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The immortal Jackie Gleason once said, “the only problem with losing 50% is… you need double to get it all back.”

Late this week, Bitcoin dropped under $7,000, to trade nearly 20% below Wednesday’s all-time high.  That shaved well over $1,000 off her sky-high price.

In a tweet in July, we called for a bounce – noted bitcoin’s support level down near its 100-day moving average.  Today, this level appears miles away at $4119 ($6581 Friday’s close), but as history’s lesson – she can be there in a New York minute.

Bitcoin dropped to $6,418 on the Luxembourg-based Bitstamp exchange by 1200 GMT Friday, before recovering a touch to trade at $6,664 only minutes later.  A violent week indeed.

Famous Asset Bubbles within 9 Yrs of Peak

Bitcoin 2011-2017: 66x
Tulip Mania 1617-1622: 53x
Nasdaq 1991-1999: 13x
Oil 2001-2008: 7x
Silver 2004-2013: 6x
Miami Condo Mkt 1998-2007: 6x
Nikkei 1982-1990: 5x
Nasdaq 100: 2009-2017 5x
US Stocks Dow 1921-1929: 5x

“But, but but… Bitcoin is the future” the young man screamed across the room.  The thing about manias comes down to measuring just how much goodwill is priced in?  The Amazon AMZN lesson is an investor classic. From June in 1997 to June in 1999 the stock was 7100% higher (yes 71x!) – only to lose 95% of its value by 2001. In took over a decade but Amazon was able to take out its 1999 high by early 2010. Eleven years of growth was priced into its first two years as a publicly traded company. Ultimately, the equity grew into its expected growth profile, but this lesson remains one for Bitcoin investors today. In determining your entry point into a once a decade secular trend, we must determine how much is priced in relative to the long-term upside. Bottom line: most investors DO NOT have the patience to capture long-term gains once a major drawdown takes hold.

Bitcoin’s $7882.10 perch was reached Wednesday after a software upgrade anticipated for next week  – would have split the cryptocurrency in two,  news of a suspension triggered a relief surge.

The Rocky Trading History of Bitcoin
A 2013 investment in bitcoin took nearly three years to get back to even after a nearly 80% loss.  Indeed, Bitcoin is not for the faint of heart. 

FAANG Equities

Netflix $NFLX 2008-2017: 78x
Amazon $AMZN 2008-2017: 31x
Apple $AAPL 2009-2017: 14x
Facebook $FB: 2012-2017: 9x
Google $GOOGL 2008-2017: 7x

FAANG equities are a POUNDING the table, screaming sell.  Since 2010, Amazon has had six drawdowns of 15 to 30%, three of which were thirdy percent.  Sit in the boat and buy fear in fangs.  

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“In the coming weeks, we expect a super mean reversion. This summer’s weak inflation data (CPI, PPI, PCE, AHE) is unsustainable in our view.  U.S. economic data (Citi Economics Surprise Index), the level of expected Fed hawkishness (less accommodation), Washington policy (fiscal policy expectations) have all moved sharply lower with remarkable cohesion. They’re singing the same song.  At the same time, geopolitical risks have surged to their highest level of 2017 – suppressing bond yields.   The perfect storm of good news for bond bulls has run its course.   We are bond bears – looking for higher yields – out over the next 90 days.”

The Bear Traps Report, August 30, 2017

Friday we learned U.S. unemployment declined to 4.2% in September, from 4.4% the previous month – the lowest level since 2001.

AHE’s Move North

Average Hourly Earnings surged 12 cents in September to $26.55. That was the largest move higher since 2007.  For the 12 months that ended Sept. 30, wages were up 2.9%, well above the low inflation rate.

Sell Off in US Treasuries Meets Resistance

The U.S. 10-year treasury yield has surged up to an important Fibonacci resistance level near 2.39%.  As we examine treasury futures using the Bloomberg terminal,  TY1 has reached important lows recorded in July and May at 124-25+/124-23.  Lower bond prices meet higher yields indeed.   After the yield spike – since September 8, the Bloomberg Barclays Global-Aggregate Market Value of Bonds has lost nearly $1.5T.  

