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Markets Weekly April 20, 2024

发布时间 2024-04-21 01:25:58    来源


federalreserve #marketsanalysis Fed scares the market IMF concerned about US fiscal deficit A potential Trump Accord 00:00 ...



Hello my friends, today is April 20th and this is Markets Weekly. So this week was a terrible week in markets. We had relentless non-stop selling every single day. And if you look at the leaders of the last rally, like Nvidia, it looks like they're imploding. Markets seem to be more and more concerned about higher interest rates and also the potential for geopolitical conflict. Now I was thinking that we would get support at the 50 day moving average, but that was totally wrong. Right now we're around the 100 day moving average, so let's see if we get some support there.

So today I want to talk about three things. First, over the past week we got a lot of FedSpeak and it's sounding more hawkish than usual. In fact, there are even whispers that maybe the Fed's next move is going to be a hike. Let's listen to what the Fed's speakers are saying and discuss what it might mean. Secondly, this past week the IMF came out with its latest fiscal report and they are sounding the alarm on the US fiscal situation and expressing concern that it might spill over to other countries. Let's take a look at the report.

And lastly, Politico is out with a very interesting story noting that former Trump officials are suggesting that a future Trump administration might be willing to deploy currency devaluation as one of its tools in its trade war. Now this is something we haven't seen in decades, so let's talk about what it might mean.

Starting with FedSpeak. So this past week we got FedSpeak from Chair Powell himself and also president of the New York Fed, John Williams and they were sounding more hawkish than usual. So just to love us a little bit, over the past few months inflation data has been coming in hotter than expected. Now as recently as March, the Fed still guided towards three cuts this year.

And when Chair Powell was asked about the hotter than expected inflation data, he basically just shrugged and said it was seasonal stuff. So he gave a pretty double spin. He's changing his tune now though. Let's listen to what he said this past week. The recent data have clearly not given us greater confidence and instead indicate that it's likely to take longer than expected to achieve that confidence. That said, we think policy is well positioned to handle the risks that we face. If higher inflation does persist, we can maintain the current level of restriction for as long as needed. At the same time we have significant space to ease should the labor market unexpectedly weaken. So basically, Chair Powell was noting that progress towards this inflation seems to have stalled.

So the Fed targets PCE and PCE year over year seems to be around 2.7%. We don't have the latest data yet. That comes out next Friday, but it looks like the Fed is expecting it to be too high. And so Chair Powell is unhappy with the progress he's made towards this inflation and now signaling that he wants to hold rates around here for longer than he had anticipated. So I'm listening to this and thinking that he's probably taking a June cut off the table.

Now in addition to Chair Powell, we also had a discussion from a New York Fed person John Williams. Now interestingly, John Williams was asked point blank whether or not he would high rates given the strong economic data we've seen so far. Let's listen to what he said. So is there a possibility the Fed could even raise rates? It's not my baseline. My expectation right now is that interest rates are in a good place and eventually at some point would want to lower interest rates as the economy really gets to the 2% inflation that we're headed towards. Of course, you never know what can happen.

If the basically, if the data are telling us that we would need higher interest rates to achieve our goals, then we would obviously want to do that. So John Williams, of course, being a central banker, he's never going to say he never, right? He's never going to say I'm never going to high rates or something like that because he doesn't know what the future is. He wants to keep his options open. He just said that he thinks that we're going to cut rates this year. But of course, if data evolves in an anticipated way, like inflation goes back up and so forth.

He doesn't want to preclude his options, which is of course what else is he supposed to say. But I think there are some people who listened to this and thought, well, you're saying it's not impossible, right? So maybe the Fed will high-crate again. But I think that's really missing the point. Later on in the discussion, he goes on and he explains that the stronger than expected US data seems to be largely due to increases in supply rather than overheating demand. And again, the Fed acts, the Fed's tools act on demand. If demand is too strong, then they will try to raise interest rates to cool it down. But if strong job growth, strong economic growth is due to increases in supply like migration and stuff like that, then it really doesn't call for the use of the Fed's tools. So I think that seems to be a bit of a misunderstanding. In any case, the market looking at all the data and taking the Fed speak in stride is right now pricing in about 1.5 cuts this year. As early as January, it was pricing in seven, Fed guided towards three in March and now they're pricing in 1.5. It's a very volatile series.

