“I need to decide,” whispered Biden to himself, struggling, unsure. “Lael is just terrific, no doubt, and her Fed wouldn’t dare cut off my funding,” thought the President, old enough to remember bond vigilantes. “But you can’t help but like Jay, a fine gentleman, a decent human being, and face it, he’s still buying over $100bln of bonds a month with CPI humming hotter than 6%,” thought Joe, having lived through the 1970s inflation. Heck, he was born during WWII and grew up during the post-war financial repression. “Hard to say we need someone more dovish than Powell,” whispered Biden. But of course, all such considerations were beside the point and Joe knew it deep down. The only thing that mattered now, was whether it would be better to fire Powell before or after the Democrats lose mid-terms. Because at this point in the cycle, Jay’s greatest political value is in being a scapegoat.
Overall: “Climate chaos is an urgent threat to our health, communities and economy,” tweeted Senators Merkley and Whitehouse. “We need a Fed Chair who recognizes the urgent need for bold climate action. That person is not Jerome Powell,” they added, the scent of mission creep thick in the air. In 1977, following a horrendous run, Congress tasked the Federal Reserve with an oxymoron – a dual mandate with three objectives: maximum employment, stable prices, and moderate long-term interest rates. And having been born of original sin, into a world where 1+1=3, the central bank’s mandate quite naturally propagated. Slowly at first. Then faster. Until there appeared almost nothing in economics and politics that resided outside the Federal Reserve’s mandate. In 1998 it added to its mission the necessity of bailing out wildly overleveraged hedge funds managed by PhDs with more Nobel prizes than imagination. Blinded by math, they failed to conceive of the possibility that historically stable correlations could break for no reason but for the fact that markets inevitably find a way to inflict the greatest possible pain on those who lack humility. Ever since, in each downturn, the Fed bailed out such characters, always in greater size. It takes an active imagination to envision a world where the Fed is unwilling or unable to fulfill this mandate. Which makes this a real risk. But the central bank’s mandate expanded in far wider ways. In pandemics, the Fed funds the government and buys mortgage bonds, even as house prices surge. Some Senators now call on the Fed to “recognize the urgent need for bold climate action.” It is neither right nor wrong that the Fed does so, it is simply a mandate choice. And the central bank can do anything, everything, just so long as we continue to believe that money is real. Which of course it is not. And inflation is the one thing that can pierce the illusion.
Week-in-Review (expressed in YoY terms): Mon: EU to issue more sanctions against Belarus for engineering a migrant crisis, Germany/France warn Russia against invading Ukraine, Delhi tells people to stay home due to hazardous air pollution (17x worse than WHO tolerable level), ECB Lagarde reaffirms the risks of hiking rates too soon, BoC’s Macklem indicated getting closer to raising rates, BoE Bailey says “on hold” decision in Nov was a very close call, Biden signed the bipartisan infrastructure bill into Law ($550b over the next 10y), US empire mfg 30.9 (22e), S&P unch; Tue: Biden/Xi ended positively but with little substantial progress, reports that Biden to decide on Fed chair “in the next four days”, Germany suspends the approval process for Nord Stream 2 – sending gas prices surging, IEA says end of oil rally is in sight, Hungary CB hikes 30bps as exp, US ret sales 1.6% (0.9%e), US impt prices 10.7% (10.3%e) / expt prices 18% (16.3%e) / IP 1.6% MoM 0.9%e), US NAHB house mkt index 83 (80e), S&P +0.4 %; Wed: Biden calls on Japan / China / others to tap its oil reserve in coordinated fashion, US drug overdoses up 30% YoY, US/China agree to hold talks on nuclear-arms controls, Japan impts 26.7% (31.8%e) / expts 9.4% (10.3%e) / Machine Orders 12.5% (17.6%e), UK CPI 4.2% (3.9%e) / RPI 6% (5.7%e), EU final CPI 4.1% as exp / core CPI 2% (2.1%e), Canada CPI 4.7% as exp, Russia 3Q GDP 4.3% (4.5%e), US housing starts 1520k (1579k exp), S&P -0.3%; Thur: CBT cuts 100bps and indicates more possible – Lira surges to new ATH, S. Africa CB hikes 25bps as exp, China says plans to release crude from its strategic reserves, FL to fine companies that enforce strict vaccine mandates, Disney cruises requires vaccination for all people 5 and older, Sweden unemp 8.5% (8.4%e), US init claims 268k (260k exp), US philly fed 39 (24e), US leading index 0.9% (0.8%e), US KC Fed 24 (28e), S&P +0.3%; Fri: Austria imposes full lockdown if unvaccinated / German health minister does NOT rule out a similar move as covid cases surge, Japan PM Kishida announces $490bn stimulus package, Biden considering a diplomatic boycott of winter Olympics in China, Kyle Rittenhouse acquitted in highly followed trial, FDA authorized MRNA booster shots for all adults, ECBs Weidmann says inflation likely to stay high for longer – contradicting Lagarde who expects infl to “fade”, S. Korea PPI 8.9% (7.5%p), Japan CPI 0.1% (0.2%e), German PPI 18.4% (16.2%e), S&P -0.1%.
