Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Massive Retail Capitulation
This week, TSLA equity traded 61% below the 200-day moving average, the most in a decade — Tesla reports Q4 unit sales before trading starts Tuesday, January 3rd.

Tesla vs. CAT, the Mad Rush into Industrials
Investors are falling all over themselves to exit tech stocks and increase exposure to industrials. Hard asset plays have dramatically outperformed financial assets – and long-duration “growth” equities. The street is looking for $112B of sales in 2023 vs. a $384B equity market capitalization for TSLA stock.  She used to trade at 80x sales, just wow.

A $1T Loss?

If TSLA touches $98, the market cap loss is near $1 trillion,  she traded at $105 pre-market this week. Close to $25B value of shares traded Tuesday, more than Apple, Amazon, Microsoft, and Google combined. Nearly 700m shares in 3 days this week, that´s 25% of the float. This is an epic retail exit – tax loss selling. Daily RSI was near 17 this week, the lowest of all time for this capitulation measuring stick. Tesla was 5th largest in the S&P, now 18, now less than UNH, Lilly, and Chevron. If you sell TSLA equity in December – the investor can buy the stock in 31 days and still book the loss for tax purposes. In years with LARGE Q4 equity market losses – the “January Effect” can be fairly impressive. Looking back over the last 50 years – when you have a down December, stocks are up 1.2% in January. Since 1991, with stocks off more than -2% in December, they have been up +3.7% on average in January, Bloomberg terminal data. 

**The January Effect is a tendency for increases in stock prices during the beginning of the year, particularly in the month of January. The cause behind the January Effect is attributed to tax-loss harvesting, consumer sentiment, year-end bonuses, raising year-end report performances, and more. – CFI.

“Historic forced by margin calls for Tesla – it´s all retail Larry, ALL retail – rather than sentiment shift, see large scale TRF (Schwab, Ameritrade, etc) volume. The SIZE TSLA margin calls are forcing (triggering) ALOT of cross-selling through the entire long duration – speculative equity campgrounds.” — Equity Portfolio Manager on the West Coast, in our Bear Traps Portfolio 

TSLA normally reports quarterly unit sales in the first weekend after the end of each quarter. Consensus is looking for a total of ~420K cars sold (down from 450K est. a few weeks ago). Given that New Year falls on the weekend, there is some uncertainty as to when exactly TSLA reports Q4 unit sales. We believe either Monday or Tuesday, January 3rd around the market open is most likely.

Previous January Report Date / Time

Sunday 1/2/2022 11am Stock +13.5% the next day
Friday 1/2/2021 9:55am Stock +3.4% the next Monday
Friday 1/3/2020 8:17am Stock +3% that day
Wednesday 1/2/2019 8:34am Stock -1.5% that day

Is Team Biden coming to Tesla’s Rescue?

At the start of the new year, buyers will once again enjoy a tax credit when they purchase a Tesla vehicle. The original 2010 EV tax credit had a quota of 400K units. For Tesla, the tax credits fully disappeared in early 2020 when Tesla reached that unit sales quota. But thanks to the Inflation Reduction Act (IRA) that Congress passed earlier this year and Biden signed yesterday, the tax credits are back in 2023. In the IRA there is a $7,500 tax credit for buyers of EVs, including TSLA and GM, who lost their previous tax credits. However, there are other strict limits on which brands would be eligible for the full credit, based on the selling price and where the cars and components are made. Unless the car is made in North America (NAFTA), the buyer is not eligible for the full tax credit. In addition, at least 50% of the battery parts will need to be made in North America. Lastly, a minimum of 40% of minerals used in the batteries must be sourced from the US or countries with free trade agreements with the US. So even buyers of GM and Tesla cars might only be eligible for half ($3,750) of the tax credit because their batteries and minerals come from a “foreign entity of concern” (China/Russia).

