couple of miles of downtown. In fact, the further one gets from downtown the higher the price per square foot gets.

Australia’s sovereign bond yields surged Thursday after the central bank chose not to defend its yield target, raising speculation that it could adjust its policy guidance next week. 

The rate on the April 2024 note more than doubled, jumping as much as 30 basis points to 0.51%. That took the gap to the Reserve Bank of Australia’s 0.1% target to the widest since yield control was introduced in March 2020.

Governor Philip Lowe and his peers are being challenged by market expectations that they’ll need to tighten policy more rapidly than previously thought. Data Wednesday showing Australia’s core consumer prices rose at the fastest pace in six years helped spark a flattening in global sovereign yield curves, with Bank of Canada adding to the impetus by signaling a rate hike as early as April.

“I think if the RBA doesn’t step in to buy the April 2024 bonds tomorrow, then the risks are certainly increased that the RBA will announce a change to its forward guidance next week,” said Hayden Dimes, an economist at ANZ Banking Group “Not buying bonds tomorrow will fuel the markets expectation that next week Governor Lowe will move away from his guidance of no rate hikes till 2024.”

Yield curve control didn’t last very long in Australia. Today’s upward dynamic in short-dated yields suggests the RBA is abandoning the policy and preparing the market for interest rate hikes.