The week looked sunny for the economy: Jobs were hot, barometric pressure in unemployment remained stable, but the weather around the horizon looks threatening at best, and there is a cold layer of atmosphere about to flow over the top of this heat bubble …
The week arguably offered some clarity on key facets of today’s murky financial, economic and policy backdrops. At this point, the U.S. economy is anything but falling off a cliff. A stronger-than-expected 390,000 jobs were added during May (April’s revised slightly higher to 436k). The unemployment rate was unchanged at a multi-decade low 3.6%. Wednesday’s JOLTS data registered a larger-than-expected 11.4 million available jobs in April, down from March’s (revised higher) record 11.855 million. At 200,000, weekly unemployment claims remain exceptionally low from a historical perspective.
Some pointed to the 0.3% monthly gain (5.2% y-o-y) in Average Hourly Earnings as indicating waning wage growth momentum. Unprecedented labor market tightness will keep pressure on companies to continue to boost pay to attract and retain workers. And there is little reason to believe Wage/Price Spiral Dynamics will offer Fed officials much breathing room anytime soon. There are segments of the economy that will be absolutely booming this summer.
The strongest pushback to the recent dovish tightening cycle narrative was delivered Monday by Fed Governor Christopher Waller.
May 30 – Reuters (Lindsay Dunsmuir and Tom Sims): “The Federal Reserve needs to move interest rates much higher and soon if high inflation does not begin to subside, Fed Governor Christopher Waller said… ‘If inflation doesn’t go away, that… rate is going a lot higher, and soon,’ Waller said… ‘We are not going to sit there and wait six months…I am advocating 50 on the table every meeting until we see substantial reductions in inflation. Until we get that, I don’t see the point of stopping.’”
A similar view was espoused by Vice Chair Lael Brainard: “From where I sit today, market pricing for 50 bps, potentially in June and July, from the data we have in hand today, seems like a reasonable path. Right now it’s very hard to see the case for a pause. We’ve still got a lot of work to do to get inflation down to our 2% target.” Cleveland Fed president Loretta Mester also weighed in: “I’m going to come into that September meeting and if I don’t see compelling evidence, then I could easily be a 50 bps in that meeting as well.”
We also learned this week that JPMorgan CEO Jamie “storm clouds could dissipate” Dimon is not the optimist portrayed by the media last week.
June 1 – Bloomberg (Sally Bakewell): “JPMorgan… Chief Executive Officer Jamie Dimon warned of a ‘hurricane’ as the economy struggles against fiscally induced growth, quantitative tightening and Russia’s invasion of Ukraine. Dimon, who had said in May that there were storm clouds looming over the US economy, said he wanted to change that assessment given the challenges faced by the Federal Reserve as it braces for an unprecedented environment.”
Dimon: “It’s a hurricane. Right now it’s kind of sunny, things are doing fine, everyone thinks the Fed can handle this. That hurricane is right out there down the road coming our way. We just don’t know if it’s a minor one or Superstorm Sandy – or Andrew. You better brace yourself.”
I’ll place my bet on Sandy-like. And that’s the Fed’s historic predicament. There’s a Cat Five Hurricane lurking somewhere out there, yet the various models – unreliable in the best of times – these days greatly diverge in the timing, size, location and ferocity of Hurricane Peerless’ landfall. Meanwhile, each month of elevated price pressures ensures inflation becomes more deeply entrenched and difficult to contain.
WTI Crude jumped another $3.80 this week to $118.87, the high since the March price spike, and boosting 2022 gains to 71%. Heading into the busy summer driving season, Gasoline futures jumped another 5.9% this week to a record high, while increasing y-t-d gains to 91%. And while Natural Gas declined 2.3%, prices are still up 129% this year.
The bond market’s dovish Fed narrative relief rally was notably short-lived. Ten-year Treasury yields surged 20 bps this week to 2.96%. In general, the prospect of Hurricane Peerless has maintained downward pressure on bond yields. And low market yields and loose financial conditions continue to support elevated inflation. At some point, however, I expect bond market focus – Hurricane Peerless notwithstanding – to gravitate to increasingly ingrained inflation dynamics.
