Outlook
The top news today is the Fed minutes, which will not tell us anything we don’t already know—three members worried about inflation and wanted a hike, but got outvoted. That doesn’t mean analysts won’t try to make hay out of straw, but realistically, the situation is unchanged.
The bond crisis got attention everywhere in the press—historic new highs in yields, worries about inflation and government deficits. As always happens, everyone went overboard on the hysteria and that has lessened considerably today. See the chart of the 10-year from Trading Economics.
Just about everybody says this can develop further into a genuine crisis. Not the WSJ, which ran an op-ed saying the bond market freakout is silly. It’s just yields returning to the historical norm after the 2008 financial crisis got us accustomed to ultra-low levels. As long as the tech companies are willing to pay these rates, government bond investors should be happy to recalibrate the yields they need for government debt.
“While it sounds frightening to say rates are higher than they’ve been in nearly 20 years, the past two decades are the era that was abnormal. The U.S. economy has survived—thrived, actually—during periods of higher interest rates. The return of normality augurs well for the productive allocation of capital, which is good for growth and job creation.”
Yes, we should worry a little about inflation and over-indebted governments. But normalcy is a good thing.
Meanwhile. Reuters and Bloomberg are not so sanguine. For one thing, the bond sell-off set off alarms in equities. The Nasdaq lost 1.7%, led by the semiconductor sector SOX, down 5.5%. For another, the energy issues facing the world today point to on-going stresses. We would add that third, the Iran war can all too easily re-start and spread.
This leads to No. 4, whatever the incompetent and erratic Trump is going to do next. It promises to be a shocker. No. 5, we don’t know if the weird weather, especially in Europe but elsewhere, too, is going to persist from now on. Environmentalism can become a necessity and a very expensive one.
No. 6, it’s becoming increasingly evident that AI is the genie we have let out of the bottle. Even sophisticated people can’t always detect truth from fiction. We can’t expect those not paying attention to do it. That means liars and scamsters will abound, destabilizing societies.
No, all this is a lot worse than the 2008 financial crisis.
Forecast
We have two big threats in the world today. First up is the price of oil and its effect on inflation everywhere. The US doesn’t have to worry about outright shortages, but Europe and much of Asia do have that worry. At some point down the road we will need to worry about recession, too.
In fact, that may be Mr. Warsh’s only bolt hole—he may argue against raising rates at the Sept meeting because it would throw the US economy into recession. Stagflation is more iike it…
The other Big Thing is what Trump is going to do about Iran’s intransigence. Iran has won the war so far. Trump looks ridiculous and pathetic. His vanity is suffering. He is going to do something, but nobody knows what, including him. Invade Greenland, maybe. Anything to distract attention from his mismanagement in the Middle East (and having been suckered by Netanyahu, too).
Political pundits say Trump won’t re-start the shooting war (which they name “kinetic,” to everyone’s annoyance) until after the mid-term elections. Well, Trump is nothing if not unconventional, so we are not so sure about that. One is reminded of NYC Mayor Giuliani asking for a third term after 9/11 as the tried-and-tested leader in a crisis.
While US yields may retreat a little today in the usual normal reaction to a freak-out, the bigger trend is clearly to the upside. See the chart. We have been naming this as the core excuse for a stronger dollar, given the assumption that other countries’ yields do not rise by more, reducing the differential.
If and when US indebtedness becomes a critical issue—and it keeps escaping that fate—the outlook could change. We would like to see the dollar take a licking but that’s wishful thinking. We feel it should reflect the unbelievably corrupt and incompetent president. FX traders are all too willing to ignore these “political” issues in favor of hard data.
So, bottom line, rise in US yields, rise in the price of oil, threat of war and rise in risk aversion—dollar gain. As we say in economics, bah.
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