It’s clear, labor force participation is moving higher for the young and able – this development has wages heading north.  Bottom line, when measuring risks to higher bond yields, Average Hourly Earnings AHE is far more important today than the actual jobs number.

Rate Backup Victims Include Commercial Real Estate

Since September 8, the yield on the 10 year US Treasury bond has surged from 2.01% to 2.39%, while the Real Estate Select Sector SPDR Fund XLRE is nearly 5% lower.  In interest rate futures, the probability of a December Fed rate hike has surged from 21% to 80% – large cap REITS have been one of the big losers on the follow.  Technically, the XLRE is on a key level – a possible trend line violation (top right above) has longs nervous.

Yelvington’s AHE Revisions

An important observation from our associate Brian Yelvington, we must NOT overlook the July Average Hourly Earnings AHE revision (see the chart below – yellow line), the revisions’ IMPACT is impressive.

A Colossal Bounce in the Revised Data

Average Hourly Earnings AHE risk to higher bond yields is real.  Lost in all the noise this week are these meaningful developments.  Not only did September print at 0.5% but August was revised to 0.2% (from 0.1%) and July to 0.5% (from 0.3%). Inflation has finally arrived!

Fed’s Rosengren Saturday

“Already-tight labor markets are likely to tighten further as the economy continues to grow faster than its potential.”

Federal Reserve Bank of Boston President Eric Rosengren said on Saturday.

*ROSENGREN: ALREADY-TIGHT LABOR MKTS LIKELY TO TIGHTEN FURTHER – October 7, 2017
*ROSENGREN SEES RISKS IF FAIL TO RESPOND TO VERY TIGHT LABOR MKT – October 7, 2017

Rosengren is not a voting member of the rate-setting FOMC this year.

Data Pointing to (further) Bond Yield Spike

The relationship between 25-54-year-olds actually in the labor force to Average Hourly Earnings points to a coming problem for bond yields.   As labor force slack has been chewed up, AHE’s summer reversal (bounce) speaks to bad news for the crowded long duration trade.

Correlation US Treasury Bond Yields vs Gold*

2017: -0.81%
2016: -0.62%
2015: -0.45%
2014: -0.32%
2013: -0.23%
2012: +0.21%

*Rolling 1 Year, Bloomberg – Citi data

Investors in the gold trade are just starting to realize, they’re not trading gold they’re trading (interest) rates.  The negative correlation between higher bond yields and lower gold prices has exploded in recent years, north of 80%.  Gold prices are clearly rates driven – since the September 8 reversal higher in bond yields, gold prices (XAU) are 7.1% lower (gold miners GDX -10.1%).

Inflation Expectations

Low inflation expectations in the marketplace have been a trouble spot for the Fed.  Sure, inflation has remained tame throughout most of this year – but recent price action is getting attention.  Since August, the surge in breakeven rates, a gauge of US inflation expectations, is a foundation of hope for dollar bulls. The 5-year 5-year forward breakeven rate is near 1.90%, well above the June lows.  The possible wedge break (above in the purple circle) is a key technical level.  A break above into new real estate will put the Fed on notice that market participants are taking inflation far more seriously.  This is something which will draw more rate hikes (raise expectations) out of the FOMC in our view.  

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Breaking: *CHINA AUG. PRODUCER PRICES RISE 6.3% Y/Y; EST. 5.7%
Breaking: *CHINA AUG. CONSUMER PRICES RISE 1.8% Y/Y; EST. 1.6%

HOT Data:  In China, the producer price index rose 6.3 percent in August from a year earlier, versus an estimated 5.7 percent in a Bloomberg survey and a 5.5 percent July reading.

Weak Dollar Side Effects: PPI exceeded all but one of 38 estimates in Bloomberg’s survey of economists.

China Inflation: The consumer price index climbed 1.8 percent, compared with 1.4 percent a month earlier, the statistics bureau said Saturday.

