“These crises are really a form of domestic default that governments employ in countries where financial repression is a major form of taxation. Under financial repression, banks are vehicles that allow governments to squeeze more indirect tax revenue from citizens by monopolizing the entire savings and payments system, not simply currency. Governments force local residents to save in banks by giving them few, if any, other options. They then stuff debt into the banks via reserve requirements and other devices. This allows the government to finance a part of its debt at a very low interest rate; financial repression thus constitutes a form of taxation. Citizens put money into banks because there are few other safe places for their savings. Governments, in turn, pass regulations and restrictions to force the banks to relend the money to fund public debt….”
~ Carmen M. Reinhart, This Time Is Different: Eight Centuries of Financial Folly
Good short video from Elliot Clarke & Richard Franulovich at Westpac IQ about Aussie/US Dollar prospects and the outlook for the US economy.
Rising yields are lifting the Dollar but the Fed’s dovish stance is expected to cap the Dollar going forward, with the Aussie likely to strengthen above 80 US cents.
The Biden stimulus is likely to help the US economic recovery this year but will wear off by year-end. There are many obstacles to passing a major infrastructure bill but that would be the best way to lift growth prospects over 2022/3 and beyond and help the US keep pace with growth in Asia, where there are more development opportunities.
Good progress has been made combating the pandemic but daily COVID cases seem to be struggling to break through a floor between 50 and 60 thousand. The vaccine roll-out is ahead of schedule but people need to stop listening to idiots like Rand Paul — who went to the Senate gym while infected — and listen to the Chief Medical Adviser whose advice is to wear a mask.
Stocks have paused after the recent run up in Treasury yields. When both stocks and bonds are being sold, there is nowhere to hide.
The Nasdaq 100 is testing support at 12000. At this stage the correction looks mild, with declining Trend Index remaining above zero, but breach of 12000 would signal a test of the Sep 2020 low.
The S&P 500 is performing better but Volatility troughs above 1.0% still warn of elevated risk.
The big five tech stocks are a mixed bag. Alphabet (GOOGL) and Facebook (FB) show strength. Microsft (MSFT) looks stable, while Mazon (AMZN) and Apple (AAPL) are trending lower.
When leaders no longer lead normally signals the final stage of a bull market. The chart below shows the Russell 2000 small caps ETF (IWM) clearly outperforming the large cap Nasdaq (QQQ) and S&P 500 (IVV) indices with all the tech heavyweights.
The steeper yield curve benefits banks, who profit from the wider net interest margin. Major banks have climbed 60% to 80% over the past six months, with Goldman Sachs (GS) leading and Bank of America (BAC) the laggard.
Consumer durables sectors are, again, a mixed bag. Household Goods (HG) is flat, Apparel Retail (RA) is climbing steadily, while Automobiles (AU) is down sharply — mainly because of Tesla (TSLA).
Though light vehicle sales were down a million units in February.
And heavy truck sales were down 4,000 units compared to January.
Prospects for the tire industry are improving. Goodyear (GT) retraced to test its new support level after breaking out above its high from late 2019. Respect would confirm another advance.
The recovery is going to be a long hard slog with frequent setbacks. Banks are doing nicely but stocks generally are over-priced and ripe for a major adjustment. There are signs that this is the final stage of the bull market and market risk is elevated.
The rise in Treasury yields accelerated over the past week, with 10-year Treasuries closing at 1.54% on Thursday and 10-year TIPS at -0.60.
A sharp fall in daily new COVID-19 cases has fueled optimism about a rapid re-opening of the US economy.
As well as fears of higher inflation.
What the sell-off means
Investors are selling Treasuries at a faster rate than the Fed (and banks) are buying, out of fear of accelerating capital losses. Fixed coupons have been badly affected, with iShares 20Year+ Treasury Bond ETF (TLT) showing a loss of 13% over the past 6 months. But even inflation-protected bonds have lost value in anticipation of higher real interest rates, with PIMCO’s 15 Year+ TIPS Bond ETF (LTPZ) falling more than 6%.
The Fed response
The Fed is likely to respond by weighting purchases towards longer maturities. The 10-year Treasury yield has already started to anticipate this, falling to 1.39% by Friday’s close.
The result is a 16 bps fall in the real 10-year yield, to -0.76% on Friday (1.39-2.15).
Fed purchases are expected to suppress long-term Treasury yields over the next few months, with inflation breakeven rates continuing their upward trend, while real yields remain negative.
The S&P 500 continues, unwavering, in a strong up-trend.
But compare the growth in the S&P 500 index relative to growth in the money supply (M2). In relative terms, the S&P 500 appreciated only 29%, or 2.6% p.a., over the past decade. Most of the stellar performance over the past 10 years can be attributed to the Fed’s expansionary monetary policy.
