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The Market Is A Harsh Mistress

Financial markets have been dishing up some harsh lessons to the accepted narrative this week. Having been blithely unkerned about US inflation since the FOMC, the renomination of transitory inflation dove, Jerome Powell, to the Federal Reserve Chair has seen long-dated bond yields ramping higher this week. Markets are now flapping about a faster Fed taper and earlier rate hikes.

Oil jumps despite SPR release

Overnight, it was the turn of US President Biden to receive a similar lesson. Markets thanked Mr Biden for his early signalling of an SPR oil release by taking back their shorts and sending oil over 3.0% higher overnight, after the President formally announced a release, in conjunction with other countries, totally between 70 and 80 million barrels. The devil is in the detail of course. The release will be dripped in gradually over the coming months. Given there is no way that President Biden can construe the present level of oil prices as a supply disruption, it’s just a market with rising prices; that caps his ability to release more oil. The overnight announcement was a one-shot wonder, and markets responded appropriately. OPEC+ refused to be cowed, but I do not expect them to fly too close to the sun and reduce their planned 400,000 bpd increase next month.

Today, the Reserve Bank of New Zealand raised its policy rate by 0.25% to 0.75% and signalled interest rates had seen their lows. I would argue we have seen the lows globally, and not just in New Zealand. The RBNZ signalled a steady pace of hikes ahead, but instead of rallying, the New Zealand dollar is 0.50% lower at 0.6915. That was despite the government announcing an easing in its totalitarian quarantine requirements for overseas visitors (and citizens) which should have also been ostensibly bullish. The street had priced in 0.25% and, like me, was probably looking for 0.50% to be meaningful.

Despite inflation concerns ramping up in the US as if it was a new and worrying development, gold is now around 90 dollars an ounce lower than a week ago, at USD 1794.00 this morning. Bitcoin continues to look wobbly as well. Both are allegedly inflation hedges and should thus, outperform in this environment, both having shrugged off a stronger US dollar recently. I would argue that though, that gold, and possibly maybe infinitesimally, bitcoin, are only inflation hedges when inflation is running really really hot and real yields are collapsing. That’s not the case at the moment. US front-end yields have risen in recent weeks in response, flattening the curve, and long-dated yields have now started to play catch-up. A faster Fed taper, removing the oppression of QE, will help this process along.

Technology stocks have been under pressure this week and rising US bond yields (and yields elsewhere), lie behind the shakiness. Technology valuations have been sub-orbital for a long time now, and they are thus, more vulnerable to an upward adjustment in interest rates. It is hard to justify paying a 14285 P/E with a yield between -1.50% to 1.50% when you may be able to earn 2.0% on a “risk-free” US government bond in a couple of months’ time. I’m not calling the top in technology, by the way, there are a number of oligopolies out there in the space that will remain cash-generating machines. If US bond yields continue to rise though, those of us mere mortals may finally be able to contemplate buying the dip, a real dip. Legacy sectors, such as banking and energy and resources, should theoretically outperform in this environment.

The Korean won has held steady this week as other regional currencies have weakened in the face of the mighty dollar and higher US yields. My reasoning behind forthcoming Asian FX weakness is well documented in past notes, so I won’t repeat myself again. I believe the won has remained firm because the Bank of Korea is expected to raise policy rates by 0.25% tomorrow. I do, however, feel it will play catch-up and have a kiwi moment if the hike is less than or equal to 0.25% as like oil, gold and kiwi, the news is priced in. Markets are hedging their bets for now in case there is a surprise.

The buy/sell the rumour, buy/sell the fact (depending on the asset class), price action this week can be traced back to one occurrence, the sudden jump in the US 30-year yield this week, and to a lesser extent, the 10-year yield. For evidence, look at the rally in USD/JPY, the world’s premier yield differential play. USD/JPY has topped 115.00 this week, a 45-month high by my calculations, although I ran out of fingers and toes to count and the kitten asleep next to me refused to make her paws available. I will just add, the Japanese Ministry of Finance has no intention of intervening in USD/JPY at these levels so let’s put that to bed right now. Call me back when we get to 135.00.

Until long-dated US yields start reversing their recent gains, and the author has long believed that is not a given, we shouldn’t expect an end to US dollar strength, nor should we be getting excited about equity markets for the rest of this month and possibly into Christmas. The FOMC Minutes tonight might bring solace if they have a dovish tone; my bet is that they will not and that the FOMC members are as divided as the US Congress on the next course of action. US GBP Q3 estimate tonight is old news, but Durable Goods and Personal Income and Spending should be good for some volatility. If anything, markets are more vulnerable to the data reflecting more inflationary pressures, especially if Personal Income exceeds 0.50% for October.

Germany’s IFO this afternoon may reinforce the Covid-19 Euro-gloom if it is weaker than expected. For now, Europe’s issues are being thrust from the spotlight by events in US markets and are unlikely to materially impact energy prices, for example, this week, short of a German and/or France lockdown, partial or otherwise. Tomorrow is Silence of the Turkeys’ Day in the US, and I expect most Americans will make a long weekend of it. Thus, in an act of famous last words, I expect markets in Asia especially, to coast into the end of the week.

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