China Producer Price Index (Output)

Deep inside the Federal Reserve, there’s a growing concern. Commodity prices are rising at the fastest pace in five years.  The global reflation picture is nearly on the Fed’s doorstep.  In our view, there’s a surging probability the Fed gets thrown off track in 2H 2017.  They are behind the curve relative to suppressed market expectations* (outlook for low inflation) – which the Fed has fostered, embraced and enabled.  Over the last decade, we’ve learned academics at central banks are poor risk managers – especially when it comes to misjudging sharp moves in the U.S. dollar.

*Thanks to dovish Fed guidance (leaving the punch bowl filled at the party far too long – more accommodation), the interest rates futures market now sees September 2018 (yes 2018!) as the earliest FOMC rate hike (with >50% chance of Fed hike).  A year from now, the FOMC will have serious regrets looking back on their latest policy moves.  Nearly 10 years after Lehman, it’s sad – they have NOT learned the error of their ways.

As Long Time Bond Bulls, we’re Now Bears – The Fed is Behind the Curve

If we look back at the 2014-2016 regime and ask what did the Wall Street’s economists get most wrong in “trying to read” the Fed?  Far and away the answer to this question is found in global economic (disinflation) pressures.  Back then, U.S. economists were far too focused on “robust” domestic (U.S.) economic data.  The Fed coached them into looking for 12 (yes twelve!) rates hikes (2014-2016) – while ultimately the central bank only delivered two.

Global Economic Strength

In August, China reported imports up 13.3 percent in dollar terms. Street forecasts were looking for a 10.0 percent move higher in the same period.  Keep in mind, since January, China imports have sustained 11% growth.  This is the most impressive level of sustained trade growth we’ve seen in six years.

China Imports, Strong thanks to a Weak U.S. Dollar

Friday’s strong (August) import data, points to domestic demand in China far more resilient than expected in the second half of 2017.  China can thank the Fed and a weak U.S. dollar in our view.  We must NEVER forget, the Federal Reserve is conducting monetary policy in an $80T global economy, NOT a petri dish.  As the Fed attempted to hike rates 2014-2016, the dollar surged and the global economy suffered (see above – left). Today, as the Fed has dramatically softened the rate hike outlook – the dollar plunged (top – right) and the global economy is picking up steam (see above – bottom right).  In the months ahead, it will be pure entertainment – watching the Fed try and deal with this global economic feedback loop back yet again.

Policy Path Veto

It’s clear, the lessons from 2014-2016 come down to the “global economic picture” overpowering the Federal Reserve’s STATED policy path.  In the end, the global wrecking ball found in U.S. dollar side effects – vetoed the Fed’s beloved rate hikes.

From 2014 – 2016, U.S. economists were blinded by the positive U.S. data and couldn’t see the deteriorating global macro risk factors tied to the U.S. dollar’s violent surge (see above).  Global economic weakness was a colossal drag on Fed policy – eventually forced the central bankers to lay down on their loudly promised rate hikes.  The old Lucy and the Football, “sorry Charlie Brown.”

$80 Trillion Global GDP

Outside the USA: $62T*
Inside the USA: $18T

Why are U.S. economists so myopically focused on U.S. economic data?  It’s 2017, NOT 1997.  Bloomberg GDP data.  The St. Louis Fed Real GDP Nowcast Model Sees U.S. Q3 GDP up at nearly 3.7%.  The question no one is asking: If economic growth is picking up sharply in the $62T bucket above, how with that impact the $18T economic output in the USA and Fed policy???

*11% plunge in the dollar (in 8 months) is fueling growth here.

Twelve Rate Hikes 2014-2016?

Of course, Lucy became the FOMC and Wall Street’s economists were poor Charlie Brown.

The Ultimate Question of 2017?

If global – strong dollar induced – disinflation pressures (2014-2016) vetoed the Fed’s widely advertised policy path (beloved rate hikes), why won’t global – weak dollar induced – inflation pressures today do the same (force more rate hikes)?  How do you spell complacency?  Wall Street expectations for this year have moved from 4 rate hikes to just two?  If you look at the December euro dollar contract – in just three months – we’ve moved from a 70% chance of a December rate hike to just 24% today.  Ignoring global reflation risks – this summer the Fed has dramatically talked DOWN rate hike expectations.

