Notes From Underground: The Summer Doldrums

There are storms brewing but for the moment markets are stuck in the Doldrums waiting for the winds to increase in velocity. The issues confronting the market are all too familiar as NOTES FROM UNDERGROUND has been categorizing for the previous months.

On July 5, me and Rick discussed an issue that has finally caught the attention of the financial media pundits. Those who have little knowledge of yield curves are now dictating the narrative now that the U.S. 2/10 curve has flattened through 30 basis points. My previous blog post generated a great deal of commentary and I advise you read the comments and pay close attention to the thoughts from STEFAN.

Click on the image to watch me and Rick discuss the yield curve.

The ferocious bulls fill the airwaves, telling viewers to ignore the yield curve for the current environment is DIFFERENT than all prior flattening events. Maybe SO but as I have cautioned over the last two years, it is difficult to time equity moves to yield curves. In my research over the last 40 years there is definitely a lag effect. It’s worth looking at this 25-year chart of the 2/10 curve overlayed with the S&P 500. Note the lags in stock market corrections following rounds of curve flattening.

***Issues we have discussed but certainly have the power to disrupt markets:
1. Trump is heading to the NATO summit and he will be as disruptive in Brussels as he was at the G-7 meeting in June. The Trump team believes that the most relevant days of NATO are over and if the U.S. allies wish to sustain the alliance they will have to bear  a greater financial burden. NATO is a relic of the Kennan State Department in which containment of the Soviet menace was the major component of U.S. security/economic policy. I raise the question again: Will the Western powers go to war to protect Erdogan’s Turkey if the brash dictator in Ankara were to conflict with Moscow? Remember that Article 5 of NATO‘s mission statement calls for collective action. Raise your hand high if you believe that Turkey in its current form is worth embarking on a war for any reason. While Trump is not a diplomat in manner it doesn’t mean his substance is wrong.
2. Now this is a perplexing situation. The Shanghai Composite has dropped dramatically in recent weeks  as has the CHINESE YUAN. Typically when a major exporter of goods undergoes a currency depreciation its equity market receives a BID as a weaker currency is considered positive for its exporters. However, the correlation has been recently broken. I am watching this to see if the market senses that this correlation breakdown is signalling a major slowdown in China and the negative ramifications for the large debt load that the Chinese private sector has piled on.
The recent break in COPPER has been blamed on a large Chinese speculative position gone awry. When it comes to China it is often difficult to separate private from public so it will take time to analyze the outcomes of the recent COPPER weakness. The initial fears about the emerging markets undergoing stress from a DOLLAR SHORTAGE have not created a rush from long-established emerging market positions but the recent weakness has caused concerns but not fear. Mexico has stabilized  as fears over the election of AMLO has subsided. Argentina remains an issue but the $50 billion IMF credit line has helped to lessen concerns about financing its debt coverage. Other emerging market s are certainly a concern but not enough to cause the winds of volatility to be freshened.
3. The tariff issue we have raised in NOTES continues to fan the flames of economic uncertainty. The argument continues about the impact from tariffs. Are they inflationary or potentially deflationary? (Inflationary because domestic prices will raise as imported goods are taxed higher. Deflationary because of the effect on global trade as disruption of supply chains leads to a global economic slowdown.) Even the FED‘s June FOMC minutes raised the issue of economic impact from tariffs, but the concern did not prevent the central bank from raising interest rates. Several months ago I alerted readers to the ridiculous use of the Trade Expansion of 1962 and its section 232 to invoke tariffs on aluminum and steel as a matter of national security.
Last week, William Poole wrote a piece for the Mises Institute that is well worth the read. The former St. Louis Fed President detailed out the bad politics of the recent use of tariffs by the Trump White House.
Also, last week the Reserve bank of Australia used “uncertainty regarding the global outlook stems from the direction of international trade policy in the United States.” The FOMC is raising rates in the face of Trump tariffs while other central banks are using the tariff issues to keep their interest rates low creating downward pressure on their currencies versus the dollar. On Wednesday the Bank of Canada meets and is expected to raise rates by 25 basis point to 1.5%. Let’s see if the BOC decides to refrain from raising and cite the tariffs as a reason to fear the uncertainty.
4. On June 10, I warned to watch Russia and the rouble as President Putin would try to leverage his position as the Syrian/Mideast kingmaker as a way to get Trump to ease the sanctions on Russian oligarchs. This would be in exchange for Putin’s cooperation in forcing Iran out of Syria and other nations that the Sunni Arabs and the U.S. are concerned. Since then, Trump has arranged to meet Putin in Helsinki before he arrives home from the NATO summit. The rouble has recently strengthened, as has the Russian ETF–RSX. The world is far more confusing and volatile then the lack of winds in the doldrums would suggest.

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20 Responses to “Notes From Underground: The Summer Doldrums”

  1. silverbug2155 Says:

    Thought Turkey bought some nice military equipment from Russia recently? That marriage seems ok. Do you think the trade war is really companies that left here to manufacture there vs USA? Many keep saying China but underneath it’s Nike. Just saying.