Weekly Close: S&P 500 +0.3% and VIX +1.62 at +17.91. Nikkei +0.5%, Shanghai +0.6%, Euro Stoxx -0.1%, Bovespa -3.1%, MSCI World +0.1%, and MSCI Emerging -0.9%. USD rose +12.9% vs Turkey, +9.2% vs Bitcoin, +8.4% vs Ethereum, +3.6% vs Chile, +2.8% vs Brazil, +2.6% vs South Africa, +2.2% vs Sweden, +1.5% vs Mexico, +1.4% vs Euro, +1.3% vs Australia, +0.8% vs Russia, +0.7% vs Canada, +0.1% vs China, +0.1% vs Yen, and flat vs Indonesia. USD fell -0.3% vs India, and -0.3% vs Sterling. Gold -0.9%, Silver -2.2%, Oil -4.7%, Copper -1.1%, Iron Ore -16.7%, Corn -1.4%. 5y5y inflation swaps (EU -7bps at 1.90%, US +1bp at 2.56%, JP +15bps at 0.52%, and UK -3bps at 3.91%). 2yr Notes -1bp at 0.51% and 10yr Notes -2bps at 1.55%.
YTD Equity Indexes (high-to-low): UAE +65.5% priced in US dollars (+65.5% priced in dirham), Argentina +40.1% priced in US dollars (+67.3% in pesos), Saudi Arabia +34.8% in dollars (+34.8% in riyals), Israel +31.9% (+26.6%), Czech Republic +25.7% (+32.7%), India +25.1% (+27.1%), S&P 500 +25.1%, Canada +24.9% (+23.6%), NASDAQ +24.6%, Russia +23.8% (+22.1%), Austria +22.7% (+33.5%), Taiwan +22.3% (+20.9%), Norway +22% (+26.3%), Netherlands +21.6% (+31.6%), MSCI World +19.9% (+19.9%), Russell +18.6%, Denmark +18.6% (+29%), France +18.4% (+28.1%), Sweden +16.2% (+26.6%), Euro Stoxx 50 +13.3% (+22.6%), Italy +13% (+23%), Venezuela +12.8% (+353.7%), Hungary +11.6% (+22.4%), Switzerland +11.5% (+17.2%), Indonesia +10.7% (+12.4%), Singapore +10.4% (+13.7%), Mexico +10.3% (+15.3%), UK +10.2% (+11.8%), South Africa +9.4% (+17.5%), Poland +9% (+21.7%), Germany +8.3% (+17.8%), Belgium +8% (+16.8%), Finland +7.7% (+17.2%), Australia +5.7% (+12.3%), China +4.8% (+2.5%), Greece +4.5% (+13.1%), Ireland +3.8% (+12.3%), Thailand +3.6% (+13.5%), Portugal +1.1% (+9.4%), Spain +0.2% (+8.4%), Japan -1.8% (+8.4%), Philippines -3% (+2%), New Zealand -5.2% (-2.7%), Korea -5.5% (+3.4%), HK -8.4% (-8%), Malaysia -10% (-6.2%), Chile -10.4% (+4.3%), Brazil -19.9% (-13.4%), Colombia -21% (-9.7%), Turkey -22.4% (+17.6%).