The Dollar Index continues to test support at 90. A Trend Index peak below zero warns of strong selling pressure. Breach of support is likely and would signal another primary decline.
The Chinese Yuan, however, has halted in its appreciation against the Dollar. Trend Index peak below the 7-week MA warns of secondary selling pressure. Breach of support at 15.4 US cents would warn of a correction.
The S&P 500 is likely to continue rising for as long as the Fed expands the money supply. The Dollar, however, is expected to weaken for the same reason.
Interesting question from Steve:
Bitcoin has broken through $50k, so there is now some USD940 billion in circulation. What would be the impact on the Gold price? It seems to me that many Bitcoin purchasers are buying as an alternative to buying Gold as a store of assets.
Bitcoin may be diverting some investors from gold but we believe this is marginal. Global gold reserves ($9.6T according to Perth Mint) are still 10 times the size of Bitcoin.
If we look at 2018, when Bitcoin fell from $19,000 to $3,200….
There was little benefit to Gold which also fell for most of the year.
Again in 2020, when Gold peaked at the beginning of August….
Bitcoin remained flat for 3 months before commencing an up-trend in November 2020. And broke $20,000 on Dec 17th, while Gold was rallying.
The rise in Bitcoin is not the cause of recent weakness in Gold.
We see Bitcoin as speculative and would not hold it as a store of value — any more than Dutch tulips.
Gold has served as a store of value for thousands of years and this is unlikely to change.
A reader asked me to explain MMT. I am not an economist and will try to avoid any jargon.
The basic tenet of MMT is that government has the power to reduce unemployment by increasing stimulus spending. Government spending in excess of tax revenues (a deficit) is funded by an increase in public debt. Deficits are likely to cause inflation but MMT holds that inflation can be reduced by raising tax revenues.
Problem with Lags
There is normally a lag between an increase in debt and the resulting increase in inflation. If you wait for inflation to rise before raising taxes, underlying inflationary pressures have already built and will be hard to contain.
There is also likely to be a lag between raising taxes and a resulting fall in inflation. This means that authorities will keep raising taxes for longer, causing an eventual contraction in employment.
The second problem is that it is far easier to increase government spending than it is to raise taxes. Voters seldom object to an increase in public spending but are likely to punish any government that increases taxes. This is likely to make the lag between identifying inflation and raising taxes even bigger.
Third, regular increases in government spending followed by tax increases (to subdue inflation) are likely to ratchet up government spending relative to GDP. Rising levels of public spending followed by rising taxes is simply creeping socialism and is likely to slow long-term economic growth.
Finally, sharp increases in public debt no longer deliver bang for buck.
Has inflation been tamed?
The consumer price index (CPI) is nowadays a lot less volatile than producer prices (PPI) which it tracked quite closely in the 1960s and 70s. Some of this can be attributed to better management at the Fed but the primary reason is the offshoring of manufacturing jobs to Asia.
The service sector is largely immune from producer prices and fluctuations in offshore manufacturing costs are partially absorbed through a floating exchange rate.
We have witnessed a decline in global trade over the past two years and this is likely to develop into a long-term trend towards on-shoring key supply chains in both Europe and North America. On-shoring is likely to drive up prices.
Inflation is not dead. On-shoring of supply chains is likely to drive up prices. Rapid expansion of public debt is expected to weaken the Dollar, slow growth and fuel inflation. Long-term costs of bringing inflation under control are likely to outweigh the shorter-term benefits of MMT-level stimulus.
Daily new COVID-19 cases in the US are clearly falling as the vaccine roll-out takes effect.
But daily deaths are still rising and may take another few weeks to level off.
January payroll figures show the economic recovery has stalled, with total jobs contracting by 6.08% compared to January 2020.
Hours worked are down 4.4% compared to last year.
Average hourly earnings jumped 5.44% for production and non-supervisory workers but these are distorted by strong job losses in the lowest pay grades.
Retail sales (excluding food) have also been artificially boosted by government stimulus which added roughly 20% to disposable income.
Light vehicle sales are similarly boosted.
While housing starts are climbing in response to record low mortgage rates.
Total unemployment claims (state and federal) declined to a still high 17.8 million for the week ended January 16th.
The proposed Biden stimulus will support households and businesses but employment is likely to remain weak until the COVID-19 outbreak is clearly under control.
Economic activity is expected to remain weak in the first half of 2021. A key determinant will be the length of time it takes to bring the COVID-19 outbreak under control. Subsequent recovery is likely to need strong fiscal support, with federal debt expected to grow faster than GDP in 2021. This will require continued Treasury purchases by the Fed and commercial banks, with interest rates remaining low throughout 2021.