A couple overlooked facts

1) US10Y started 2020 at 1.875% and is quickly closing in at 2.25%. The Fed's barely started raising rates, if you want to see what they're likely to do look no further than the end of Q3 2018. 

2) Russian OFZ 10Y was showing 20% pre mkt, and is trading at 13% atm. The only thing keeping it from spiraling even more out of control is the CBR. 

3) China/US 10Y spreads are closing down 

4) Germany's PPI running over 25%/year, for reference, it's the highest it's been since 1949 (when they started to use the measure). 

5) Some retail loser piled $2 billion into $TLT last week

Central bank tightening

It always amazes me when people try to say that equity markets go up during the early stages of a central bank tightening. It doesn't make much sense, when the CBs tighten it raises the cost of borrowing driving demand down, and thus the equity markets as well. Not sure who's promoting this false narrative of a bull rally, but it's going to cost a lot of people a lot of money. 

Real Estate

It's crazy that the demand for real estate is as strong as it is in the midst of war, market volatility, and inflation. We expected rates to increase over 2022 from 3.3% to 3.8%. That happened in January alone. Then, we got a hike of nearly the same size, to 4.4%. When Russia invaded Ukraine, real estate web traffic fell 3% - 5%. Any big headline-grabbing event, like an election, has that effect. But this has lasted longer. Recently, tours of listings were down 13%, though that's compared to freakish 2021 sales activity. Even still, we’re supply-constrained. Last quarter, 18.4% of homes sold to investors, a record; the 10-year average prior to the pandemic was 12.6%. Another record: 71% of homes in February sold in bidding wars. Pre-pandemic, when inventory was still low, the average was 55%. Year to date, the number of new listings is down, but only 6%. The average number of homes for sale is down much more: 24%. The amount of food being served is nearly the same, but it’s being eaten much faster. It’s not just that demand is stronger than before; tech made it faster. This tech includes Redfin’s app, the DoorDash equivalent for real estate. The time it takes us to notify a customer about a new listing, schedule a tour, then write an offer is measured in minutes. Even when the market cools down, it may not slow down: good homes will sell in a weekend. The rest will be discounted after two pundits gauge impact on commissions, which in 30 years fell from 6.1% to 4.9%. Brokers are a bit cheaper, but a lot faster: a lifestyle gig is now 24/7. Another misconception: Rising rates affect home-buyers more than owners, limiting demand not supply. But the monthly payment for a median-priced U.S. home with a 2.65% mortgage is $1,264. That home will rent for $1,900. Many would-be sellers would rather have ~$600 a month. That difference is why investors & individual homeowners would rather rent than sell. The Fed’s actions may have done the economy a solid in 2020 but clearly lacked any concern about the future or the byproducts of their policies, these actions will limit housing inventory for years to come. The bidding wars created by this inventory crunch have been the worst I've seen in my lifetime. #EndTheFed

Bear Market!

I started seeing a ubiquitous chart a while back showing AAII % bull tanking and % bear soaring used to promote an imminent mean-reversion rally. Here is a chart that shows why these bull market indicators can fail you very miserably in a bear market.

Riddle me this

Riddle me this, how do Swiss banks have huge lines of credit out to massively levered Swiss commodity traders that are systemically critical to the functioning of the global economy but sit entirely outside the financial system?

Inflation #2

Surprise surprise inflation exists! Moreover, this self-imposed shock via stimulus checks has had larger implications. Who is the single largest debtor in the world? US Government. What does an inflation shock do? Rubs the nominal creditor to benefit the nominal debtor. This is the biggest inflation shock in 40 years.

Debtors include US corporations who loaded up massively on debt to prepare for buy-backs. EZ and ECB with pretty much the same vibe. How big was the theft? For USTs alone the Fed’s own economists estimate it at 3.3% of GDP, the largest in history! That obviously doesn’t even include corporate debt. Who are the ones that got screwed? Split is simple 40% foreign / 60% US HH. The sheer size of the theft is unsurprising given how the UST market ballooned over the recent decades. Also shows the other side of the marginal $ no longer being a valid reserve argument.

Inflation

 I have always been amazed by the fluidity of the "transitory inflation" argument, in the sense that it changes every time you realize another way it is wrong. 

- March 27, 2020: Don't worry about the $2.2 trillion we created out of thin air, inflation won't be a concern

- April 2020: Inflation exists, but don't worry its "transitory"

- September 28, 2021: Inflation is longer lasting than expected

- February 25, 2022: Labour and wages could drive persistent inflation

- March 2022: PUTIN DID IT!!

- March 10, 2022: We can solve all of our problems by creating another $1.5 Trillion and ofc TikTok stars gotta know top secret info about Ukraine

Now, this is not to deny the implications of geopolitical conflicts with regards to inflation, but the notion that we can print more money than has ever been printed in human history and expect no one to foot the bill is asinine at best. We printed a fifth of every dollar in circulation in 2020 alone. Inflation has never been and will not be "transitory." The Stimulus bills and Congress getting a little too comfortable with making the money printer go brrrrrr are the root of the problem, not Putin. 

