Summer of Discontent and Instability
Doug Nolan
It was another important week – and I’m not referring to Nvidia’s market cap surpassing Apple’s to reach $3.0 TN (or Roaring Kitty’s podcast touting GameStop attended by 600,000).
There were market-surprising/shocking election results in Mexico, India, and South Africa.
Volatility was notable across international markets.
The ECB and Bank of Canada cut rates this week, with markets seeing the global central bank community’s easing cycle now underway.
And Friday, another stronger-than-expected Non-Farm Payrolls report rattled the bond market.
Could there possibly be a common thread?
The Mexican peso sank 7.2% this week, with over half the loss on post-election Monday.
Mexican stocks (S&P/BMV Index) were slammed 6.1% in Monday trading.
Indian (Nifty50) equities were hit 5.9% in Tuesday’s session.
June 6 – Bloomberg (Ezra Fieser):
“Early Monday morning, one of the world’s most profitable currency trades unraveled, done in by a twist in Mexican elections few saw coming.
Twenty hours later, investors in India started frantically dumping stocks, triggering a one-day, $386 billion wipeout, when they realized they had badly miscalculated the scope of Narendra Modi’s election victory.
Around the world, surprise results in some of the biggest developing countries are illustrating how much markets have riding on the politics of 2024…
From Mumbai to Mexico City, the Year of the Election — in which 40 countries are holding national votes — is already burning investors, providing an early warning as elections in the European Union and UK near, and five months ahead of the US presidential contest.”
Highly speculative (and levered) markets don’t mix so well with voter acrimony.
Importantly, speculative Bubbles and public enmity are not coincidental.
They are inevitable consequences of inflationism and monetary disorder.
Given enough time, policies so revered by the markets will be viewed with increasing disdain by the masses.
Wealth inequalities become only more pronounced late in the cycle, creating a sprawling divergence between market euphoria and deepening public dissatisfaction.
Political class market embracement/accommodation at some point shifts to the appeasement of ever more powerful populist movements.
Markets this week at least acknowledge the unfolding power-shift to disgruntled electorates.
Booming markets have a way of disregarding corrosive fundamental factors.
Especially in today’s backdrop, there are competing narratives: the golden era of markets and capitalism versus increasingly vulnerable historic global Bubbles.
Overwhelming evidence supporting the latter ensures ample hedging and shorting – fuel for recurring squeezes and rallies.
It all becomes too alluring, with short-term speculation coming to dominate.
Irrespective of underlying fundamental trends, speculative markets will innately gravitate to opportunities associated with bullish narratives.
This was a fascinating week in the bond market.
After trading at 4.63% the previous Thursday, 10-year Treasury yields were down to 4.29% Friday morning ahead of the May jobs report.
Sure, there were some weaker data earlier in the week.
The ISM Manufacturing report (48.7) disappointed, especially the four-point drop (to 45.4) in New Orders to a one-year low.
Job openings (JOLTS) fell to 8.059 million (expected 8.350 million), while ADP came in at a weaker-than-expected 152,000 (175k estimate).
With a pretty good bond market squeeze in progress, sentiment shifted emphatically to the “a weakening economy will soon unleash a Fed loosening cycle” narrative.
The market ended Thursday pricing two cuts by the Fed’s December 18th meeting.
Wednesday was noteworthy.
What I view as the week’s most meaningful data for the U.S. services-dominated economy was completely disregarded.
The May ISM Services Index surprised strongly to the upside, with a 4.4-point jump in the index (2.8 points above estimates) to the strongest reading since February 2023.
The Business Activity component surged 10.3 points (largest gain since March ’21) to the highest level since November 2022.
Prices remained elevated at 58.1 (down from 59.2), while Employment rose from 45.9 to 47.1.
New Orders increased to 54.1, with Export Orders (61.8) at the strongest level in eight months.
Why would the market ignore such relevant data?
The simple answer would be that the bond market was getting squeezed, and one report was not going to detract from speculative dynamics and the bullish narrative.
A more complex explanation deserves a hearing: nascent trouble at the global “periphery.”
June 4 – Bloomberg (Maria Elena Vizcaino, Vinícius Andrade and Michael O'Boyle):
“For the last two years, the world’s fund managers had a recipe to mint money in Mexico.
Borrow anywhere interest rates were low, pile into Mexican assets — and clean up as the peso marched higher and higher.
Virtually overnight, it’s no longer such a sure thing.
The landslide victory by Claudia Sheinbaum in the presidential election on Sunday has rattled markets by promising to significantly strengthen the hand of the nation’s ruling leftist party in legislation.”
The global “periphery” is acutely vulnerable.
EM countries have added enormous amounts of debt over recent years, and we should assume that much of it was purchased by speculators with borrowed money.
