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Natgas is down 63% from its high in late August. The average price before Q2 ’21 was $2-3, so we only have 7% more to fall to below $3. While we saw Natgas rise – along with every other commodity – in 2021, prices had begun to fall until Russia invaded Ukraine.
Russia and Ukraine are still at war, but we have this issue with the restart of the LNG terminal. Tracy Shuchart tells us what’s behind the fall in Natgas prices and what she’d look for before expecting prices to stop falling.
The Fed pivot has been wishful thinking for quite a while and Sam Rines has been repeating this for months or so. As the Fed’s minutes were released last week, Sam pointed out that NO MEMBER saw the need for a rate rise in 2023. He stated many times that the Fed has been very clear about its indicators. We see this so often that it seems obvious. Why is this so difficult for some people to see? Sam Rines explains that in this episode.
This week, Sam also made the point that the Fed is maybe “stuck in the middle”. Literally, employment in the middle of the US could be a factor that keeps the Fed from slowing down. Sam explains why the middle is so important.
We’ve seen a lot of chatter in research notes, op-eds, and tweets over the last week stating that the future is a multipolar world. This seems largely based on a call for the decline of the USD and the rise of the petroyuan, etc. Albert Marko walks us through this.
Key themes:
1. Natgas sub $3? 2. The Fed Pivot is Dead 3. Multipolar, Post-USD World
This is the 48th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. This week we are joined by Tracy Shuchart, Albert Marko, and Sam Rines. Thank you guys for taking the time to join us this week.
It’s been a pretty volatile short week, and there are a number of things we’re talking about. First is Natgas. We’ve seen Natgas come off pretty dramatically this week, and we’re going to talk to Tracy about whether or not we’re going to see Natgas below $3 soon. Also the Fed pivot. There’s been a lot of statements from the Fed, and Sam’s covered that in detail, so it looks pretty dead. But we want to find out from Sam what’s going on. And we’ve also seen a lot of coverage of or a lot of commentary about a multipolar world in the last week or two, which sounds like 2006 era rhetoric or something, but we’re seeing a lot of that kind of rear its head again, and we want to talk through that with Albert. Thanks, guys. Tracy, let’s jump into it with with Natgas. Natgas is down something like 63% from its high in late August. I’ve got a price chart on the screen right now.
The average price before Q two of 21 was in the two to $3 range, 260 or something like that. So I only have 7% more to fall below $3. So we’ve seen it rise with every other commodity in 2021. But of course, with Russia invading Ukraine, we saw that spike up. So Russia and Ukraine are obviously still at war. And then we have this issue with an LNG terminal in Texas with Freeport. So we’ve got that story from Bloomberg up on the screen right now.
Can you tell us what is behind that Nat gas price fall, and what are you looking for in that market for that to stop?
Tracy
Well, first, again, Freeport, since you already put that up right, which went down in August, and people have been waiting for that facility to reopen because it’s an export facility. What happens is that since that facility is shut down, that landlocked US. Nat gas or that pushed downward pressure on US. Nat gas. Originally they were supposed to reopen in October. Then it was November, then it was December, and now it’s mid January. So that does contribute to a lot of problems. We’re also seeing warmer weather right now in the EU, and stocks are full in the EU. This market has become very complacent. That said, if we’re looking forward, there is a cold front coming in, I think January 22 to the EU. It’s supposed to be really cold for a few weeks. So what traders will be watching is to see how much does their build bring down during that time. But again, yes, the markets have become very complacent. They think that they’re indicative that this crisis is over, but that’s not necessarily true. We’ll have to see this winter how much stock is brought down in Europe due to cold weather.
Tracy
And you have to remember that in 2022, half of their storage came from cheap Russian gas pipeline. Right. So looking forward to when we have to refill this, they’re going to have more expensive LNG coming in, and that takes longer and it’s more expensive. And then we look at US. Export capacity. It’s still not built out enough for the contracts that we actually signed with the EU. So that may put pressure on US. Nat gas, but that would put upward pressure on European nat gas.
Tony
So does that pressure, does it drive the price up or does it just hold the price steady? Is there a mean reversion at some point where we go to, say, 260 or 270 on average and kind of some of these weather issues and Restocking just kind of maintains it? Or do you expect things to go back up to $9 or whatever?
Tracy
I think we could see a spike. Again, there’s a lot of mitigating factors in this market right now, and we really have to see how much is pulled from storage in Europe at this point. And hopefully Freeport is supposed to open mid January. We’ll see if that happens.
Tony
Okay.
Tracy
But that would really leave a lot of the downward pressure on prices in the US. Market because it would open us up to being able to export that.
Tony
We also saw the Japanese buying a US. Nacas company this past week. Right. Can you talk to us a little bit about that?
Tracy
Yeah, which makes sense. I mean, Japan has been one of the largest natural gas importers in the world, and they’re very concerned right now about energy security, as most countries are, particularly in Asia. They’ve had some problems with their deal with Russia because they have a joint project together, and due to sanctions, there are some problems involved in that. And so I think that was a very smart move, again, for Japan to kind of secure energy. I mean, they’re looking forward, much more forward than I would say Europe is.
Tony
Okay. Very good. So it sounds to me that there’s not really anything decisive coming up in the near term to change the direction, but the magnitude may slow.
Tracy
Is that yeah, technically speaking, we are very oversold at this point. That said, what we really are going to have to be looking at, or what traders should be looking at moving forward is do we have this reopening of Freeport mid January and this cold front coming in? If it does, traders will be looking at how much draw is is going to happen in in Europe or Bill stock? Okay.
Albert
Not to mention, Tony, that planting season for 2020, late 2023 and 2024 is coming up in Fertilizer. You need that gas fertilizer. So that’s that’s something else to look at. I’m not sure exactly how much it weighs on it or a bullish case from that gas by any means, but something will keep your eye on.
Tracy
Right.
Tony
But we have had some fertilizer volatility over the past couple of years, right? Oh, yeah. Russian invasion.
Albert
Yeah, I’ve been a big mosaic fan, which is a phosphate play, but also nat gas is the other component on the other side for the fertilizers that they use.
Tony
Great. Tracy, what’s your thought on fertilizer?
Tracy
Yeah, absolutely. I mean, I think we’ve seen that obviously pull back, but we’re heading into planting season again starting in the spring. So again, that’s going to be another factor as far as not gas is concerned. And the fertilizer analysts that I’ve talked to say they expect another price spike coming into about March.
Albert
Yeah, I believe also there’s going to be a price spike on the fertilizer front because the soil that the farmers haven’t used can’t sit as from what I’m told, can’t sit around not being used for too long. So 23,024 they’ll have to be replanting, those fields.
Tony
Interesting. Okay, well, good to know. Thanks for all of that. So let’s move on to the Fed. Sam, you’ve put out a few notes this week about the Fed and the Fed Pivot. Obviously, you’ve been saying for about nine months that the Fed Pivot is kind of wishful thinking. You’ve said it over and over and over again and there haven’t been hasn’t been a lot of kind of listening to it or people really haven’t heeded that necessarily as we see kind of run ups and and hope that we’ll see a pivot. But Fed minutes were released this week and you pointed out no member saw a need to raise rates in 2023. So that from your newsletter is on the screen right now.
So you’ve stated many times that the Fed has been very clear what their indicators are. And honestly, we’re seeing what you’ve said many times, that it’s vu and nominal wages. So vacancies and unemployment as well as nominal wages as well as core services, excluding shelter inflation.
And those have been very clearly stated by the Fed chair in his briefings. So why is it so difficult for people to see these things that seem to be very clearly stated by the Fed?
Sam
It’s personal preference. Right. The presuppositions and the initial conditions that you want based on the way you’re positioned. Right. So our brains really like to be correct. So if we can convince ourselves that the Fed is doing the wrong thing and should do something else and ignore the Fed will do something different, then it makes us feel a little bit better. So I think that’s part of it. But I do think that there’s something to be said for when no member of the FOMC sees the need to cut rates in 2023. That should be heated. That’s a pretty one sided trade. And you listen to some of the members of the Fed this week, bostic, who could be considered one of the more dovish individuals. He was still somewhat indeterminate between hiking 25 and 50 at the next meeting. When the most dovish member that I can kind of come up with or one of them doesn’t know if they’re going 25 or 50, that’s, that’s problematic. Right? That’s, that’s something that I think people are somewhat ignoring, particularly market participants, is that the Fed is not the Fed is not pivoting towards being dovish at this point.
Right. That the narrative that they have put out for the last six months has not changed. It has been very consistent and it has been very clear that vacancies to unemployment is a problem because one, when you poach people, you have to pay them a lot more money. So instead of call it the ADP report is really intriguing because they release what the pay rates are for people who aren’t switching jobs. It’s somewhere in the seven percentage range and the people who are switching jobs are getting 15% pay bumps. So the differential there is somewhat stark and somewhat shocking. I think that is somewhat underestimated by people when they look at what’s going on in the labor market. We have had a very good year for job creation and we just finished it off with a number that was well above expectations. And, you know, you can kind of nitpick and say, well, the average hourly wage was only up 30, basis points 0.3%. And you know, that’s that’s a positive for the Fed. Well, yeah, it’s only going to be up .3% because the vast majority of jobs were created in lower paying industries.
When you create jobs in leisure and hospitality, those are below the median. So you’re going to drag down the wage growth just naturally on that front. So I think a lot of it is going to be evolutionary for the Fed, right. They’re going to have to evolve their rhetoric at some point, but they’re not going to do it yet and they’re certainly not going to do it before the February FOMC meeting and they’re probably not going to do it until after the March 1. And that to me is probably not priced in at this point. And what’s really not priced in is the Fed just not really caring about the data until sometime in early 2024.
Tony
So you mentioned that in one of your newsletters, I think it was yesterday, talking about on Thursday most recent employment report. You talked about the Fed being stuck in the middle and literally you put some maps, which I put on screen.
Employment in the middle of the US could be a factor that keeps the Fed from slowing rate rises or at least from kind of pivoting. So why is the middle so important? We get so much coverage of what’s happening in Silicon Valley or New York or whatever, but why is the middle so important? And why is the Fed paying so much attention to the middle?
Sam
Sure, so the regions to the west were the only ones that lost jobs, according to the ADP report, which is pretty interesting. And the rest of the country made up for it and made up for it in spades. So while all the tech layoffs get a lot of headlines, you never really hear about the opening of XYZ plant in Kentucky or Tennessee, or the building of a plant in Tennessee, right? Those don’t get the headlines that Facebook laying off a few thousand people get. Quite frankly, who cares about a bunch of people getting laid off from Facebook? They probably shouldn’t have had jobs in the first place. Even say I’ll say it about alphabet. I’ll say it about all the tech companies. They overhired and they overhired in the wrong area, and now they’re laying them off. I mean, that’s what happens. It’s called the tech cycle. It’s not that difficult. But middle America is more than making up for it, and it’s making up for it in spades. And I think the Fed actually might be getting caught by the middle of the country. And it’s kind of the revenge of middle America, right?
Middle America always takes the brunt of the BS from the coast in terms of being dominated on monetary policy, being dominated on economic policy, and now they’re the ones kind of driving the ship. And I think that’s really underestimated within people’s frameworks that when we’re isolated to New York and California and see people getting laid off, that doesn’t really matter to the Fed as long as it’s being made up for by people in the middle. And people in the middle are making more money and they continue to spend. And there’s a lot of states in the Midwest and call it just flyover states. There’s a lot of states with a two handle on unemployment. A two handle. So if you want to hire people in middle America, guess what? You’re going to have to pay up if you want to hire a tech worker on the West Coast. Maybe you don’t, but that’s what’s going to get the headlines. But you’re going to have to pay up in the middle.
Tony
Well, you may not have to in terms of the rise on the West Coast, but the wages there aren’t necessarily coming down, are they, on the West Coast?
Sam
No, they’re not coming down, but it’s all about wage growth at this point. As long as you have a pretty sharp deceleration, you have some people on the market to hire. That’s important, right? Nevada and California have two of the highest unemployment rates in the country.
Tony
So is it fair to say that the middle is not say perfectly, but in some extent kind of catching up with the coast in terms of, say, real wages or something or no. No. Okay, so it’s still pretty cheap, but still just wage growth. Okay, very good. What else are we missing? Because look, you have been consistent on all of this. And you have for anybody who’s either listened to us or read your stuff for the last nine months could have seen this play out pretty much exactly as you’ve laid out. So what are people missing? I think the Fed has been fairly boringly, consistent, and you’ve said they would be, and that’s what’s happened. So are there any lines to read between that we should be looking at right now?
Sam
Yeah, so I laid it out about a week ago that I think what you really want to look for is the Fed going from a hawk to a grackle, hawkish to grackleish. And if you live in Texas, have lived in Texas, grackles are the worst birds ever because all they do is squawk. They wake you up and you can’t shoot them. They’re not like dubs, so play that all the way through there. But Grackles are an incredibly annoying creature. And when the Fed goes from being pure hawkish to really starting to grackle up its communication, squawk, squawk, squawk. You have no idea what they’re looking at. You have no idea what the metrics are. That’s when they’re getting ready to pause and pivot. And frankly, we have seen none of that right. Until the Fed process is not hawk to dove or dove to hawk, it’s dove, grackle, hawk, hawk, grackle, dove. And until they really begin to confuse their messages, they’re not changing shape. That we simply haven’t seen them begin to change shape. I do think that sometime this year, probably in the call, it the May to June time frame. That’s when you’re really going to begin to see the Grackles come out.
And a lot of confusing language about what they’re watching. A lot of confusing talk about the balance sheet. A lot of confusing talk about the future, the path of Fed Funds rates. And that’s really when I’ll get a little more bulled up on a Fed pause in the length and the structure of the potential to pivot. I don’t think there is a reasonable case to be made at this point. The Fed is going to cut in 2023. If there is a credible argument, it’s that the Fed breaks something and has to cut a lot. Right. So it’s it’s a little bit of a call. It a convex play here that if the Fed does cut, it’s not it’s not cutting 50 basis points, it’s cutting two or 300. And if and on the other side, you know, if nothing bad happens or nothing very bad happens, the Fed is just going to hold it there. So I think there’s a little bit of skew here.
Tony
Great.
Tracy
Okay, thank you. I have one question. Yesterday we had, like, Fed george came out and said the Fed, quote unquote, Fed, still has a lot to learn about how balance sheet policy works. Can you explain that to the audience? And would that not be one of your grackle birds? What is it called?
Sam
No, I think it was actually George just being honest. I think we had this convers we had this conversation a few weeks ago, Tony and I, with a guest that the Fed really doesn’t understand or doesn’t have quite the concept to pinpoint exactly how much tightening or additional tightening to Fed funds. Quantitative tightening does that’s, that’s what George was getting at. She’s a little bit behind the curve there. The Fed does have a proxy rate that I pointed out earlier this week in a, in a note. The Fed has a proxy rate that they publish that’s sitting at about 6.4%, give or take. So it’s about a 260 basis point spread, 2.6% spread to the current Fed funds rate. I think that’s something to kind of pay attention to, is that the Fed does have measures. I think it’s more that if you’re out there talking all the time, it’s difficult to get into the math.
Tony
They’re not stupid, they’re just annoying at times.
Sam
Exactly. They’re not stupid. They’re really not stupid. They know how tight they are. They know they’re sitting at about six and a half percent, 6.4% on an overall tightening basis. They don’t care that’s number one. They don’t care that it’s that tight. Number two, they’re going to continue to do it until they actually achieve their mission. Right. And it’s a multipronged process. And as long as markets seem to be fixated on what’s going on with the Fed funds rate and not going on with the entirety of tightening, that’s going to continue to be an issue for them. Like today, when everybody’s like, oh, look, we printed 223,000 jobs. Maybe this gives them reason to pause because average hourly earnings didn’t go up that much. Guess what? I mean, you can’t rip markets 2% and have financial conditions loosen like that and have the Fed go, yeah, I think we’re accomplishing our mission. Inflation is still high and unemployment is at 3.5%. Yeah, it sounds like a great time to pivot. Yeah, that’s the dumbest thing I’ve ever heard.
Tony
Right? Yeah. Okay, that’s great. Speaking of stupid not you, Sam. Albert, let’s talk about multipolarity.
Albert
One of my favorite.
Tony
Yeah, so we’ve had a lot of op eds and research notes and tweets over the past week or two stating that the future is a multipolar world. And this seems to be based on a lot of talk about the decline of the US dollar or the rise of the petrieon or something like that, around Chinese crude purchases from the Middle East or whatever. So, Albert, you put a series of tweets out, which I’m showing right now on screen about this very diplomatic, as you always are.
So can you walk us through this and help us understand what’s going on? And I’m going to try to play devil’s advocate as you lay.