But I suspect that the market is a bit too hawkish here. Now this re-pricing of the path of Fed policy is also what's pushing up interest rates up across the curve where the 10-year yield is as high as 4.6%. And that is causing some stress, I think, in the risk assets. But if we rewind a bit just two years ago, I think when many everyone was saying that Fed funds at 5% interest rates so high, it's going to cause the US economy to tumble into a recession. Things are going to be really bad. Now today, of course, Fed funds comfortably above 5%, US economy continues to grow above trend. So that perspective was totally wrong. People misunderstood the impact of interest rates on the real economy. And I suspect they are also misunderstanding the impact of interest rates on the financial markets as well. And that's what I'm going to write about in my blog this week.

I suspect that the risk assets, the equity markets are going to shake off these, say, high interest rates because honestly, they are not that high given where we are, given the fiscal situation and so forth. Okay. The second thing that I want to talk about is the IMF's latest fiscal report. Now the IMF, again, is a political organization. So whatever they publish, it's going to be improved by the respective government. For example, if they write a report on the economy of France, whatever they write is going to be a subject to the approval of the French government. So you're never going to get anything super cutting edge or super controversial from these public sector organizations, but they are really good at doing bread and butter economic analysis.

Now, in their latest report on the fiscal sustainability of countries, they are highlighting concern about the US fiscal situation. So in it, you can take a look at this chart where they show that going forward, the fiscal deficit in the US is strikingly high compared to other countries. So other countries, it looks like over the next few years, their fiscal deficit is expected to, let's say, be around 2% and 3%. But the US really stands out as having a fiscal deficit that's expected to be about 6% for the foreseeable future. Now again, this has tremendous implications for asset pricing. And I think that this is basically inflationary and also it boosts asset prices. It's something that is honestly, we see over and over again throughout history and across the world in many different kinds of fiscal regimes. But what the IMF is highlighting here is that this is going to be, this is going to create problems for other countries. Why? Because there is a link between US interest rates and the US fiscal deficit. Obviously, everything is just supply and demand. So when you have a higher fiscal deficit, you have more issuance in treasury securities and so, treasury use go higher. Here's the IMF doing some analysis showing that 1% increase in the primary deficit pushes up what they call term premium, basically interest rates slightly, slightly higher.

Now this is something that's, this type of analysis, it's not physics, so it's going to be subject to a lot of things like sentiment, like all sorts of other expectations, it's ends and things like that. But again, not rocket science issue more treasuries, interest rates go higher. So that's one thing that they are noting. The other thing that they're noting is that when treasury yields go up, it also drags up bond yields across the world. After all, capital is global and the US is the reserve, US dollar is the reserve currency.

So when US interest rates go higher, obviously global investors are looking across the road and saying, hey, why am I investing in say this country at 3% when I can invest in, let's see in the US at 5%. After all, the US is a reserve currency, deep and look at markets, dollars are better than whatever other currency that I'm investing in. So when US treasury yields go up, it tends to drag up yields in other countries.

So this analysis by the IMF shows that 1% upward move in treasury yields basically drags up advanced economy yields and also developing economy yields up by around 1% as well. So if the US continues to run a fiscal deficit of 6%, well, treasury yields are going to go up and that's going to tighten financial conditions globally. The problem arises when, well, everyone's economy is in different situations.

As we know, the US economy is doing fine, growth is above trend, but that's not necessarily the case, say in Canada, in the UK or in the Eurozone. So in a sense, the US economy, US fiscal deficit is going to maybe make policy too tight for other countries and maybe push them into recession. And that's something that other countries are going to have to deal with. So that's the IMF saying this and I'm pretty sure that no one in Congress is going to listen, but it's something to keep in mind because it would also have implications on let's say currency, for example, as the US economy runs a large fiscal deficit, we could have treasury yields go higher that could draw in more cash from other countries and continue to strengthen the dollar like it's doing now, which leads us to our third topic.