It’s certainly possible that so-called “carry trades” total in the Trillions.
“Leveraged funds have been the main force behind the recent Mexican peso rally, propelling it to again become the best performing currency in the world this year.”
Bloomberg, May 20th, 2024.
Two weeks later: “Unwinding of hugely popular currency trade rocks markets.”
Trouble in Mexico, and to a lesser extent India and South Africa, raised the odds of general risk aversion, contagion, and destabilizing de-risking/deleveraging.
Such a scenario would likely spur dollar strength, outflows, and rapid deceleration in EM Credit and economic growth.
This deflating Bubble scenario supported the bond market earlier this week.
I also believe this risk has helped keep a lid on U.S. and developed market sovereign bond yields – countering the impact of resilient inflation and “higher for longer.”
Friday’s stronger-than-expected payrolls data provided a reality check.
Ten-year Treasury yields surged 14 bps (MBS yields up 16 bps), with two-year yields jumping 16 bps to 4.89%.
The market ended the week pricing 37 bps of rate reduction by the Fed’s December 18th meeting (versus 49 bps at Thursday’s close).
Count me skeptical of the view that inflation and growth are on the descent.
Sure, there are ample signs of weakness to support the thesis that the Fed will soon have the all clear to begin cutting rates.
The household sector has added significant debt, and a rising number of consumers face financial stress.
Of course, an inflationary economic environment will burden major cross-sections of the population.
But that’s the overarching issue: inflation remains a major force.
And one of this cycle’s greatest inflationary manifestations is a gross inequitable distribution of wealth.
The lower and much of the middle class suffer from higher prices, while the wealthier see their wealth continue to inflate.
June 5 – Wall Street Journal (David Uberti):
“Growing investment income and household wealth have joined near-full employment and rising wages to keep millions of Americans… spending their way through price hikes.
The economy’s charge through higher interest rates is putting unprecedented sums into consumers’ pockets, pushing U.S. asset values to records and helping many high earners avoid the withering effects of inflation.
Americans in the first quarter earned about $3.7 trillion from interest and dividends at a seasonally adjusted annual rate…, up roughly $770 billion from four years earlier.
In the last quarter of 2023, wealth held in stocks, real estate and other assets such as pensions reached the highest level ever observed by the Federal Reserve.”
June 5 – Fox Business (Kristen Altus):
“So far, we’ve had disappointing retail sales.
We’ve had disappointing PMI manufacturing numbers.
The ISM numbers were disappointing.
[Tuesday's] job vacancies were considerably below expectations," Mohamed El-Erian, president of Queens' College at Cambridge University, said…
‘Citi has this ‘index of surprises,’ and we've had nothing but negative surprises.’
‘And all that is saying to us is that the economy is slowing much faster than most people expected, including the Fed’…
‘That is where the policy mistake comes in.
Monetary policy acts with a lag…
So you are really targeting the economy of tomorrow.
But if you do that based on yesterday’s data, you are likely to get it wrong.’”
There will be revisions, and there are contradicting household survey data, but I wouldn’t dismiss the Friday report of 272,000 additional jobs.
And that y-o-y Average Hourly Earnings growth remains at 4.1% suggests the labor market has entered a new paradigm (avg. 2.4% for the decade 2010-2019).
I’ve already mentioned the strong ISM Services data.
June 4 – Yahoo Finance (Pras Subramanian):
“Ford reported May US auto sales that jumped considerably, once again powered by hybrid vehicle and truck sales.
For the month, Ford sold 190,014 vehicles, an 11.2% increase from a year ago and up 6.4% sequentially from April.
Ford delivered 17,631 hybrid vehicles for the month, driven by the new F-150 hybrid and Maverick hybrid.”
Receiving no attention whatsoever, May vehicle sales were reported at a stronger-than-expected 15.9 million annual rate – near the strongest pace since 2021.
From Bloomberg Economics:
“With two months' data in hand, this implies vehicle sales potentially rose as much as 10.4% in 2Q on an annualized quarterly basis.”
Mr. El-Erian (and others) believes that “remaining too tight, it will inflict unnecessary damage to a US economy that will already be facing more growth headwinds.”
This misses the most crucial analysis: The U.S. (and much of the world) is a Bubble Economy.
There will undoubtedly be much more than future “growth headwinds.”
Acute financial and economic fragilities are fundamental to aged Bubbles.
The issue I have is that “remaining too tight will inflict unnecessary damage.”
There will be no escape from the consequences of damage already done.
The policy priority when confronting Bubbles should always be to limit the type of deep structural damage that ensures destabilizing financial crises and severe economic downturns.
Systemic risk rises parabolically during “Terminal Phase Excess.”
