Be Careful What You Wish For

The market isn’t even open yet, and already the administration is starting with the algo-inspiring messaging.  A China deal is imminent!  Actually, quite likely.  Well, there’s a decent chance…

Playing this outcome is no better than a roll of the dice — which is why the VIX gamesmanship has already begun.  Note that ES’ two threatened dips below the 2.24 extension at 2728… …were promptly met with VIX smackdowns.  As Blondie would say, “one way or another.”Speaking of which…I went in yesterday for a simple extraction of a tooth which had been bothering me for quite a while.  It was time to think about an implant.

The procedure ended up taking four hours, involving three oral surgeons, three assistants, a tech, and 22 injections.  Damn tooth had three roots, two of which were hooked at the end and refused to let go.  So, they essentially drilled the tooth out.

I learned two important lessons from the experience.  First…brush and floss. Duh.  Second…some conditions which seem simple and straightforward can become excruciatingly complex in a hurry.  So it is with QE.

Ten  years ago, when central bankers first delved into the suppression of interest rates and accumulation of trillions in assets, it probably seemed like a fairly simple way to protect the stock market and economy from ruin.  Now, the market hangs on every Fed utterance to find out when the party might truly be over.

But, like tooth # 19, easy money is proving to be darned near intractable.  Consider the complex relationship between rates and the US dollar.Since the April-May equity plunges, DXY and TNX have been rising in lock step.  A strong dollar kept inflation under control while oil and gas prices soared.  Rising 10Y rates helped prop up the dollar, and kept the yield curve from inverting while the Fed worked the short end higher.

It’s hard to say, but I imagine they didn’t anticipate the aggressive manner with which Trump attacked high oil and gas prices and interest rates.  With November CPI due to tumble, the 10Y is finally tumbling — which means the Fed must stop hiking or face a yield curve inversion.

This has been the basis for our inflation and interest rate forecasts since mid-April [see: Oil & Gas, Inflation and Interest Rates: A Delicate Balance or Goal Seeking.]  In it, we forecast a sharp decline in oil and gas prices and a lid on interest rates and inflation.

We also forecast that stocks would follow suit unless USDJPY angled higher and VIX came under attack.  Not surprisingly, all of these things have come to pass.

Oil has plunged 35% from its recent highs.  The 10Y briefly punched above 3%, but is about to drop below it as the 2s10s lingers in the low 20s.  USDJPY, which plunged to 104 in March, is about to test 114 again.  CPI, which reached 2.95% in July, could test its 2.07% 2018 lows for November.

Unless oil and gas suddenly spike higher or Trump’s tariffs are expanded, the Fed can’t justify further rate hikes.  The “market” is just fine with that.  Central banks can still buy stocks, hammer VIX, toy with the yen carry trade, etc.  And, politicians can still cut taxes so corporations have more money with which to buy back shares.

But, it remains to be seen whether USDJPY can hold its uptrend in the face of stable or declining interest rates.Remember what happened the past couple of times USDJPY threatened to break down.

continued for members


Sorry, this content is for members only.

Click here to get access.


Already a member? Login below

Remember me (for 2 weeks)

Forgot Password