However, the Treasury Department recently said that the final decision on the critical minerals’ requirement won’t be available until March. As a result, all the requirements in the IRA governing EV cars, minerals, and parts will be waived. This means that, until Treasury issues its final set of rules, it will allow the full $7,500 tax incentive on all qualifying models.**

“We don’t expect them to reach 400K (unit sales) in Q4, data comes next week – early January. But, we also don’t think they always tell the truth. So, who knows? The IRA (Inflation Reduction Act) is about the only thing here between TSLA and a complete collapse in demand from what we can see. Also, many other countries have subsidies that are ending on December 31st. So, TSLA is benefitting from demand pull forward in those other countries. That will reverse in the March quarter, and may offset some of the benefits stated by the bulls.” CIO, Large Fund.

So, prospective EV buyers in the US will be extremely motivated to buy their EV before the Treasury issues their final list of requirements in March, as it could potentially save them thousands. We could therefore see demand for Tesla cars and other EVs (2 out of every three EVs sold in the US are Tesla’s) being pulled forward into Q1.

Musk is keenly aware that all this might have led EV car buyers to postpone purchases until Q1 and he increased year-end rebates to $7,500 and 10K miles of free charging in early December. Whether this was enough to meet Tesla’s estimates for 420K unit sales for Q4 remains to be seen. We will know this before trading starts on January 3. But the IRA waiver could still cause a burst in US sales in early 2023.

This is not the only boon for Tesla starting next year. The EPA is proposing to increase the cellulosic ethanol component in the renewable fuel standard will climb to 2.13 billion gallons from 630 million. Refiners will be allowed and by necessity required to comply with these mandates by buying “eRINs” credits from EV manufacturers. Since Tesla has by far the most EV cars on the road, refiners will have to buy most eRINs from Tesla.

In years past Tesla always boosted gross margins from “Zero Emission Credits” that other car makers bought from Tesla to offset carbon emissions. Now the administration is giving Tesla another back door subsidy, although it is yet unclear when these rules go into effect.

** EV and plug-in models were manufactured in North America in the 2022 and 2023 model years that DOE says are eligible: Audi, BMW, Chevrolet, Chrysler, Ford, GMC, Jeep, Lincoln, Lucid, Nissan, Rivian, Tesla, Volvo, Cadillac, Mercedes and Volkswagen. Yet because of price limits or battery-size requirements, not all these vehicle models will qualify for credits. Note that IRS details issued on Dec 29 indicated that only 20% of Model Y would be eligible for full tax credit, unless Tesla lowers their price on certain versions of the Y.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

At 9 am Friday morning, the WSJ’s Nick Timiraos made a market-moving call from the highest mountain.  The talented financial journalist — a classic pawn of the Fed — startled investors from the beaches on Long Island to the skyscrapers of Japan. After talking up extremely aggressive (rate hikes) action from the U.S. central bank for much of the last five weeks – Nick published a piece that pushed back against excessive rate hike expectations and suggested the Fed is not going to overcook the Porter House.  An hour later, the BoJ (Bank of Japan) comes in and starts a massive forex intervention, pushing the yen up 3% in the span of an hour. Coincidence? It was an “inside job” — let us dig in.

Catastrophic Damage Potential
In our view, Joe LaVorgna is the best economist on Wall Street, he shared this important chart with clients this week. “Interest-rate changes have their peak effect on growth in about one year and on inflation in three to four years. “ IMF Paper recently released. 

Over Cooking the Porter House 

More than 300bps of rate hikes in six months, $50T more debt on earth since 2018 – how does one calculate the damage? The MOST important fact of the day, week, and month?  The Federal Reserve DOES NOT know the extent of the damage they have ALREADY inflicted!

“It always takes 6-12 months to quantify a move in rates impact on the underlying economy – thus central bankers most often over ease and over-tighten” – Milton Friedman.

Yen Move and its Connectivity
The U.S, ten-year bond yield (orange) vs. Japan´s yen (blue)  — Always, always. Always, always connect the dots. There are no coincidences. The Fed, the White House, the Wall Street Journal, and the Bank of Japan – were all working closely together on Friday morning.

Yen Move vs. Gold Miners
The prospect of a softer Fed policy path juiced gold miners on Friday.  The probability (interest rate futures) of another 75bps rate hike in December plunged from 65-70% to 25-30% and February´s formerly expected 50bp hikes fell from 50% probability to 25-30%.

