Rule of Thumb
Doug Nolan
Let’s get November documented, starting with notable headlines: “Biggest Blowout in Bonds Since the 1980s Sparks Everything Rally.”
“S&P 500 Has One of Best November Gains in Century.”
“Munis Haven’t Rallied So Much in a Month Since Volcker Ran Fed.”
“Munis Make It a November to Remember While Smashing Records.”
“November Was Once-in-a-Generation Month for Assets.”
“Short Sellers See $80 Billion Hit as November Rally Upends Bets.”
“Treasuries November Gain Biggest Since 2008.”
“Global Stocks Soar in November as Appetite for Risk Returns.”
“Investors Swarm Junk-Bond Funds, Spurring Record Monthly Inflow.”
“Emerging-Market Assets Have Best Monthly Rally Since January ’23.”
The S&P500 returned 9.13% during November, with the Nasdaq100 returning 10.82%.
The KBW Bank Index returned 15.45%, the Semiconductors 15.95%, the NYSE Financial Index 11.37%, the small cap Russell 2000 9.03%, the “average stock” Value Line Arithmetic Index 8.88%, the S&P400 Midcaps 8.50%, and the Dow Transports 8.36%.
The Goldman Sachs Short Index jumped 11.4%.
The NYSE Arca Gold Bugs Index (HUI) surged 11.20% in November.
Gold jumped $52.53, or 2.6%, to $2,036.41.
Silver surged $2.43, or 10.6%, to $25.27.
Ten-year Treasury yields sank 60 bps, the largest monthly drop since December 2008 (71bps).
Benchmark MBS yields collapsed 81 bps, also the biggest fall back to December 2008 (94bps).
Two-year yields fell 41 bps.
Since the great financial crisis, only pandemic March 2000 (67bps) and banking crisis March 2023 (79bps) posted larger monthly declines in two-year yields.
Investment-grade CDS prices dropped 17 bps (largest monthly drop since Oct. 2022) to the low since January 2022.
High yield CDS sank 122 to 402 bps, trading to lows since April 2022.
JPMorgan CDS closed the month down 18 bps to the lowest price (52bps) since January 2022.
Investment-grade spreads to Treasuries narrowed 25 bps to a 22-month low 1.04 percentage points.
High yield spreads narrowed 67 bps to 3.70.
For the most part, CDS prices are lower and spreads narrower now than when the Fed began its “tightening” cycle.
And the trend continued the first trading day of December.
Midday headline: “US Two-Year Yield Falls 10 Basis Points on Powell.”
The Goldman Sachs Short Index surged 6.2% Friday, with the small cap Russell 2000 jumping 3.0%.
Market expectations for the Fed funds rate at the January 2025 meeting collapsed 52 bps this week to 3.84% (down 95 bps from the October 18th peak).
It's worth noting that the week’s largest decline in two-year yields (15bps) came Tuesday, largely in response to comments by hawkish-leaning Fed Governor Christopher Waller.
November 28 – Associated Press (Christopher Rugaber):
“A key Federal Reserve official raised the possibility Tuesday that the Fed could decide to cut its benchmark interest rate as early as spring if inflation keeps declining steadily.
If inflation continues to cool ‘for several more months — I don’t know how long that might be — three months, four months, five months — that we feel confident that inflation is really down and on its way, you could then start lowering the policy rate just because inflation is lower,’ Waller said…”
To have a prominent FOMC “hawk” openly discussing rate cuts, perhaps as soon as in three months, was everything giddy markets could have hoped for.
Never mind that rate cutting talk was inconsistent with Waller’s prepared remarks (i.e., “inflation is still too high, and it is too early to say whether the slowing we are seeing will be sustained”).
Waller’s off-the-cuff comment came during Q&A, in response to a question from the Wall Street Journal’s Nick Timiraos.
“If you think about central banking, we talk about a “Taylor rule” – or various types of Taylor rules – that kind of give us a rule of thumb about how we think we should set policy.
And every one of those things would say if inflation is coming down – once you get inflation down low enough – you don’t necessarily have to keep rates up at those levels.
So, there’s certainly good economic arguments from any kind of standard Taylor rule that would tell you – if we see disinflation continuing for several more months – I don’t know how long that might be – three months, four months, five months – that we feel confident that inflation is really down and on its way [to target], then you could then start to lower the policy rate just because inflation is lower.
It has nothing to do with trying to save the economy or recession.
It’s just consistent with every policy rule I know from my academic life as a policymaker.
If inflation goes down, we’d lower the policy rate.
There’s just no reason to say you would keep it really high if inflation is back at target.” Fed Governor Christopher J. Waller, November 28, 2023, American Enterprise Institute
There’s nothing unreasonable about Waller’s comments.
But he made a mistake as a member of the FOMC, which has too often demonstrated a lack of discipline.
Fed officials have specifically avoided signaling looming rate cuts, knowing that doing so would spark a major market speculative response and resulting easing of financial conditions.
The Fed Governor let his guard down.
Moreover, he did so with markets in the throes of a major squeeze rally and upside market dislocation.
Comments from a bevy of Fed officials this week make it clear the Fed is not ready to signal impending cuts. Markets were having none of it.
Richmond Fed President Thomas Barkin: “I think you want to have the option of doing more on rates.”
New York Fed President John Williams: “I expect it will be appropriate to maintain a restrictive stance for quite some time…”
San Francisco Fed President Mary Daly: “I’m not thinking about rate cuts at all right now.”
Governor Michelle Bowman: “My baseline economic outlook continues to expect that we will need to increase the federal funds rate further…”
It was left to Powell’s Friday morning “fireside chat” to get the markets more aligned with Fed thinking – and to “lean against the wind” of speculative excess.