The Weak Dollar Ignites Global Inflation Pressures

Fresh Year Highs this week*

Palladium: 16 yr high
Zinc: 10 yr high
Lithium: 6 yr high
Aluminum: 6 yr high
Copper: 3 yr high
Coal: 3 yr high
Iron Ore: 0.4 yr high

*Side effects of weak dollar FOMC, China regulatory issues heading into 19th Congress, demand expectations for electric cars (Lithium, Copper).

Oil, the Upside Trend Break

The last holdout has been oil.  Several global secular pressures have been suppressing this beast, but she’s making some noise lately.

Dinner with Bill Dudley of the New York Federal Reserve

Thursday evening, we attended a  dinner with the NY Fed’s Bill Dudley,  He delivered a speech at the Downtown Association with a hawkish tone. Dudley kicked the “financial conditions targeting” door back open in our view. He said the FOMC with an eye on FCIs should be able to remove accommodation with low inflation.

“Even though inflation is currently somewhat below our longer-run objective, I judge that it is still appropriate to continue to remove monetary policy accommodation gradually,”

New York Fed’s Bill Dudley

“I expect that the U.S. economy will continue to perform quite well, with slightly above-trend growth leading to further gradual tightening of the U.S. labor market,”

New York Fed’s Bill Dudley

A Q&A focused on Harvey and Irma

In the Q&A, the sleepy event became far more interesting. Governor Dudley opened the door to inflation shock concerns with an eye on the two historic hurricanes with a meaningful impact on the U.S. economy this season.

*AIR WORLDWIDE ESTIMATES INSURED LOSS FROM IRMA AT $20B-$65B

(Insured losses understate the fiscal policy rebuilding/infrastructure funding needed from Washington – $220B for Harvey and Irma in our view).

The colossal rebuilding projects concentrated on greater Miami, Tampa, greater Houston, and Beaumont will require hundreds of thousands of new workers.

Keep in mind, Texas and Florida represent 12% of US GDP.  Dudley mentioned labor market in construction is “tight” in those states.   According to the National Association of Home Builders – over 75% of its members report acute shortages in the latest survey.

Bond Yields and Cat 4+ Hurricanes

Our latest Bear Traps Report takes a look at bond yields and category 4+ hurricanes in the U.S. – the data is impressive.  Each time, bonds rally into the tragedy – (GDP growth worries) on near term economic risk concerns.   What comes next is a mind blower. 

It’s clear, any substantial fiscal policy changes coming out of Washington will have a meaningful impact (wages, average hourly earnings, cost push inflation). The colossal rebuild (as high as $220B in our view) comes with wage inflation risk in Q4 and beyond.

The Road Ahead

Today, many U.S. economists are asleep at the switch again.  They’re far too focused on “Goldilocks” calm U.S. inflation data, NOT global Inflation Pressures, Irma and Harvey.   Hello, BIG MISTAKE. In a dramatic reversal, the global inflation picture could very well force the Fed into surprise rate hikes, NOT cuts this time around.

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Friday’s ISM data showed U.S. factories surged in August to the fastest pace of expansion in six years, largely powered by an employment uptick.

• Factory index climbed to 58.8 (est. 56.5) from 56.3 in July.
• Employment gauge jumped to 59.9, highest since June 2011, from 55.2.
• Economists polled expected a reading of 56.8%. Any reading above 50% indicates improving conditions.

Friday’s jobs report in the U.S. displayed the strongest month for manufacturing hiring since August 2013.  Manufacturing and construction accounted for an additional 64k new jobs.