Albert
No, that’s fine. I mean, you can play devil’s advocate if you want, but when it comes to multipolarity, it’s not simply a financial or economic thing that you need to look at. There’s multiple variables, including legal frameworks of the nation that is the currency issuer, the military strength of the reserve currency issuer. There’s multiple, multiple variables for it. And for some reason we have these economists that come out and say, oh well, the petroleum is coming into effect and that’s going to destroy the petro dollar and therefore the dollar is going to fall and blah, blah, blah. I’ll let Tracy get into the petrowan stupidity, but the dollar is simply the lifeblood of all trade in the financial system. You’re talking about for me, it’s like taking out your blood into Transfusion and putting in Mountain Dew and saying, oh yeah, everything’s healthy, you’re going to be fine. The whole system is raring to go. It’s a dumb argument. It just boggles my mind how people can sit there and even claim multipleity when there’s literally no alternative on a global scale for anyone to be thrown.
Tony
So let’s take this bit by bit. Okay? So a lot of these people are saying that the CNY will become more powerful partly on the back of crude coming out of the Middle East and crude coming out of Europe that could be denominated in CNY. Okay, so let’s take that. Tracy, can you talk to us about the Shanghai benchmark for crude? How successful has that been?
Tracy
Not at all. Even the futures market hasn’t been successful.
Tony
What percent of world order oil, just as a wild guess, do you think is traded on the Shanghai benchmark?
Tracy
2%.
Tony
2%. Okay. And it’s been around for how long? Two years?
Tracy
Yes. And if you look at their futures market, which has been around since 2016, we’re still only saying that domestically traded, you’re not seeing big players come in and hedge like they do with WTI or bread. So that aside, China came to Saudi Arabia with a suggestion after this new summit, the latest summit that they just had, and said, yeah, we would love for you to we could trade this on Shanghai and this could be traded in yuan. Saudi Arabia still has not yet come back with an answer. And so everybody jumped to conclusion saying it’s a petrol. Saudi Arabia is giving up dollar denominated oil. This is not true. I’ve talked to a lot of people in Saudi Arabia about this. I’ve talked to a lot of journalists. I actually had a spaces about it. So this is not true. And even if Saudi Arabia did decide to sell some oil in yuan on the Shanghai exchange, for whatever reason, all that would happen is they would be paid in yuan and instantly changes into dollars. Nobody wants you.
Tony
Wait a minute, let’s dig into that. Why does nobody want CMY?
Tracy
Well, because it’s not globally traded like the dollar is. Everybody wants dollars. People don’t want you on it.
Tony
Not freely convertible.
Tracy
Right. At all. Right. And especially if you’re in a merging market with USD denominated debt. You on. Nobody wants you on. Nobody wants you on. Right. And it’s not really free floating, right?
Tony
It’s not at all. We talk about crude and the ability for the Chinese purchase crude. We talk about their currency, CNY. But behind the CNY and the lack of convertibility is the PDOC, right. China central bank. So ultimately, if you trust a currency, you ultimately trust their central bank. So is there a basis for people globally to trust the PBOC? That’s a sincere question. It’s not a cynical question.
Tracy
No, I think people are not trusting central banks anywhere, but especially in China right now. People don’t believe what’s going on in China right now. People haven’t believed the data in China right now. And so, again, there will be a small amount of oil traded globally in yuan if China wants to do so and another country chooses to do that. Right? Russia has india was brought up for them, but that’s a very small 1% to 2% of globally traded oil, which is certainly not going to put the U on in a position to overtake the dollar in traded markets.
Tony
And something I’ll point out is the PBOC has literally, at times, used numerology to determine their benchmark rate. Okay? For people who go down this path, that the CNY is a rising currency. If you’re going to trust a currency, first of all, it has to be convertible. But second of all, you have to trust the central bank. And you can’t have people using numerology. I know we all complain about the Fed, right? But at least there’s a standard approach and there is a level of transparency as to the way decisions are made, right? Everybody knows what the Fed says, what minutes are released and all that stuff. But when you have a central bank that has at times and it’s rare, but at times use numerology by raising by anything that ends in eight or whatever, something like that, I mean, this is just stupid. And it’s not a credible central bank when those sorts of things are happening. Okay, let’s go on to multiplarity, to have defense. Okay? So is there a defense to enforce decisions that are made? So does China or whatever other multipolar places that these people are talking about have the ability to enforce their decisions overseas?
Albert
No, none. None whatsoever. I mean, even to take the Saudis as an example, right? The Saudis rolled out the red carpet for the Chinese, and the Petrowan argument started coming out all over research papers. But what will happen when Iran decides to press the Saudis once again in Yemen, or just through airspace violations and threatening missiles? Do you think that Riyadh is going to run to the Chinese? Are they going to run to Moscow? Or are they going to call up the Pentagon and say, hey, we need more, you know, Patriot missile batteries, you know, we need your support.
Tony
You tell me why. I think I know the answer, but I want to understand why.
Albert
The US. Has the most advanced military hardware there is on Earth by far.
Tracy
Right?
Tony
But why would they not call, let’s say the Chinese.
Albert
Do you want an effective defense system? What are the Chinese have for defense system? Are the Chinese able to put Chinese troops to defend against Iran if something happens or against the Yemenis? I mean, they failed in every single aspect of China.
Tony
Just some basic questions. Does the PLA have the logistical capability to get their resources to Yemen if needed?
Albert
Zero. They couldn’t even invade Albania if they wanted to. That’s how ridiculous it is.
Tony
I’m sorry.
Albert
How are you going to move 250,000 troops across the world, right? You have no ability. The Russians can’t even barely invade Ukraine. That’s on their border, and we’re sitting there talking about multipolarity. For an example, is the United States took out Manuel Noriega. That’s because he was in the Panama Canal area and he was screwing around. If that situation happened, do you think the Chinese or the Russians did hop on over there and take it out? They cut it.
Tony
Noriega fell out of a building, which is plausible.
Albert
Well, that’s the Russian way to fix things. But, I mean, this is just a silly conversation. I have no idea where this multiplarity is coming from unless it’s investment banks putting their analysts out there to help their clients get out of gold or get out of crypto or something. We know with the whole death of the dollar thing coming, what are we.
Tony
Missing on multi polarity? Is there something that we’re missing from this discussion on either side?
Sam
I don’t think we’re missing much. I mean, there’s always the want for multipolarity if you’re not the United States, right? Everybody wants it, but to the point. You have to have a credible currency, you have to have an open account, you have to be willing to have a deficit, trade deficit, period. And you have to have incredible military and defense. And guess what? In this world, the only country that ticks those boxes is the US. And if Europe ever got its act together, maybe it could have the military part, but that’s it. China simply does not have the capability to be a global offsetter to the US dominance. That’s simply what I would call fantasy, at least for the foreseeable future. Could it become one down the line?
Tony
Maybe.
Sam
We were all concerned about Japan 20 years ago. Look how that worked out. Then we were concerned about the Euro. Look how that worked out. I mean, it happens. Yeah, it happens on a cyclical basis. Every 20 years, we come up with a new thing to be concerned about on the multiplayer front, and every single time, nobody has the willingness to do what the US does. Somebody call it the exorbitant privilege. Right? It’s not. It is. Actually a pretty big load to bear, particularly on the military and spending front. So I think that’s wildly overlooked. And I think the other thing that’s overlooked is oil for dollars will persist for a meaningful amount of time. Nobody wants oil for Trinkets.
Tony
Right?
Tracy
And another thing I have to mention, does China even want to open up enough to be the world? They like to be shrouded in kind of secrecy, right? And they have to be secret. Whatever. If you’re world current reserve currency, you have to be completely open to the world, and they don’t seem to like that.
Tony
Well, part of it is they don’t want to be embarrassed. They don’t want to be seen to be making a mistake. It’s easier to point out other people’s mistakes. If they had transparency and they made a mistake, it’s embarrassing. If you remember, in 2015, they tried to devalue a little bit, they messed up and they way overshot, and it was really embarrassing. And then they did nothing for, like, four years. So they don’t want to be embarrassed. That’s a huge issue.
Albert
These are all complexities that have to be taken into account. And like Sam said, there’s only one nation at the moment that ticks the box. And listen, I’d be the first one to throw out warnings, red flags. If there was a competitor stepping up in the US’s shadow, they’d be the first person to say this, but just not right now. None of the components are there at the moment.
Tony
Right? And I mean, having said all this, I don’t want this to sound super pro American. Like, we’re all Americans, and I think we can all agree that the US is kind of a lumbering idiot around the US at times. Well, this is not trying to say raw, raw US. We’re just saying the Pragmatism of the moment is this.
Albert
Yeah, there’s so many different details that have to be looked at. And I spoke with Mike Green on this in our podcast and our spaces. It’s like the United States has water, has geography, is isolated from the rest of the world, has a military, has this, has that. It’s nothing to do about RA America. It’s just the way things have been laid out at the moment.
Sam
We’re lucky in that.
Tony
So if anybody’s watching and has a counter argument, please let us know. Honestly, we want to hear it and put it down there, and I’ll try to talk to Albert and see if he can come back to you. You may be careful what you wish for, but we’ll try to get Albert to come back to you. But let us know seriously, if there are valid counterarguments that encompass all these issues, just let us know in the comments, and we’d love to engage. So, guys, thank you very much. Really appreciate your time and all the thought you put into this. And have a great weekend. Thank you.
This Week Ahead is a special episode because it was recorded live, with guests Albert Marko, Sam Rines, and Mike Smith, together with host Tony Nash in a face-to-face conversation. It’s also the first time that we had a Twitter Spaces, joined by a few people and taking their questions.
Gasoline prices have continued to decline here in the US. Since June, RBOB has been pretty much one way, sliding from ~$4.30 to $2.16. That’s half. Of course, lower crude prices are a huge factor, but over the summer we were hearing all about refinery capacity. Is there more to it than the oil price? XLE vs crude – XOM closing in on 100, etc. How much of an impact is this having to help affordability given the broader inflationary environment?
Inflation is proceeding unabated, as we saw in Sam’s newsletter this week. Some Goldman guy was out this week saying there may be a recession in 2023. Sam looked at the terminal rate in his newsletter this week. How would accelerated inflation or steepening of recession worries affect the Fed’s actions?
We had BOJ head Kuroda (who has been in the job for a decade) begin talking about Japan hitting its 2% inflation target. If that were to happen, how likely would the BOJ be to scale back its ultra-loose monetary policy? Impact on Japan’s equity market, govt bonds, etc.
Key themes 1. How low will gasoline go? 2. Inflation/Recession worries 3. The day after Japan hits 2%
This is the 45th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
I just want to say hi and welcome to The Week Ahead. I’m Tony Nash. We’ve got a couple of special items for this show today. First, Albert Marko is in Houston, Texas. So we’re doing a live in-person Week Ahead with Sam. Tracy will be on Spaces eventually. We also have a special guest, Mike Smith, who’s a partner at Avidian Wealth here in Houston. Second, this is our first Twitter Spaces, so this may be a little clunky and we may make some mistakes, so just bear with us, if you don’t mind.
So Mike, Sam and Tracy eventually, and Albert, thanks for joining us. I really appreciate the fact that you guys have come today.
We have a couple of key themes today. The first is how low will gasoline go? Gasoline prices I think nationally are around $2.99 are approaching that in the US. So we want to take a little bit of a look at that to understand what’s happening there. We also want to talk about inflation and recession worries. Sam will go into that quite a lot and we’ll try to figure out what’s happening with inflation.
And then we’ll talk about Japan post 2% inflation. So there have been some comments from Abe at the BOJ about Japan hitting 2% inflation, and we’ll talk about that a little bit.
Okay, so Albert just joined us. So let’s get started on gasoline prices. Guys, since June, RBOB has really come down from 430 to about 216. So it’s about 50% or 49 point something percent.
Of course, lower crude prices are a huge factor. We’ve seen crude prices come down in that time as well. So is there more to go on crude prices? On gasoline prices? Like I said, we’re waiting for Tracy, but she’s not joining. So I’m just going to throw it open to you guys. What’s your thought on gasoline? Because we’re entering the holiday season, it’s going to be a lot of driving. There’s a lot of inflationary pressures, which we’ll talk about in the next segment. But I’m just curious what your thoughts are on room for gasoline prices to fall.
Albert
Well, I think they guess some prices are going to fall because price of oil just keeps on going down. I think at the moment, whatever brokers, government entities or whatever we want to talk about is starting to drive down the price of oil because it’s beneficial to the political situation. So I think that oil, as it drifts down towards 60s, mid sixty s, the price of gasoline will also come down.
Tony
What are you hearing? We’re in Houston, energy capital of the world.
Sam
What are you going to yeah, it’s hard to make a call on the energy price kind of in its relation to gasoline for a couple of reasons. One, we really don’t know where any spare capacity can come from in terms of the ability to refine at this point.
You’re running at 96% utilization rates for refinery capacity, that’s pretty much peak. So if you have any sort of hiccup there, you’re going to have a problem on the gasoline front.
Tony
So hurricane season is over. Do you see any reasonable hiccups coming? Obviously may be unexpected, but when you’re.
Sam
Running at 96% capacity, it doesn’t take much to have a small problem. Right. And if you go from 96% to call it 90% because of an accidental outage, that could be something rather significant for the gasoline market. So while oil prices, you know, appear to be fairly volatile right now, it’s, it’s hard to translate that back into a gasoline price.
Mike
I know if 86 degrees here in Houston, but unpredictable winter can happen. I know it’s a little bit of a delay, but we don’t know. These weather patterns can happen. We could have a colder than expected winter and that could probably trigger as well.
Albert
Rail strikes is another issue. Talking about any kind of strikes in the transport industry, diesel prices making truckers, you know, trucking more. It’s not anything.
Tony
Right. I just saw Tracy pop in and then she popped out. So once she comes in, we’ll come back to her on this. Thank you. Okay, that’s great. And we’re seeing, we’ve seen XLE, the energy companies, the energy operators, we’ve seen XLE stay pretty elevated as crude prices have come down. There’s typically kind of a four to six month lead between crude prices coming down and XLE coming down. So when we look at some of these major operators, is there an expectation that those prices will come down? Or are we kind of I’m just inviting Tracy to co host. Okay. Hi, Tracy. Are you there? Sorry. Just back to XLE. Do we expect XLE, the traded operators like, say, ExxonMobil, those sorts of guys? ExxonMobile is about to break 100. They’re headed back down after topping out like 115, something like that. So do we expect their share price to follow the crude price directionally?
Albert
I would say no. Really? It’s tough. It’s a tough call, to be honest with you, because we just don’t know which way the markets are going to go. Crude prices is acting like bitcoin at the moment, just being up and down 10% per week. I can’t even give you an honest answer on that.
Sam
I mean, it’s certainly not going to be the same data that you would expect in a decade ago, but you’re likely to have the sentiment at least have some effect on XLE or XOP, whatever it might be. But the issue now is that you’re not going to have the same sort of capital expenditure catch up and overshoot that you did in previous cycles simply because investors have already said, we will punish you for that. And producers don’t want to be punished.
Sam
They’re making a lot of money at 50, 60, $70 barrel oil. I don’t think you’re going to see the level of beta to the underlying that you would normally expect.
Tony
Okay, great. So basically they’re using your old equipment at the current energy prices and they’re maxing it out. But when the capex cycle does come on, will it come on with huge force or will that trickle out? Like when will invest? Will investors decide at some point that they won’t punish these operators for capex?
Sam
No, they won’t. No. Okay. Why spend for something that has a five to seven year time rise? We’ve been told that the oil companies aren’t supposed to exist in a decade. So as a shareholder you want that return of capital. You don’t want that capital put back to the ground. And if you begin to see any sort of significant uptick in capital expenditures, you’re going to have it absolutely crushed from a stock perspective. Right. If Exxon announced that they were going to begin a significant capital expenditure program, that stock would get absolutely hammered and you can just go through any of the companies. It’s all about what are you doing for my dividend? How much stock are you buying back and maintaining output, not expanding because you talked about it.
Mike
We’ll be short or fast. I think it’ll be going to take a long time for that to happen unless some major catalyst happens that actually sparks that in.
Tony
When you think about how long it.
Mike
Is to legislate get permits, it’s a decade.
Sam
Yeah, absolutely.
Mike
So it’s got to be some major catalysts.
Tony
Tracy, are you there? I see you as a co host but I’m not sure if you can speak. Okay. Once you’re in Tracy, just speak up and I’d love to get you involved in this discussion. Sam, how much of an impact is having is say lower gasoline prices having on the affordability in broader inflationary environment? So basically are gas prices helping the inflation discussion much or is it just a relatively small thing since a lot of people are working from homes?