“When former Federal Reserve Chair Paul Volcker took office in the summer of 1979 and quickly pushed interest rates to about 20%, it brought an almost immediate recession, but inflation took about three years to fall to manageable levels.” IMF

BOJ and Fed – all Together
Bank of Japan – after their first intervention failed – they brought in the Fed for support in round #2.

No Coincidences

All the drama was no coincidence – since August – many market participants have piled into the same trades, a) Yen weakness – USD strength, b) yields up – bonds down, c) equities lower. This has been the playbook – a classic over-crowded trade. Suddenly the Fed pushes back against excessive hawkish market expectations, opening the door for BoJ to buy up the yen, thus forcing position unwinds.  The BOJ wants and needs Fed support after their last – failed attempt to support the yen a few weeks ago. We believe they put a phone call in to Fed chair Powell seeking important, corroborating support.

Midterm Elections and the Market Bounce
The Nasdaq is close to 9% off the October lows – Why now?

White House Makes the Call
US PredictIt 2022 Senate Party Control Republican — The White House is as nervous as a long-tailed cat in a room full of rocking chairs. After months of kicking ass on the chances of keeping control of the U.S. Senate – there has been a fierce reversal.

More Dots to Connect – Asset Prices and Elections

The Fed was put on notice from the highest levels – White House officials were knocking on Fed chair Powell´s door this week. They couldn’t get OPEC to help oil prices lower, to support the inflation fight. Now politically – the S&P MUST move higher ahead of the BIG DAY on November 8th.  Midterm elections are won and lost in suburbs, where 401Ks are even more important than the price at the pump. If you are inside the Biden White House – you desperately want equities higher, and fast and soon. 

“San Francisco Fed President Mary Daly Says More Rate Hikes Needed, Dismisses ‘Pivot’ Talk” MarketWatch – October 5, 2022

Just after lunch on Friday it was Mary Daly, president of the Federal Reserve Bank of San Francisco. Daly stressed, “We don’t want to be too reactive;  one can easily find yourself overtightening.” — “we don’t just keep going up at 75 bps increments, we will do a step-down, not to pause, but to 50 bps or 25 bps increments.” This is a SHARP reversal from Daly´s comments above from October 5th. 

Quiet Period

“Heading into the quiet period – which started Friday evening – the Fed started to lay out a policy path shift to help support asset prices during the quiet period.” CIO NYC in our live chat.

Later in the afternoon – James Brian Bullard – the chief executive officer and 12th president of the Federal Reserve Bank of St. Louis came barreling in with further evidence of a coordinated policy path shift.  He stressed the Fed should use more caution next year. Bullard is looking for a disinflationary process going into 2023. The slowdown in money growth is a positive factor for inflation. The Fed wanted to calm markets on the eve of their blackout period (which started Friday night, no more Fedspeak) ahead of their Nov. 1-2 policy meeting. This is an extremely dovish sales pitch relative to PREVIOUS – extremely hawkish expectations – “You’ve come off zero. You’ve gone to this much higher level of the policy rate. But once you’re at the right level, then you can just make minor adjustments at that point — maybe to stay where you are, maybe to go a little bit higher, based on incoming data,”

The Fed Just Opened the Door to a Softer Policy Path

“This judgment about where you need to be to put meaningful downward pressure on inflation, I think that’s a key part of the policy debate in the next two meetings.”

Fed governor Mary Daly said that policymakers should start planning for a reduction in the size of rate increases, though it’s not yet time to “step down” from large hikes. This is a SIGNIFICANT shift.

“It should at least be something we’re considering at this point, but the data haven’t been cooperating,” Daly said during a moderated discussion hosted by the University of California Berkeley on Friday. At the November meeting, “we might find ourselves, and the markets have certainly priced this in, with another 75 basis-point increase, but I would really recommend people don’t take that away as it’s 75 forever. A slowdown to more incremental increases of 50 or 25 basis points will be appropriate as the Fed’s benchmark rate gets closer to its terminal level for this hiking cycle, Daly said, per Bloomberg.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Economic Signposts

Classic economic bellwether – UNP is close to 9% lower in two days – this is an extremely important leading indicator.

