We’re going to do sometime a little different today, and take a look back at 2011. IMO, it’s an excellent analog for the current macro scene — particularly as it concerns inflation, interest rates, and oil and gas.
For those who’d like a primer on the relationships between the above and equities, check out April’s Inflation, Oil & Gas, Inflation and Interest Rates: A Delicate Balance or Goal Seeking?
We start with CPI — immensely understated, but the official measure of inflation that’s closest to reality. CPI had turned negative during the GFC — bottoming shortly after stocks did. But, it wasn’t stocks’ recovery that reignited inflation; it was rising oil and gas prices.The 2009 bounce was enough to get CPI back over +2%. But, it wasn’t enough to keep it there. A second leg up in 2010-2011 did the trick – but too well. In April 2011, CPI topped 3% and by September it was nearing 4%.
Needless to say, interest rates noticed. The 10Y rose from 2.33 in Oct 2010 to 3.74 in Feb 2011. Total federal debt had doubled in the past 7 years ($7.3T to $14.8T), so higher interest rates were a pretty obvious problem. And, the lack of inflation had been an important rationale for the massive QE to date — so, it made the Fed’s argument for more QE sound downright silly.
Having overshot 2% inflation and with rising interest expense becoming an obvious problem, it was time for oil and gas prices to come back down. But, by now, the algos had come to recognize higher oil and gas prices as positive for stocks.
In fact, SPX and WTI both hit their highs on the same day: May 2, 2011. Could inflation (and, therefore, interest rates) be reduced to acceptable levels without derailing the bull market? In a word, no. Having peaked on the same day, SPX and WTI would also bottom on the same day: Oct 4, 2011. WTI fell from 114.83 to 76.25, a 34% drop. SPX shed 22% over the same period.So, what does this have to do with 2018?
In 2011, with debt at $14.8 trillion and the average interest rate at 2.326%, interest expense was $454 billion
Here in 2018, average interest rates are currently 2.421%. With average debt of about $22 trillion this year, we’ll shell out somewhere around $532 billion — a 17% increase even though the 10Y is back below 3%.
The chart below is from February [see: Why Rising Rates Are a Problem This Time] when average gas prices were $2.49 (a 12% YoY increase) and CPI was 2.2%.
It’s not the sort of development that will bring interest rates back down to an acceptable level. A quick glance at the chart below shows that gas prices, interest rates and inflation are joined at the hip, escalating in unison.
Look, if you believe that oil and gas prices are driven strictly by supply and demand and that the government doesn’t intervene in order to achieve necessary economic goals, God bless you. The world needs more wide-eyed innocents who won’t foul the interweb with cynical drivel such as you’ve wasted the past ten minutes on.
If, on the other hand, you see the presidential tweets, congressional legislation, and backroom negotiations with Saudi Arabia and Russia as signs of something more deliberate or, dare we say, manipulative… Well, now you understand why I’ve been uber-bearish on oil and gas prices for the past month.
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Now, on to a recap of where things stand this morning. Last night’s ramp was all about the USDJPY, which spiked through the SMA200 and broke out of a rising channel, only to tumble back to the SMA200 and channel bottom this morning. It won’t hold.We know the breakout wasn’t meant to be simply because NKD still has some unfinished business: it’s SMA200 and channel backtest. Look for yesterday’s rally to come undone — and more.Our focus, however, is on oil and gas – which are closing in on our next downside targets.
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