Sam
There’s kind of two ways to think about that. There’s the inflation dynamics, the actual inflation dynamics that lower gasoline does have that headline CPI narrative.
Tony
It’s a tax cut. I’m kidding.
Sam
The problem is that over time gasoline has become a much smaller portion of the wallet. The average person does not spend anywhere near as much on gasoline as they used to and that’s just a fact. So is it really helping people on the margin? Yes. Gasoline and groceries are the two things that you can kind of see and one you see in a big bull sign, the other you see every week when you go buy groceries. So gasoline, grocery prices coming down, it’s good for the consumer mentality. Is it good for the action and spending levels?
Tony
Okay, great. Okay guys, just so you know, this is a live spaces. We are recording this and we’ll upload on the YouTube channel probably tomorrow. Tracy has joined us. Tracy, if you’re there and you want to chime in please join. Okay, let’s move on to the next topic for inflation and recession worries. So inflation is proceeding pretty much unabated salmon, and we saw this in your newsletter this week and I’d love to talk more about that. We also had some Goldman guy, I can’t remember who it was yesterday, saying there’s probably going to be a recession in 2023. And all these people are coming out saying maybe back half of 2023 there’s a recession, which it’s a convenient time to say that right? Right now to say something’s going to happen in the back half of 23. So you look at the terminal rate in your newsletter.
So how would, say accelerated inflation, if that’s actually coming or the steeping of recession worries affect the terminal rate from the Fed?
Sam
I think you have to divide that into the first part. That is, what would inflation call it a deceleration in inflation pressures mean for the Fed? Unless it’s significant? Not much. Does a recession matter for the Fed? Not if it doesn’t come with disinflation. Does the Fed care if we have real GDP decline? No. I mean we have real GDP decline, q One, q Two. They got their mandate, they did not care. Right. You currently have north of 7% CPI and you have an unemployment rate of 3.8, maybe percent. It’s really hard for me to see which one of those metrics is comforting to the Fed at this point. So does it affect the Fed’s trajectory? Maybe it’ll take a 25 out of the terminal rate, but that’s about it. You’re simply not going to have this type of immediate Fed pivot with inflation at north of 6% and this type of unemployment rate, it’s just not going to happen.
Tony
Okay, great. Now for you guys on spaces, if you have a question or want to put up your hand, put a question in the channel or put up your hand. We’ll take some questions later on in the podcast.
Albert
That inflation is just so sticky right now. We spoke about it earlier for podcast about wage inflation just sitting there, you know, just rising every single month. Politically, it’s a great thing for people to wait 40 years to get wage inflation, but I just, I can’t see how all these consumer prices are going to come down and talk about this inflation or wage inflation is just going to stay elevated for the next 1015 years.
Tony
Yeah, that’s a good point. So I get that there’s this expectation out there where people expect prices to come down to say, 2019 levels at some point. And, you know, we were talking about this, Sam, that do you expect prices to go back down to 2019 levels? We’ve seen a dramatic rise in a lot of different areas. So do you expect that to fall back down to what it was two, three years ago?
Sam
No, I don’t even think that in the best of all possible worlds, that’s not one of the worlds.
Albert
The only people talking about that are the political people that are trying to sit there and trying to gain votes because people are struggling at the moment. But the economic guys exactly. It’s only what you want to hear, but the economic guys are looking at the numbers and, like, we have never seen I mean, why would why would companies bring the prices back down that much when they know they can get away with it?
Sam
I mean, Cracker Barrel expects wages in the coming year to be up five, 6%, right?
Tony
Those of you who aren’t in the US.
Sam
Year, right?
Tony
For those of you who aren’t in the US. Cracker Barrel is a very kind of middle America restaurant comfort food, right? It’s biscuits and gravy. It’s fried chicken, that sort of thing. And so this is not the high end yet. It’s not McDonald’s. It’s very much the middle market in the US. And so Sam’s done a very good job in his newsletter over the last couple of years covering price hikes at Pepsi, at Home Depot, at Cracker Barrel, at other places. So many of these companies have raised prices by, like, 8% to 10%, generally, or more. Who’s raised more?
Sam
So Campbell Soup this morning came out with earnings, and they divide them into two categories. They divide it into soup and kind of prepared meals type deals and then snacks.
So think Snyder’s Pretzels is one of the brands. The prepared meals, which include soup, they increased pricing, 15% from last year, and they increased on snacks, 18. And that was price that they pushed. Volumes were slightly negative, but negative 1% and 2%. Okay, you’re talking almost no budge on volume and a huge move in pricing, and that is for the most boring of all commodities. This is soup we’re talking about.
Tony
And I want you guys to understand what Sam is saying. Campbell Soup has raised their prices between 15 and 20%, and their volume declined 1%. So do we ever expect Campbell Soup to reduce their prices by 18%?
Sam
No. That’s the beautiful part if you were corporate America right now, is you get a free pass to really find the elasticity in the market for your product by raising prices until you begin to see pushback from consumers, and you just haven’t seen a significant pushback from consumers. And to the narrative of inflation peaking. Inflation is peaking. If you look at the last four quarters of price increases from Campbell Soup, it was something like 6%, 11%, 11%, 16. Right? So maybe the second derivative is negative, but the first derivative isn’t.
Tony
And it’s positive in not a small way.
Sam
Correct.
Tony
We’re not talking about 2% price rises. We’re talking about 18% price rises, which.
Mike
Is we’re seeing that for consumers, the biggest increase. But, I mean, I guess in future years, that probably somewhat levels off. And then on top of raising prices, I’m sure all of you have noticed the shrinkflation, the items have less in it and we’re paying more for it on top of everything else.
Sam
Well, that is part of the pricing element. Right. So when they take packaging down a couple of ounces that shows up in the pricing mechanism.
Albert
It’s incredible that Campbell Soup and all these other companies raised their prices by 16% to 19% because that is actually the true inflationary number. When you go back to what they used to do it in the 1990s, it’s 18 19%, not the 7% that the Fed tells you. CPI.
And on top of that, these inflationary numbers give you a tailwind for earnings. So all these companies that surprise earning beats, if you look at them, what inflation has done into their products, it’s not a surprise that they beat.
Sam
Yeah, right. And it’s somewhat stunning because if you think about it from a 23 24 perspective, if you have your input costs begin to move lower, or at least decelerate, and you’re holding your prices at these current levels, or even increasing slightly from here, or increasing from here, all of a sudden you begin to think about what that does to a bottom line. That is an extremely attractive thing for a business. As we begin to move into the latter part of the margin expansion that everybody kind of thought was over after COVID, that really might return to some of these boring, staid old stocks.
Tony
Right. So guys, just, just to be clear, what we’re saying here is prices are not going to go down or they’re highly unlikely to go down to what they were two or three years ago. We’ve hit an inflation level, it’s a stairstep. And companies are comfortable seeing reduced volumes, but they’ve compensated that with higher price and consumers are generally accepting higher price. Right. So as an aside, I’ll be shameless here and say complete intelligence does cost and revenue forecasting. If you guys need any help with that, let us know. Okay? So, terminal rate, you’re still looking at five to five to five somewhere in there.
Sam
Well, I think it’s probably closer to five and a half to somewhere between, I would say five and a half to six because you have the stickiness in wages, right? And the stickiness in remember this is important, that Powell, week ago at the Brookings Talk pointed out one thing, and that was Core Services Ex shelter. In other words, they, they are already throwing shelter out. Even when shelter decelerates, they’re not going to pay attention to it. And he also made it very clear that Core Services X Shelter, the main input cost for many of these businesses is wages and personnel. So while you have these wage pressures, building the Fed is not your friend in any meaningful way. So I’m much more on the give it five and a half to six. There’s this idea maybe we get 50 50 25 then done. Or 50 50 done. It’s more like 50 50. 25 and 25 and 25. It’s just slower.
Tony
You said this a month or so ago. It’s a matter of the number of 25 that we get.
Sam
Yes, it’s 25 delays.
Tony
Okay. So it’s not over, guys. We’re going to continue to see the Fed take action, and they haven’t even really started QT yet. And we’ve talked about that for some time. And when they start QT is really when markets feel is that fair to say? Yeah, depends on the market, of course.
Sam
Yeah, they’ve started QT It’s just a small 200 billion or something that’s still QT. They’re not going to sell them.
Mike
I think one of the things he said is the Fed is not your friend. And just think about that statement for a minute. For two decades, all investors we’ve all come to known as the Fed is our friend. Anytime the market was down, they’re out there doing press conferences. But I think it’s critical for people to understand we’re not going to see a return of that for a significant amount of time.
Tony
Right. You’re not public servants. Right. Exactly. They don’t like you.
Albert
It’s important that as Sam mentioned, that 50 50 and then the repetitive 25s correlates with their rhetoric of soft landing that they keep talking about whether they can actually achieve a soft landing. Well, that’s another debate that we talk about. But that’s exactly what their intentions are. Those are 25 US to the end of their they get to where they want to be.
Tony
Right. Okay, very good. Let’s move on to Japan. Bank of Japan Chairman Corona was on the wires this week talking about Japan hitting the 2% inflation rate, which they’ve been trying to hit for 30 years or something. And then they made a policy with Avionics in 2012, and they still have been able to hit it. And now that we have crazy inflation globally, they’re going to claim the win. Right. And they’re going to say, we hit it and abe nomics. Although Avi is not empowering where it was ultimately successful. So, Albert and Sam, I’m just curious, what does that mean if Japan hits 2% inflation and they tail off their quantitative easing, their kind of QE infinity and they stop buying government bonds, all this stuff. First of all, do you think that’s going to happen? Okay. And second, if that does happen, what did Japanese markets look like? And then what does the yen look like? I realize they just threw a bunch of stuff out there, so just take it away. So you might like jump in here. Sure.
Albert
The fiscal monetary setup is quite favorable, right. If they do whatever they’re going to say they’re going to do quite favorable. There are only headwinds that I can see is the US. Stock market equities. If the US equities fall, without a doubt it will affect the Asian market, specifically Japan. It’s a tall order for them to sit there and get their 2% inflation target. So I don’t even know if that’s even a valid discussion, but I guess we’ll sit there.
As much as a set up as favorable for Japan, they’re combating China. And I still think that China, because they don’t have as much connection to the US. Equity market, is a little bit more favorable. I would go China over Japan right.
Tony
Now, yes, but I’m tired of talking about it.
Albert
I know not to talk about China when Japan is so interconnected with China, so everything is interconnected in that region. But I do think that the fiscal monetary set up for Japan is favorable.
Tony
Okay, sam, what do you think?
Sam
Like Albert said, theoretically, it’s really interesting. It’s intriguing. The one thing that I think is important to remember about Japan is that every time they seem to have the monetary policy setting correct and they were heading to actually hit their 2% target, they always seem to raise taxes or do something to make sure that they missed it. Was MMT on steroids? Very good example of MMT actually working. Right. You can do as much monetary policy as you want as long as every time you’re close to an inflation target, you just race to that or taxes. So I think that’s something that I’m always somewhat skeptical of Japan doing. If they begin to lift yield curve control on Japanese government bond yields, I think it’ll do two things. One, it will make for an interesting market in Japanese bonds. The BOJ owns such a large amount of that market that is almost difficult to fathom that it actually has a functioning market. It doesn’t really have a functioning yield market. So that’s kind of the first thing is we’ll finally get a feel for how that market actually functions. The second one is that you’ve had a 2% inflation win with the yen sitting between 130 and 150, a very weak yen.
That’s a tailwind to inflationary pressures. If they do lift YCC, it doesn’t matter what else they do. If they raise interest rates, whatever it might be, the yen going back to 120 is going to undo a lot of that inflation pressure in and of itself. You’re going to really bring that in. It’s also probably a positive. Having a stronger yen in this environment when you’re at an energy shortage globally is a positive for the Japanese economy because they import so much energy. Having that stronger yen makes it cheaper in domestic terms from that perspective. So I think there’s a number of things that could line up pretty well, and there’s always the opportunity for the Japanese government to mess it up somehow. Of course, I do think that it’s a very interesting market, particularly if you can do it on a call it an outright basis investing and get some of that currency dynamics mixed in with your investment, that could be a very interesting opportunity going.
Albert
You know, what’s interesting is what you’re saying about MMT on steroids. It’s like, you know, you’re making all these descriptions of what’s going on in Japan, and I just look at the fed, and I’m just like, well, oh, my God. We’re starting to be on the verge of Japanification at the moment right now, because the 30 year bond from who I talked to the 30 year is.
Sam
Completely controlled by the federal government.
Albert
And at the moment, it’s completely controlled. And if they can sit there and pump those bonds and pump the markets, you got Japan right here in the United States with MMT and Leil Bernard and yelling, doing whatever they want to do.
Sam
You just have to raise taxes.
Albert
Yeah. So so masters at that. Yeah.
Tony
So I used to go to Japan a lot, and in the late, say, 2010, 2011, when the yen was at, like, 75, when I would go to Tokyo and I would go down to breakfast in the hotel, I was the only one there. And I remember when Abe was elected and even pre election, the yen started to weaken him taking office. The yen started to weaken. Right. And I remember the first time I went down to the hotel lobby and there was a line to get to breakfast rather than just it being wide open for me. So a devalued yen means a huge amount of power for the Japanese economy. So when you say JPY going back to 120, I remember in 2010 eleven. When people would say, gosh, if we just had a yen at 95, we’d be happy. Right. And now it’s at 145, or whatever it is.
Sam
I haven’t 130 yet.
Tony
136. So, you know, it’s you know, it’s a completely different environment and puts the Japanese economy in completely different context. But you have nationalization of bond markets, you have nationalization of ETF markets. Is it really an open, competitive economy? It’s certainly a highly centralized economy. Right. And that’s really dangerous. But they love to use demographics as the justification to intervene in markets, right?
Albert
Yes.
Tony
Okay, guys, if anybody has a question, raise your hand. Or I’m not exactly how this works. Again, this is our first time to do a spaces. So put something in the messages or raise your hand or do whatever, and we could potentially have you come on and ask your question. I’ll be very honest. If you have an anonymous Twitter handle and we don’t know you, I’m not going to let you speak. So don’t waste your time. But if you’re someone we know, then we’re glad to have you on. So I guess while we wait for people to come in with questions, we’re pre Christmas holidays here in the US. We’ve got a Fed meeting coming up, the expectations for a 50 basis point hike. What do you guys expect? We’re seeing equity markets really kind of gradually move lower. What do you guys expect for the next week? Or so in the US before the Christmas holiday.
Albert
I think the CPI is actually going to be a little bit less than consensus and probably get a rally going to the end of the year, to be honest with you. I think everybody knows it’s going to be 50 basis points. The question is what’s the guidance after that? What do they say? If it’s a good CPI number, well, then you can have this dough stock for another month.
Mike
Sentiment has been so low and kind of got your seasonality right now. I think that probably prevails here.
Sam
If you think about it, a few.
Mike
Months ago everybody was kind of in this panic, Seymour. People kind of there’s this nice little calm right now everybody’s just kind of floating around waiting to see what’s next. And what’s your point? I think everyone expects to raise another.
Albert
50 basis point, which is amazing, because 50 basis points is not dovish. I guess everyone’s expecting 75 or 100 about a month ago, you know, their.
Mike
Condition as to.
Sam
No, I would say there’s there’s a couple of interesting things about the Fed meeting it into the back half of the year. One is what does the dollar actually do here? Because if you begin to actually have a significant move in CNY stronger right lower on this chart. But if you get a significant move back towards the 650 area on CNY, that is going to have a spillover effect. To a stronger Euro continued strength in the British pound you could begin to have a number of dynamics that are somewhat negative dollar and therefore pretty bullish on the risk asset front that I think could catch some people off guard simply because of the spillover effects. But the Fed, the one thing to remember about this meeting is it’s not just a 50 basis point height. It’s also that stupid dot plot that they do that actually has some pretty serious potential consequences because if 23 comes out with higher than expected dots and 24 dots move higher, the terminal and the long term rate begins to creep a little bit higher. If you begin to have that hawkishness, I kind of want to say this, so going to, if you begin to have the hawkishness become less transitory in the dot plot, that could become somewhat problematic for markets that could take some of the sales out of what we’ve seen to be a moderating dollar effect.
So I think, I think it’s worth being a little careful until we see that dot plot and begin to hear how Powell is approaching 2023 because I think they’re somewhat aggravated about the way that the Brookings Institution, the Brookings speech was received by markets they did not want a significant asset rally going out of that right. That was counterproductive to what they want. So I think they’re going to be very careful about the rhetoric into the.
Tony
Back half of the year because they would just. Not be so jerky in their communication. They’re super bearish. They’re bullish. They’re super bearish. They’re bullish have a consistent message.