2Y Short

Just a friendly reminder that with 2Y @1.75% ish and spreads blowing up, you can pick up a decent paper short dated for 3%-4% - yield farming starting…ways to go

2000 in 2022

I've been a bear on the market for months now. I know, no one likes a bear, but the similarities between now and the dot com bubble are not something to be brushed over. With the rise in speculators and "Robinhood traders" entering the market, fundamental analysis thrown right out the window, terrible companies such as GameStop ($GME) and Movie theater chain AMC ($AMC) with extremely high prices, with extremely low valuations and Reddit sticking it to wall street, a recession is overdue. While blank check SPAC mergers may not have been popular 22 years ago, companies did begin spinning off their online divisions or setting up "tracking stocks." For example, Barnes and Noble isolated their Barnsandnoble.com unit into a separately traded division. It wasn't just them, Disney ($DIS) set up Go.com, and the same story could be told with AT&T, NBC, etc... the overarching point is they are serving as a glorified SPAC. Moreover, very unprofitable companies with razor-thin streams of revenue were rushing to go public. The spectacular collapse of Pets.com stock after its IPO in February 2000 just before the Nasdaq peaked is still the poster child of wretched market excess. Does this sound familiar? Robinhood, Palantir, Airbnb, Doordash, the list goes on and on, but I think you get the point. Regardless of your personal views on these companies, the point remains, we are seeing these largely unprofitable companies IPO just as we did in 2000. This leads me to QQQ. in 2022 the sector that got hit the hardest was the sector that was the most overvalued, tech. We have seen the NASDAQ enter a bear market and IMO it is only the beginning. when you look at the log chart on the trading view you see the percentage drop, and from this view over a twenty percent correction (to the right) seems like nothing, compared to the 80% correction we saw in 2000 (to the left). In sum, because of the large amount of speculation that has gone into stocks for the past two years, an accommodative Fed, highly inflated assets, etc... we will see another 2000 type recession. 

Risk update

Complex theories of what will happen next in financial markets seem pointless to me. Risk is always the first to fail, and this time it is no different. We went into this epic commodity shock (and not only energy) with the U.S. economy overheating. Wage pressures were accelerating, inflation broadening, and consumer sentiment collapsing. Corporate margins have been a key theme on this TL for over 9 months now and time is finally up. The combination of rising energy costs together with mortgage rates will be the final nail in this cycle’s long expansion. An energy crisis alone would have been enough to trigger a massive credit event. Combine remaining commodity complex imploding, sanctions triggered credit losses, risk of multiplying conflicts in many EM (triggering sovereign credit events)

ECB press release

The ECB released a terrible presser. While they started to slowly withdraw absurd policies with a hope that APP will be halted in Q3 which could possibly herald the possibility of a rate hike before year-end, they seem to be in total discovery mode. The language is so convoluted that no actionable guidance emerges other than « we are watching carefully ». They seem to be overly relaxed on the systemic risk front when they shouldn’t. And come across as having zero ideas what’s going to happen to inflation. Inflation risks are to the upside, but also to the downside. Textually. That leaves staff projections. But these are not really projections. They are reprojection. Staff adjusted their ‘22 numbers to adjust to what their models totally missed. A doubling almost. But they kept their ‘23 and ‘24 numbers almost unchanged (up by 10 bp a piece). Meaning they have no clue and just waiting on data to come so that they can follow. This is problematic because neither the governing council nor staff seems to be offering any anchoring. What will the reference point be for the curve in terms of pricing a terminal rate? Your guess is as good as any. Said differently, the ECB has no guidance and no leadership. There is no reference to anchor rates. It’s an unmitigated disaster. 

EUR risk reversal overlayed with €/$

 

EV revolution concern

I've long been a supporter of the EV revolution, namely Tesla ($TSLA), but the constant rise in the price of certain necessary parts of a battery such as Nickle, Cobalt, Lithium, and Graphite cannot be ignored. Add supply chain constraints on top of this which are likely to persist everywhere except China who is likely to have strengthened their geopolitical ties with Russia in the recent weeks, and you get an extremely expensive, non-profitable sector of the economy leading to yet another asset bubble. 

A look at crypto

I can't say I am too familiar with the crypto space, but the part I know the most about is the part that it is a Ponzi scheme. In the sense that you need more and more people in on it to keep it going. This isn't to downplay the success of cryptocurrencies, take Ethereum for example, Its initial release was on July 30th, 2015. So in a matter of 7 years, it has grown from essentially nothing to $2667.30 as of March 9th, 2022. This is without a doubt a success story in the Market. It's not just Ethereum, it's other cryptocurrencies as well Bitcoin, Litecoin, Dogecoin, you name it, we have seen a meteoric rise in its market cap. Now, the individual differences between the blockchains aren't so much important so much as the fundamental goal of all of them. To be a decentralized medium of exchange whose price cannot be determined by any centralized government authority such as the U.S. Federal Reserve, the ECB, etc... So it claims to be this revolutionary part of modern finance, which it may well be. After all, the price of these coins although volatile has only been shown to continue skyrocketing which indicated people are believing the story it is telling. However, dispute this success, the trepidation I am having is understanding that if it really is so revolutionary why is the price of every coin always depicted in USD? Why do we always hear the "new high" or the "new low" these currencies are hitting relative to the USD? Why not talk about the actual inflating or deflating of these currencies as we do with fiats? In my view, it is not the new decentralized medium of finance, it's another glorified fiat.

