wknd notes: Losing Faith in Fiat

“I am requesting that the Federal Reserve return the unused funds to the Treasury,” wrote Steve Mnuchin, in a letter addressed to Fed Chairman Powell, shutting the lights off on his way out. “In the unlikely event that it becomes necessary in the future to reestablish any of these facilities, the Federal Reserve can request approval from the Secretary of the Treasury,” continued Mnuchin. Days earlier, Chairman Powell had stated, “The Fed will be strongly committed to using all of our tools to support the economy for as long as it takes until the job is well and truly done. When the right time comes, and I don't think that time is yet or very soon, we will put those tools away.” So apparently, the time has come. In any other period, such a public disagreement between the Treasury Secretary and Fed Chairman would have sparked an abrupt 10% decline in the S&P 500, particularly when the Fed has so few tools at its disposal and fiscal policy is the only true lever capable of lifting the real economy. But not now. Equity markets barely budged, the S&P 500 finishing the week -0.8%. Bond markets rallied, 10yr Treasury yields falling 7bps to 0.83%. In fact, the only thing that really moved was Bitcoin and its brethren, which staged a stunning rally on the accelerating loss of faith in fiat along with a vague sense that something powerful, apolitical, transnational, is emerging in the cloud. You see, the market seems to have so little confidence in our politicians that they no longer even trust them to engage in a proper fiscal fight. Instead, markets increasingly believe that no matter how dysfunctional our political parties, how damaged our democratic institutions, how deep our self-inflicted wounds, in the end, all paths lead to an increasingly abundant supply of debt and dollars. And the market is not wrong.

Week-in-Review (expressed in YoY terms): Mon: Ten members of the Association of South-East Asian Nations plus Australia, China, Japan, New Zealand and South Korea sign trade pact (Regional Comprehensive Economic Partnership) which covers 30% of global GDP, Japan annualized Q3 GDP +21% (Q2 -28.8% and Q1 -7.1%), Germany finance minister expects 4-5mths of sever covid measures, US reports its 11-millionth covid case, Moderna vaccine 94.5% effective, Tesla to join the S&P 500 (TSLA market cap $400bln – larger than 95% of S&P 500 companies), Trump plans to open Arctic Wildlife Refuge to drilling, SEC chairman Clayton to step down at year-end, S&P +1.2%; Tue: US announces plan to cut forces in Afghanistan from by 2,000 to 2,500, Trump fires head of cyber-security agency (after he declared 2020 election the most secure in history), Senate fails to advance Judy Shelton to the Fed (she advocated for return to the gold standard), Walmart online sales +79% (in-store +6.4%), S&P -0.5%; Wed: Japan and Australia announce new military pact, US covid deaths pass 250k, NYC to shut public schools, Pfizer vaccine final results show 95% effectiveness, S&P -1.2%; Thur: Turkey hikes rates +475bps to 15.00% (CPI ~12%), UK October monthly government borrowing hits record $29.6bln, US unemployment claims +31k to 742k (10mm remain unemployed vs pre-pandemic), CDC urges Americans to refrain from Thanksgiving travel, YouGov poll finds 88% of Trump voters believe the election result is illegitimate, S&P +0.4%; Fri: Global tourism collapse costs global economy $4.7trln and 174mm jobs in 2020, US record 180k daily covid cases (daily deaths hit 2,000), Georgia completes recount and confirms Biden win, S&P -0.7%; Sat/Sun: US daily covid cases hit 193k (82k hospitalizations), PA judge throws out Trump lawsuits alleging voter fraud.

Weekly Close: S&P 500 -0.8% and VIX +0.60 at +23.70. Nikkei +0.6%, Shanghai +2.0%, Euro Stoxx +1.2%, Bovespa +1.3%, MSCI World +0.4%, and MSCI Emerging +1.8%. USD fell -12.3% vs Bitcoin, -7.3% vs Ethereum, -1.5% vs Mexico, -1.3% vs Brazil, -1.3% vs Russia, -0.8% vs Chile, -0.8% vs Sweden, -0.7% vs Yen, -0.7% vs South Africa, -0.7% vs China, -0.6% vs Sterling, -0.6% vs India, -0.4% vs Australia, -0.3% vs Canada, -0.2% vs Turkey, -0.2% vs Euro. Gold -1.0%, Silver -2.2%, Oil +5.1%, Copper +3.8%, Iron Ore +5.9%, Corn +2.4%. 5y5y inflation swaps (EU -2bps at 1.14%, US +5bps at 2.16%, JP flat at 0.08%, and UK +3bps at 3.47%). 2yr Notes -2bps at 0.16% and 10yr Notes -7bps at 0.83%.