“US railroad workers prepare for a strike as rail companies see record profits – As Biden’s recommendations fall flat, negotiations between management and unions are at an impasse – and workers are prepared to walk.” The Guardian

September 15 Update – File Under NOT Deflationary – Freight – Rail Labor “Deal” includes – a 24% wage increase over 5 years, including a 14.1% effective immediately, as well as five annual bonus payments – National Carriers Conference Committee.

*Inflation is juicing labor bargaining power, and demands.

Secular Trends – Headwinds for Equities
A large bear reversal in the classic economic bellwether, UNP – major technical fail. Some would say labor threatened national strike risk is high, which is true and obvious, but the larger picture is the power of labor, back to 1960s era strength. Many equities are NOT priced for a secular change in the power of labor, indeed.  This week, street research is picking up on macro crosswinds, a pending reset in the rails and trucking market, and stubbornly high labor inflation juices the risk of top-line growth and margin expansion into 2023.

“What makes inflation sustainable? Inflation has a traditional pattern: an exogenous shock (war, pandemic, an oil embargo, what have you); followed by the rise of the power of labor in the form of wage inflation; followed by the government mucking things up.  An example of the latter, to pick one among many, is that not only are there not enough trucks and truckers but there are not enough parking spaces for the truckers to park their vehicles. Why? Because of restrictions on how close trucks can park to highways (where, naturally, there is plenty of space for them to park!).” Bear Traps Report, January 2022.

Labor Power vs. Profit Margins
Bernstein notes – “labor cost inflation for agreement workers will at best be the worst we have seen since de-regulation.” The Street is still looking for $244 (down from $258) in S&P 500 eps next year. The SPX is at 3950 ish, that´s a PE of 16.2x — a very pollyannish 2023 earnings outlook. Sure nominal earnings are helped by inflation but, real bottom line earnings get hammered in an inflation-enhanced “power of labor” world. 

A Look Back at Labor

While Covid is nowhere near as bad as the Black Death of the mid-14th century, precisely because the latter was more extreme, its ramifications are easier to see and learn from. In 1348 the plague crossed into England and wiped out half the population. With fewer peasants and serfs, labor was in scant supply and the peasants, and those serfs that could escape the manorial estate or had fulfilled their obligations to their lord, charged much more for their labor. Landowners’ profits plummeted. This in turn destroyed commerce in the towns, with dire financial consequences. Chaos ensued. Various laws were enacted in an attempt to hold wages to pre-plague levels. Never before had the royal government allied itself with the landowners against the workers in such an obvious and heavy handed way. This proved extremely unpopular. Nonetheless, wages continued to rise and many peasants were able to join guilds from which they had priorly been barred and learn trades, moving up the socio-economic ladder.

The off-again-on-again Hundred Years War against France heated up again and taxes were raised in 1379 and again in early 1380. The taxes were innovative, extensive, and unpopular because they were poll taxes, levied on every eligible individual regardless of rank or income. A third poll tax was instituted at the end of 1380, the most unpopular of all. Poll tax collectors interefered with life in every town and London seethed in unrest. Furthermore, political partisanship was extreme and the ruling class divided.

Finally, when investigations into failure to pay the poll tax in villages in Essex occurred at the end of May 1381, outright revolt ensued and spread like fire across the country, an uprising historians now call The Peasants’ revolt. Eventually the Tower of London was sacked and many royal officials murdered. The revolt was finally suppressed. 1,500 people were killed in the process. The population had not revovered from the plague and is estimated at 1.8 million at the time. It would be like over 300,000 US citizens being killed today.

In any event, there was a clear relationship between the plague and the ensuing power of labor and wage inflation. Furthermore, while the poll tax was thorough-going, our inflation today is more so. Geopolitical risks abound and if war ensues, inflation will take another leg up. We’ve had revolts in our own history, not to mention civil war. So a risk for civil strife exists now and over the near term. We may see more riots, and more violent ones, in the coming years.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

No One is Doing the Math

There is nearly $200T more debt on earth today relative to the days of Paul Volcker – so why does much of Wall St. constantly compare Fed Chair Jay Powell to central bankers from an entirely less levered era?

