wknd notes: The Fed Dot Plot is Dead

“What you want is nice and boring,” said John Volanthen. “Underwater, things happen slowly. If a parachute fails on a base jump, you have seconds to contemplate your fate,” continued the hero. “If something goes wrong 10km down an underwater tunnel, you usually have until your air runs out to find a solution or make your peace.” Down he slithered, through the crack, tethered to Rick Stanton, the best of Britain, of humanity. “How many are you?” they asked, triumphant, euphoric, flashlights counting stunned Thai children, eyes illuminated by hope. “13? Brilliant!!” cried Stanton, the world cried too. And so began the rescue. You can always count on the Brits in a pinch, the Aussies, Kiwis, Canadians too. Thai Navy SEALS are running the multi-national operation. Elon Musk sent his team, equipment, innovative ideas, America is always there. Nothing unites humanity like a struggle against mother nature; win or lose, our finest moments. It’s the battles amongst ourselves that are the only true tragedies. Unleashing our darker nature, turning it upon one another. “We refused to fire the first shot,” declared China’s Ministry of Commerce, matching America’s new tariffs, the opening round of an inevitable escalation, headed to an unknown destination. But of course, trade wars are not real wars, they’re renegotiations. And we Americans voted to renegotiate everything: foreign trade, military alliances, immigration, taxation, environmental protection, healthcare, education, financial regulation, affirmative action, even abortion. For each winner in such renegotiations there’s a loser. For every victor, a vanquished. America will surely win the foreign trade renegotiations, which we seem happy to call wars, making our voters feel victorious in battle when the truth is we’re retreating as global hegemon. And, as the process unleashes our darker nature, at home and abroad, hope that things happen slowly, giving us time to find solutions to the unintended consequences that lay ahead.

Week-in-Review (expressed in YoY terms): Mon: China’s renminbi hits 2018 low (equities -2.9%), China PMI manu 0.1 to 51.0, Japan’s Tankan -3.0 to 21.0, Libya suspends oil shipments due to turmoil, German PMI manu -1.0 to 55.9 (France -1.9 to 52.5), Mexico’s AMLO wins landslide victory, Tesla hits Model 3 production target, Trump recommends denying China Mobile access to US market, soybean prices hit 9yr low, S&P +0.3%; Tue: Chinese exports to US +5.4% (sharp deceleration from last year’s +19.3% pace), Renminbi hits 11mth low, China blocks purchase of some Micron Technology semiconductors for patent infringement, Aussie rates unch at +1.5%, Saudi’s reiterate pledge to boost supply after WTI hits $75 (4yr high), Turkey CPI +15.4% (14yr high), Merkel/Seehofer reach immigration compromise agreement, Italian gov’t rules out further austerity as growth softens, Sweden’s Riksbank holds rates at -0.50% (lifts 2018 CPI forecast +0.2 to +2.0%), EU PPI +3.0%, AMLO pledges to implement infrastructure and social projects in Dec budget, US senators call for improved Russian relations, S&P -0.5%; Wed: China intervenes to support renminbi, Poland’s PM defends right to reform judicial system (tensions escalate with EU), 2nd UK couple poisoned by novichok nerve agent, Trump warns OPEC members that failure to lower oil prices jeopardizes US military support, S&P closed (July 4th); Thur: Chinese regulator warns against shorting renminbi, Turkish administration says lower rates and inflation top priorities, EU extends 2014 Russia sanctions to 2019, German factory orders +4.4%, Carney confident UK economy will bounce back, AMLO appoints former Mexico City mayor as foreign minister and picks market friendly finance minister (equities +2.7%), Fed minutes affirm “strong economy” and flag trade concerns, Pruitt resigns as EPA chief, US imposes tariffs on $34bln in Chinese imports, S&P +0.9%; Fri: China imposes retaliatory trade tariffs on US, emerging market bond funds suffer 11th weekly outflow, Russia enacts retaliatory US tariffs, May gains support for pro-business Brexit plan, UK Q1 productivity an anemic +0.9% (hiring remined strong while GDP softened), UK home prices +1.8%, Canada employment +31k (wage growth +3.6%), US payrolls +213k (unemployment rate +0.2 to 4.0%, wage growth unch at +2.7%), Biogen Alzheimer’s drug shows promise, S&P +0.9%; Sat/Sun: North Korea accuses US of a “unilateral and gangster-like demand for de-nuclearization.”