U.S. 10 Year Treasury Bond was 3.73% the last time ISM Data was this Strong

Inside the data, the measure of new orders fell to 60.3 from 60.4; order backlog gauge rose to 57.5, matching a three-year high.   The August PMI is at its highest level since August 2011, when it touched 59.1. And the August PMI is 3.4% above the 12-month average of 55.4 and 2.1% above the 2017 average of 56.7.  ISM noted, 14 of the 18 manufacturing sectors contributing to the report expanded in August.  It’s clear, bond yields are being suppressed by U.S. political and global geopolitical risks – not economic growth data.

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Breaking: Japan’s Topix falls 1.4% as yen firms in face of rising North Korea tensions.

On Tuesday, the CBOE Volatility Index surged nearly 12% percent after President Trump was quoted saying further threats from N Korea would be met with “fire and fury.”

One Month Look at Stocks in Japan

Overall, stocks in Japan are 3% off their recent highs.

Earlier reports of a Defense Intelligence Agency analysis indicating Pyongyang has successfully developed a miniaturized nuclear warhead that could fit onto its missiles sent a chill through markets.  The yen surged with gold, while crude dipped below $49 a barrel.

First Time – Long Time

For the first time since June, S&P 500 futures drop greater than 1%.  Per CNBC, the Dow Jones industrial average climbed for 10 straight days, through Monday, for its second winning streak of 10 days or longer this year (after its 12-day win streak in February). That means that 2017 already marks the first year in which the Dow has had two winning streaks of 10 sessions or longer since 1959.  Geopolitical risk is now poised to upset this apple cart.

We believe the Pentagon is considering a request from South Korea to allow it to develop more powerful ballistic missiles as tensions with North Korea continue to escalate.

“There is currently a limit on the warhead size and missiles that South Korea can have and yes, it is a topic under active consideration here,” Pentagon spokesman Capt. Jeff Davis told reporters at the Pentagon, as reported by Reuters.

Cost of Default Protection in South Korea Continues to Surge

This year, Asia’s stock and credit markets have been flashing bullish signs. Per Bloomberg, outside of Japan it costs less to insure Asian corporate and government debt than at any time since before the financial crisis – see the white line above.  Meanwhile, the MSCI AC Asia Excluding Japan Stock Index is near a 10-year high.   On the other hand, geopolitical risks coming at markets from North Korea are raising the cost of default insurance on countries like South Korea – see the orange line above.  Markets depend on continued economic growth and the importance of the region in global debt markets supports stability in CDS prices – but geopolitical risks could turn all the goodwill upside down.  As you can see above, for much of the last five years the cost of default protection in Asia rose with South Korea – high correlation was the name of the game.  In recent months, as Asia credit risk has improved – South Korea continues to deteriorate at an alarming pace.

Council on Foreign Relations

North Korea is believed to have between fifteen to twenty nuclear bombs and has successfully tested a series of different missiles, including short-, medium-, intermediate-, and intercontinental- range, and submarine-launched ballistic missiles. In July 2017, the regime conducted two intercontinental ballistic missile (ICBM) tests capable of carrying a large nuclear warhead. The Pentagon confirmed North Korea’s ICBM tests and analysts estimate that the new missile has a potential range of 10,400 kilometers (6,500 miles) and, if fired on a flatter trajectory, could be capable of reaching mainland U.S. territory. U.S. analysts and experts from other countries are still debating the possible nuclear payload that the ICBM could carry.  “Prior to these tests, North Korea had conducted five nuclear tests: in October 2006 and May 2009 under Kim Jong-il; and in February 2013 and January and September of 2016 under Kim Jong-un’s leadership. Future nuclear tests are anticipated. North Korea possesses the know-how to produce bombs with weapons-grade uranium or plutonium, the primary elements required for making fissile material—the core component of nuclear weapons.” CFR

The Bear Traps Report

We still believe Beijing has a prominent role to play.  Behind the scenes, the US is likely attempting to delegating the North Korea regime change to China.  As a colossal trading partner, China has substantial leverage over North Korea’s generals.   Of course, China likes idea of having buffer in peninsula facing the West, she won’t sacrifice that even if Kim Jong-un is a madman.  Ahead of their coveted 19th Congress this October – war is not in China’s interest at all.  North Korea knows this, helps explain their elevated and annoying resolve.

