Eurodollar Curve
The eurodollar curve has nothing to do with euros or dollars. Rather it is an interest rate curve and one of the world’s most widely traded futures.
After peaking at about 3.9% this year, eurodollar betters believe the Fed will then cut rates all the way down to 2.8%.
Five Not-Quite-Impossible Things the Market Believes
Wall Street Journal Contributor James Macintosh discussed the above chart in Five Not-Quite-Impossible Things the Market Believes
- Inflation is transitory.
- The Fed realizes this in time.
- The jobs market cools enough to slow wage rises.
- But not so much it means falling household spending.
- So consumer spending rises in real terms.
In reference to the led chart, Macintosh says “The first assumption is the hardest to believe.”
I disagree. The hardest thing to believe is the overall goldilocks scenario and that the current rally makes any sense at all.
Inflation may easily come down if the Fed tightens too much too fast causing a severe recession. What would that do to corporate profits?
But assume otherwise, that inflation does not come down more. What would that do to corporate profits?
While any of the first three points may easily be correct, the combination of all five being correct and that stocks will rise in a goldilocks scenario is what I find hard to believe.
Is the Market Forward Looking?
Goldilocks proponents will tell you that the market is forward looking.
The market isn’t forward looking and never was. It is a coincident indicator of current sentiment, wildly wrong at major turns.
If the market was forward looking, what precisely was it looking forward to at the November 2007 peak with recession starting the next month?
What was it looking forward to at the 1929 peak, the 1933 bottom, the 2009 bottom or any other top or bottom?
The Fed Will Hike Until It Breaks Something
I believe the eurodollar curve is more likely to be correct than the Fed. When has the Fed gotten much of anything correct?
The eurodollar view has two ways to win. The first is the Fed actually does tame inflation to the degree that it wants.
That’s possible in a severe enough recession. And the global picture is easily weak enough for that to happen.
The second way the eurodollar curve might be correct is if the Fed breaks the credit market.
The Fed would immediately reverse course, regardless of inflation, should that happen.
Neither a credit event nor strong recession would be good for the stock market.
The least likely thing is that the Fed achieves a goldilocks soft landing. Yet, assume that happens.
Macintosh says, and I agree, “The bull case that stocks and corporate bonds are pricing requires the combination of low joblessness and wage rises to allow spending to rise faster than inflation even after pandemic savings run out. But not so much faster that it hits capacity constraints and accelerates inflation.”
The problem with goldilocks is stocks are priced so much beyond perfection that they may decline anyway.
Globally Speaking
- China Does Surprise Rate Cut to Help Its Economy, But It Won’t Work
- German Costs to Ship by Barge are up Twenty Times and May Soon Be Impossible
- UK Average Electricity Cost Will Soar to $5,370 Per Year By 2023
- US Industries Are Buckling Under Pressure of Surging Electricity Costs
Good luck with goldilocks, especially with the Fed still hiking.
This post originated on MishTalk.Com.
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Mish
As
I said: The only tool, credit control device, at the disposal of the monetary
authority in a free capitalistic system through which the volume of money can
be properly controlled is legal reserves. The FED will obviously, sometime in
the future, lose control of the money stock.
May
8, 2020. 10:38 AMLink
“However, on March 26, 2020, the Board of Governors reduced the reserve
requirement on checkable deposits to zero. This action ended the Fed’s ability
to control M1. In February 2021 the Board redefined M1 so that M1 and M2 are
very nearly identical. Consequently, it makes little sense to distinguish
between them. In any event, the checkable deposit portion of M2 cannot be
controlled now because there are no longer reserve requirements on these
deposits. Here is the reason the Fed cannot control these deposits.”
https://www.dlthornton.com/images/services/Some%20Thoughts%20About%20Inflation%20and%20the%20Feds%20Ability%20%20to%20Control%20It.pdf
needed no “disclaimer”. Economic prognostications were
infallible within a year. The Ph.Ds. in economics never used the FED’s
“elephant tracks” (required reserve balances). As Dr. Richard
G. Anderson said 11/16/06 (the world’s foremost authority on bank reserves): “Since no
one in the Fed tracks reserves”.
Roc’s in
required reserves moved GDP and the markets. The distributed lag effect
of required reserves were mathematical constants. This was corroborated
by the G.6 Debit and Deposit Turnover release (as money is the measure of
liquidity, the yardstick by which the liquidity of all other assets is
measured).
Today we have to fall back on DDs (and a disclaimer).
We have to assume that the fixed distributed lag effect applies to DDs
also. We also have to assume that DDs underweight the demand for money,
or its inverse, the transaction’s velocity of funds.
The trend in inflation is down (however unacceptably high), based
on the roc in DDs. But M2/Gross Domestic
Product (potential AD) is still too high:
https://fred.stlouisfed.org/graph/?g=eTtE
Stagflation is the most probable outcome.
No need to worry. Energy is just over 60% of my stock portfolio. And my stock portfolio is roughly 25% of my wealth. So energy stocks are presently just 15% of my wealth.
over the next 35 years. At $70 oil, cash flow is 20% and shareholders
get their money back 7 times.”