Importantly, elevated inflation is unrelenting – and it’s global. “Eurozone inflation hit a record 8.1% in May amid surging energy and food costs” (from AP) – as German consumer inflation hit a record 8.7%. Meeting next Thursday, the Apathetic ECB is widely expected to delay the start of baby-step (25bps) rate increases until next month. Despite a few outspoken hawks, Christine Lagarde and the doves are not dissuaded. From Bloomberg (Alexander Weber): “Italy’s Ignazio Visco pushed back on Tuesday against the prospect of a more aggressive rate step, saying the ECB must proceed in an ‘orderly’ manner to avoid potential bond-market turbulence.”
“Potential bond-market turbulence”? Even with steadfast ECB dovishness, European bond-markets are turning increasingly disorderly. I wonder how Bank of Italy Governor Visco processed Italian 10-year yields surging a disconcerting 50 bps this week to 3.40% – up 131 bps in nine sessions to the highest yield since November 2018. Portuguese yields jumped 40 bps (110bps in 9 sessions) to 2.47%, the high since September 2017. Spanish yields rose 40 bps (97bps) to 2.44% (high since August 2014).
Importantly, this is not a typical bout of periphery bond bludgeoning. French yields jumped 32 bps (78bps in nine sessions) to 1.80% – the high since June 2014. German bund yields rose 31 bps to 1.27% (72bps), also the high since June 2014. Moreover, German two-year yields surged 30 bps to 0.64%, the high all the way back to November 2011.
UK yields rose 24 bps to 2.16%, the high since June 2014. Canadian yields jumped 28 bps to 3.06%, and Australian yields rose 23 bps to 3.48%. EM bonds were not spared. Yields jumped 28 bps in Romania, 25 bps in Mexico and 25 bps in Peru. In dollar-denominated bond land, Mexico’s yields rose 17 bps and Brazil 25 bps.
Are European yields – embarking on another leg higher as the ECB drags its feet with interest rates still negative – foreshadowing a surge higher in U.S. and global yields? Are we now witnessing a not so subtle shift to bond markets losing patience with wimpy inflation-fighting monetary policies? And bonds reacting more constructively to hawkish monetary policy would be one more dynamic suggesting a major cycle change. When push comes to shove, bond markets will be the greatest priority of central bankers.
I’ll stick my neck out with the view that bonds have commenced a new bear market phase. There is newfound recognition that global central bankers lack the fortitude to mount the type of aggressive fight required at this point to rein inflation in. It is also becoming clear that inflation is in a secular upswing that will likely prove resilient even in the face of faltering financial Bubbles and weakening economies. Energy, food and commodities are fundamentally altered in today’s “iron curtain” world, while markets and supply chains for many things (including “tech”) are in the crosshairs.
June 1 – Bloomberg: “A deluge of new special local government bonds worth more than an entire year’s supply pre-pandemic may hit China’s debt market this month as the country revs up infrastructure investment to support the Covid-battered economy. Regions in China already have issued a combined 1.97 trillion yuan ($295bn) of new special debt from January to May… Given Beijing’s order to use up the rest of this year’s 3.65 trillion yuan quota by the end of this month, that leaves 1.68 trillion yuan worth of bonds to be sold, more than what was issued in all of 2018.”
June 2 – Bloomberg: “Chinese banks are facing growing pressure to support cash-strapped developers after months of pleas by regulators failed to boost lending to the industry. Local branches at the People’s Bank of China have called for meetings with banks in multiple cities since last week to assess why loans have slowed, along with the difficulties faced by banks and how regulators can help… The move represents increasing concern from officials following repeated so-called window guidance for faster property lending in previous months, the people said…”
June 2 – Bloomberg: “Beijing is turning to state-owned policy banks once again to help rescue an economy under strain, ordering them to provide 800 billion yuan ($120bn) in funding for infrastructure projects. The stimulus, announced at a State Council meeting chaired by Premier Li Keqiang, could help finance a significant chunk of infrastructure costs this year and give some relief to local governments grappling with plunging revenues. President Xi Jinping has called for an all-out effort to boost infrastructure this year, turning to an old playbook of driving up growth through public investment. Funding the extra spending has proven to be tricky though, after a plunge in land sales and widespread Covid outbreaks battered government revenue.”