Albert
Yeah, but it depends on what’s going on behind the scenes, what data they see. All this data, they see all the CPI and the jobs numbers a week or two heading for anybody else. Don’t kill yourselves.
So I guess it comes down to what is going on behind the scenes and what they don’t want to break. I mean, Blackstone came from what I heard, blackstone was $80 billion in the hole and having problems, and they went to the Fed, and that’s what triggered Powell to be slightly dovish.
Tony
And I thought they were the fed.
Albert
Well, whenever you guys Powell’s portfolio sitting there in your grasp, you are the.
Tony
Fan of that one.
Albert
But I guess it goes down to what is happening behind the scenes and what could potentially break is why they’re coming on this roller coaster ride of rhetoric.
Tony
Yeah. Okay, I’m going to see if Valena wants to come in she’s attending. And see if she wants to come in to see what? Invite her to speak and see if she wants to Valena, are you there? If you want to come in and let us know what you’re thinking is going into the end of the year and 2023, you have an invite to speak. You’re welcome to.
Albert
Molina is sitting there in Austria, vienna, Austria. And I know the European markets are now looking quite interesting to me. A little luxury market in Europe is absolutely exploding, and it’s just unreal that. It’s just so resilient. I mean, there’s two brands that I personally liked, laura Piano and Brunello Cucinalli, which I have a tremendous amount of polls. Brunello Cucinalli didn’t care anything about the Russian sanctions or anything. Just kept on selling, and they just blew out earnings yesterday or as of today, they were up like 7% this month. Really, the luxury retail market, luxury jewelry market is just it doesn’t stop great. And it’s counter to what everybody is saying. Recession this, recession that. You go to gucci stores, lines out the door, Louis. The time you need an appointment, it’s just resilient. It’s just actually quite amazing.
Sam
It is really similar to if you look at our markets, right, particularly the masters plotted against the price of oil. If you do a six month delay, guess what? It’s almost it’s a really interesting kind of windfall type chart. You can kind of see the oil money flowing in there. And you even had China relatively shut down, and that was a huge driver, a tremendous driver of European luxury, particularly for LVMH. Even with China shut down and not really having the tourism, you had a lot of tourists from Middle East, et cetera, really put in some of the South American countries that are doing fairly well, particularly at the higher end. A lot of that is driving this kind of underneath the surface. You had tech, then you had energy. And the question is, now you have the China reopening. Is that the next leg for a lot of these lectures?
Tony
Okay. So let’s talk China.
Albert
I wasn’t going to do that.
Sam
Tracy.
Tony
You’Re as a speaker as well. So if you want to come in, you can come in any time. Okay, so let’s talk about China, even though I didn’t want to COVID that. So let’s talk China. What’s happening, Albert, with the reopening? Like, what do you see the next two months happening with the China?
Albert
Just as we spoke about a week ago on China, those riots and the reason the Chinese even let you see these riots happen on the social media was a signal that they were going to reopen, and in fact, they did. Days later, we’re reopening in stages. And that’s just it. And get your house in order, everybody, because inflation is going to happen. I think I think copper was up, like, two and a half percent this morning. And this is this is it just barely reopened right now, manufacturing, because the odors were down I think Western odors were down 40%.
Tony
But kind of everyone told me on Twitter that democracy came to China.
Albert
Yeah.
Tony
Okay.
Albert
Those are people that have never been to China or stayed at five star hotels or actually step foot outside of Beijing.
Tony
So let’s go there a little deeper. And Xi Jinping is in the Middle East either today or over the weekend at an Arab China summit. Right. And so, first of all, him leaving China right after there were protests, what does that say to you, Albert?
Albert
Safeguard, he’s done any kind of opposition that was pushing against Xi’s Party congress moves eroded, and then these street protests are just street protests. I get it, people are upset and their livelihoods and check down the list of whatever you want to say, but realistically, they never work unless they get violent. And they never got violent.
Tony
Right. So you kind of have to let the steam come out of that valve, I think is probably what you’re saying. Right? The CGP is saying that now with CGP going to the Middle East, sam, they are the premier buyer. China is the premier buyer from OPEC clubs now. Right. It’s not the US. And this isn’t new for people who have been paying attention. The Saudis and other people in the Middle East have been spending a lot more time in Beijing for probably six, seven years. And so and and it’s been longer, but it’s been really, really visible for the last six or seven years. So what does what does that tell you about, let’s say, OPEC’s desire to, please say, a US president going to the Middle East to try to bully them, to pump more? Is that effective anymore?
Sam
No, not at all.
Tony
Hi, Tracy.
Speaker 5
Hi. Sorry, I was having technical difficulties, and for some reason I couldn’t all gone earlier.
Tony
Welcome. No apology necessary. We’re just talking about China and with Xi Jinping in the Middle East for a summit with the Saudis and the GCC members and what that means for the ability of say, a US president to kind of bully OPEC into reducing oil prices going forward. Is there really any strength there? Do you see.
Speaker 5
That’S? Absolutely done. What I would expect she landed in China today. I would expect him to get the full lavish welcome. Right. And we want to be looking at who he brought with him as far as national heads of corporations. And I would expect this to be completely opposite of what we saw the Biden meeting with and more akin to what we saw the Trump meeting with, where they I would expect that.
Tony
So they’ll touch the crystal ball.
Speaker 5
Maybe they might bring out the ball. Yes. And I expect billions and billions in new deals as far as economic, military, energy in particular, et cetera going on at this point. Again, they’re having a conference where they’re going to have multiple leaders in the Gulf nations in Saudi Arabia. So I mean they’re really going to try to rue China on this trip big time.
Tony
Right. So when you talk about military deals, what do you think about that? Albert?
Albert
I’m not really sure Saudi Arabia will.
Tony
Do major military deals with China.
Albert
I mean maybe a few just for show up for optics theatrics but the US military hardware is the best in the world and realistically Saudi Arabia is under the US defense umbrella. Whether the left or the right likes it or not, that’s just the reality of it. And as long as Iran is not poking or poking trouble from the east and Yemen not from the south, southern regions have an easy ride. So their military deals aren’t really they’re not at the forefront at the moment. But anytime that Russia wants to string that relationship, they can certainly call up Tehran and say lob a few missiles over and things go right to elegant.
Sam
To Albert’s point, I don’t think Saudi is going to work. KSA is going to become the next India where they split their arms deals among the three major powers of arms anytime soon. I mean that’s just not going to happen.
Albert
No, there will be a little bit, yeah. India is a completely different ballgame. India has got counterbalance, they need to counterbalance Russia with China and Pakistan and it’s the old mess over there and they need to do what they’re doing.
Sam
Well Nksa is also trying to hold together their market share in a world of Russia really having to begin sending almost all their stuff to call it China India.
Tony
Right.
Sam
So if you had were the two largest pieces of growing market share for Saudi Arabia over the past decade, that was India and China. And now you have the other major energy player in the region coming after your market share. There’s got to be a little handshaking here to keep everybody happy and selling at $55 a barrel.
Tony
You don’t hate that, right?
Sam
If you’re trying to. I mean, it’s the perfect time to reopen. You’re getting cheap energy. You have supply chains that have fixed in the rest of the world. So I think this is very much a visit to make sure that they can continue reopening, get those long term energy deals in place, and then move forward.
Tony
Right. Okay, so we do have a question for Tracy, and you guys jump in. So, Tracy, there’s a listener named Rasul, and he’s asking, when China opens up, is it possibility that it could use its own SPR, like in November 21, to reduce its oil cost? Is that something they would consider doing?
Speaker 5
I think not at this juncture, right now, because, first of all, they’ve already drawn it down. Right. And they’re still worried about long term energy security, as is everybody right now. In addition, they’re also getting really cheap Russian oil, so I don’t think that would be something that they would do right now.
Tony
Okay.
Albert
No, they wouldn’t do that.
Tony
Right.
Albert
There’s no absolutely no need to do that. The US. Only did that because of Midterm economics, and that’s just that China had no intention of doing that.
Tony
Great. Okay, good. All right. Well, guys, I think we’ve covered it. We’ve been here for about 40 minutes, and the hotel we’re in has threatened to call the police if we don’t leave. So I want to thank you all for joining us for this week ahead, and we’ll get this posted on our YouTube channel within a day or so, okay? So thanks for joining us, and look forward to seeing you on the next one. Thank you.
This Week Ahead, we’re joined by Daniel Lacalle, Tracy Shuchart, and Sam Rines.
First discussion is on liquidity drain and quantitative tightening (QT). How difficult is it?
Rate hikes get a lot of the headlines, but QT peaked at just under $9 trillion in April of this year. The Fed has pulled just over $200 billion from the balance sheet since then, which isn’t nothing, but it’s not much compared to the total.
Where do we go from here? Most of the Fed’s balance sheet is in Treasuries, followed by Mortgage-backed securities. What does the path ahead look like – and where is the pain felt most acutely? Daniel leads on this discussion.
We also look at the copper gap with Tracy. We don’t really have enough copper over the next ten years to fill the demand. Despite that, we’ve seen copper prices fall this year – and Complete Intelligence doesn’t expect them to rise in the coming months. Tracy helps us understand why we’re seeing this and what’s the reason for the more recent fall in the copper price. Is it just recession? Will we see prices snap upward to fill the gap or will it be a gradual upward price trend?
We’ve had some earnings reports for retail over the past couple of weeks and Sam had a fantastic newsletter on that. On previous shows, we’ve talked about how successful US retailers have pushed price (because of inflation) over volume.
Costco and Home Depot have done this successfully. Walmart had serious inventory problems earlier this year, but their grocery has really saved them. Target has problems, but as Sam showed in his newsletter, general merchandise retailers have had a harder time pushing price. What does this mean? Is Target an early indicator that the US consumer is dead?
Key themes: 1. Liquidity drain and QT 2. Copper Gap 3. Retail and the US Consumer 4. What’s up for the Week Ahead?
This is the 42nd episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Hi, and welcome to The Week Ahead. I am Tony Nash. And this week we’re joined by Dr. Daniel Lacalle or Daniel Lacalle. Daniel is a chief economist, he is a fund manager, he’s an author, he’s a professor. Kind of everything under the sun, Daniel does.
Daniel, thank you so much for joining us today. I know you have a very busy schedule. I appreciate you taking the time to join us. We’re also joined by Tracy Shuart. Tracy is the president at Hightower Resources, a brand-new firm. So pop over and see Tracy’s new firm and subscribe. We’re also joined by Sam Rines of Corbu. Thanks all of you guys for taking the time out of today.
Before we get started. I’m going to take 30 seconds on CI Futures, our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies commodities, equity indices.
Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast error.
We also forecast about two thousand economic variables for the top 50 economies globally, and that is reforcast every month.
There are a few key themes we’re going to look at today. First is liquidity drain and quantitative tightening, or QT. Daniel will lead on that and I think everyone will have a little bit to join in on that.
We’ll then look at copper gap, meaning we don’t really have enough copper over the next, say, ten years to fill the needs of EVs and other things. So Tracy will dig into that a little bit.
We’ve had some earnings reports for retail over the past couple weeks and Sam had a fantastic newsletter on that this week. So we’ll dig into that as well. Then we’ll look at what we expect for the week ahead.
So Daniel, thanks again for joining us. It’s fantastic. You’ve spoken to our group about a year ago or so. It was amazing.
So you tweeted out this item on screen right now about the liquidity drain.
You sent that out earlier this week and it really got me thinking about the complexities of draining liquidity from global markets, especially the US. Since I guess global markets are hypersensitive to draining in the US.
Of course, rate hikes get a lot of headlines, but you mentioned QT, so it’s a bit more complicated. Obviously, QT peaked in April of this year. There’s a chart on the screen right now at just under $9 trillion.
And the Fed’s put about $200 billion back from their balance sheet, back in the market from their balance sheet, which isn’t nothing, but it’s really not much compared to the total.
So I guess my question is, where do we go from here? Most of the Fed’s balance sheet is in Treasuries as we’re showing on the screen right now, followed by mortgage backed securities.
So what does this say about the path ahead? What do you expect? How quickly do you expect? Does it matter that much?
Daniel
Thank you very much, Tony. I think that it’s very important for the following reason. When people talk about liquidity, they tend to think of liquidity as something is static, as something that is simply there. And when central banks inject liquidity, it’s an added. And when they take liquidity away from the system, that simply balances the whole thing. And it doesn’t work that way.
Capital is either created or destroyed. Capital is not static. So when quantitative easing happens, what basically happens is the equivalent of a tsunami. Now, you basically add into the balance sheet of central banks trillion, whatever it is, of assets, though, by taking those assets away from the market, you generate an increased leverage that makes every unit of money that is created from the balance sheet of the central bank basically multiplied by five, six, we don’t know how many times. And it also depends on the transmission mechanism of monetary policy, which is at the end of the day, what the reason why central banks do QE is precisely to free up the balance sheet commercial banks so that they can lend more.
Tony
Let me stop you there. Just to dig into so people understand what you’re talking about. When you talk about transmission mechanism, and the Fed holds mortgage backed securities, the transmission mechanism would be through mortgages taken out by people because mortgages are cheaper, because the Fed is buying MBS. Is that fair to say?
Daniel
Not cheaper. They don’t necessarily have to be cheaper. They have to be more abundant. Ultimately…
Tony
That’s fair. Yeah. Okay.
Daniel
Ultimately, this is why when people talk so much about rate hikes, rate hikes or rate cuts are not that important. But liquidity injections and liquidity training are incredibly important for markets because rate hikes or rate cuts do not generate multiple expansions. Yet liquidity injections do create multiple expansion, and liquidity draining is much more severe than the impact of the rate hike.
Tony
Okay, so when you say multiple expansion, you’re talking in the equity markets?
Daniel
In equity markets or in the valuation of bonds price. That means lower bond yields or in the valuation of private equity. We saw, for example, in the period of quantitative easing, how the multiples of private equity transactions went from ten times EV to even to 15 times easily without any problem.
So what quantitative tightening does is much worse than what quantitative easing does, because the market can absorb an increase of liquidity through all these multiple assets. However, when quantitative tightening happens, the process is the reverse. Is that the first thing that happens, obviously, is that the treasury, the allegedly lowest risk asset, becomes more cheap, ie, the bond yield goes up, the price goes down, the bond yield goes up, and in turn it creates the same multiplier effect, but a larger dividing effect on the way out.
Tony
So the divisor is greater than the multiplier.
Daniel
The divisor is greater. And I tell you why. In the process of capital creation, there is always misinformation that leads to multiple expansion. Okay? So one unit of capital adds two more units of capital plus a certain excess valuation, et cetera. Now from that point, if you reduce one unit of the balance yield of the central bank, the impact down is much larger. So where it goes to, this is the problem that we as investors find it very difficult to analyze is where is the multiple at which equities, bonds, certain assets are going to stop because it is very likely to be below the level where they started.
The challenge of quantitative tightening is even worse when the process of quantitative easing has been prolonged, not just in period of compression of economic activity or recessions, but also in the periods of growth.
Tony
Okay?
Daniel
Because the level of risk that investors take becomes not just larger but exponential under QE. Under QT. Under QE, you get Bitcoin going from 20 to 60 under QT, you get bitcoin going from 60 to maybe zero.
I don’t know. I don’t know.
Tony
The comments are going to be full of angry bitcoin people.
Daniel
I just want people to understand that just like on the way up in a roller coaster, you go slowly and it seems that everything is going relatively smoothly. When you start to go down, you go down really fast and it’s truly scary.
Tony
Okay, so let me ask you this, because when you talk about multiple expansion, I’m sure we’re going to get some comments back about tech firms because we’ve seen tech firms multiple expansion decline pretty dramatically in the past, say six months, certainly past year, for companies like Meta. So although we’ve only seen $200 billion in quantitative tightening, how does that reconcile with your statement about interest rates not necessarily impacting valuations.
Daniel
No, interest rates impact valuations, but not as aggressive as quantitative tightenint. They do, particularly in tech for a very simple reason. I think that all of us can understand that a technology company is in the process of money creation. A technology company is one of the first recipients of newly created money because it absorbs capital quicker and it obviously benefits enormously from low interest rates, obviously.
But the process of multiple expansion tends to happen in the early stages of those companies. Now the process of multiple compression is much more viscious because I would be genuinely interested to have a discussion with, I don’t know, with people that invest in nonprofitable tech, but I would really like to understand how they get to the current levels of valuation comfortably.
The biggest problem I see of quantitative tightening is the same problem I see of the hidden risks of quantitative easing is that central banks cannot discern which part of the wealth effect comes from the improvement in the real economy or simply from bubbles. And the creation of bubbles obviously, we can imagine that something is a bubble, but we don’t really know until it bursts.