Bloomberg Live Blog’s “Question of the Day: How Much Should Powell Push Back?”
Well, Balanced Powell’s “premature to speculate on when policy may ease” and “Fed prepared to tighten more if it becomes appropriate” fell on the deafest of ears - token boilerplate that exuberant markets were delighted to completely brush off.
Bloomberg: “Powell Gave His Clearest Signal Yet the Fed has Finished Raising Interest Rates.”
“Bonds Up as Powell Pushback Lasts ‘A Few Seconds’”
Two-year yields dropped 14 bps in Friday trading, to an almost six-month low of 4.54% (down 68bps from 10/18 peak).
The rates market ended the week with a 15% probability of a rate CUT at the Fed’s January 31 FOMC meeting - and 76% for a cut by the March 20th meeting.
All along, markets have been skeptical of this tightening cycle.
There is simply too much debt and speculative leverage for the Fed to ratchet rates up to the point of spurring significant tightening of financial conditions.
Markets have remained confident that the Fed will pull back to avoid a recession or financial accident.
And the rapid response to March bank runs was further emboldening.
In my parlance, financial markets have maintained a strong “inflationary bias”.
This remains an extraordinarily speculative market backdrop.
There’s a $4 TN hedge fund industry.
There are millions of online traders looking to jump on the latest hot momentum stock or index.
Options trading has mushroomed, with millions trading in and out of positions – often 0DM – zero-day to maturity options.
Moreover, derivative hedging strategies proliferate across asset markets, ensuring ample short positions and hedges to spark “rip your face off” squeeze rallies.
Contemporary Market Structure incentivizes speculative leverage – both on the upside and downside.
With all the options and derivatives, a downside market break could easily unleash cascading sell orders and market dislocation.
Meanwhile, the proliferation of shorting and hedging creates the firepower for upside dislocation and melt-up dynamics.
There’s too much “money” sloshing about the markets; too much FOMO (fear of missing out); and too many Crowded Trades.
These “melt-down” and “melt-up” dynamics are notably asymmetrical.
Markets have grown quite confident that the Fed (and central bank community) will intervene to thwart illiquidity and downside dislocation.
The crash scenario can be disregarded, a market peculiarity that grossly distorts the risk vs. reward calculus, market incentives, and speculative dynamics.
This ensures acute market focus on short squeezes, the unwind of hedges, upside dislocations and melt-up dynamics.
Squeezing shorts and front-running the unwind of hedges – in stocks, Treasuries, MBS, corporate bonds, global sovereign debt, EM, and the currencies – has become a go-to strategy for generating quick speculative returns.
Let’s delve a little into Waller’s a “Taylor rule… that kind of gives us a rule of thumb about how we think we should set policy.”
Rule of thumb: “A general or approximate principle, procedure, or rule based on experience or practice…”
Okay, what might be the rate policy “rule of thumb” appropriate for an extraordinarily speculative marketplace – one characterized by a 46% y-t-d gain in the Nasdaq100, 21.5% return for the S&P500, and 134% spike in bitcoin?
Where the Semiconductor Index has gained 46.7% and is only 6% from all-time highs?
Where home prices continue to inflate despite the highest mortgage rates in years.
What is the rate policy “rule of thumb” when $2 TN federal deficits are running at 7% of GDP – when outstanding Treasury securities have increased 360% since the end of 2007 to $28 TN?
When combined Treasury and Agency Securities inflated $12.6 TN, or 47%, over just the past four years?
What is the “rule of thumb” following an unprecedented $5 TN QE program, where despite 17 months of QT, the Fed’s balance sheet is still at $7.8 TN – 87% larger than where it began 2020?
Where Money Fund Assets have inflated $1.2 TN, or 25.8%, over the past year to a record $5.836 TN?
Where Household Net Worth inflated an unmatched $41 TN in 15 quarters to a record $154.3 TN, or 576% of GDP (previous cycle peaks 444% in Q1 2000 and 488% during Q1 2007)?
Where combined Household holdings of liquid deposits, money funds, and Treasury and Agency Securities inflated $6.0 TN, or 39%, in 15 quarters to a record $21.3 TN?
The “rule of thumb” for an unemployment rate of 3.9% and 9.55 million job openings – and labor and labor unions the most emboldened in decades?
Where CPI (y-o-y) peaked at 9.1% 17 months ago - and was still 4.9% as recently as April?
I know the “soft landing” and “immaculate disinflation” narrative has become conventional wisdom.
It’s widely believed these days that there is no price to pay for years of monetary and speculative excess, for deeply flawed monetary management, and for fiscal recklessness.
That structural maladjustment is a nonissue.
I don’t buy any of it.
The day of reckoning is only on hold.
By now, the system should be well into what will be painful financial and economic adjustment.
Instead, Bubble inflation runs unabated.
Truth be told, we are witnessing wild end-of-cycle Monetary Disorder.
Evidence includes extraordinary price instability – from CPI to securities markets to quarterly GDP.
Importantly, market structure at this point precludes stability.
Speculative excess ensures sporadic upside market dislocations, where squeeze rallies create Trillions of perceived wealth, dramatic financial conditions loosening, and economic instability.
It all appears prelude to serious trouble.
Bloomberg: “Powell Pushes Back on Rate-Cut Bets But Markets Push Back Harder.”
A historic speculative Bubble has taken control – perhaps decisive, fateful control.
Gold jumped $35.81 during Powell Fireside Friday, trading to an all-time high $2,072.
For the week, gold rose $71.40, or 3.6%, with silver surging $1.16, or 4.8% (to $25.49).
The precious metals signal central bankers and their “rule of thumb” are playing with fire.
0 comments:
Publicar un comentario