Did the past week’s market action bring us some changes in direction?
Bonds, interest rates, and the dollar
- We expected the Fed to finally address rising inflationary risks, and the FOMC and Powell responded on Wednesday. Though they did not alter their policy per se, they increased their GDP and inflation estimates, resulting in an acceleration of their timetable for increases to the Fed funds rate to 2023. This implies they are more amenable to tapering sooner than previously expected.
- The Fed still wishes to see further economic growth and a sustained drop in unemployment data, so we still should have at least 6-9 months of unaltered QE purchases.
- Markets reacted violently last week on extremely overstretched conditions. The US dollar took off immediately after basing off of its multi-year lows.
- Bonds initially sold off after the FOMC, but soon regained their ground with the 10-year UST yield falling further below its 100-day SMA. With the USD rising, Treasuries look to be relatively compelling to the global investor.
- The drop in yields on the 10-year UST was not shared by the other major nations, as their 10-year equivalent yields rose slightly on the week. A rising dollar helps with domestic bond yields.
- The bond and currency markets are predicting a slowdown in federal deficit spending as the economy strengthens.
- If an uptrend in bond prices were not imminent, yields would have risen after the FOMC meeting. This is further evidence that UST bond yields may have topped out for now. A retracement to the 200-day sma over the next couple months is in the cards.
- I think the Fed will talk about tapering in the fall, begin the actual tapering in the first few months of 2022 with a drop in MBS purchases first, USTs afterwards to match the incremental increases in deficit spending next year. They should conclude the tapering by early 2023, and start hiking rates shortly thereafter.
- The Fed is saying over half of the inflation increase is transitory, and although inflation will run elevated into 2022, the rate of change will fall as the year progresses.
- Once the fiscal benefits are wrung dry, many non-skilled workers will realize they have little power to negotiate higher wages. The jobs data still looks soft when compared to other cycles, and this past week’s jobless claims came in above expectations.
- The latest batch of fiscal spending is getting stuck in negotiations and it’s likely that Biden’s $6 trillion in spending plans will be cut back. As the economy strengthens faster than expected, the federal government may finally get religion and cut back spending plans.
- I am looking at the broad stock averages closely to see how they respond to the prospects of a decrease in fiscal spending and stimulus. If traders perceive a tighter pursestrings and a hawkish Fed, stocks could continue to move lower here. The Transports seem to be leading the way.
- Deficit spending benefits the largest corporations and future profits could be affected on the margin as the prior fiscal/monetary stimulus has already been captured by these firms. Market analysts may have to address the possibility that earnings growth going out to 2023 may have to be reevaluated.
- Though a stronger dollar supports dollar-based asset markets over the longer-term, a firmer greenback at high stock index levels could hurt stock prices as overseas profits could take a hit when repatriated into dollars.
- If the dollar shows some follow through, we could see a further unwind in many of the commodity complexes. There is still some denial, given the Fed and CCP pronouncements this past week. The USDX, at 92.32, could move to 93-95 later this year, depending on how robust the domestic economic picture becomes. There is plenty of potential firepower in the USD futures market as speculation in the greenback has been muted since last Summer. If the dollar shows resilience, the large specs could climb aboard.
- I have to believe that the Fed’s view on inflation will eventually prove more correct than many think. Pressures on the supply-side should ease, the stimulus effects should diminish, and reality will set in on the lack of leverage the worker has over the employer.
- I have been in Lowe’s and HD all week, and the talk of the average shopper on the ProDesk line was one of catastrophe, astonishment, and their belief that prices will keep going higher. When a 4 x 8 x 1/2 piece of plywood is selling for $85, it only takes common sense to figure out that these prices cannot persist. I don’t see a lot of lumber turning over in the HDs and Lowe’s I frequent.
- Industrial commodity prices are also under pressure by China’s decision to cut purchases and release reserves despite rising consumption.
- The CCP chose this auspicious time to prove to the world their power to move the markets by timing their announcement to coincide with the most speculatively overstretched commodity market in recent memory. The power of this hardline stance is enhanced by the FOMCs change of heart. I have to believe that the governments are determined here and official intervention will carry through.
- While this official strategy can only last so long, I gauge the sentiment in the commodities sector as too wildly bullish, and though copper is a much needed metal in the ESG world, I see a retracement to 3.80 to 4.00 as a matter of eventuality.
- I have to believe that there has been plenty of hoarding and though LME stocks may be drawn down, I have to conclude that merchants were hoarding in anticipation of higher prices.
As you can tell, I am clearly taking the contra on just about every stance held by the consensus. Whether my assessments pan out sooner rather than later is up for debate… and future observation. If the Fed decides to get serious, and if the Federal government spending slows for whatever reason, many supply/demand equations could return to equilibrium sooner than what many are thinking. That may still be a 6-12 month arrangement.