The Fed and their collection of well-placed pawns keep lecturing us on their policy path filled with endless rate hikes to fight inflation  – but the math tells us the sales pitch is all bs.

Three Things You Need to Know

1. The income that the Federal reserve generates comes almost exclusively from their $8.8Tr portfolio of Treasuries and agency MBS. The Fed transfers that interest income to the Federal government, and this has been a nice source of income that supports Washington DC deficit spending. However, the interest income the Fed generates is reduced by the interest it pays the commercial banks for their excess reserves. The Fed likes to call these “interest to depository institutions”. Last year this interest rate was still a paltry 0.15% but as it is directly linked to the Fed funds rate, it has since risen to 2.4%. So the interest income the Fed earns is the sum of the money it makes on the QE assets minus the money it pays the banks for their $3Tr in excess reserves.

The Backstory goes all the Way to Lehman Brothers

Fourteen years ago this week – Lehman Brothers failed. How is this colossal financial collapse, tied into the road ahead? After the Great Financial Crisis – our brain trusts in Washington wanted to make sure the U.S. financial system would never again succumb to the double-edged sword of excess leverage. Regulators forced U.S. banks to “reserve up” and so – for the last 14 years – Wall St.’s financial epicenter stored an ever-enormous dollar number of reserves – mostly found in U.S. Treasuries.  Today, as promised the Fed must pay these banks MORE and MORE interest on these reserves. As the central bank hikes rates – the unintended consequences are MOUNTING along with a political backlash – potentially louder than a Donald Trump appearance on “The View.” This time next year, the Federal Government is looking at a near $400B negative swing; a) from profit to a loss on the Fed´s transfer of net interest income – triggered by a surge in interest payments to banks on reserves, b) plus $200B additional interest on their $31T debt load. Dollar headwinds are mounting from; emerging market credit risk, China currency devaluation, the Eurozone energy crisis, a weaker U.S. consumer (see Capital One CDS, the cost of default protection is on the rise), and one-year inflation expectations crashing at the fastest pace since the fall of Lehman Brothers. Sit back, think of taking the Fed Funds rate from 25bps in March to 325bps this month, that´s three years of accommodation withdrawal in just six months. The Fed is very close to table max, the risks that they have over-cooked the goose are sky high.

2. Keep in mind, that the Federal government pays interest on its now $31Tr  in debt. This interest is going up, as low-yielding securities are maturing and the newly issued paper has a higher interest rate. So while the Fed’s interest income is going down, as the portfolio shrinks (QT) the interest they pay (IOER) is going up. Sometime in the next year, the Fed will start generating losses, as IOER starts to exceed QE income. Meanwhile, Washington DC is spending more money servicing its debt as interest rates increase.

Interest on Debt will Explode Higher if the Fed Keeps Hiking Rates
In the chart, we show how this works. The blue line shows the income from the Fed’s QE portfolio and compares it to the cumulative increase in interest expenses, from both higher interest on the government’s debt and the Fed’s payments of interest on excess reserves (IOER). This shows the $400bl negative swing next year in government income due to the deterioration in net interest income.

3. The data demonstrates how the government will incur a negative swing of more than $400bl in the next year just from interest payments and income.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

“The Fed Guy” https://fedguy.com/the-reserve-gap/

QT – The Federal Reserve Promises $1T in 12 Months?
We have a Federal Reserve promising to take their overnight rate to 4.5% (in March, just six months ago – the lending rate was 0.25%) and reduce this balance sheet by $1 trillion over 12 months – we were born at night, just NOT last night. Why is this important? The speed – in the balance sheet reduction process has a colossal impact on liquidity inside the market – all with a significant impact on asset prices. In Q4 2018, when the Fed ramped up its balance sheet reduction fantasy – equities crashed.  Never – ever forget, that the Fed and their Wall St. pawns were promising $2T of QT last cycle. That was BEFORE the beast inside the market – stopped them in their tracks near a $685B balance sheet reduction. After all the bogus promises – they actually restarted QE, rebuilding their balance sheet in Q3 2019. 