So it’s going to be very problematic for a central bank to achieve almost one thing and the opposite, which is what they’re trying to do. What they’re trying to do is to say, okay, we’re going to reduce the balance sheet. Hey, we’re going to reduce the balance sheet by 95 billion a month and think that that will have no impact on the bond market, on the equity market, and on the housing market. The housing market is already showing.
Tony
Yeah, I don’t necessarily think they’re saying that will have no impact on that stuff. Sam, from your point of view, is that their expectation that QT would have no impact on asset prices?
Sam
I wouldn’t say it’s their expectation that it wouldn’t have an impact on asset prices. I think they understand that there’s an impact on asset prices from just the narrative of tightening generally. But to the point, I think it is very difficult to parse what portion of their tightening is doing what particularly for them.
You look at some of the research on coming out of the Fed, on what QT is expected to do and what QT does, and you come out of it thinking they have no idea. I think that they would probably say that quietly behind closed doors, without microphones. But to the point, I would agree that there is an effect and that the Fed likes to say set it and forget it, because they don’t really understand what the actual impact is on either the real economy or the financial economy. Come up with our star-star, which is some stupid concept that they decided to come up with to rationalize some of their ideas. But I would say no, that makes perfect sense, that they really don’t understand exactly how much it is. Which is why they say we’re just going to set it, forget it, and we’re not really going to talk about it.
Because if you listen to the Fed, their concentration is on the path to the terminal rate and the length of holding the terminal rate there. And if you Google or try to find any sort of commentary about quantitative tightening within their speeches and their statements, it’s actually pretty hard to find.
Daniel
Yeah. So just to clarify one thing, just to clarify. In the messages from, for example, of the ECB and the Bank of Japan, less so of the Fed. And I would absolutely agree with that because the Fed is not so worried because they know that they have the world reserve currency, but the ECB and the Bank of Japan certainly expect very little impact on asset prices. For example, the ECB are just saying right now that they’re expecting to reduce the balance sheet in the next two years by almost a trillion euros without seeing spreads widening in the sovereign market. That is insane to be fairly honest. So that is what I’m trying to put together is that the same… A central bank that is unable to see that negative bond yield and that compressed spreads of sovereign nations relative to Germany is a bubble. It’s certainly not going to see the risk of tightening.
Sam
I would start with saying that if the ECB thinks they are going to take a trillion off the books in a couple of years, that’s the first insane part of that statement.
Tony
Good. Okay. So what I’m getting from this is taking liquidity out of markets can be really damaging and the guys who are doing it don’t really know the impact of their actions. Is that good top level summary?
Daniel
Absolutely. That is the summary.
Tony
Okay, so since they’ve only taken 200 billion off, I say “only,” but compared to 9 trillion, it’s not much. Since they’re pulling the interest rate lever now at the Fed and they’re kind of tepidly moving forward on the balance sheet, do we expect them to finish the interest rate activities before they aggressively go after the balance sheet or are they just going to go march forward with everything?
Daniel
No, I think that’s.. They want to see the impact of interest rates first before they make a drastic action on the balance sheet. Particularly in the case of the Fed with mortgage backed securities, and the case of the Bank of Japan with ETFs because the Bank of Japan is going to kill the Nikkei if it starts to get rid of ETFs. And certainly the Fed is going to kill the housing market with mortgage backed securities are warranted.
Tony
Yup.
Sam
And then it’s kind of interesting because there’s two dynamics that I think are intriguing here. One is that the Fed’s balance sheet is getting longer in duration as interest rates rise because those mortgage backs are just blowing out to the right because you’re not going to have to have the roll down and you’re not going to have the prepays on those mortgages anytime soon. So the Fed is putting themselves in a position where hitting those caps on mortgage backs is just simply not going to happen on a mechanical basis. And they’re either going to have to sell or they’re going to have to say, we’re just not going to hit we’re not going to hit our cap on mortgage backed securities for the next 20 years.
Tony
Yup. So I get to put those to maturity like they’re doing with all the treasury debt.
Sam
Yeah, they’re just letting them roll off, which means they’re not going to have mortgage backs rolling off with a six and a half percent refi rate.
Daniel
Yeah, I agree with that.
Tony
Wow. It’s almost as if QT potentially is a non issue for the longer duration debt? Are you saying they’ll continue holding? Sam you’re saying , “No.” So what am I missing? What I’m hearing is they may just hold the longer duration stuff. So if that’s the case, is it kind of a non issue if they just hold it?
Daniel
It’s not a non issue. They are in conversations all the time with the Bank of Japan to do this composite yield curve management, which in a sense means playing with duration here and there on the asset base. But it doesn’t work when the yield curve is flattening all over the place and when you have a negative yield curve in almost every part of the structure.
So the point is that by the time that markets realize the difficulty of unwinding the balance sheet, the way that central banks have said, probably the impact on asset prices has already happened because commercial banks need to end margin calls, et cetera, margin calls become more expensive. Commercial banks cannot lend with the same amount of leverage that they did before. Capital is already being destroyed as we speak.
Sam
Into the point. As soon as you had the Bank of England announce that they were going to have an outright sale of Gilts, you saw what happened to their market. They broke themselves in two minutes.
Tony
Right. Okay. So that’s what I’m looking for. So it’s a little muddy. We’re not exactly sure. Right. QT is complicated. It’s really complicated. And liquidity is dangerous, as you say, Daniel. It’s easy on the way up. It’s really hard coming down from it. And that’s where…
Daniel
I think it was Jim Grant recently who said how easy it is to become a heroin addict and how difficult it is to get out of it.
Tony
Sure, yeah. I mean, not that I know, but I can see that.
Daniel
We don’t know it, obviously. None of us do. But it’s a very visual way of understanding how you build risk in the system and how difficult it is to reduce that risk from the system.
Tony
Yeah, just stopping adding liquidity is a good first step, and then figuring out what to do after that is I think they’re right. A lot of people like to knock on the Fed, but doing one thing at a time is, I think, better than trying to reconcile everything at once.
Okay, great. Since we’re taking a little bit of longer term view on things with some of that mortgage backed security debt, I just also was in a longer term mood this week and saw something that Tracy tweeted out about copper consumption and demand.
This was looking at long term demand, say, by 2030, and there’s a gap of what, 20 no, sorry, 10 million tons. Is that right, Tracy?
Tracy
8.1 million tons.
Tony
8.1 million tons. Okay. Now, when we look at copper prices right now, we’ve seen copper prices fall. We don’t really have an expectation of them rising on the screen as our Complete Intelligence forecast of them rising in the next few months.
So why the mismatch, Tracy? What’s going on there? And why aren’t we seeing the impact on copper prices right now?
Tracy
Well, I think if we look at basic industrial metals really as a whole, except for, say, lithium, really, we’ve seen a very large pullback in all these prices in these specific metals that we are going to need for this green transition.
Now, part of that is, I think, part of that is QT, we’re just saying money liquidity drained from the system. But I also think that we have overriding fears of a global recession. We also have seen people are worried about Europe because with high natural gas prices, a lot of their smelting capacity went offline.
And one would think that would be bullish metals, but it’s scaring the market as far as global recession fears. And then, of course, you always have China, which is obviously a major buyer of industrial base and industrial metals. They’re huge consumer as well as producer of the solar panels. Wind turbines and things of that nature.
So I think that’s really the overriding fears and what I’ve been talking about even for the last couple of years, that I think metals is really going to be more of H2 2023 into 2024 story. I didn’t really expect this year for that to be the real story.
I know you thought that energy was still going to be the focus. And I think even though we’ve seen prices come off, energy prices are still very high. And I think energy prices we’re going to see a resurgence of natural gas prices again in Europe as soon as we kind of get past March, when that storage is kind of done. Because we have to realize that even though the storage is still this year, 50% of that did still come from piped in natural gas from Russia.
I think we’ll start to see natural gas prices higher. Oil prices are still high. Even at $75, $80, it’s still traditionally high. So the input cost going into metals to bring it all together, the input cost going in metals, we are going to need a lot of fossil fuels. It’s very expensive. We also see mining capex suffers from the same problem that oil does is that over the last seven years, we’ve seen huge declines. And then when we look at copper in particular, we really haven’t had any new discoveries since 2015. So all of those are contributing factors. But again, I don’t think that’s really a story until last half of 2023 and 2024 going forward.
Tony
Okay, so to me, the copper price tells me, and I could be, tell me if I’m wrong here. Copper rise tells me that markets don’t believe China is going to open up fully anytime soon, and they don’t believe China is going to stimulate anytime soon. Is that a fair assessment?
Tracy
Yes, absolutely. I think we kind of saw metal prices. We’re bouncing on some of the headlines back and forth, but really we haven’t seen anything come to fruition, and I think most people are not looking until probably spring for them to open up. And I think China really hasn’t changed its stance, right. As far as. There Zero Covid policy, they’re still on that. So I think markets have been digesting that over the last couple of weeks or so. And that’s also another contributor to seeing a pullback in some of these metals in the energy sector.
Tony
Yeah, if you look at the headlines over the past week, you definitely see a softer tone towards China, with Xi Jinping coming out in the APEC meeting sorry, not the APEC meeting, the ASEAN meeting. And he’s a real human being and all this stuff, and he’s talking with Biden and he’s talking with European leaders and Southeast Asian leaders.
So I think there’s been a softer tone toward China and this belief that good things can happen in the near term, but I don’t think most investors will believe it until they see it, first of all. And I think places like Japan, Korea, Taiwan, US. Other places, maybe not. The Germans are also a little bit worried about short term sentiment in China. Things could turn pretty quickly. So, like you say, I think base metals prices are down on that. But over the long term, obviously, it doesn’t seem like there’s enough capacity right now. So, anyway, we’ll see. So for bringing that up. Sorry. Go ahead, Sam.
Sam
Yeah, I think there’s just two things to add there. One, if you didn’t have investment in base metals and energy at zero interest rates, you’re not going to get it at five. Let’s be honest. That’s point number one, this isn’t a short term thing. This is a much longer term thing. And you need to have much higher prices for commodities broadly in order to incentivize any sort of investment, because they’re, one, very capital intensive, and two, capital is very expensive right now. So I think that’s also something to keep in mind over the medium term, is we’re not solving this problem at five and a half percent interest rates here. That’s clearly not going to happen. And the other thing is you haven’t seen the Aussie dollar react in a positive way. So if the Aussie dollar is reacting, China is not reopening. It’s just that simple.
Tony
Yeah, that’s a very point.
Daniel
If I may, I would also like to point out that the bullish story for copper, lithium, cobalt is so evident from the energy transition and from the disparity between the available capacity and the demand. But when the gap is so wide between what would be the demand and the available supply, what tends to happen is that the market, rightly so, sees that it’s such an impossibility that you don’t even consider, at least as a net present value view, that bullish signal as Tracy was mentioning until 2023 or 2024, when it starts to manifest itself.
Right now, it’s so far between the reality of the available supply and the expectation of demand that it looks a little bit like what happened with Solar in 2007, 2008. We just saw bankruptcy after bankruptcy because you didn’t match the two. And on top of it, Tracy correct me. But this is the first year in which you had a massive bullish signal on prices, in energy and in metals, yet you’ve seen no response from a capping.
Tracy
Exactly. Nobody’s prepared, nobody wants to really still spend that kind of money, particularly not the oil industry when they’re being demonized by everybody in the west in particular. So you know, you’re not going to see a lot of, nobody wants to invest in a project when they’re saying we want to phase you out in ten years.
Tony
What’s really interesting though also is BHP bought a small midsized copper miner in Australia this week, so I forget their name, but the miners are seeing opportunities, but they’re just not seeing the demand there yet. So we’ll see what happens there. So anyway, thanks guys for that. That’s hugely valuable.
Sam, you wrote on retail this week and you have really brought out some interesting dynamics around pushing price versus volume within stores over the past several months. And your newsletter looked at Target, Walmart, Costco, Home Depot. Earnings across retail sectors.
So Costco and Home Depot seem to have pushed price successfully. Walmart, as you say, had serious inventory problems earlier in the year, but their grocery business seemed to have really saved them. But Target really has problems and their earnings report this week was a mess. So we’ve got on screen a table that you took out of some government data looking at, has made a change of sales for different types of retail firms, building materials, general merchandise and food services. And things seem to be going very well for everyone except general merchandise stores like Target.
So can you help us understand why is that the case for, I mean, maybe Target is just terribly wrong, but why is that the case for general merchandise specifically and what does this say about the US consumer? Is the US consumer kind of dead in some areas?
Sam
No. US consumers is not dead, which is the strangest part about this earning season to me is everybody kind of read into Targets reporting was like, wow, this is horrible. It’s bad, it’s bad. Target is its own problem. Their merchandising, horrible. Their executive team, horrible. I mean, I don’t know how you survive this. With Walmart putting up huge comp numbers on a relative basis. I mean, they pounded Target and to me that was single number one. That’s Target’s issue.
The general merchandise store. We bought a whole bunch of stuff during COVID that we don’t really need to buy at 17 of right? We bought it during COVID You could get Walmart and Target delivered to you, that was a boom for their business and that’s just not being repeated. Same thing with if you look at Best Buy and electronic stores not doing great because we all bought TVs during COVID and computers, we needed them at home. These are just pivots. When you look at the numbers for restaurants, when you look at it for grocery, I mean, again, a lot of it is pushing price onto the consumer, but the consumer is taking it.
And those are pushing revenues higher. Look at something, the company that controls Popeyes and Burger King, absolute blowout, same store numbers. I mean, these are restaurants that are pushing price. They’re still having traffic and they’re not getting enough pushback.
Home Depot pushed 8% pricing, well, almost 9% pricing in the quarter. They didn’t care about foot traffic, but traffic was down mid 4%. They didn’t care about the foot traffic. They got to push the price and they, guess what, blew it out? Loads had a decent quarter. These are housing companies, at least home exposed companies and building exposed companies that had great third quarters that were supposed to be getting smashed, right? The housing is not supposed to be the place that you’re going to right now. And somehow these companies could push in a price.
There’s something of a tailwind to the consumer where the consumer is kind of learning to take it in certain areas and just saying, no, I don’t need another Tshirt or I don’t need to make another trip to Target. I think that it’s pretty much a story of where the consumer spending not if the consumer spending.
That retail sales report, it will get revised, who knows by how much, but the retail sales report, even if it gets knocked down by a few bips called 20 basis points, 0.2%, it’s not going to be a big deal. It’s still blowing number. These are not things you want to see.
If you’re the Fed thinking about going from 75 to 50, 2 reasons there. One is that pricing little too much. And if it begins to become embedded, not necessarily in the consumer’s mind, but also in the business’s mind, I can push price. I can push price. I can push price. That’s a twosided coin where the consumer’s willing to take it and businesses are willing to push it. That is the embedding of inflation expectations moving forward.
Going back to I think it was last quarter, Cracker Barrel announced during like, yeah, we’re seeing some traffic flow, but we’re going to push price next year, and here’s how much we’re going to push it by. These companies aren’t slowing down their price increases, and they’re not seeing enough of a pushback from consumers.
Tony
Cracker Barrel and Walmart are not topend market companies. They’re midmarket companies. And if they’re able to push price at the mid market, then it says that your average consumer is kind of taking it. But the volume is down. So fewer people are buying things, but the ones who are buying are paying more. Is that fair to say?
Sam
It’s fair to say. Fewer trips, more expensive. It’s fair to say. But there’s also something to point out where Macy’s, their flagship brand, kind of had a meh quarter. Bloomingdale’s, heirt luxury? Blew it out.
Tony
Okay.
Sam
So you’re seeing even within general merchandise stores, you’re seeing a significant difference between, call it luxury, middle, and low.
Tony
Okay. So what is it about, say, Target and Macy’s? I’ll say Target more than Macy’s, but is it just the management, or is it the mech?
Sam
It’s merchandising and it’s the Mexican.
Tony
Right, okay.
Sam
And if you don’t have the right stuff that you can push price on, you’re not going to make it.
Tony
So will we see some of these general merchandisers move into other sectors? Grocery or whatever?
Sam
I mean, Target has grocery. TVs closed. They have everything. It’s a question of do you have the right thing to sell right now in terms of that? So I don’t really think you’ll see many big moves, mostly because they already have too much inventory. So their ability to pivot is zero at this point. So it’s going to be a tough holiday season. I think it’s going to be a pretty tough holiday season to Target. But I didn’t see Walmart taking down numbers for the Christmas season. We’ll see with Amazon, but cool.
Tony
It seems healthy. Just observationally. They seem pretty healthy.