Time is of the essence.
Analysts and central bankers who are content to disregard Bubble Dynamics while focusing on avoiding recession are missing the grave financial, economic, social, and geopolitical risks associated with runaway Bubbles.
Mr. El-Erian doesn’t utter the “B” word.
Very few on Wall Street will admit we’re in a Bubble.
Is there anyone in the Federal Reserve system even contemplating Bubble analysis?
Yet it is the most consequential dynamic in the markets, finance, and economy today.
A lot of effort is wasted on debating the appropriate “neutral rate.”
But a policy rate that is highly accommodative during the late stage of Bubble excess will turn restrictive when the Bubble begins to deflate.
Today’s policy rate continues to accommodate Bubble excess.
One can look at the booms in federal borrowings, “private Credit,” corporate debt, securitizations, muni issuance, “buy now, pay later,” etc.
And so long as Credit remains abundantly available, it will be spent.
Count on in.
June 5 – Bloomberg (Abhinav Ramnarayan and Eleanor Duncan):
“Some $175 billion worth of debt backed by assets such as cars, credit cards and consumer loans have been sold in the US and Europe so far in 2024…, in what is shaping up to be the busiest half of issuance for the sector in at least six years.
Asset-backed securitization deals, where loans are packaged up and sold in bond-like instruments, have grown in popularity as banks seek ways to offload risk and refinance loans taken out during the easy-money era.
If sales continue at the current pace, the first six months of 2024 will be the best half since at least 2018…”
June 7 – Bloomberg (Abhinav Ramnarayan):
“Companies offering buy now, pay later services like PayPal Holdings Inc. and Klarna Bank AB are selling debt backed by consumer loans, as they find new ways to fund their business in a higher-rate environment.
By offering pools of assets repackaged as securities, these firms are able to access relatively inexpensive funding via private markets…
That’s helping drive a resurgence in the sector.
PayPal signed an agreement with private equity firm KKR & Co. to sell it European loan packages, while Klarna has secured similar debt in private deals…
‘There’s a lot of buy now, pay later deals going through privately at the moment,’ said Salim Nathoo, a partner at A&O Shearman...
‘It’s a product that fintechs are pushing out in different jurisdictions and we are certainly seeing some pan-European portfolios hit the market.’”
June 5 – Bloomberg (Skylar Woodhouse and Shruti Date Singh):
“US airports are set to storm the municipal-bond market in the weeks and months ahead to raise billions of dollars for upgrades and fixes they can no longer put off as travel surges to new highs.
At the urging of airlines, facilities across the US are increasing not only runway capacity but also amenities at new or renovated terminals…
Already this year, operators of airports in cities from San Francisco to St. Louis have come to market with $3.5 billion of debt…
Heavy volume through September and another wave in December will push the total for the year to $21 billion, close to the pre-pandemic peak…”
Treasuries demonstrate powerful Bubble Dynamics.
With the Fed communicating a bias to begin cutting rates, the Treasury market quickly responds to weaker data with lower yields.
And lower yields then work to underpin Credit growth and economic momentum.
The Atlanta Fed GDPNow Forecast is back above 3%.
Moreover, there’s now nascent instability at the “periphery” that places some downward pressure on “core” yields.
How does it all end?
How long will the bond market accommodate excess that elevates the risk of ongoing massive issuance and upside growth and inflation surprises?
And now we have arguably premature rate cuts from the ECB and Bank of Canada.
From my vantage point, recent data suggest improved prospects for both the Eurozone and Canada.
In what increasingly appears a global phenomenon, wage pressures risk upside inflation surprises.
June 7 – Bloomberg (Alexander Weber):
“The European Central Bank’s preferred measure of euro-zone pay showed acceleration at the start of 2024, in the latest sign that price pressures in the region are proving stubborn.
Compensation per employee rose by 5.1% from a year ago in the first quarter, up from a revised 4.9% in the previous three months...
That exceeded a Bloomberg Economics forecast of 4.6%.”
June 7 – Bloomberg (Randy Thanthong-Knight):
“Canada’s unemployment rate rose for the third time in four months, but rising wages and a strong US labor report prompted some economists to express caution on the pace of Bank of Canada rate cuts.
The country added 26,700 positions in May and the jobless rate rose 0.1 percentage points to 6.2%...
Still, several economists flagged rising wage growth...
Hourly wages for permanent employees accelerated by 5.2%, faster than expectations of 4.7% and up from 4.8% a month earlier.
That’s the strongest pace since January…”
EM stress dissipated as the week progressed.
But it sure appears there’s some pain in various trades that is forcing de-risking.
I think it’s likely the tide has turned against the “periphery.”
Contagion watch.
The week’s developments point to a Summer of Discontent and Instability.
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