Juggling Dynamite

This week central banks are responding to political pressure around price inflation (lagging economic indicator) with accelerated monetary tightening plans.

The central bank of Norway (Norges) doubled its policy rate to .50%, the Bank of England ended its bond-buying program and hiked its base rate to .25 from .10%, while the U.S. Fed doubled the pace of its Q.E. tapering–reducing to $60 billion a month, half of what it was buying in October–and ending it altogether mid-March, three months ahead of the previous plan; with three rate hikes forecast by the end of 2022. The ECB says it will slow its bond-buying to €40 billion a month in April from about €80 billion a month now, but left its policy rate unchanged at -0.5%.  The Bank of Japan is up tomorrow; no tightening is planned.  Now we have the next tidal wave of COVID upending plans and forecasts.

The Bank of Canada ended its bond-buying program in October, and 4-rate hikes are pencilled in by the end of next year (from .25 to 1.25).  With 40% of new Canadian mortgages in 2021 taken with a variable rate (which increases with BOC rates)–at obscene ratios of price to income and rents–a 400% rate increase is no small feat.  The larger question is to what extent forced selling prompts a surge in supply and self-feeding home price deflation with negative impacts on the economy and stock market, well within the range of probable outcomes.

The fragility inherent in highly levered households and businesses is one reason that we doubt the Bank of Canada will end up hiking to the extent planned (and presently priced into the Treasury market) next year.  Central banks have been consistently over-optimistic on their economic forecasts, failing to acknowledge that their debt-adding policies serve to reduce future growth prospects.

Fed Chair Powell revived animal spirits yesterday when he acknowledged that falling asset prices would prompt the FOMC to rethink its tightening plans.  That’s been their number one dovish catalyst for years now.  But as Japan has reminded us since 1989, when stock, debt and property market bubbles burst together, no amount of central bank easing can stop or reverse the secular force of gravity on asset prices and interest rates.

In the end, much lower prices are not the enemy, they are necessary to restore financial viability, and valuable investment prospects rather than counter-productive speculative frenzy.  Best to embrace the cure than waste more time and money trying to extend the unsustainable.  The era of central bank worship is moving toward its predictable end.

Today, Fed chair Powell will try to appease political pressure to “do something!” about inflation caused by supply-side shocks (which are already resolving themselves) and asset markets loco on the irrational belief that central banks won’t let asset bubbles burst.  Sure thing!  Of course, the policy mistakes were already made in not tightening financial conditions appropriately during the expansionary phases and speculative manias of the last two decades.

Now, as expectations for Fed tightening accelerate, the risk-trade is tumbling (stocks, corporate debt, commodities, cryptocurrencies, and yes, even real estate is in this group). At the same time, Treasury bonds keep gaining on slower and slower growth prospects for 2022.  A new sheriff’s in town, and it’s called mean-reversion.  Global liquidity is retreating amid a consumer-led economic slowdown with market participants never more long or leveraged.  Perfect storm indeed.

The Economic Cycle Research Institute’s Lakshman Achuthan warns consumer spending is in a cyclical slowdown, and it will weigh on holiday sales. Here is a direct video link.

The last 18 months have been the zenith of two decades of monetary madness and speculative mayhem.  For the few possessed of fundamental and historical context, conditions have been both amazing and disturbing to behold.

Fear of missing out (FOMO) is a form of mental illness when it diverts focus and capital from time-tested first principles of risk management and financial prudence towards gambling and self-destructive behaviours.  As typical, the throng knows not what they do. But most damaging, those trained and paid to know better have abandoned their duty of care, funnelling capital into asset bubbles with reckless abandon.

It is time, once more, for agonizing reappraisals. 

The IPOX SPAC index, a mix of 50 SPACs and De-Spacs (another marketing euphemism for junk), is, so far, down 32% from its 2021 peak. 

The basket of so–called “meme“ stocks–37 retail trading favourites tracked by Bloomberg–has lost nearly 25% of its value over the past three weeks and is now back to where it was last January, as shown below. 

While the Goldman Sachs index of profit-less U.S. tech stocks has lost more than a fifth of its value over the past month–mean-reversion here is barely begun.

Following the risk-off trade, most global commodities are also sharply below their springtime peak.  With default contagion spreading through Chinese property developers (some of the largest globally) and the China Real Estate Index already at a 5-year low, commodity demand is less robust than commonly forecast. Today, the IEA sees global oil markets back in oversupply by early 2022.  WTI (West Texas Crude), already down 16% since October, appears to have gotten this memo weeks ago, and before the latest and most contagious COVID variant further damps travel plans.

The U.S. Fed drives with its rear-view policy mirror, but commodity currencies are already giving up on the ‘inflationary’ ghost.  As shown below from my partner Cory Venable, after bouncing off $1.20 in June for the third time since 2015, the U.S. dollar is through C$1.28 this week.  International capital flows seeking liquidity and shelter from melting asset bubbles make further greenback gains against commodity currencies a base case. 
Ditto for North American government bonds.  As shown below, since 2018, the U.S. 10-year Treasury yield is back below 1.50, with the next test in the 1.35 area as safety-seeking inflows continue to boost treasury prices.
The misplaced confidence of asset-heavy, cash-light participants is deeply entrenched.  But it will melt with their misallocated capital.  Of that much, we can be sure.