Weekly Close: S&P 500 +1.5% and VIX -2.72 at +13.37. Nikkei -2.3%, Shanghai -3.5%, Euro Stoxx +0.6%, Bovespa +3.1%, MSCI World +0.3%, and MSCI Emerging -1.4%. USD rose +0.6% vs India, +0.4% vs Chile, +0.3% vs Russia, +0.3% vs China, and +0.3% vs Indonesia. USD fell -11.7% vs Ethereum, -10.2% vs Bitcoin, -4.4% vs Mexico, -2.4% vs Sweden, -1.8% vs South Africa, -0.6% vs Sterling, -0.5% vs Euro, -0.4% vs Turkey, -0.4% vs Canada, -0.4% vs Brazil, -0.3% vs Australia, and -0.3% vs Yen. Gold +0.1%, Silver -0.6%, Oil -0.4%, Copper -4.9%, Iron Ore -0.5%, Corn +0.3%. 5y5y inflation swaps (EU flat at 1.72%, US +2bps at 2.42%, JP +2bps at 0.42%, and UK -3bps at 3.39%). 2yr Notes +1bp at 2.54% and 10yr Notes -4bps at 2.82%.

Manufacturing PMI (high-to-low): Switzerland 61.6 (prev 62.4), US 60.2 (prev 58.7), Netherlands 60.1/60.3, Canada 57.1/56.2, Czech Republic 56.8/56.5, Austria 56.6/57.3, Germany 55.9/56.9, Vietnam 55.7/53.9, Taiwan 54.5/53.4, UK 54.4/54.3, Sweden 54.2/55.8, Poland 54.2/53.3, Greece 53.5/54.2, Spain 53.4/53.4, Italy 53.3/52.7, India 53.1/51.2, Hungary 53/55.2, Japan 53/52.8, France 52.5/54.4, Singapore 52.5/52.7, Mexico 52.1/51, China 51/51.1, South Africa 50.9/50, Indonesia 50.3/51.7, South Korea 49.8/48.9, Brazil 49.8/50.7, Russia 49.5/49.8. Hong Kong 47.7/47.8, Turkey 46.8/46.4. Services PMI: Australia 63/59, Sweden 59.8/57, Ireland 59.5/59.3, US 56.5/56.8, France 55.9/54.3, Spain 55.4/56.4, UK 55.1/54, Germany 54.5/52.1, Italy 54.3/53.1, China 53.9/52.9, India 52.6/49.6, Russia 52.3/54.1, Japan 51.4/51, Brazil 47/49.5.

2018 YTD Equity Indexes: Saudi Arabia +12.5% priced in US dollars (+13.2% priced in riyals), NASDAQ +11.4% in dollars (+11.4% in dollars), Russia +1.6% in dollars (+11.2% in rubles), Russell +10.3% (+10.3%), Portugal +7.6% (+10.1%), Norway +11.6% (+9.4%), New Zealand +4.2% (+8.2%), Colombia +11.9% (+7.4%), Finland +3% (+5.4%), UAE +4.7% (+4.7%), Australia -1.7% (+3.4%), S&P 500 +3.2% (+3.2%), India -5% (+2.3%), Netherlands -0.7% (+1.7%), France -1.1% (+1.2%), Canada -3.4% (+1%), Italy -2% (+0.3%), Czech Republic -4.9% (-0.1%), Israel -4.7% (-0.1%), Taiwan -2.9% (-0.3%), Ireland -2.8% (-0.5%), Mexico +2.5% (-0.8%), UK -2.8% (-0.9%), Spain -3.6% (-1.4%), Euro Stoxx 50 -3.8% (-1.6%), Brazil -16.8% (-1.8%), South Africa -10.6% (-2.7%), Germany -5.5% (-3.3%), Sweden -9.3% (-3.3%), Japan -2.5% (-4.3%), Austria -6.6% (-4.4%), Chile -11% (-5%), Denmark -7.4% (-5.1%), Belgium -7.4% (-5.2%), HK -5.8% (-5.4%), Singapore -7.7% (-6.2%), Greece -9% (-6.9%), Switzerland -8.8% (-7.3%), Malaysia -6.9% (-7.4%), Korea -11.5% (-7.9%), Thailand -9.5% (-7.9%), Argentina -38.9% (-8.2%), Hungary -14.6% (-9.1%), Indonesia -15.1% (-10.4%), Poland -17% (-11.4%), Turkey -29.1% (-14.4%), Philippines -21.3% (-16%), and China -18.6% (-16.9%).