The Fed Guy

The “Fed Guy” says Quantitative Tightening may be more difficult than the Fed hopes. What a revelation!!! Moses has come out of the desert. Why? Because along with its QT aspirations, the Fed would like total bank reserves to be about ~$2 trillion, about 8% of GDP. They have NO clue whether or not that’s the appropriate number – but they want us all to believe they have a clue. The Fed believes that is the requisite amount to keep the financial system running smoothly. In Q4 2018, they proved — beyond a shadow of a doubt — that they have ZERO clue whether or NOT that’s enough liquidity. Now, the Fed wants us all to believe they control liquidity with precision – hilarious!!! And YES, the largest central bank on the planet is reducing liquidity like a blind man reaching into darkness.

2022

Bitcoin: -55%
Nasdaq: -23%
Russell 2000: -15%
S&P: -14%
Dow:  -11%
Gold: -5%
US Dollar: +14%
Oil: +18%
Uranium: +22%

Finger Sandwiches

Of course – the Fed does not control where that liquidity is drained from. If liquidity drains from banks’ reserves, it is possible reserves could go below the Fed’s pain threshold, in which case, QT would stop. Tim Duy is a nice guy, a real talent – but a constant Fed lap dog, God bless him. Of course, guys like Tim want to make sure they still get those finger sandwiches at the sucking-up cocktail parties complete with Fed Governors and ex-central bank farm hands. For more than a decade – we have seen this charade up close and personal in Manhattan. This is as critical as you will EVER see the “Fed Guy” – this fact, in itself means a lot. Likewise, if Treasury issuance was also to be funded mainly by cash investors, and not by hedge funds buying through leverage accessed from the Repo market  — You know those “relative value” clowns that blew up the financial system heading into Covid with 8-1 leverage – see the penny – insert steamroller, insert face plant crowd — that would also drain cash from the banks, hurting reserves. It will take some time. Bank reserves now are at about $3 trillion. Indeed, the Fed may like to see excess reserves decline, reducing the amount it has to pay on reserves thereby.

The $300B Hole Treasury Must Fill

As macro maven – Ben Melkman points out – the higher the Fed pushes up Fed funds near 4% – the higher the probability they are going to be short $250B to $500B annually (interest on reserves owed to Jamie Dimon and the rest of the big banks). Complete with hat in hand looking up into the eyes of Senator Elizabeth Warren next summer at the Humphrey Hawkins sit down with Powell on Capitol Hill. You see – the side effects of the collapse of Lehman Brothers and the financial crisis are on stage here.  Regulators forced US banks to “reserve up” and so – for the last 14 years – Wall St.’s financial epicenter stored an enormous amount of reserves – US Treasuries.  Today, the Fed must pay these banks interest on reserves as promised. But as the central bank hikes rates – the unintended consequences are MOUNTING along with a  political backlash bigger than a Trump appearance on “The View.”

Massive USD Credit Risk

With nearly $13T of dollar-denominated debts oozing through the smallest countries on earth – there are significant side effects as the Fed tries to conduct monetary policy. Emerging markets are blowing up as the Fed´s strong greenback exports inflation to our planet´s poorest countries. Inflation-driven, political instability is at multi-decade highs and U.S. dollar headwinds are picking up with intensity.  People do NOT understand – it’s GAME OVER for the US dollar – the MOST crowded trade on earth. Over the next 24-48 months – the Fed´s ability to support asset prices is highly limited without significant USD decay (Modern Monetary Theory). It is a COLOSSAL maturity – cash flow mismatch – your U.S. front-end rates are extremely high (borrowing 350bps) – and the yield on the average weighted maturity on their bond portfolio is low (trillions paying 75bps or less). For the last 20 years – this WAS NOT the case. Foreigners own $20T MORE U.S. Treasuries than U.S. investors own foreign debts. Furthermore, there are those who think banks don’t need as many reserves as even $2 trillion.