Sam
Yeah. And the other thing to mention, just as a side note, there’s a lot of this consternation around FedEx and UPS and their estimated deliveries for Christmas. This is the first year that Amazon has had a very, very large fleet going into the Christmas holiday season where they don’t have to send packages through FedEx and UPS only. They have a very, very large in house fleet of vehicles to do so with, and they built that out massively over the past 18 months. So I would read a lot less into that for the Christmas season, et cetera, than people are. That’s something I think it’s kind of taking the big picture and missing the finer points.
Tracy
I had a question really just on that same vein. I’ve seen a lot of the freight companies that report on freight, like Freight Waves, have been screaming at the top of their lungs, loadings are falling. People are going out of work. They’re firing everybody. Nobody’s delivering anything. Nobody’s delivering any goods. Do you think that’s sort of cyclical or because it seems like there’s a mismatch right now. There’s a lot of goods out there to be delivered, but for some reason, these guys can’t get loading.
Sam
I think it’s two things. One, everybody double ordered in spring and summer. So I think Freight Waves and a lot of other companies saw a lot of livings that they wouldn’t have seen otherwise. And you spread those out, and I think that’s point number one. Point number two is these retailers are stuffed with inventory. Target, even Walmart is somewhat elevated. They don’t have that big problem. They have the inventory. I would say it’s much more of a timing issue. You’ll probably see Freight Waves have too many loadings, called it in the spring and summer of next year because people are playing catch up and trying to get the right merchandise, et cetera, et cetera. So I think it’s just more of a Covid whipsaw than anything else.
Tracy
Makes sense, right?
Tony
Okay, so bottom line, us. Consumer is still taking it, right? They’re still spending, they’re still okay. Despite what bank deposits and other things tell us, things are still moving. And is that largely accumulating credit or how is the US consumer still spending? They’re accumulating credit?
Sam
A couple of things. One, they have their bank deposits are fine, particularly at the middle and upper levels. They’re still relatively elevated. Two, you’re getting a much higher wage. So your marginal propensity to consume when you see a significant pay raise, even if prices are higher, is higher, right. So you’re going to spend that dollar.
So you’re getting paid more. You’re switching jobs a lot more. Your switchers are getting something like a double digit pay increase. These are rather large chefs, so I would say the consumer feels a lot more comfortable with taking the inflation because they’re getting paid a lot more. Unemployment is sub 4%, so they’re not afraid of losing their job unless they’re at Twitter. So the consumer is sitting there like, all right, I’m not losing my job. I’m getting paid increases. Why would I stop spending? I think it’s that simple.
Tony
Great.
Sam
Yeah, they have credit cards.
Daniel
That is a very important point. What you just mentioned, employment. Employment makes all the difference. The pain threshold of consumers is always being tested. Companies raise prices. Volumes are pretty much okay. So they continue to raise prices to maintain their margins. And that works for a period of time.
I think that what is happening both in the Eurozone and in the United States is that after a prolonged period of very low inflation, consumers also feel comfortable about the idea that inflation is temporary. Basically everybody and actually I have this on TV this morning, we’re talking about everybody is saying, okay, so prices are rising a lot, but when are they coming down? But I’m still buying.
The problem, the pain threshold starts to appear when employment growth, wage growth, starts to stop, and at the same time, prices go up. And obviously the companies that feel comfortable about raising prices start to see their inflation rate, rise. So it’s always difficult because we never know. There’s a variable there that we’re very unsure of, which is credits. How much credit are we willing to take to continue to consume the same number of goods and services at a higher price?
But it is absolutely key what you’re saying, which is as long as even though wage growth in real terms might be negative, but you’re getting a pay rise and you still feel comfortable about your job, you feel comfortable about your wealth to a certain extent and credit keeps you safe, consumption in the United States is not going to crack.
However, where do you see it cracking? And we’re seeing it cracking in the eurozone. In Germany, where you don’t get the pay rise, you don’t get the benefit of taking expensive credit from numerous different sources or cheap credit from different numerous sources and at the same time you get elevated inflation. Consumption is actually going down the drain. The way that I see it is that the problem, the consumption, not collapsed, but certainly the consumption crack is very likely to happen more north to south in the eurozone than in the United States at the rate at which the economy is growing.
Tony
Yes, yes, very good. Thanks for that, until on Europe, Daniel, that was really helpful.
Okay, let’s do it very quick. What do you expect for the same week or two weeks ahead? We have a Thanksgiving holiday here in the US, so things are going to be kind of slow. But Tracy, what are you looking for, especially in energy markets for the next couple weeks? We’ve seen energy really come off a little bit this week. So what’s happening there?
Tracy
Yeah, absolutely. Part of the reason of that, besides all the global factors involved, the recession didn’t help UK him out and said they were already in the recession. That then sparked fears. We have pipeline at reduced capacity right now, which means that’s going to funnel some more crude into cushion, TWI contract is actually cushing. So that’s putting a little bit of pressure. I think holidays, obviously I think this next week we’re not really going to see much action as usual. So really looking forward to the following week is we have the Russian oil embargo by the EU and we also have the OPEC meeting and I would suspect that at these lower prices they would probably, they might be considering cutting again. So that’s definitely those two things. I’m looking forward to in that first week in December.
Tony
Great, thanks. Daniel, what are you looking for in the next week or two?
Daniel
The next week or two are going to be pretty uneventful, to be fairly honest. We will see very little action or messages that make a real difference from Fed officials or from the ECB. On the energy front, there’s plenty of news that we pay attention to Tracy’s Twitter account. But in Europe we will get quite a lot of data, quite a lot of data that is likely to show again this slow grind into recession that we’ve been talking and very little help. I think that from here to December, most of the news are not going to change where investors are and that will probably start to reconfigure our views into the end of the trading season, 27 to 28.
Tony
Okay, very good. And Sam, what do you see next week? The week after?
Sam
I’ll just be watching Black Friday sales that are coming in. Honestly, I think that will be a pretty important sign as to how things are developing into the holiday season and begin to set the narrative as we enter in December. Again, there’s no real interesting Fed talk coming out next week, but we’ll begin to have some pretty good data coming from a number of sources on Black Friday, foot traffic, internet traffic, etc. Tuesday and Wednesday.
Tony
Very good.
Sam
The following week. That’s all I care about.
Tony
Excellent. Really appreciate that. For those of you guys in the States, have a great Thanksgiving next week. Daniel, thank you so much. Have a fantastic weekend. Always value your time, guys. Thank you so much. Have a great weekend.
Emma Muhleman, Boris Ryvkin, and Albert Marko join us for this Week Ahead episode. We talk about FTX and why it happened. FTX transferred about $8 billion of customer deposits to a trading arm called Alameda, and they lost it. FTX was assumed to be a regulated institution. It wasn’t. So customer deposits evaporated. There was a desperate attempt to merge with Binance. That didn’t happen. FTX filed Chapter 11 on Friday, and then Sam Bankman-Fried apologized as if that just absolves him and makes everything better.
Albert, Emma, and Boris help us understand what happened here and what it means not just for FTX executives, but for markets in the week ahead.
We also saw some selling in crude markets as FTX collapsed. Emma talks us through that and tells us how long the crypto unwinds will impact commodity markets.
Based on the market reaction to Thursday’s CPI print, you may think inflation is solved. CPI seemed to override FTX worries and there was this huge sigh of relief in markets. Not so fast. Boris, Emma, and Albert talk us through the CPI print and where we’re seeing persistent inflation (diesel, food, etc). Will the Feds raise by 50 in December followed by some 25s? How will this affect layoffs across the economy?
This is the 41st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Tony Nash: Hi, everyone, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Emma Muhleman. She’s a macro strategist and if you don’t know her, you’re not on social media. We’re also joined by Boris Ryvkin. He’s with Montefly Holdings. He’s also a former M&A attorney with Skadden and a bunch of law firms, and he was National Security Advisor in Capitol Hill. And Boris has an amazing perspective on macro, on history, on markets. It’s really great to have both of you guys. And we have Albert Marko. You guys know Albert. So it’s just great to have you guys. Thanks so much for being here.
Before we get started, I’m going to take 30 seconds on CI Futures. Our core subscription product. CI Futures is a machine learning platform where we forecast market and economic variables. We forecast currencies, commodities, equity indices. Every week markets closed, we automatically download that data, have trillions of calculations, have new forecasts up for you Monday morning. We show you our error. You understand the risk associated with using our data. I don’t know if anybody else in the market who shows you their forecast there. We also forecast about 2000 economic variables for the top 50 economies globally, and that is reforecast every month.
So we had a lot going on this week, particularly kind of in the second half of the week with FTX. Unless you’ve been kind of on vacation or away, you probably know about this already, but I’ll recap a little bit.
FTX transferred, I think, something like $8 billion of customer deposits to a trading arm, Cart Alameda, and they lost it. FTX was assumed to be a regulated institution. It wasn’t. So the customer deposits evaporated.
There was a desperate attempt to merge with Binance. That didn’t happen. FTX filed Chapter 11 on Friday, and then Sam Bankman-Fried apologized. We’ve got his tweet from Thursday on the screen. He sent another apology out today. And if that just absolves him and makes everything better.
So, Albert, I know you’re a huge fan of crypto, so can you help us understand kind of what happened here? And really, what does it mean not just for Sam, but what does it mean kind of for markets going into next week?
Albert Marko: Well, for Sam, you can look at my shirt. That’s I purpose wore stripes, because that’s where he needs to go to. He needs to go to prison. The crypto space has been just littered with fraud. I mean, just incredible fraud. This guy had the nerve to go up into Congress and talk about transparency and central banks are illiquid and there’s no transparency.
Meanwhile, he’s taking customer deposits, not only just setting it to Alameda, right. But then now there’s a political component of it because he was spreading it around to super PACs for the Democratic, for Democrats.
This is a bigger story than people are alluding onto. On top of that, you had a bunch of Republicans come out and say, why was Gary Gesler helping him get through loopholes in the system?
TN: Was that actually happening? Because I saw that gossip on Twitter, but I’m just not sure if that was actually happening.
AM: Well, yeah, this is political season, so I’m not sure if it actually happened. But you don’t just come say something like that, right? You don’t just make those kind of accusations out of nowhere.
So there’s definitely going to be congressional hearings on this. SBF could be in jail at some point in time.
Concerns of where the customer’s money is. This is not funny. As much as I just absolutely despise crypto, this is not funny when you take people’s hard earned money and put it into different outfits without
any transparency whatsoever.
TN: I hear a lot of comparisons of this to Corzine from, like, 15 years ago. Are there similarities between what Jon Corzine did and what Sam did?
AM: That’s a really good question. I don’t think I can really answer that because we know exactly what FTX actually did with all these funds, where they’re at. Because there are stories that there’s penthouses and condos all over the Bahamas and the Caribbean that they can’t even touch yet. We’d have to find out a little bit more detail of what went on, what transpired into FTX.
Emma Muhleman: Because a lot of the deposits don’t invest in them in illiquid private equity investments, including VC funds that were invested in FTX.
AM: Like Sequoia put in a little bit of money and then they get 500 million back.
EM: Sequoia put in like $420 million that they wrote down to zero.
TN: And they got 500 back? It’s a great deal.
Boris Ryvkin: What was interesting was that Kevin O’Leary, he had a Jim Cramer moment with FTX. He said, if there’s one place where I could feel totally safe and fine, it’s FTX, apparently, because he was confident in their compliance capabilities. Because apparently the CEO was like his parents were like compliance lawyers or something. And he’s probably that’s not one of Mr. Wonderful’s more wonderful calls, I think.
AM: Well, when your parents are compliance lawyers, it just means that they’re going to teach them how not to be compliant and not get caught. That’s what happens when that occurs.
TN: Okay, so what does this mean for crypto generally? I know you’ve been not been a crypto fan for a long, long time. So is this an FTX issue or is this a crypto issue?
AM: This is a crypto issue. This ruins the credibility of any crypto that’s even valid in people’s eyes at the moment. Even Bitcoin is the 800 pound gorilla. There’s other cryptos that are trying to be stable and compliant and everything, and it kills.
TN: Do you know how many crypto pages we’re going to get in the comments to this?
AM: I bring it on because I’ve been telling these people for years that the space has been just a positive scheme after another.
TN: So does this permanently kind of impair crypto, or do you think there’s a time that two or three months from now, everyone forgets about it and people are back in and crypto is back on?
I just think that the crypto excitement is so persistent that I’m just not sure that this hurts it for the long time. They haven’t had that moment yet.
AM: No, not yet. It doesn’t hurt it. Actually, I want to say it actually kind of makes it better because it is weeding out the real problems and showing the problems that are in the space.
But the bigger problem that they have now is one side of credibility is getting retail money into the space. Retail money is just not going to get into the space, and even institutional money is going to have to think ten times more about getting an investment in the future.
TN: So what was it, thanksgiving of 2019, I think, when all the retail money went into the space Something like that, right? We got Thanksgiving coming up here in the States, and we’re probably not going to have the same effect this year.
AM: Oh, God, no.
TN: Are there any other players, do you think, that are likely to fail as spectacularly as FTX has failed?
AM: I don’t think so. At this point, I think that the FCC is going to have to really crack down on the entire crypto space and really force these guys to be compliant with, your know your customer rules and whatnot. So that’s something, actually, Boris could talk about, but I think they’re going to have to do something drastic here with the whole space.
TN: Boris, I guess from a legal perspective, how much do these guys have to worry? Do you think Sam can get away with this?
BR: I just don’t. No, I don’t. I think that, you know, the issue, of course, is just going to be the chain of ownership, first of all, of all, these shell companies. Where’s the money? Where did the money go? Because the money’s gone. I think it was something I know that there were a lot of jokes. He went from 16 billion net worth to a dollar, and he can’t afford his verification badge on Twitter now.
I think there was specifically because he’s now requesting, what, 94 billion as a rescue package. Once you’re already, and today he officially announced today was that they were filing for Chapter Eleven. So that was the official name today after requesting 94 billion, which was already I mean, when you’re already at that point, it means that nobody’s keeping the book.
So first of all, just in terms of any kind of account, whoever the accountant is, if there even was an accountant tied to this, whoever was signing off on this needs to worry a great deal. It’s not just Sarbanes Oxley and everything related to that, but it’s just simply who are these accountants and who was actually keeping these books? Because these numbers that were being thrown out, putting aside that it was impossible for him to get any kind of rescue package that quickly. But that number, it’s a number that is simply not credible.
TN: I’m going to get really boring on you for a second. Most companies have a DOA delegation of authority, right? And so I would think that to transfer $8 billion, the delegation of authority would go up to the board level. Is that fair to say?
BR: Well, I mean, it should, because again, it depends how these companies are actually managed, right? Because these could be not under US law managed, board managed, or there could be LLCs involved here which are member managed or have separate managers or what have you. It should go to the board level.
And in any event, you should have the senior management sign off on the accounts, not just the account. Even though that’s the position with public companies now since Starbucks and everything else. But even when it comes to private companies, to have for sufficient transparency, to really have investors comfort, you would need to have that chain of control.
So the DOA would have to come depending on who actually the board would have to authorize the management to give the DOA either broadly upfront or specifically for a specific transaction as it would happen.
TN: Because of $8 million, that’s still a fair bit of money, right?
EM: There were several acquisitions that he made that were private companies with the tune of over a billion each. So I guess you got like two $1.5 billion private investment, 500 million here. So I guess that’s how that all works out.
TN: You would guess that those have to have board approval at some point, I would think.
BR: I’ve done in the past very discreet deals where it’s sort of like, we’ve already transferred 100 million for this property. Please paper all of that over retroactively.
I’m sure that that’s what happened here. In other words, there was a lot of money moving around, nobody papered over what they needed to paper over. And I would be surprised if there’s actually a chain where all of the documentation that was needed at each stage of the transfer was actually put in place.
I’m certain that money just moved around all over the place, which makes it now very hard to track because there’s going to be a very limited paper trail to find, which is going to be a problem for him and everybody who’s authorized per the corporate documents of these companies for having to move the money around. So it’s going to be multiple levels of potential liability.
TN: Okay, so I would guess also that everyone in every crypto company is probably also coming up with their policies, if they didn’t have them already.
BR: So what are the investors are going to start calling to talk major policies. But I think the bigger issue, and Albert sort of touched on this, is the fact that this is an exchange, fundamentally.
So the issue isn’t we’re talking about Bitcoin as a currency, but if you can’t trust one of the largest exchanges and I forgot that was it, it wasn’t Coinbase, it was one of the others that pulled out of an attempt to that’s a last minute shotgun. Binance. And that has a second and third order effect. So not only did this huge exchange fail, it was such a disaster that the Binance, which is one of the more credible exchanges like Coinbase and what have you, just simply said, you know, this is beyond saving.
