Weekly Market Update - 21/06/2021

The week that was

The big news during the week was on Wednesday when the Fed seemed to signal that we had seen ‘peak stimulus’. Long bond yields jumped 0.1% immediately (a biggish deal these days) and markets sold off a bit. With the release of the Fed minutes and associated ‘dot plot’ of individual rate forecasts it became apparent that some votes on the Fed committee were seeing short-term rates being lifted from the zero bound during 2023 (a little earlier than previously flagged) as signs of a persistent uptick in inflation emerged. Most observers have assumed that tapering (the Fed starting to buy fewer longer-term US governments bonds) would happen before short rates rose so potentially this raised more questions than it answered. Then on Friday (after trading had closed in Asia and Europe) James Bullard (a committee member from the Federal Reserve Bank of St. Louis) mentioned that the Fed has been surprised by the extent of inflation being seen in the US economy and that rate rises could actually be seen in early 2022. US markets then sold off more precipitously, with US markets ending the week down just over 2%. The real surprise though was that world value stocks (and the industrial stocks that hold sway in the Dow Jones Industrial Index) fell the most (down by 4%) while tech stocks were resilient. The market play book has been - inflation up then value/industrials good, inflation down, rates down and growth is good.?When writing a weekly market newsletter, one has to be careful of reading too much into this stuff, especially in such a noisy data environment. That said this is too interesting to ignore, and there might be clues in all of the noise as to what comes next. One explanation lies in the old market saying ‘buy the rumour, sell the news’ - maybe the value/inflation thesis was so priced in that its confirmation was enough to see a partial reversal. By design the market is meant to surprise us this way - George Soros famously coined this tendency as ‘reflexivity’. On the other hand, it could be something more fundamental - perhaps the market is looking through the inflation spike and seeing an economic slowdown.

Another clue potentially lies in the performance of different equity sectors. While tech stocks held their own, cyclical sectors like energy and materials were down 5-6%, as were financials. This points to expectations of moderating economic growth and a flattening yield curve (higher short-term rates along with lower long-term rates). Or, again, it could just be reflexive noise. Either way Australia fared relatively well last week, partly because our markets closed before others during a downward trend and partly because our banks proved relatively resilient and were actually up for the week. IT stocks, consumer discretionary and healthcare stocks were up 5%, 3% and 2% respectively while materials were down almost 5%.

While oil prices were up slightly, industrial metals were down 2-6% and gold and silver were also down 3% and 6% respectively. Soft commodities were mixed but mostly down. Bond markets were mostly flat having been up and down in the week and implied volatility of bond markets has increased markedly.

Lastly, currency markets are also starting to get a little more interesting and the US Dollar strengthened markedly against most currencies and especially the Aussie Dollar last week.?

What we are watching and working on.

If we have (big “if”) reached ‘peak easy money’ then now is a good time to have a go at working out what comes next. It is still too early to answer the trillion-dollar ‘are inflation and rates going higher’ question but we are starting to see more data that at least gives us an idea of what might be priced in and what the Fed and market’s reaction function might be under different scenarios. We have been looking at this through the lens of what we are seeing in real time versus what is being predicted by economists versus what is being implied by the market - they are all surprisingly different. This is still mainly observational, but we will tentatively move towards a more analytical assessment of what comes next over the next few weeks and months. There are some important US inflation reports and quite a few global producer price reports being released next week, which will provide more grist for the mill.???

The relative performance of value vs growth in the context of rising inflation and bond rate expectations challenged the dominant narrative of value outperformance. This may be just noise and due to the fact that tech stocks had become somewhat oversold. It may also be a warning sign that of a more stagflationary scenario merits more attention. Either way there is quite a bit of work to be done understanding different ways in which such negative real rates might normalise. Last week we got an insight into one where inflation expectations moderate but nominal yields rise, and value stocks didn’t like it much.???

As mentioned above currency markets started to move last week and it may be that in an era characterised by implicit yield curve control, currency markets could prove to be the pressure valve for markets and the canary in the coal mine.?????

Lastly, and looking further out, we were lucky enough to attend a talk by Professor Bill Mitchell (self-professed father of Modern Monetary Theory). Having seen the same talk by Prof Mitchell two years ago it was interesting to note that, while MMT has entered the mainstream since then, anecdotally at least the mainly institutional audience seemed to have become more circumspect. A common refrain in informal chats afterwards was “there are points of merit that will undoubtedly affect future public policy but taken as a whole it all seems ‘a bit much’”. Last time we saw this talk there seemed to be a few more true believers in the audience but, as a concept, it is not going away. Perhaps unsurprisingly Prof Mitchell’s posture was much more energetic this time around, but at times verging on hysterical (the word religious was bandied around by some observers). A decent lens to see this through, we think, is that the concept of unconstrained deficit spending has certainly been given a fillip by COVID and moved the fiscal centre of gravity to the left, but we are still a long way from a 1970’s style regime where MMT becomes orthodoxy. Not many people in officialdom and in markets now were of working age in the 70’s but the experience is still well-remembered.

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