“Across what Zoltan would call the ‘Outer Rim’ of USD funding. The banks are flush, and UST repo demand is low (thanks in part to the Fed itself) so the cash is deployed into more profitable funding silos like FXswaps and AAA ABS. Read the OFR report on bilateral repo, it’s 2Tn! The Fed will begin ‘selling UST at 100Bn, while Treasury increases issuance 100Bn. That will spike demand for UST funding, which can be met with RRP cash. But that balance sheet must be held PRIVATELY. MMFs (money market funds) cant buy coupons, only repo. A dealer must offer that repo.” via @Stimpyz1.

We think they do, but we recognize estimates as low as $900 billion. Nobody really has a clue, that is a fact. This lower theoretical level is based on the fact that banks can increase reserves at will when the financial system is operating normally. However, we note that reserves aren’t even needed at $900 billion when the financial system is operating normally. Reserves don’t exist for normal times. They exist for abnormal times. The Fed itself can directly increase reserves by buying T-bills, as they did in 2019. The Supplementary Leverage Ratio (SLR) creates regulatory expenses for banks holding reserves. Apparently, these are not so onerous as to stop banks from having more reserves than they need. Nonetheless, the SLR could be relaxed if reserves fell towards $2 trillion. Thus, there are methods the Fed could use if Reserve levels were to fall too much. And, of course, they may not fall all that much. Net net, we think the Fed would indeed like to see Excess Reserves decline moderately without threatening the current mandated reserve levels.

“I don’t doubt Ben’s math for a second. and I can’t wait for the Elizabeth Warran – Powell shakedown in July 2023 – I am sure he is right. But given the Fed owns $8.2 trillion of stuff that yields on balance on average something, that income is subtracted from the $208B the Fed would pay out if rates jacked to 4% (AND reserves did not decline AND RRP assets did not decline after a QT of any kind at all – unlikely). This means there is some other line item that Ben is looking at besides interest to be paid on Reserve Balances and RRP. It would be nice to get a back of the envelope from him on how 4% leads to $250B to $500B net expense. Clearly, I am missing something.”  NY-based CIO in our live client chat.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Bear Traps Report – Opening – August 28, 2022

Italian Yields – Energy Prices Driving Political Risk
Most are focused on the U.S. Federal Reserve as the interest rate driver – global yields – gas prices – are setting up Lehman-like credit risk. 

ITALY AUG INFLATION RATE RISES TO 9%; HIGHEST ON RECORD – Hundreds of billions (EUR) of energy cost liabilities are rolling up from consumers – corporations – and utilities — to sovereign credit risk across Europe.

One never forgets that smell of an Amtrak coach car at 5 am – rumbling into Manhattan. At the wise old age of 18, the bags were packed for a long journey with most of my worldly possessions in tow. Coming into New York for the first time with no parents – no siblings, was a very big day indeed. When the train stopped at Penn Station, I could hardly wait to get off. It was a feeling of heart-pounding excitement, dancing on every step. With dreams, goals, and opportunities everywhere, the only thing missing was the free lollipops and candy canes. The next thing I knew, this nice gentleman with a blue sport coat, gold cufflinks, and even a pressed handkerchief in his top right pocket approached me. “Let me help you with all that luggage, young man. If you´re hungry, the best 24-7 diner in this part of town is right over there.” Famished, I glanced over toward the restaurant. Now turned around – in a full 360, I looked down and all my bags were gone – running away with that man into a mob of humanity. Robbed right out of a scene from Trading Places, welcome to the big city. On Friday afternoon, nearly every human being on earth with capital to invest had their eyes on the Fed. It was a “look here”, “NOT over there” kind of day. Steve Jobs always said – “´it´s the scar tissue from mistakes that keeps us focused on all the pieces across the chess board – NOT just one or two.” Surprise, the biggest news by far out of “Jackson Hole” was coming out of the ECB NOT the Fed – who would have guessed? As the day moved on Friday, it was clear Don McLean´s “American Pie” was a touch longer than Jay Powell´s torpedo of a speech. Then – more and more clients we respect across our live chat on the Bloomberg terminal kept saying the same thing. The institutional – buy-side investors were all pointing to Europe as the driver of U.S. equity volatility.  For most of the last 10 days, even with the much talked up “China economic slowdown” and a surge in recession certainty in Europe – global bond yields kept moving higher. In just a few weeks, Italian 10s marched from 296 to 370bps. Since Q4 2020, negative yielding bonds on the planet have plunged from $18T to almost $2T, and much of those are in Japan. Sovereign credit risk is on the rise in Europe – we have the ECB on September 8, the Fed on the 21st, and the all-important Italian elections on the 25th.