A look into the past

As many of you know the 70s were characterized by deeply negative real interest rates as well as rampant inflation rates. Borrowing boomed, both public and private. So did asset bubbles. Because the financialization of the economy had not yet benefited from deregulation, asset bubbles were more localized. Farmland in places like Nebraska and Kansas and oil-rich land in Oklahoma. Farmland, mineral rights, and rigs were used as bank collateral. Land prices rising led to more valuable collaterals that led to more borrowing that led…you know the gig. Oil rigs were booming in the same way. Investments going through the roof on cheap borrowing. Mineral leases, energy loans, you name it.You know how this ended. Volcker doubled FFR to break the psychological vicious cycle of price and asset inflation. The need to shock and awe was the result of years of negative real interest rates as Fed stood by idly watching the economy spin in price/asset bubble frenzy.Volcker succeeded as you know, and inflation was brought back under control but farmland prices crashed by almost 30% and oil tanked from $120 / b to…$25 /b over a few years. And as a result, 1600 banks collapsed in the aftermath of this asset bubble popping. To put this number in perspective, the GFC saw a total of less than 400 US banks collapse over 08-13. Asset price collapses => bank collapses => contraction of credit. Unemployment hit 10%. Let’s break down the mechanisms at play. The Fed enabled and encouraged lending growth. Animal spirits led to unbridled speculation on the value of assets. Banks played their role in facilitating the self-reinforcing nature of this speculation. Then the music stopped. Levered players got wiped out. Late buyers got wiped out. Collateral value collapsed. Banks went bust. All throughout that inflationary/asset bubble cycle, there was a prevalent school of thought that blamed inflation on…supply cost-push. Sounds familiar? Lots of organizations got blamed. Unions for fueling wage-price spirals. Middle-Eastern oil cartel for juicing up oil prices. Price and wage controls were imposed. Failed. Sounds familiar? (leftists narratives abounded recently) But Fed’s own research advanced an explanation based around the notion of « monetary policy neglect » which refers to this obstinate policy of negative interest rates in the face of evidence of excessive lending and demand fueled price pressures. Sounds familiar? This gets us to today. Are there any similarities in the way the Fed has conducted monetary policy during this bout of inflationary burst? Fed used the same policy tool as in the 70s by maintaining large negative real rates in the face of a shift in the fiscal paradigm. Negative real rates with trillions spent directly on stoking demand (including totally mistimed tax cuts). But that’s not all. This time the Fed introduced a new policy since the GFC and that’s QE. It did many rounds of it but then went unhinged in ‘20 with the COVID shock. While QE is unambiguously not directly inflationary, it does have an incidence on the persistence of inflation. If I was to lay it out very simply, it would go like this. QE has a very powerful signaling effect. You have the largest player in the market with unlimited B/S buying unholy amounts of a certain asset. That signals that the price of such assets will be supported well into the future. As it happens, that price is the reverse of the cost of capital. As a result, and given the absolute certainty that this cost will be kept under control into the foreseeable future, what does any rational economic player do? Load-up on debt and buy assets. Or load up on debt and spend if you are a government. And so debt (corporate + sovereign) went into the stratosphere. This did fuel an asset bubble as many channels directed proceeds of leverage into assets. Buy-backs are an example. Leveraged loans another. Margin loans. Mortgages…you name it…Enters inflation. We did specify that the Fed went ballistic just as the demand side was being stoked by unholy spending. So there are clearly elements of monetary policy neglect at play. Anyway, Enters inflation when sovereign and corporate debt has increased a lot. Take your pick whether you want to measure in absolute or as % of GDP or whatever. But corporate and sovereign debt increased a lot. So comes a time when inflation is rising fast and rational economic players will develop serious doubts as to the system’s collective ability to repay all this debt. So it starts making sense to dump all this load of debt and buy some more assets (resources, physical, energy and consume more). This is the point when the pile of negative-yielding debt contracts massively. That tipping point is now. Debt will continue to be sold until it reaches a level that is deemed sustainable. Fed’s awakening after slumber will only reinforce this dynamic. That’s a long way from here. Now, will that lead to a pop in various asset bubbles? Yep. Will we see bank failures? Yep. But there are obvious differences. Mostly, bank lending was far from unbridled this time around. That’s because banks are in a better reserve and regulatory place than they have ever been in a while, and that can be credited again to Volcker and Fed. Corollary, a lot of the dirty work got lifted by swaths of shadow banks that are less regulated. In return, these get financed by traditional banks but not through traditional loans. Think Archegos blowing but costing banks money after all. The last difference is that current bubble proportions are biblical as the financial market got infinitely more complex and interconnected, with lots of illiquidity and counterparty risks built-in.