Yoda: “What does it mean when stocks rally into the first shot of a trade war?” asked Yoda, high in the Rockies. The S&P 500 finished Thursday +0.9%, the deadline looming. And certain his question did not require an answer, I waited quietly. “When that same market closes sharply higher on the day the trade war begins, what is it telling you?” asked Yoda. In the distance, peaks everywhere, each unique in shape, though formed by identical forces. “The market never likes to be told what to do. It moves on its own terms, none other. And it was too short.”

Beep Beep: “There’s plenty of anxiety in markets,” said Roadrunner, surveying the landscape. “Risk premiums aren’t cheap. The selling of volatility into rallies is no longer massive,” continued the market’s biggest equity volatility trader. “On the slightest fear in the world, the VIX jumps to 18 almost immediately.” Since mid-April the VIX index has oscillated between 11 and 20. “This is a healthier market than when the VIX gets stuck between 10-12. And it just trades like the market believes Trump will be more talk than action. I guess we’ll see.”

Beep Beep II: “There’s one market where the volatility selling is relentless,” said Roadrunner, his army of market makers filling the void left by investment banks. “There is almost constant selling of 5yr, 10yr and 30yr interest rate volatility. We keep getting buried.” Having pushed through 3.00% in May, 10yr bond yields are back to 2.83%, stuck amidst the 2.71% - 3.10% range since February. “Feels like it’s one of these big structural sellers, though hard to say for sure. All I know is that at these levels, I’d rather be long it than short.”

Beep Beep III: “The resiliency of Bitcoin is impressive,” continued Roadrunner, building a presence in crypto trading. “It’s held up despite talk of bursting bubbles and exchange hacks.” Bitcoin is down 67% from its highs, which takes it back to last October’s price. “Down the road, everyone will hold some percentage of their wealth in digital assets. The winner may not be Bitcoin, but right now it feels like the one.” Bitcoin market cap is $112bln, Ethereum is #2 at $46bln, followed by Ripple at $18bln, Bitcoin Cash $12bln, EOS $6bln, and Litecoin $5bln.

Beep Beep IV: “2017’s rally was total euphoria,” explained Roadrunner. “People anticipated a Bitcoin ETF at the end of the year.” It never happened and the price tanked. “People then were either unaware or underestimated their capital gains tax liabilities into April, and that cut prices in half.” Ever since it’s been in a $9,900 - $5,900 range (last price $6,500). “The futures market trades in light volume but it’s a start, a success. Coinbase (the dominant exchange) will go public at some point with a crazy valuation. And when the Bitcoin ETF arrives, the price will double.”

Anecdote: His passion for it was fading. He knew that much. “But what to do?” whispered the Economist, mostly to himself. For decades he’d examined every word, placing it into context, comparing the endless stream of Fed statements to their predecessors. He took great pride in not missing a single interview by all twelve voting members. While he couldn’t recite Fed Chair press conferences verbatim, he got close. And that impressed his employer’s biggest clients who considered him Rain Man. He loved it, even if more recently it felt narrow, hollow. In his early years, Greenspan had been exciting in a nerdy kind of way. Alan knew that in a fiat system it is vital that the central bank exude confidence, wisdom. But deep down the Maestro understood how little we know. So he hid that truth in obfuscation, erudite nonsense, saying much and nothing, all at once. Bernanke was an authority on the Great Depression’s monetary mistakes. And this assured that his zealous commitment to prevent a repeat blinded him to the far-reaching unintended consequences of his policies. Every major central bank followed Bernanke’s lead. Politicians ceded control, central banks ruled supreme. As global interest rates fell to zero and below, debts soared while interest payments sank. This increasingly fragile construction proved stable provided nothing changed. Yellen inherited the bizarre legacy in 2013. She had previously invented the Dot Plot, an experiment in communicating expectations for the future by an economics team that consistently misjudged it. The goal was to abolish policy uncertainty. But uncertainty is immutable, and escaping the central bank’s grasp, manifested in an anti-establishment political wave. “What use am I now?” sighed the Economist, having devoted his career to Fed watching, still hanging on to every inconsequential word, as the age of the central banker passed, and power returned to politicians.

Good luck out there,

Eric Peters

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, drink with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.