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Car sales in America are rolling over at the fastest pace since the great recession.   There’s debate about whether the downshift is due to normal economic cycles or indications of secular or structural change.

Large auto makers – Ford, General Motors and Toyota, have reported meaningful sales contraction in the first half of the year.

Automakers are reporting substantially weaker than-expected sales for the month, with some companies posting double-digit declines in business.

General Motors sales fell 15.5 percent compared to July of last year when industry sales were close to a record high. While some of the decline at GM can be attributed to a deliberate pullback in fleet sales to rental car companies, the automaker’s retail sales at dealerships came in almost as weak, falling 14.4 percent. – CNBC

Forecasters expect US sales to fall to about 17 million this year – off 500,000 from last year’s pace.

Earlier this year we addressed these risks- The Bear Traps Report with Larry McDonald; A Turn in the Credit Cycle for clients.

U.S. Auto Inventory Build, 1970 – 2017

It’s clear – the inventory levels of unsold cars are at recession levels. As we can see above – unsold automobiles are piling up at the fastest pace since the great recession.   In recent years, sales growth was supported by unusually low borrowing costs and pent-up demand, as cash-strapped households delayed purchases during the economic downturn around 2009.  Credit growth is contracting in the auto-lending sector at the fastest pace since 2008 – this is having a big impact on sales.  On the other hand, as more Americans move to urban areas – the Uberization of transportation is creating significant structural challenges to the U.S. auto industry.

 

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Updated July 30, 2017

Breaking: *IRON ORE FUTURES IN SINGAPORE SURGE 5.9% AFTER CHINA PMI DATA, 9:27pm ET.    PMI came in solid, above its 12-month average. The China’s yuan fixing was set at the strongest level since October – a sign the PBOC doesn’t see any major growth concerns around the corner. 

It was a picture perfect week in Manhattan.  Dry air, a light breeze, the birds were chirping in central park and we witnessed a high of just  72 degrees in late July?  It was a treasure to behold.

No Stress, Relax

St. Louis Fed’s Financial Stress Index is right on five year lows.  Since February 2016 – just as the Fed arrested the U.S. dollar’s vicious accent – month after month financial conditions have eased.  Which begs the question?  From 2014-2016, as the strong U.S. dollar contributed to global dis-inflation – lower commodity prices – won’t the weaker dollar contribute to a surprise burst of global inflation?  Central bankers think they can contain the beast inside the market, but he’s in there – the unintended consequences are a plenty.

All is calm, but something is lurking beneath the surface of the financial markets.  Investors expect no surprises from the Federal Reserve this summer – this week the chances of a September rate hike fell below 10%.  It’s motionless seas as far as the eye can see.

How Low is the Bar?

In recent weeks, Fed rate-hike expectations have plummeted given the market’s myopic focus  on the Fed’s long promised balance-sheet normalization kickoff.  The odds a December rate hike are now priced at less than 35%, down from 70% just six weeks ago.

At this week’s Federal Reserve Open Market Committee meeting, there were a few developments lifting  eyebrows on Wall St.  Officials removed references to inflation declining “recently” and being “somewhat” below their 2% target in a portion of their eager monitored statement.

Five Year Look at the Dollar Index DXY

After lofty promises, uncertain fiscal policy out of Congress and the White House has laid a beating on the dollar.  After a post election surge to 104, she touched 93 this week.  A weak dollar is fueling the reflation trade globally – commodities and emerging markets have been major beneficiaries.  The CRB (Commodity Research Bureau ) index is nearly 10% higher over the last year, while the $EEM (iShares MSCI Emerging Markets ETF) is 25% higher since January.

There’s something on Janet’s (Fed Chair Yellen) mind. Commodity prices are rising at the fastest pace in five years.  The global reflation picture is nearly on the Fed’s doorstep.  In our view, there’s a surging probability the Fed gets thrown off track in 2H 2017, they are behind the curve.

Calm Inflation Expectations?