Copper was up 3.8% this week. Platinum surged 6.2%, while lead, nickel, tin and zinc all posted strong gains. Are the industrial metals responding to Chinese stimulus prospects? Beijing appears to have finally hit the panic button. The upshot could be massive, prolonged and historic fiscal stimulus.
I recall years of “bridges to nowhere,” as Tokyo responded to Japan’s collapsing Bubble. China’s Bubble has been at a whole different level. Moreover, Japan wasn’t fixated on achieving global economic and military superpower status. There was no life and death “arms race” – economic, military and geopolitical – with the U.S.
Beijing is increasingly assuming a war footing, an economic and financial war that could easily escalate into a hot war. For China’s communist leadership, the stakes apparently couldn’t be greater. Especially in response to the unfolding geopolitical backdrop, I expect Beijing to counteract faltering Bubbles with overwhelming force and determination. And we can assume inflation is not today at the top of their list of concerns.
For the past couple of years, I’ve posited vulnerable Chinese Bubbles were a significant factor in restraining Treasury and global bond yields in the face of mounting inflation risk. Today, collapsing Bubbles still pose disinflationary risks. Increasingly, however, there is a risk of a powerful countervailing inflationary impetus out of China. I can certainly see the possibility of Beijing compelled to administer aggressive shock therapy stimulus, as it attempts to reverse the profound “Covid zero” hit to general confidence.
Moreover, the Ukraine war and unfolding “iron curtain” dynamic elevate the risk that massive Chinese stimulus measures exacerbate global inflationary impulses. Ponder how things have evolved: A year ago, the preponderance of risk was with a collapsing China Bubble unleashing disinflationary forces upon a world of relatively contained inflation. As recently as four months ago, a faltering Bubble would counter heightened global inflation.
Now, following the Ukraine/Russia War, “Covid zero” lockdowns and surging worldwide inflationary impulses, a disparate risk profile has emerged. Beijing now appears poised to embark on historic stimulus measures in a world of powerful and increasingly embedded inflationary forces. As such, the likelihood of disinflationary outcomes has significantly receded, with this dynamic now being priced into global bond markets.
U.S. equities and corporate Credit were resilient this week in the face of surging Treasury yields. High-yield spreads (to Treasuries) traded below 400 bps for the first time in a month, down from 481 bps on May 24th. After the slowest May in twenty years, the junk bond market was open again for new issues. At more than $7 billion, this week’s issuance was “the busiest since mid-January.”
But this could be the eye of the storm. Wind and rain reemerged Friday. High-yield CDS rose 13 bps (after collapsing 66 bps the previous week), as junk spreads widened nine bps. The Semiconductor (SOX) dropped 3.0% in Friday trading, with the Nasdaq100 down 2.7%. The unimpressive crypto rally also ran aground. Tesla was slammed 9.2% in Friday trading, with Micron down 7.2%, and Etsy falling 7.2%. No reason to back away from the bursting tech Bubble thesis.
Friday offered inklings of Hurricane Peerless. I have posited for a while now that highly levered contemporary markets are acutely vulnerable to a surge in Treasury yields, accompanied by a risk-off jump in CDS and options prices, along with widening Credit spreads. It is this combination that is most problematic to a wide range of levered strategies. And the announcements from hedge funds hit by big losses are starting to pile up – which equates to heightened industry-wide vulnerability.
It’s now definitely not a low probability scenario: yields spike on heightened inflation concerns, exacerbating faltering Bubbles (certainly including “tech”) at home and abroad. And with the general economy resilient and inflation relentless, the Fed would remain focused on its inflation-fighting credentials. The Newly Amorphous – and Precarious – Fed Put.
It was another week where it seems the U.S., the global epicenter of technology development and excess, has become the proverbial eye of the storm. A faltering dollar would be a feature of the Hurricane Peerless scenario, providing additional fuel to global commodities booms, while weakening international confidence in U.S. securities markets and policymaking. It’s as if everyone is prepared to hold their ground – determined to enjoy a tranquil summer market respite (trying really hard not to think ahead to the Autumn Market Hurricane Season). I wouldn’t bank on peaceful: long, hot and illiquid summer; lots of storm warnings.
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