Tightening into monetary contraction, a soaring dollar and a deeply inverted yield curve are prelude to market crash
U.S. Federal Reserve chair Jerome Powell has hiked interest rates aggressively, just about the most on record in a short period. Photo by REUTERS/Kevin Lamarque There is no way the current unrest is about the consumer or inflation any longer. Commodity prices are plunging, the United States dollar is soaring, freight rates are tumbling and supply delivery delays are sagging.
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We just came off a month, where for the first time since April 2020, both the U.S. unemployment rate went up and capacity utilization rates went down (each by 20 basis points). Available supply is now outpacing demand by a three-to-one margin as the output gap begins to widen. The 8.3-per-cent inflation rate is set to melt like an ice cream bar on a Houston sidewalk in the middle of July. Rents? Please, a lagging indicator and already yesterday’s story. Wages? Sure thing, they have been running behind prices each and every month since April 2021. Give it a break.
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The 8.3% inflation rate is set to melt like an ice cream bar on a Houston sidewalk in the middle of July
What happened to the refrain so commonly used on bubblevision in the summer that “whenever we have seen a rebound that reversed 50 per cent of the initial slide, the S&P 500 never goes back to set a new low”? Never is a long time, isn’t it? The S&P 500 closed Monday at 3,655, undercutting the June 16 closing low of 3,667. The Dow industrials and transports have done likewise (the former -20 per cent and the latter -30 per cent) and together confirmed the bear market backdrop (both off -1.1 per cent Monday — a day when only consumer staples didn’t finish in the red). The same thing is happening to the NYSE composite, which has sliced below the mid-June trough.
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In the bond market, the front end is getting killed, and the real rate (10-year) shot up 24 basis points to 1.56 per cent. It was last there in April 2010 and consistent with a further squeeze on the market multiple to 14x. We get a recession hit to EPS, and we are talking about the S&P 500 sliding below 3,000. Wait for it.
Meanwhile, as nominal bond yields rise, market-based inflation expectations are coming down to their lowest levels in three months: for all the bellyaching, roughly 2.3 per cent for the 10-year TIPS breakevens and five-year/five-year forwards. The long bond, at 3.68 per cent, is actually behaving admirably, as it now trades at a yield discount to the entire Treasury curve, and try as the bears do, they can’t get it anywhere close even to where the 30-year was during some of the worst moments of financial and economic history: the 1998 Asian crisis, the 2001-02 tech wreck, the early 2008 Bear Stearns failure and the mid-2008 crisis at Fannie and Freddie.
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The big problem is the surge in the corporate cost of both debt and equity capital, because one can make a reasonable bet that capex is about to join residential construction in the deep contraction environment.
The Fed has hiked aggressively, just about the most on record in a short period, into a significant tightening in bank lending guidelines. Make no mistake: the central bank is guiding us into a credit crunch, all the more so as collateral assets deflate. And the tightening by the Fed into monetary contraction, a soaring dollar, and a deeply inverted yield curve is a prelude to a market crash.
The day the straw breaks the camel’s back is the day you will have regretted dumping your long bonds just because the Fed was busy taking the carry away in the ninth inning of the economic and market cycle — keeping an eye on those inflation expectations will win the day.
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We choose to stay long duration because we believe the Fed is setting us up for a break in the “wealth effect on spending,” a break in the decades of a too-tight (and unhealthy) link between the financial economy and the real economy, and the asset deflation that already is upon us, first in equities, next in real estate, will trigger a renewed cycle of deflation for the consumer and producer — and we will be back to a more normal business cycle.
But, seriously, to be in front of the cameras lamenting yesterday’s inflation in the face of the maelstrom in the commodity pits is practically comical. It certainly isn’t every day that the Commodity Research Bureau index slides 1.6 per cent, oil dives 2.8 per cent, and the yield on the 10-year T-note jumps 24 basis points to 3.93 per cent.
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Recommended from Editorial David Rosenberg: Slumping equity risk premiums mean there is more bear market to come David Rosenberg: Time to get defensive as Fed chair’s ‘pain’ comment unravels markets There isn’t anything fundamental here. It is all about a complete lack of liquidity — shades of February-March 2020 — and the forced selling of the highest-quality assets to meet margin calls on the most-cyclical securities, which are taking it on the chin and then some.
Look at what these commodities have done from the peak — keeping in mind that this was the area that first got “inflation” going back to late 2020: lead: -30 per cent; copper: -33 per cent; zinc: -35 per cent; oil: -37 per cent; cotton: -43 per cent; nickel: -54 per cent; aluminum: -45 per cent.
Do you see the “inflation” here? Because I sure don’t.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on Rosenberg’s website.
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