Swipe: “The past year has seen many countries promise to achieve net-zero emissions by mid-century. The next must focus on curtailing emissions in the coming decade. The 17bln-20bln tons of greenhouse gases that need to be cut by 2030 correspond to a 45% drop from 2010 levels. Even then, there would be only a 50% chance of limiting global warming to 1.5°C says the Intergovernmental Panel on Climate Change. Yet current nationally determined contributions (NDCS) will result in a rise in emissions, not a drop, by 2030,” reported The Economist.
Swipe II: It should be rather obvious to everyone at this stage that global governments, in aggregate, have no intention of meeting the emission reduction goals they set for themselves. That is in no way due to a lack of desire. But rather an unwillingness to pay the price required to meet the deadline. For the first time in decades, we are confronting problems that cannot be solved with the swipe of a pen. For as long as anyone can recall, each problem that appeared intractable was solved by kicking the proverbial can down the road and accruing more debt.
Swipe III: How will national and geopolitics be altered by a problem that cannot be solved solely with a swipe? The global pandemic will be a helpful guide. Although a far smaller problem than climate change, Covid also affected all and defied a strictly monetary solution. Wealthy nations prioritized their interests over others. China deflected blame, intimidating any nation that dared press for answers. The most vulnerable suffered disproportionately. No globally coordinated effort was made to marshal every possible resource to tackle the problem. And to soothe the stresses, unprecedented sums of money were created at the swipe of a pen.
Don’t Know: I don’t know why 10-year US gov’t bonds yield 1.55% when CPI is 6.20% and inflation appears increasingly persistent. I have some theories to be sure. But I don’t definitively know. Nor does anyone else. And I don’t know what the Fed will do if inflation stays high, but interest rates remain low. It might be that it does little, or nothing. And if that’s what happens, I don’t know why stocks and housing wouldn’t keep surging. But if that started happening, I’m not sure what would stop everyone from borrowing more and more to leverage up.
Don’t Know II: And I don’t know what the Fed would do if everyone started leveraging up, while inflation remained firm, but interest rates remained low. If they hiked as gradually as markets now price, I’m not sure why that such an incremental rise would dampen speculative demand. If the Fed hiked to curb speculation in the name of promoting financial stability and this caused a sharp stock market decline, even as inflation remained high, I’m not sure the Fed could quickly reverse those hikes without sparking a run on the dollar, which would then lift inflation.
Don’t Know III: But what I really don’t know is how markets start to behave when there are so many things that people don’t know. Naturally, there are always many uncertainties when it comes to such things. But the new set of unknowns we face today arise from the reappearance of inflation after many decades of dormancy. And because the economy is vastly different from when we last endured an inflation, while our financial markets are wildly more complex and interconnected, those of us who are being honest truly don’t know. Nor does anyone else.
Anecdote: In my twenties I read everything, my religious ritual. The Economist, cover to cover without fail. Barron’s. Their roundtables. So many newspapers, my Sundays utterly consumed. Wall Street research, countless numbing reports. Week in review. Ahead too. Year after year in preview. If I learned anything at all, it is that there is no single truth, just interpretation. And it’s not that there is anything wrong with being well informed, but for me anyway, I grew tired of ingesting so many views. I don’t like being told what to think as a general matter, and having hit my natural limit, I increasingly turned to books. Not trading books, those had come earlier. Mainly classics. You will learn more about trading emerging markets from reading Nostromo than the entirety of all things written since Conrad published the novel in 1904. And you’ll discover a common structure to the world’s recurring business disasters in Moby Dick, although Melville published it in 1851. It may be impossible to truly succeed without Dostoevsky’s revelations as to what makes us human. Survival stories are another genre I turned to. Into the Land of White Death, written in 1917 by Valerian Albanov sustains me in the dark moments that periodically return. But of course, such masterworks do not connect us directly to the present. So in my thirties and forties I worked hard to cultivate relationships with others who had struggled to develop their own unique approaches. What connects each of these people is a child-like curiosity, passion, drive. An ambition to become better, which is impossible without introspection, humility. Such wonderful qualities can be found in the mature, just as they appear in the young. And unlike research reports and articles that tell you what to believe, such people share ideas, questions, facts and figures that make them think. Sometimes, they reveal those things they find most perplexing. Such a network, diverse in background, economic philosophy, political persuasion, investment focus, and trading time horizon, is invaluable. In the pursuit of an interesting life.
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.