YTD Equity Indexes (high-to-low): NASDAQ +32.1% priced in US dollars, Denmark +31.6% priced in US dollars (+24.1% priced in krone), Korea +20.7% in dollars (+16.2% in won), Taiwan +19.8% (+14.3%), Sweden +17.7% (+8.7%), China +17.5% (+10.7%), Japan +13.2% (+7.9%), Finland +12.9% (+6.8%), New Zealand +11.4% (+8.3%), S&P 500 +10.1%, Russell +7%, Portugal +5.2% (-0.4%), Netherlands +5% (-0.5%), Switzerland +5% (-1.1%), Germany +4.8% (-0.8%), Ireland +4.7% (-0.8%), Saudi Arabia +2.3% (+2.3%), Australia +1.8% (-2.2%), India +1.6% (+5.7%), Malaysia +0.3% (+0.3%), Canada -1.1% (-0.3%), Euro Stoxx 50 -2.3% (-7.4%), Italy -2.4% (-7.7%), France -2.9% (-8.1%), UAE -3.2% (-3.2%), Philippines -3.3% (-8.3%), Belgium -4.3% (-9.4%), HK -5.7% (-6.2%), Israel -5.8% (-8.7%), South Africa -6.8% (+2.2%), Norway -7.2% (-5%), Argentina -7.9% (+23.6%), Poland -8.8% (-9.5%), Mexico -9.6% (-3.8%), Turkey -9.7% (+15.7%), Spain -11.8% (-16.5%), Singapore -12.7% (-12.7%), Thailand -12.9% (-12.1%), Indonesia -13.4% (-11.6%), Czech Republic -13.9% (-15.5%), Chile -14.3% (-13.2%), UK -15.7% (-15.8%), Austria -17% (-21.5%), Russia -18.6% (+0.2%), Hungary -19.4% (-17.1%), Greece -19.4% (-23.7%), Brazil -31.5% (-8.3%), Colombia -32.6% (-25.4%).

Telling: “If ten years ago you would’ve said that on a scale of 0-10, monetary policy was a 10 in its ability to influence the economy, what would you say now?” I asked a G-7 central banker. Such policy makers largely think alike, embracing economic orthodoxy, so if you ask one, you’ve effectively asked them all. He had been talking about the prospect of negative interest rates which is the most boring topic imaginable. I found myself unable to resist the urge to shake things up. And while I already knew the answer, it is in the act of telling that a story is told. 

Telling II: “I’d rather not answer with a specific number,” said the central banker. “I wouldn’t want to be held to something so precise, but it is fair to say that monetary policy effectiveness is lower than 10,” he added. I offered that the number is close to zero, because, while monetary policy can very obviously lift asset prices, amplifying inequality which in turn undermines economic vitality, it has little effect on the real economy. And this leaves politicians with one choice, which is to transition to fiscal policy as the dominant tool to influence the economy.

Telling III: “As you know, central banks cannot control fiscal policy, so we do what we can in order to achieve our inflation target,” replied the central banker, in a tone of resignation. “The problem that we have is that R* is too low, and this is truly a global problem,” he continued, referring to the inflation-adjusted, short-term interest rate consistent with full use of economic resources. And the way he said it confirmed everything I already knew, which is that global central bankers are impotent until politicians spark an economic boom, a great inflation, or both.

Doc: “It slowed to a linear rate, no longer exponential,” said Doc, Saturday evening. “We’re dialing down elective admissions with one hand, accommodating the Covid surge with the other,” continued one of America’s most prominent respiratory disease experts, fighting a noble battle. “ICUs are filling, the people sicker, but it’s more in control than March/April.” Hospitals hit capacity most January’s due to influenza. This year they’ll be overwhelmed - a self-inflicted wound amplified by our ineptitude. “Once I’m in the fight I calm down. And I’m now calm.”

The Wall: Early in recessions, the end is nowhere in sight. Fear overwhelms hope, darkness dominates. Asset prices race ahead, which means they lead the economy lower. But they also begin their recovery even as the data appears bleak. As equities climb back to ebullience, fear slowly fades that the recovery will somehow falter. At some point, that wall is scaled, and without the promise of greater heights, something far below grabs our attention. We are drawn to those things we turn our attention toward. And at some point, we tumble, again and again.  

The Wall II: The pandemic will end this spring, the wall scaled. In the interim, we’ll endure another catastrophe of the kind that 8mths ago sparked global depression. But those unknowns have faded. Now markets look across the chasm. On the other side, we see ongoing stimulus that is unprecedented in modern economic history, post-pandemic euphoria, yet society terribly fractured. How these things intersect in a vaccinated world are the new unknowns. Though it remains too early to tell whether they are things we see near the top of the wall or far below.  

Anecdote: “A night sky, dancing with stars,” said Charlie in the kitchen, reciting his latest poetic creation. He’s produced a few at this point, online learning assignments. Mara flagged the first one, surprised by what he’d written, and ever since, I tuned in. She and I love words, their endless combinations. If well engineered, the most wonderful ideas and images form, blend, bend, magic. “A river, full of stones,” continued my eleven-year-old. Not a person on the planet will forget 2020. It’s an indelible moment, connecting us forever in our fears, hopes, and in our differences, divisions, tribes. For all the tragedy, suffering, there are also the opposites, for one cannot exist without the other. And this is surely true, even as the blessings from every curse only manifest in time, propelling us forward, wiser, wounded, stronger for the scars. “A sunset, cradling your eyes.” We all have things we hope to teach our children before they fly. Be a good person. Brush your teeth. Mow the lawn. Stand up for those who cannot. There’s so much else. Own your mistakes. Overcome adversity. Take risk. Don’t fear failure. Persevere. Love. And through it all, I’ve tried to teach them the world is always changing, sometimes abruptly, for both the better and worse. And to truly live is to embrace impermanence. “A drop of water, flowing with the rest.” But perhaps the greatest gift of this pandemic is that it forced us to stop. Slowed the pace. Interrupted this mindless race. And into that space, nature crept back, to teach. Rope swings arcing. Water sparkling. Catching bull frogs, turtles. Waltzing egrets, stalking minnows. Coyotes. The fat fox, our terrified chickens. A golden eagle, soaring, supreme, sublime. Our children, amidst it all, awed. And while we cannot know what their future holds, it is profoundly altered, they are changed, in ways that will forever remain mysterious, magnificence. “All the same, all beautiful.”

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management          

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.