ECB Meeting September 8th into this Mess
Credit risk in Europe is near 2020 Covid Panic levels – central banks were cutting rates and handing out checks back then.

The ECB has yet to pick its poison – 1) a plunge in the Euro is fueling runaway inflation in the periphery – this risk could place a right-leaning coalition in control of Italy for the first time in decades. Putin would be all smiles – from Moscow to Vladivostok – with that outcome. 2) aggressive rate hikes force more price discovery in Europe and put colossal pressure on a banking system – stuffed to the gills with sour loans. The tell – Jamie Dimon doesn´t suspend stock buybacks every day, he´s playing defense. Apple and Tesla are nearly 10% of the S&P (SPY) and 20% of the QQQs – have roughly $100B in sales coming out of the EU. On August 11th – we distributed our largest – take down risk – “high conviction” trade alert sell since February of 2020, eleven positions with new shorts on the Nasdaq. U.S. equities have been priced for an American economy on Mars or Venus, NOT Earth. Into this mess – we have a Fed that is expected to do $1T of QT over the next 12 months, NO way. Bullish hard assets > Financial assets.

Here is one of our most recent Turning Point reports – it´s a recap of our live institutional buy-side conversation on Bloomberg – an important take.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

Institutional investors can join our live chat on Bloomberg, a groundbreaking venue since 2010 – now with clients in 20+ countries, just email tatiana@thebeartrapsreport.com – Thank you.

Lawrence McDonald is the New York Times Bestselling Author of “A Colossal Failure of Common Sense”  – The Lehman Brothers Inside Story  – one of the best-selling business books in the world, now published in 12 languages – ranked a top 20 all-time at the CFA Institute.

China – 3000 Coal Plants – Come with a Price

Half of China is stressed by drought – rice crops and lithium production are in danger – all threatened by the worst heatwave on record. Southern China records its longest continuous period of high temperatures since records began more than 60 years ago — above-average temperatures even touching the normally chilly Tibetan Plateau.

In Q1 2022 – Out of pocket, Tesla owners were dealing with costs of around $10,000 to $13,000 for the battery itself, depending on the model. Now, after the latest surge – what are the implications?

On planet Earth – China is now the third biggest producer of lithium behind Australia and Chile. The stakes are sky-high.   Per Bloomberg – China accounts for about 60% of the world’s production of refined lithium, so Sichuan’s power crunch is a wake-up call for the global lithium and battery-material industries.

Dear Elon, Who Pays for This?
The lithium-refining spread — the price of lithium carbonate (LCE) or hydroxide minus that of spodumene concentrate — may surge through end-August. Bloomberg Intelligence notes the volume loss in lithium carbonate/hydroxide due to Sichuan’s drought-induced power crunch could amount to 12% of China’s monthly output, that´s after factoring in electricity rationing until Aug. 25. This would further tighten the market, already in severe shortage. Downstream demand among iron-phosphate and nickel-cobalt-manganese cathode makers has also been hit by power cuts, but the impact is smaller than for lithium refining. Sichuan’s lithium-hydroxide and lithium-carbonate production capacities are about 40% and 15% of China’s total. This winter, brine-based producers in West China may have to halt output as lakes freeze, adding to upward pressure on prices.

The EV Dream is Still Alive?
We are lectured weekly – Electric vehicle sales could reach 33% globally by 2028 and 54% by 2035. Really? Mining needs to grow 30X by 2040 to meet CO2 reduction goals using solar, wind, & batteries. Lithium production needs to increase by 40X. – Oklo data.

Where are We Now?

EVs accounted for less than 8% of global sales last year, and just under 10% in the first quarter of 2022.  Large players – automakers and suppliers now expect to invest at least $550 billion on EVs and batteries from 2022-2026. That is more than double the five-year EV investment forecast of $230B from 2020-2024.

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