So there's a very interesting story in Politico citing Robert Leitinger, former trade official and the Trump administration saying that these guys, they're thinking that it would be a good idea to depreciate the dollar to fight a trade war. Now just a level set a little bit. Now if you went to school and you studied economics, they would tell you that free trade, everything super good compared to advantage makes the pie bigger. And that's totally true, but the gains in trade are not evenly distributed.
在Politico上有一个非常有趣的故事,援引了特朗普政府的前贸易官员Robert Leitinger的话,他们认为贬值美元是对抗贸易战的一个好主意。现在稍微澄清一下。如果你上学学过经济学,他们会告诉你自由贸易很好,比优势使蛋糕更大。这完全正确,但是贸易带来的收益并不是均匀分布的。

So when we had free trade, well, we have free trade. For example, what's happens is that, well, US companies, the all-source manufacturing to other countries like China and US companies are really happy because they reduce their costs, profits go up. China is very happy because it creates jobs for millions of people and the US consumers are happy because they get cheaper products. But there is a group who loses due to free trade and that's the American factory workers. They basically become jobless and lose their place in society and have really difficult times fighting work.

Now again, the overall pie is bigger, but it's unevenly distributed. Now how you value these distributions is ultimately a political judgment and the Trump administration has pretty consistent that he thinks it's more important for these manufacturing workers to be able to have jobs than it is for say companies that have bigger profits or for American consumers to have slightly cheaper products. And so the Trump administration, the first Trump administration has been employing tools to try to adjust the trade saturation and to encourage more products to be made in America.

They did this by putting on tariffs to China and thus raising the price of imported goods hoping that it would make American companies a bit more competitive, maybe create jobs here. Now the success of that, it's mixed and it's always hard to say. Largely it seems to be continued by the Biden administration. Now these policies actually have a very long history. Do all hundreds of years governments wanting to protect their jobs of their own workers have enacted trade barriers. Another common tool that governments have employed is to depreciate their currency.

So the whole point of this of course is to discourage imports and encourage exports. You can do this by increasing the price of imports through tariffs or you can also depreciate your own currency and make imports more expensive and your own exports cheaper to foreign markets. Now Robert Leitinger is suggesting that hey let's let's you know we can do trade barriers like tariffs but we can also depreciate the dollar. Now this is something the US has done before as recently as the 1980s which during what was called the Plaza Court.

Now at that time if you can see from this chart the US dollar strengthened to just crazy levels. It strengthened rapidly for two reasons. One as we recall at that time Fetchur Volcker was raising interest rates really high trying to get inflation under control and at the same time we also had pretty profligate physical spending and that seemed to be pushing up longer dated treasury yields. So kind of like where we are today. Higher US interest rates higher than the rest of the world and treasury yields rising that led the dollar back then to appreciate significantly and it was causing a lot of political problems for the administration. American manufacturers were complaining and so what they did was they got everyone together and said hey I want to depreciate the dollar so I want you to appreciate your currency against the dollar. And if you don't do this we're going to put tariffs on you and everyone basically complied and we did see the dollar depreciate as a result of that meeting. So this is something that could definitely happen again and if monetary policy at the Fed continues to be more hawkish than the rest of the world we can actually easily see a scenario where you know maybe we have a repeat where the dollar continues to strengthen and strengthens the case for a dollar depreciation some kind of Trump accord in the event of a second Trump administration.

Now depreciating a dollar historically speaking is very risk positive. It loosens financial conditions throughout the world and is positive for equity prices. Again there's a lot of different ways that they can do this and I think in the future I will write about different ways they can do this. Right now of course this is very preliminary we don't even know who's going to win the election and we don't even know if Robert Leitinger is going to have a senior role in the Trump administration. But I think it's very interesting that they are talking about this and basically bringing currency depreciation which was a common tool used by governments throughout history back out.

Alright so that's all I prepared for today thanks so much for tuning in check out my blog fengai.com for my latest market thoughts and if you're interested in learning more about how markets work check out my online courses at centralbaking101.com talk to you all next week.