So it could really have a cascade effect. I know some are calling it the Lehman moment for crypto, although Albert would say there have already been five or six of those.
TN: Right, well, and before we get too critical of FTX as an exchange, let’s look at the LME and the credibility of kind of traditional exchanges. So, I mean, it’s easy to point the finger at crypto exchanges, but the LME has done some pretty screwy stuff over the years. So I think we need to be really careful
of just saying, well, I know you didn’t say this Boris, but crypto exchanges do screw things. Other exchanges do screw things as well.
EM: might I mention, though, with the LME, they are now under the control of the Communist Party of China via HVX. Great. Who is running the show? Real competent folks at the CCP. Binance is even shiftier if you ask me, but we’ll see.
TN: Speaking of markets and crypto, Emma, can we talk a little bit about kind of markets and correlations? How are we seeing this crypto activity and how do we expect this crypto activity to kind of flow through into other markets, equities, commodities, other things? Obviously it didn’t hit equities yesterday and today, but it seemed to be hitting earlier in the week.
EM: Yeah, just as it was all falling apart, we saw a big risk off move in equities. We saw the Nasdaq coming down, we saw some weakness in oil that may have not had anything to do with the
fundamentals in the oil market. I would venture to guess or argue that it had more to do with the FTX sell off because there were several companies, including pension funds, that had significant exposures in FTX. So that oil related selling around the time that FTX all this broke. It may not have to do with the report, this actual EA report.
TN: So I’ve got a graphic from Tracy’s newsletter earlier this week where she talks about the funds and the investors that were deleveraging in oil because of FTX. BlackRock, Ontario Pension Fund, Sequoia, Tiger Global, et cetera, et cetera.
So there were some big players impacted by this and I can’t believe that it just impacted oil. I also have a hard time believing that it was a one time, say, 48 hours event.
EM: Yeah, I would think that. Not having done any diligence for a pension fund, Ontario Pension Fund,
like for BlackRock. I mean, I don’t want to call out too many names. We all know what SoftBank is about. They were intimately involved. There’s going to be a lot of problems and a lot of spillover that we’ll just have to wait.
TN: At the end of the day, I hate to say “only”, but in terms of global fund flows, it’s only $8 billion of retail money that was lost. It’s I say “only”, but, you know, it’s not a huge amount in terms of flows, but I just don’t know how much is in these funds themselves.
AM: Yeah, you don’t know how much the funds have lost and what they’re trying to make up and like yeah, sure, 8 billion doesn’t sound a lot, but in a market that’s so illiquid with a lot of these funds blowing up right now, it can be a lot. You don’t know what they’ve leveraged off of it.
EM: And what they might be being forced to sell as a result.
TN: So we probably haven’t seen the end of that. Fair to say?
EM: We’ll see a long restructuring or not restructuring Chapter Eleven. Not a restructuring, but a liquidation.
TN: Yeah, it’ll be liquidation.
AM: Discovery will be fun. See where all this money went to.
TN: Great, that’d be great. Okay, perfect. Anything else on markets and FTX and crypto? Are we looking at is this impacting, say, European markets or Asian markets? Since crypto has been so big in Asia, are we seeing impacts in Asian markets, like in China?
AM: I don’t think so. I think that’s really Binance’s territory at the moment. Right now, I think FTX was solely the US and Western Europe.
EM: I would think you would see an impact on Japanese investors as well, who own a lot. But just like, not the kind that puts out life insurance companies or puts you a lot of business, but more like retail investors getting screwed.
AM: retail investors have just been taking it on the chin for the last 18 months. It doesn’t stop. 30 years.
BR: Except for Warren Buffett and those who invest with him because yet again, everyone’s underwater, he’s up like 2.3%.
TN: Boris, say, can you talk us through the CPI print this week? Because it seems like CPI, the rate of rise of CPI slowed. CPI didn’t slow, but the rate of rise of CPI slowed. And so it feels like it kind of overrode the FTX worries and there was this huge cyber relief in markets for the past couple of days that we’ve kind of conquered inflation. And the Feds only going to raise by 50 in December, and then after
that we have some 25s. What’s your sense of that? Do you feel like kind of inflation is conquered? Is that base effects? Is that kind of core inflation coming down? What does that seem like to you?
BR: Yeah, I don’t think that it’s conquered. I mean, what’s interesting to me is sort of the degree to which all that matters is what the Fed may or may not do and trying to price in factional differences within the Fed. That’s how granular it’s now become. Because I think the markets were waiting for any reason, anything, to cling onto for Powell to reverse course and to after his very hawkish last meeting, where he said, ignore all of the pivot talk.
Essentially, you know, we’re going to continue to do this as effectively as long as it takes to see a sustained reduction in inflation over that’s defined. So he essentially was very angry and Albert and I were talking about this as well, that he was very angry by some of the Pivot talk from brainer than some other people yelling, was saying certain things. It looked like some of the more devastated member. And then Powell comes out and basically says, I don’t know what you’ve heard about any Pivot talk, we’re going to stay the course until we see more evidence of multi quarter reductions and declines in inflation.
But it looked like the market really was desperate to find a reason to not believe them and to hope that anything that might persuade him to in other words, the market is looking for anything to latch onto to have a pivot, even if we don’t actually get one.
So initially it was the official position, if you were even to read the kind of the superficial financial media was they were worried if we focused on the red wave, that was what was going to get the relief rally. Then we forgot about what was happening with the midterms. And now we have this softer inflation report that as you said, to slowed the rate while most of the slowdown was because of on energy, used cars and a couple of these other, in my view, short term fluctuations which are, I mean, to the extent that CPI has already been massaged to death.
Obviously the listeners of this podcast of course know that very well. If we measure inflation how it used to be measured from the 1970s on, we’d be in double digits. I mean, that’s just a fact. So taking even to the extent that they were able to massage it, what I saw here was the market latching onto the top line figure, hoping that this would block the Fed into doing what the markets want the Fed to do, rather than actually looking at what’s happening to the core and actually looking below the hood and the underlying trend.
That’s what I’m seeing. You also can’t have to take into account biden’s political depletion of strategic petroleum reserve. You have to take into account the unseasonably milder sort of late fall that we’ve been having, I think that’s been having an impact on natural gas prices which have this very sharp decline and now have rebounded a little bit.
Certainly that’s coming out of Europe as well, but I’m not seeing anything fundamental that would actually allow us to conclude peak inflation and sustained reduction inflation has been achieved. So I’m not saying that when it comes to energy, I’m not seeing that when it comes to food, I’m not saying that. I mean, the housing market is not doing well. I’m not seeing any fundamental changes in the housing market. Really. This to me seems like a short term story and the market overreact, in.
TN: My view at least, this is that’s great. So I’ve got on screen Sam’s from Sam Rines newsletter, the core CPI and all CPI items, just showing a bit of turnover there. So it could be encouraging to people who like lines. Right.
But if we look at the target rate probabilities for the Fed, which is the second item on the screen, it does look like we have from a 4.5 almost to a 5.5 target rate.
So that shows there may be ongoing tightening, say maybe into Q one, if we don’t see a dramatic continued decline in the rate of rise of inflation. Is that fair to say?
BR: Yeah, I think so. I think that it seems that the growing chorus is shifting from do what continue as long as it takes to fear of overtightening, at least outside of Powell and maybe one or two other people. And Albert really, I think, is the resident expert on FOMC, inside of baseball on that and sort of thinking, et cetera.
But once that rhetoric shifts to fear of overtightening, that tells me that they’re looking for any excuse to stop and to begin moving back. And that will just bring the inflation genie back out. Because again, these policies are being set by people who don’t fundamentally understand what inflation is and isn’t and what’s causing the inflation. So they’re looking at the wrong things still, in my opinion.
So none of the fundamentals that I’m seeing, as I said, that would really drive a sustained reduction in inflation have changed in that direction. And once if they do decide, as you said, Tony, if they do continue to tighten into the first quarter and then decide to do a sharp 180, that’s going to just bring everything back, if not make the situation even worse.
So they’re in a very difficult position and I think, as I said, there’s a lot of political pressure for them to move back, especially given what’s happening with these midterms, certainly on the part of Yellen and the bike administration. But I think maybe Albert can also chime in.
TN: Let’s talk about the Yellen Fed factor and also since she’s a labor economist, Albert, let’s wrap some of these layoffs that happened this week into that discussion.
AM: How coincidental that these layoffs come right after Midterms and after Yellen has done everything in her power to keep equities up so they don’t have to have layoffs until now. Well, now all the layoffs are coming. Like we’ve talked before, they’ll do this right before Christmas.
But also on the CPI and the inflation front, there are two glaring problems that they’re staring at the moment right now. How’s y’all going to deal with the Chinese reopening in March? Because that’s going to be really announced in February. They did a little bit about real estate today. They talked a little bit about real estate supporting the real estate market. And every Chinese name that was on my screen was up by 7%.
And then you talk about oil and then we have a big diesel shortage in New England at the moment and it’s leaking down all the way into the Southeast. And those are just going to add to costs across the board. And I don’t think that they understand how bad inflation can really get. They can only suppress it for so long with SPR releases and whatnot. But it’s coming to a head and I don’t think that Paul is going to be able to release. I think he’s going to have to do another 75 again.
EM: The thing that’s just disturbing to me about that is that, like, for instance, we are going to have a serious diesel shortage coming here currently and it’s only getting worse. Powell cannot fix that problem. So let’s just shoot the consumers even more like his policies. They’re not helping. Unless you want to completely destroy the economy and have a complete disaster blow up with Deleveraging and the whole shebang.
TN: Default rate in auto loans this week. Right. I can’t remember the percentage of people who were two months behind in auto loans.
AM: Skyrocketing wastelouses start kicking into that, too. Started kicking in. But just to touch on what Emo is saying about Powell trying to kick the teeth into the consumers from his perspective, he’s trying to do the right things, but he’s just not getting any help from yelling or other members coming out there talking about pivots.
TN: What would that look like? Help from Yellen. What would that look like?
AM: Well, she can drive the dollar down to Dixie. That rallies the markets pretty easily.
EM: Well, he doesn’t want a market rally, right? She can help.
AM: Powell does not want a market rally. Brainer and yelling did want to market rally for the midterms. So this is the problem that they have. There’s a civil war within the Fed and treasury that is just making these policies look even stupider than usual. And I know Powell is going to get the brunt of it because he’s the Fed chair, but he only has two other members that are on his side. The rest of them are against them. So he doesn’t really have much of a choice. He’s going to have to do 75 in December.
TN: Well you say he’s going to have to do 75 in December.
AM: He’s going to have to do 75 because we have a CPI print coming out December 14. It’s probably not going to be as nicely massaged as this one was. And on top of that he’s running out of time because the Chinese look like they’re going to stimulate in February, March.
TN: Yeah, you’re right. I agree with the timing on China opening and Chinese stimulus in the meantime is going to be really ugly in China. Do you think that it’s possible that there’s some sort of regulatory relief especially for energy that allows, eventually allows more US. Supply, this sort of thing? Or are we too far down that path with the current administration?
AM: Me and Boris are bred from DCP, the Beltway guys, we’ll just laugh at anyone with the notion that think that anything is going to get done legislatively in the next two years.
TN: Okay, but nothing getting done legislatively is not terrible, right? At least we know the rules of the game and their content.
AM: Yeah, it’s not if there wasn’t problems but there’s glaring problems everywhere and things need to get fixed. So you need something from progress.
TN: Okay, let me throw this out to you guys. We have seen a little bit of move on CPI, whether it manipulated or not. We all kind of know it’s always in there a little bit. But what’s the timing on inflation coming back into a reasonable area? Let’s say five to six, I don’t know. Are we a year, two, three years from that, six months from now? What do you guys think? Emma, what do you think?
EM: If we’re ignoring energy and then we’re ignoring fertilizer prices and food prices, we’re looking at goods, those we may see services come down and wait the wage issue come down a little bit. Just like we’ve seen with auto delinquencies, used cars, these sort of things. You see numbers starting to roll over as demand destruction and liquidity has been pulled.
But I think you’re going to see the opposite in energy and you’re going to see diesel shortages which pushes goods prices up. Right. If every trucker in the nation has to spend a time for every time they fill up with diesel and they can’t even fill up enough, then there’s going to be not only a shortage of goods but goods prices will less go up.
I don’t see how we fix that situation. We only have extra finding capacity. It takes like 30 years to build a new one so I don’t see how that gets fixed. So that’s something that really looks like it would push inflation upwards. So if we add all that together, I’d say we’re going to have a problem with inflation for good at least another year if we include energy and food.
TN: OK, let me ask this. That’s a great answer. Let me ask this divorce, because I know I’m going to get an answer that doesn’t agree with what I think is there pressure to broker a Russia Ukraine piece? And if that happened, would that alleviate some of these diesel price issues?
BR: I think that there is. I know that Orban, for example, and Erdogan met and basically said to Zelensky’s, time to use this window of opportunity to start negotiating. So they liberated Kirstan today, which was.
They liberated Kirsten today, which was the one major city that the Russians were able to occupy and they were offensive earlier the year. So this is kind of a huge move with the Russians on the back foot. And these are people who are everyone is playing all sides.
And Orban, of course, is more kind of the one European leader that’s closest to Putin major leader. But I don’t think that the US is. I know that there was some discussion from the Biden administration about don’t be so categorical about Zelensky, about saying you’re not going to negotiate with Putin. It’s irritating African countries, South America, et cetera.
You have to start taking advantage. I don’t think there’s any pressure and will be in the near term, and especially after these midterm results, I think that the risk of any major, immediate cutoffs in military economic aid from the US to Ukraine are going to be somewhat subdued now, given the kind of the risk from right and left. So I don’t think there’s going to be any nearterm pressure on the Ukrainians right now to start looking at essentially trading land for some kind of an intermediate piece.
But as a side issue, there was some in terms of alleviating the diesel and the gas problems, especially in Europe, there was some discussion about Erdogan purchasing Russian gas at a discount and essentially creating an alternative for the Europeans through that pipeline that was being built basically through the Black Sea, et cetera.
And there was a lot of kind of talk in the US and some European capitals like Erdogan is going to save us because he’s playing everybody and he’s going to create a new gas hub in Turkey, as he declared with the Russian gas. What he’s actually going to do, and Albert and I were talking about this too, in my opinion, is because of Turkish elections next year, he’s going to keep the discounted gas, sell it at home, domestically cheaply, in order to drum up support for his reelection next year. He’s not going to resell that to the European.
So that life raft is not going to be sailing. So therefore, I think that unless there is some relief from the weather, I’m not seeing any, because I know that at that moment, because the weather was unseasonably warm to a large extent, you have this natural gas flood in Europe now, which has driven down natural gas price, at least in the short term.
Dutch and et cetera, the benchmark. But I don’t think that’s necessarily going to sustain. I think we could have a colder winter and Erdaman is not going to provide that relief. I know the Ukrainians are looking at alternatives themselves, but the Ukrainian economy doesn’t exist anymore, really.
Right now, we’re basically balancing their budget through direct cash transfers at the moment. I think it’s only going to be bad news and it will reinforce what Emma has said about her predictions about the diesel shortage and about just energy in general and how that would impact inflationary changes. So I’m not seeing any major improvement.
And also, in terms of the broader discussion on inflation, I also agree that, again, kind of what I said before to dovetail off of that, like, none of the fundamentals to reduce inflation have improved, have changed markedly. So we could be, it’s really, to me, a risk tolerance for recession on the part of the Fed.
When will the Fed decide that if they’ve given up on a soft landing, then we’re going to have one projection in terms of when inflation is going to start coming down dramatically. If they still are insisting on the fantasy of a soft landing, then there will come a point where they might decide.
Regardless of what happens with inflation, recession is a much bigger problem. And we’re going to have to, sooner than we had hoped, begin to pivot, which is probably not something that Powell would want to do, but that’s a recession versus a soft landing versus hard landing balancing act that they’re, I think, going to have to perform over the next couple of quarters.
And I think that’s sort of their near term focus and to kind of close that point off. Right. I mean, I think that the layoffs and I mean, the fundamentals are cooling, the economy is slowing. We’re seeing that with the layoffs, the housing market is going to get worse, in my opinion. Oh, yeah, it’s a disaster.
TN: Look at the MBS holdings at the Fed. They’ve just started to tighten them. They’ve just started. Right.
BR: But then you also have to take we talked about you said auto defaults for auto loans. What about credit card debt, consumer credit card debt? And also, what about the leverage that’s on the books of these companies? Why is the tech, which is tech at the tip of the spear? Why are we seeing all of them down 70%, 60, 70% on the year? Why are we seeing the layoffs hit tech massively? First, because they grew too much too quickly and are over level.
