By Michael Every of Rabobank
Big Bear, Big Bird, Big Bad
So, a bear market. A BIG bear market. And a BIG bear market in almost everything.
The S&P is -22.1% year-to-date (y-t-d). The Nasdaq worse, -30.1%. Equity carnage is widespread in the US and globally too. All those who had gone long risk again, having no idea what is actually happening in the real economy, are in tears.
US 2-year Treasury yields has leaped over 60bps to top 3.40% since Friday's CPI print, driven higher by a Wall Street Journal ‘Fed whisperer’ saying a 75bps hike this week, not July, is on the cards. That's an entire mini-cycle. In short, most of the curve is inverted from 5s onwards, and is then also as flat as a pancake: which is how US stock and bond bulls are feeling.
In Europe, German 2-year yields leaped almost 60bps since Thursday's ECB statement to 1.23% and 10s by 43bps to 1.76%. The last time Germany was here was almost a decade ago, when the “whatever it takes thing” was still working its temporary magic. Far more worrying for the ECB, Italian 2s soared 100bps to 2.13% and 10s 86bps to 4.18% since Lagarde's words failed to soothe. The latter is even higher than the spike seen in the bad old days of Italian political risk in 2018, and just a month ago, said 10s were trading at 2.89%. Does anybody think the Italian economy can take that kind of increase in borrowing costs? What exactly is the ECB plan, beyond hope, prayer, rhetoric, and playing the UEFA champions league theme? To step in and buy peripheral bonds?
In Japan, the BOJ’s 10-year JGB yield peg held, barely, due to huge official bond buying. JPY had crashed through 135 before recovering slightly as offshore selling in everything saw some Japanese capital repatriated. However, given Wednesday may see the Fed go 75bps and flag more, while the BOJ on Friday will only flag more bond buying, JPY is not going to stay at these levels for long. It’s going to get much, much worse.
Australian 3-year yields are now 3.63%: just months ago they were pegged at 0.10%. Aussie 10s are at 4.10%, racing after Italy, higher than the pre-Covid peaks of below 3%. The Aussie housing gods will not be pleased with this offering.
Despite the above, commodities held up well and energy went*up*, meaning the physical cost of production/supply of almost everything from food to goods will too, with a lag. Then either wages do, and it’s a wage-price spiral; or wages don’t, and we are all much poorer. Anecdotally, funds are still chasing commodities as both an inflation hedge and a flight to safety, which makes sense. Yet it also means the Fed has to keep raising rates more than markets thought they would…. and even the threat of a 75bps hike didn’t buck that trend yesterday.
Naturally, the US dollar went up sharply. DXY is now above 105 again and shows no likely cause to head sustainably lower. That makes commodities even more expensive for everyone not using the dollar (or producing and hoarding them). The broader Bloomberg FX index incorporating emerging markets is up 7.9% y-t-d: next is surely the 2020 peak.
The crypto complex is proving to the anti-commodity as a ‘haven’ from volatility, inflation, and to preserve capital. Bitcoin alone is trading this morning in Asia at around $22,000, having been above $30,000 just 3 days ago. As one crypto-shill tweeted in 2020, “Bitcoin is a swarm of cyber hornets serving the goddess of wisdom, feeding on the fire of truth, exponentially growing ever smarter, faster, and stronger behind a wall of encrypted energy.” Well, higher Fed funds are pest control, and Celsius is freezing.
Watch the likes of big pension funds scramble to explain to real money clients really underwater that what lies ahead is a ‘slow-down’ or a ‘correction’. Also watch them predict this ‘unforecastable’(!) event will be rapidly reversed because their DSGE GDP models automatically mean revert to growth. Meanwhile, in the real world, if commodity (and goods) supply does not adjust upwards –which will take *years*– then there is no way to see a V-shaped growth profile without a V-shaped inflation profile to match.
Ordinarily, what we have seen in the last two sessions would be enough for a Fed U-turn. Indeed, Wednesday could still see ‘merely’ a 50bps move and a misplaced relief rally. Yet the Fed cannot U-turn properly to save 401Ks without ensuring the dollar tanks, pushing imported inflation higher, while commodities soar as an inflation hedge, and supply-side inflation becomes entrenched, with wage-price spirals to follow, i.e., structural CPI of perhaps 4-5%, not 2%.
It would also flag a staggering decline in US geoeconomic and geopolitical power. On which, a Twitter thread doing the rounds, sees @d_jaishankar note that from recent Chatham House conferences he has attended:
“I was left with the strong impression that traditional US elites are still very preoccupied with their domestic politics, and haven't internalized the enormity of the geopolitical challenge they face. They're trapped in the 1990s. There's a reluctant acknowledgment that the neoliberal model is discredited, but the answers to how to address inequality, immigration, and trade is… more neoliberalism, immigration, and trade. There's a grudging understanding that state management might be back.”
The key questions now are which awful choice the Fed makes; and if it opts to hike, if it also throws in help for key parts of the *real* economy at the same time – i.e., quasi-MMT slash China-style economics slash a pumped-up ECB acronymtastic band aid.
Many readers may find this either very uncomfortable or very hard to grasp. Allow me to use a Twitter meme to explain. @Rainmaker1973 shares, “Crested mynas, as many other birds, are born altricially, which means young are underdeveloped at the time of birth, therefore fed by parents. When they grow up, they have to learn that food doesn't simply jump into their beaks”. Click the link and watch the myna bird walk around with its mouth open waiting for the worm to jump in.
The bird has to feed itself now. So do we. Even the mighty American Eagle will go hungry if it doesn’t realize that fact. And yet traditional economists and market participants, like big birds, are waiting for juicy returns to jump into their mouths as the Fed saves them, if not this week, then next month, next quarter, next year, etc. That may no longer be how the real world works.
A final point on this all. I am on record as saying ‘Bretton Woods 3 Won’t Work’. I reiterate that despite the present mess, it won’t, because there is nothing to ‘work’ globally – just breakdown, chaos, and even higher geopolitical tensions. Indeed, Bretton Woods 3 is just old-fashioned military mercantilism – and once upon a time, the West was very good at it. It will need to be again, and soon. That will shake markets even further as it happens. If we have a Big Bear and big birds, that geopolitical backdrop is our overarching Big Bad.