    • David Richards Says:

      Yes I’ve thought the same, that today it seems to be more about protecting companies than individuals, eg. Apple imports tariff-free.

  2. Gregg Slutsky Says:

    No mention of the fact that Brexit was phony?? That the British government has collapsed, and that the truth about the Russian money and involvement in the Brexit campaign. ( sound familiar ?) this is a much much bigger event than you obvious think. Why? Brexit has yet to occur and Europe is in a much much worse place than 2 years ago. Incredible rise of Neo- Nationalism. Nazi s , etc. how can this eventually not have a massive impact on the financial markets .?

    • yraharris Says:

      Gregg–good question s and it will have a large impact but with negative real yields cheap money trumps politics

  3. Arthur Says:

    Let’s start with geopolitics 101. NATO main purpose was to defend each other from the possibility of communist Soviet Union taking control of their nation. The Soviet Union was gone, right? Why do we still have NATO? I understand why Russia is continually angry. Burocracy eats strategy for breakfast… doesn’t sound a good policy to me.

  4. Stefan Jovanovich Says:

    From 1793 until the Southern Democrats literally seceded from attending as members, the Congress spent more time in its sessions arguing over tariffs and money than any other topics. They were really the same subject because, until the discovery at Sutter’s Mill, the U.S. was chronically short of specie; and Federal government revenues were entirely from excises and taxes on imports. What is not generally known is that, during the period when there was general agreement – up to 1820 – the average tariff was nearly 22%.

    Trump’s “tariff war” is, by 19th century standards, not yet even a serious domestic quarrel.

    But, as our host wisely suggests, one is coming. If I have the temerity to suggest that this time the inversion in rates is different, it is because I share Harley Bassman’s that the shift is ocurring not because the Fed is pushing up at the short end but because the markets are pushing down at the long end

    • yraharris Says:

      Stefan thanks–and for history buffs they may want to investigate the role of Sam Slater in the development of U.S. economy–intellectual property indeed

    • yraharris Says:

      Stefan–thanks for the great link to the Convexity Maven

      • yraharris Says:

        Stefan–1828 redo as Poole notes as the Tariffs of Abomination

      • Stefan Jovanovich Says:

        Is this where I use that awful phrase, “with all due respect”? I don’t presume to judge Governor Poole as a banker or academic economist, but he is all wet as an historian of Federal taxation. Yra and Mr. Santelli, with help from Professor Irwin, disposed of the Smoot-Hawley myth in their video; and I fail to see how Trump’s elegant revival of the Monroe Doctrine can be compared with Clay’s noisy and unsuccessful fuss over the Tariff of Abominations. Even by 1828 the Western farmers had as yet very little interest in shipping to Europe or Asia; what they had wanted a decade earlier was to have their Caribbean market protected from the European competition. Against that interest and the New Englanders, the “consumers” (sic) from the South had no chance. Even the Walker tariff kept rates where Washington had first set them.

      • Stefan Jovanovich Says:

        Governor Poole might, given the chance, want to make a comment about my historical ignorance. I wrote “Henry Clay”; but the comment only makes any sense if the words were “John C. Calhoun” instead. Mea culpa.

    • yraharris Says:

      Stefan–can’t thank you enough for the introduction to Convexity Maven

  5. David Richards Says:

    About that time lag, in addition 31 years ago in 1987 the US bond market crashed about a month before the equity market. Just saying (not predicting an equity bear, as there’s too much bearishness already, and of course the bond market hasn’t crashed yet, plus in 1987 cash paid high real yields to park into unlike today).

    • Yra Says:

      David–we had the help of the Bundesbank for that situation as they failed to adhere to the Louvre Accord and raised rates which forced the FED into an untenable position to placate James Baker

  6. Richard H Papp Says:

    For the curious the CBOT long bond in 1987 had an 8% coupon and bottomed the week before Black Monday. On a daily closing basis, which is the only record I have, the close that day was 77 & change. If you draw a trendline on my point and figure and connect it to the low of 4/2011 and 5/13, with appropriate coupon changes, said trendline was broken after the top of 2016. It was briefly recaptured in June, 2017 and recently made a new low for the move.
    A great post today with good comments!

  7. Chicken Says:

    Trump will be meeting with Putin in Helsinki on the 16th.

  8. Eli Franzino Says:

    I gave this some thought and the fed gave the banks many years to shore up their books the yield curve will now force these banks to loan to real businesses to get the yield curve working again. Does this make sense oh great sage?

    • yraharris Says:

      Eli—the yield curve has traditionally made the banks cautious on certain loans because of fears of impending recession–there are certain types of lending that are increasing with short term floating loans tied to LI BOR –but these tend to be more risky oriented.High quality borrowers are flush and not in need of loans

      • Eli Franzino Says:

        Thanks Yra for the response. Im now 1 degree removed from Rick Santelli. Your insight and podcast are very rewarding but demanding as you always refer us for further reading. Just one of your blog posts can take a few days to put your hands around.

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