What’s copper telling us about inflation expectations here?  Believe it or not, one of the keys to 2H equity market stability is a sustainable path of sleepy inflation expectations.  Wall St. has taken their inflation outlook lower and lower in recent months.  Any surprises to the upside – in inflation expectations – would motivate the Fed to put forth a more aggressive withdrawal of policy accommodation (employ more rate hikes).  This outcome would be would be fairly disruptive in our view – signal that the Fed is behind the curve. 

Majority of Rate Cuts Globally are coming from Emerging Market Central Banks

Central Banks Globally in 2017

Rate Cuts: 43*
Rate Hikes: 20

*majority from emerging markets

Central banks in Brazil and Colombia cut rates again this week – despite many developed market central banks signaling less accommodative (Canada, U.S., U.K., ECB) monetary policies looking ahead, emerging market central banks still have the punchbowl in “fill’er up” mode.  So we have a large group of EM central banks easing monetary policy  with the U.S. dollar in the middle of its sharpest decline in five years – how do you spell “over-heat” risk?  Developed market central banks are “trying” to remove accommodation while EM bankers are adding at a 2-1 pace (see above)?

Coal’s 24% Surge Since June 1st, Hello Janet… Can you Hear Me Now?

Calm CPI (inflation data) in the U.S.A. has the Fed in relax mode but when you look around the world – other forces are driving prices higher.

This week, copper surged to the highest level in more than two years on expectations that demand in China will fuel a global shortage.  There were even plans in the country to curb metal-rich waste imports reinforcing a bullish outlook.  Benchmark three-month prices rallied as much as 2.8% to $6,400 a metric ton, the highest since May 2015, and were at $6,296 at 11:09 a.m. in London. That’s a fourth day of gains, and adds to Tuesday’s 3.3% jump, Bloomberg noted.

An Unsustainable Divergence, Global Pressures are Coming at the Fed

2012 through 2017

Yesterday’s news? U.S. PCE Inflation – the orange line above – the Federal Reserve’s preferred measure of inflation has declined for three straight months, to 1.4%, from 2.1% in February.   Tomorrow’s news – the global inflation backdrop is a major problem for the Fed – there’s far too much attention focused on the sleepy U.S. inflation picture.

Strong infrastructure investment in the first five months of the year is helping China reflate their asset bubble in desperate search of maintaining 6.5% growth rate in 2017.   The question remains – did those ten “mad men” in a room in Beijing put too much pressure on the gas pedal this time?

Over the Last Year

Iron Ore +50%
Copper +30%
Oil +16%
Gold -6%

Bloomberg data, July 29 2016 to July 29, 2017

Oil: Best Month in 12 Years

Total petroleum deliveries moved up 2.6 percent from June 2016 and were up by 1.0 percent from May to average 20.3 million barrels per day in June. These deliveries were the highest this year and the best month in since 2007.  For the second quarter, total domestic petroleum deliveries increased 3.0 percent compared to the second quarter 2016. For year to date, total domestic petroleum deliveries increased 1.6 percent compared to the same period last year. API Data

Lessons from 2014-2016

If we look back at the 2014-2016 regime and ask what did the Wall St.’s economists get most wrong in trying to read the Fed?  Far and away the answer to this question lies in global economic (disinflation) pressures. Back then, U.S. economists we far too focused on “robust” domestic economic data and were looking for 12 (yes twelve!) rates hikes (2014-2016) while ultimately the Fed only delivered two. Economists were blinded by the positive U.S. data and couldn’t see the deteriorating global macro risk factors tied to the U.S. dollar’s violent surge.  Global economic weakness was a drag on Fed policy – eventually forced the central bankers to lay down on their loudly promised rate hikes.

Today, many U.S. economists are asleep at the switch again.  They’re far to focused on “goldilocks” calm U.S. inflation data (see the orange line above).   In a dramatic reversal from 2014-2016, the global inflation picture could very well force the Fed into surprise rate hikes.   That picture perfect view over the Manhattan skyline could very quickly turn to darkness.  If the Fed is forced to take Mr. Punchbowl away too quickly, the global reflation revival could be the a summer spoiler.

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