Currency and Bond market volatility flags elevated market risk

Local market followed the US market on short covering pop to reverse the bashing from the day before. It was another lower than usual turnover day as recent volatility on macro risk and that is keeping fund managers on the sidelines while hoping the markets don’t fall over before month end. Energy and Banks were the best sectors while Health Care and Tech were the laggard sectors. Mid Caps were the best size category while Micro Caps were the laggards. Asian markets were mainly positive. Overall macro indicators remain risk off as USD remains in a short term break out higher while US bond yields are in a death cross lower.

The main show tonight will be the testimony of US Fed Chair Powell. 

The Fed left the target range for its federal funds rate unchanged at 0.00-0.25% in June 2021 but policymakers signaled they expect two increases by the end of 2023. Officials noted progress on vaccinations and strong policy support led to a strength in economic activity and employment. Bond purchases will also remain at a rate of $120 billion a month. Meanwhile, new economic forecasts showed the GDP is seen growing 7% in 2021, above 6.5% in the March projection. The 2022 growth was left at 3.3%. Unemployment is seen at 4.5% this year, unchanged from the March projection but inflation is seen much higher at 3.4% in 2021 (2.4% in March) although it is expected to slow to 2.1% in 2022 (vs 2% in March). The so-called dot plot showed 13 of 18 officials favored at least one rate increase by the end of 2023, versus seven in March.

US Fed is at the epicenter of the reflation cycle due to the global currency status. EU has followed Japan into endless money printing and socialization of the economy and corporates. It is a clear signal that capitalism is dead in EU when ECB starts to justify cutting rates from negative level is delivering growth. More to the point, ECB sees this as a policy to drive growth for years to come. Bernie Madoff foundation will soon legally charge ECB of ponzi scheme trademark infringement!!!

The problem facing US is completely expected and inevitable. US was heading into a recession pre pandemic and then again pre-election. The long shot blue wave after the US election delivered substantial stimulus and that removed double dip recession risk while delivering elevated risk of stagflation. US Fed is currently running great recession level of stimulus while the economy is running red hot. Inflation is the result of that unsustainable mix. The pandemic has damaged the global supply chains and new waves continue to do more damage and delay recovery. Emerging Markets were the low cost supply chains and they are under pandemic affected inflation cycle as well. China is exporting higher inflation to the world while the rest of Emerging Markets are still in the grasp of new pandemic waves. Even if Chairman Powell calms market, the supply side issues and USD debasement are not going away in 2021. Inflation may not run much higher but it is likely that it will be well above the US Fed threshold into 2022.

Every Central Bank has pivoted their media spin from inflation to wages growth. The simple reason is that we are unlikely to see real wages growth for years to come and that will allow them to keep rates low and claim inflation is transitory. Even the bulls are realizing the job market data is weak. RBA is a poor man’s US Fed. RBA will follow US Fed. If they don’t, AUDUSD will tank and we will get inflation. Central Banks can ignore it but inflation is a weapon on mass destruction. It hits corporate margins, consumer spending and bank lending capacity. No amount of money printing is going to change that. 

The central bank stimulus is now purely about asset bubbles and nothing to do with supporting the economy. That is why margin lending into equities in the US is three times the peak pre GFC leverage. The asset bubbles have evolved into leverage bombs. It is no different in the property bubble. Property bubble is global and yes…it is not different this time!

Let us run through the main data points released in the last 24 hours…

The Chicago Fed National Activity Index increased to 0.29 in May of 2021 from a downwardly revised -0.09 in April, pointing to a pick up in economic growth, led by improvements in production-related indicators. Production-related indicators contributed +0.29, up from -0.05 in April; the contribution of the employment, unemployment, and hours category rose to +0.16 from +0.06 and the contribution from the sales, orders, and inventories category was +0.02 compared to -0.06. On the other hand, the personal consumption and housing category contributed -0.18, down from -0.04. The index’s three-month moving average went up to +0.81 from +0.17.

Producer Prices in South Korea increased 6.40 percent in May of 2021 over the same month in the previous year.

Comments on US market last close…

US market popped back up on short covering after DOW was down every day last week to close out the worst week since Oct. All the major indices popped in the first hour and then mainly traded sideways. NASDAQ +0.79%, S&P +1.49%, DOW +1.76% and RUSSELL +2.16%. Yields bounced higher and USD pulled back. VIX fell below 18. AUDUSD and commodities recovered. It was a lot of unwinding of Friday moves as algo's started to unwind positions. It is never normal when bond yields move by 5 bps or more. Crypto currencies were getting hit hard on China restrictions again. US Fed is out again in the media saying they will keep helping the economy and inflation is hotter than expected. The market needs weak economic growth, low inflation and high stimulus. We don't have the first two and the third catalyst is fading. US Fed needs to move to curb stimulus or inflation bites corporate profits and consumer spending. Now that the shorts have been burnt, markets will struggle to move higher without upgrades to earnings or more stimulus. Inflation curbs both. Energy and Banks lead the green day while Retail and Tech were the laggards. The rising volatility and Central Bank QE for yield control has driven all bond yields into a falling death cross pattern with 50 day MA breaking below 100 day MA. Inflation is likely to remain elevated till Central Banks move on stimulus and that will hit markets. Everyone is now stuck in a Mexican standoff and it's ripe for a left field event to ramp up volatility.

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