EM: They did refinance in 2021 when they had a chance. So they’ve got like a couple of years.
BR: I don’t know who’s advising Zuckerberg here and his colleagues. I think what we’re going to do is we’re not going to refinance, we’re going to double down on Meta, which we don’t really know what to do with and we’re going to double up on the head count dealing with Meta, on the Metaverse thing, that isn’t getting adopted the way that we would want it adopted. It’s like everything, every mistake that could possibly have been made from the financing to the head count to the rollout, and that’s happening across the tech sector, but we’re financing.
TN: Would you have done differently? I would have taken on all that too, because it was fun. I’m kidding. But I actually think that there are more rounds of layoffs in tech coming. I don’t think this is the only round. I think that in the auto sector, tony and auto and other guys.
So I think I was in Silicon Valley in 1998 to 2001. I know that’s ancient history, but my company went through six rounds of layoffs. I didn’t know when I say my company, the company I worked for, they went through six rounds of layoffs.
So I think all these stories about people at Meta thinking they were going to dodge it and all this stuff, I don’t think that I don’t think this is the only one. I think they’re going to have to do more in three to four months.
I think you’re going to see more companies bandwagon on top of this to say, hey, Meta is doing it and Stripes done it and all these other guys are doing it. So let’s use this opportunity to become more productive and we’re going to see a flood of these before the end of the year. Just a flood. I think the tech sector is going to be wrecked in terms of employment.
AM: Oh, yeah, without question. Even going back to your previous point about the Ukrainians and the Russians getting some kind of peace agreement, even if they did, that would solve the diesel problem overnight.
Even if they did that today, it would take a year, maybe 18 months until all that got rolling in again if they looked at the sanctions, because they still have to go through that whole process for all the countries.
EM: Russia doesn’t send us diesel heavy crude and then we have to process it at refineries, which are running at max capacity. Hence the crack spreads being so wide, we can only convert so much crude into distillates, which diesel of which is one of which jet fuel for planes is another, but both things that cost a lot of money when the prices of the input key input goes up.
TN: Okay, great. Let’s do just a really quick round the week ahead. What are you guys looking for for next week? Albert, you go first.
AM: I’m actually going to look at to see what the House majority and Senate majority makeup comprises of and whether the markets are going to react negatively towards it. Because if the Republicans, I know they’re going to take it, but when they get announced that they take the House, the stimulus packages all but die at that point for two years. So I’m very curious to see how the markets react to that.
EM: I’ll be continuing to watch what’s going on in Crypto to see if anything’s happening with Bitcoin ethereum, because we’ve already seen a lot of other tokens just literally, basically go to zero. So just see how that continues to play out.
TN: Great. My $20 a DOJ is still at, like, three times where I bought it at, so I’m just holding on to it just to see where it goes.
EM: And then I’ll also, obviously, as usual, be watching China and certainly the bank of Japan and just the end period.
BR: Yeah, like Albert, the makeup in Congress and also going to be looking at some of the emerging markets. I think maybe if we’re going to get more evidence out of China as to when they’re still pursuing COVID Zero, I think they’re now recording again, like, a record high number of cases from April. It’s not working yet. They’re continuing to double down and reward everybody who’s pursuing that.
So I want to see if they’re going to continue with that and they’re going to be on track for what Albert said to reopen early next year or if it’s just going to get worse. So that’s what I’m going to be focused on.
TN: Yeah. You’ve heard of the great league forward, right? I mean, these don’t really take sound policy advice. When they get their mind on something, they just push it and push it and push it until it harms everybody they can.
EM: I often when you’re trying to when you have, like, the worst debt crisis ever and the population that’s, like, you know, put the equivalent of $50,000 down on apartments, like, millions of people have done that, and they’ve got nothing to show for it, and you want to keep them from acting out and protesting in the streets. It’s pretty convenient to have them all segregated where they’re not communicating. I wonder really what the motivation behind COVID Zero is. And so I don’t know if I buy that it’ll ever end until it’s convenient for it to end economy wise, where she feels no threat.
TN: I don’t necessarily disagree with you. I think things in China don’t necessarily end until they want them to end. Right. And if you look at exports from China to the US. They’re back up to preCOVID levels now. So in terms of that export machine in China, it’s humming, right? So there’s not feeling economic pain, at least in terms of trade.
So if they’re comfortable feeling the domestic economic pain, then why would they stop? So I think what Albert talked about is Code Zero ending in March, and he and I’ve talked about that a couple of months ago as well. I think that’s the best case. So I think there’s a best case that they end it and they stimulate in March, but it’s quite possible it continues going on because there may be social reasons, there may be other reasons to not open up.
So I don’t think, as westerners, we can look at the Chinese government necessarily and understand the perspective they have on policy and the reasons they have for policy. There is so much inside of Jungkonghai and all of the different things that happen that we just can’t look at it rationally and say they should do A, then B, then c, and very few Americans can look at that and understand why and how it’s happening. You may be exactly right.
EM: Yeah. It’s not a logical I mean, it’s more like if I’m she or if I’m trying to do this, it’s not really like what westerners typically associate as logical things to do economically. It’s more like it’s possible.
TN: Yeah. Anything’s possible. Guys, thank you so much. I really appreciate the time you took to talk through this. Have a great weekend. And have a great weekend. Thank you so much.
In this episode, we’re joined by Isaac Stone Fish, who is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years.
We talk about how are foreign companies dealing with the political changes in China? Or what should they be paying attention to? We’ve seen changes in Xi’s team that, to be honest, weren’t all that unexpected, but seems unexpected anyway. It’s certainly a hard turn to the CCP’s commie roots. This tweet really underscores how desperate Xi is to set an old school tone.
Markets have seemed a little spooked this week, so we saw orders from Beijing to prop up the CNY and Chinese equities, which didn’t work all that well. But with all the political and market backdrop, what does all of this mean for US and other foreign businesses? Are foreign employees at risk? Do we expect direct investment to slow down?
On the risk side, we look at tech earnings, which are super bad. Hiring is a huge issue and tech firms seem to have been hiring based on their valuation not based on their revenues. When will we see headcount reduction announcements? One of Meta’s investors was saying they should cut 20%. Albert shares his views on this.
And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages. We saw another draw on global inventories this week. As OPEC supply is contracting ~1.2m bpd. Russian crude sanctions start soon. And US exported 5.12m bpd last week, making it the 3rd largest crude exporter. We know global inventories are low, but when will it start to bite? Tracy shares to us what’s going in.
Key themes
1. China risk for Western companies 2. Tech earnings & China 3. Crude inventories & Asia stockpiling
This is the 39th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
0:00 Start 1:00 Key themes for this Week Ahead 2:52 What the news about China means to Western businesses 6:38 What has changed around the concept of Communist Party membership over the last ten or 15 years? 8:20 Anybody who’s overseeing a business in China has to understand modern Chinese history 9:31 Risks for foreign staff in China 12:34 Congress does not want US companies to do business with China 14:14 Danger of a rush to the exits in twelve months 17:58 Tech earnings are super bad – how bad will layoffs be? 21:10 Is it possible to cut 20% of Meta’s workforce? 22:44 China and US competition in India and other countries 24:52 Crude inventories – when will this start to bite? 28:31 Japan is stockpiling crude – is it because of geopolitical concerns? 29:47 China stimulus – will they do it in February? 31:55 What happens to the crude demand of Covid Zero ends? 34:27 Will oil prices raise by 30% before 2022 ends?
Transcript
Tony Nash: Hi, everybody, and welcome to the Week Ahead. I’m Tony Nash. Today we’re joined by Isaac Stone Fish. Isaac is the CEO of Strategy Risks. He’s the author of a book called America Second, and he lived in China for seven years as the New York Times in New York Times bureau. So we’re really lucky to have Isaac with us. We have Albert Marko, of course. And Tracy Shuchart. We’re very fortunate to have them again today with us.
So, Isaac, welcome and we’re really happy to have you.
Our theme today that we’re going to talk through first is how are foreign companies dealing with the political changes in China? Or what should they be paying attention to?
On the risk side, we’re looking at tech earnings and the impact that tech earnings will have on other earnings and headcount reductions and other things over the next few months. And we’re also looking at crude oil inventories and refined product inventories. They’re way below averages.
And we want to hear from Tracy as to what’s going on.
Please take a look at our product, CI Futures. It’s a forecast subscription product. It’s $99 a month. We cover a few thousand assets over a twelve month horizon. Economics, currencies, commodities, equity indices. So please take a look at that. The URL is on the screen. Thanks a lot for that.
So, Isaac, welcome. Would you give us a quick overview of what Strategy Risks does?
Issac Stone Fish: Strategy Risks works with corporations and investors to help them manage and reduce their China risk. And with increased tensions between the United States and China, and growing awareness of the liabilities in both China and the United States of working with the People’s Liberation Army or the United Front or the Ministry of State Security or the Chinese Communist Party more broadly, it’s been a good couple of months for us.
And so excited to be joining you and chatting with you on these issues.
TN: You must be working 24 hours a day. I have no idea how you stay, how you get any rest right now with all the stuff that’s going on in China.
ISF: Under drugs right here.
TN: Isaac, I’m curious, with all of the political changes announced this week, of course, that’s been way analyzed, a lot of different perspectives on things. I would warn people as they read through that analysis, just be careful of kind of some anti China bias, but we have to kind of read things for what they are too.
We saw changes in Xi’s team that, to be honest, weren’t all that unexpected. People have talked about this for months, but the fact that he actually carried through with it, I think made people feel like it was a little bit unexpected.
But it’s certainly a hard turn to the CCP’s communist roots. I’m showing a Tweet right now looking at Xi taking his team to pilgrimage where the long march ended during the Communist revolution. And so he’s just the optics around the hard turn to the party’s communist roots are front and center.
So Isaac, markets were spooked this week. Of course, we saw orders from Beijing to prop up CNY and prop up Chinese equities. Obviously didn’t work very well. But with that backdrop, what does all this mean for US and other foreign businesses? I know it means a million things, but if you had some top level takeaways, what are the things that you’re seeing that it means for, say, US and other foreign businesses in China?
ISF: Have a really good understanding of leftist ideology. If you decide that you want to stay, which oftentimes we discourage, and if you decide that you don’t want to reduce your exposure, which we always discourage. Have a really good understanding of how Communism works, and read the tea leaves. Spend a lot of time on analysis. Understand that every Chinese company or every company in China that has at least three party members has to have a party cell. And for a long time people overlook that law.
But companies like Alibaba have tens of thousands of party members. So understanding that you’re partnering with the Chinese Communist Party and things that you used to be able to get away with, you can’t anymore. I think the other high level take away is with increased media, consumer and congressional scrutiny on China.
What happens in China doesn’t stay in China. So the work that you do with a major Chinese charity which does say party building exercises in Chinese orphanages, aka Brainwashing Chinese Children on Party ideology, we can get that information here. Congressional staffers can read that, journalists can pick that up, and you’re going to have to start dealing with the liability of that from a PR perspective. The final highlevel takeaway, the more Xi marches to the left, the more draconian things get. And the more saber rattling we see with Taiwan, the more likely it is that the US and China go to war over Taiwan.
Right now, I would say that’s still not the base case. War is very avoidable. It probably won’t happen. But it’s a very concrete risk and investors and I would argue especially boards of major corporations, need to be discussing this risk. And perhaps the best thing to do with the risk is to say, okay, we know this, we’re not going to change.
But I think if there is a war, companies are going to have to face some pretty serious shareholder lawsuits because it’s a viewable risk and you didn’t do anything about it.
TN: Right. So let me ask you, take two questions. First is, in 2010 or ’11, I spoke at the Central Party School in Beijing, and the person who drove. I was giving an economic update. I was working with the Economist at the time, and it was so surreal for me. The person who drove me to that event was a venture capitalist. And so I think the view that many people have of Communist Party members is, oh, you know, they’re these soft guys, they’re capitalists like us too, you know, that sort of thing. What has changed around the concept of Communist Party membership over the last ten or 15 years?
ISF: Think of the perception. So when Rupert Murdoch in early 2000s was going into business in China, he would downplay the importance of the Communist Party and say things like, oh, they’re just like us, there’s really no difference. And some people just join the party for opportunistic reasons, and some people do it because they believe, but they’re fairly soft spoken and gentle. And then there’s the very hard security element of the party.
And I think people are realizing that for every venture capitalist, there’s also the PLA secret agent or the MSS agent or the public security agent in that these people are increasingly important in the Chinese system.
And the other piece of it is that it used to be seen from a Western context, both PR and regulatory, relatively benign to be working with party members in the Communist Party. But after the genocide in Xinjiang, after Xi’s increasing authoritarianism, people are not getting the pass that they had before when you and I were out there.
TN: Right. And so I think it’s really critical. Anybody who’s overseeing a business in China has to understand modern Chinese history. You have to start from the great famine, really. I mean, start from the revolution, but really the great famine through the Cultural Revolution, through the 70s, through Deng Xiaoping, through… That era is really critical to understand what’s happening today. Right. Because that’s when Xi Jinping grew up and that’s when his ideologies were formed. Is that safe to say?
ISF: Good is safe to say. I think the other thing that we have to understand is we do have to be incredibly humble about our ability to understand what’s going on at the top of the party. We have very little idea. People are going to keep speculating about that crazy video with former Chairman Hujing Tao. We probably won’t know what happened there for decades, I would guess.
And I think when we talk about war with Taiwan, we talk about what’s going to happen between the US and China, we have a lot of insight into how Biden thinks and almost none into how Xi Jinping thinks. We just need to bake that into our predictions.
TN: Yeah, that’s absolutely right. And I cautioned on that earlier this week about the Hoojin Tao exit. It could be health, you don’t know. Right? It could be intrigue. You don’t know. So none of us know.
So let me also ask you, when you talk about you had a tweet about potential China-Taiwan war earlier this week, and you talked about Chinese staff for American companies or Western companies, sorry, and you talked about Western staff in China. So can we talk about some of those risks, like the real people risks for multinational companies who hire Chinese employees. And none of this is intended to be Xenophobic.
This is intended to be purely practical in understanding really what the risks are. And also with those foreign staff in China. Can you help us understand some of those risks?
Tracy Shuchart: Yeah, I was going to ask something along that line, if I can just tag on my question to that one. We saw a bunch of people who are Americans pulling their staff from Chinese chip companies right, lately. So I was wondering if you saw that, see that trend continuing and bleeding into other sectors besides just the tech sector.
ISF: I very much do, and I think there’s two ways to think about this. One is the economic and regulatory so increasing difficulty doing business in China, desire for localization of staff, Biden regulations that restrict the ability of Americans to work at certain Chinese chip companies. And then you have the potential for war.
And the idea is that if the US and China go to war, American staff in China and also Chinese staff for certain American companies could be seen as enemy combatants. And we saw this with Afghanistan, we saw this with Ukraine. There’s orders of magnitude, more staff for Western companies in China than in these places. I mean, it’s not even comparable, the numbers.
And I think from an ethical perspective, I get really worried that people don’t talk about war because then war could just be on us. And the United States has a terrible history of interning Japanese during World War II and harassing Germans during World War I. I think with the dynamic with Chinese people here, we need to have a concrete conversation about it so that we can defend the rights of Chinese and Chinese Americans in America if we go to war.
And from a corporate perspective and from a risk perspective, companies need to have exit plans for their staff in China because they’re going to be dealing with major, major ethical and insurance risk issues if this happens. And they can’t just take the foreign staff out to Hong Kong anymore. Because that’s not like a free zone anymore. And you hear stories of people being smuggled out now, and I think we’re going to hear a lot more of those, and that’s going to be more and more common.
TN: So, Isaac, what are we missing when you see the discussion about China right now and with American businesses, what are we missing? What’s not being discussed that you’re like, Gosh, I can’t believe people don’t see this.
ISF: Congress does not want American companies to do business in China. And with the UFLPA, the Uighur Forced Labor Prevention Act, we talked to a lot of corporates about that, and they don’t seem to understand how to comply with the law. And that’s the point. It’s a law that’s meant to deter behavior as opposed to shape behavior.
So it’s okay, we can’t invest in Xinjiang, but this company that we work with, has a branch of Xinjiang. Well, don’t work with that company. And I think the American political calculus of this too.
People don’t really get Pelosi’s trip, I think didn’t really bake into corporate behavior in the way that it should have because people think this is a Republican issue. They hear Marco Rubio, they hear Ted Cruz, they hear some of the awful remarks that Trump made, and they don’t realize that Nancy Pelosi and Chuck Schumer sound almost exactly like Rubio and Cruz on these issues. They think it’s a Republican issue. It’s not a Republican issue. There are holdouts on the progressive left, there are holdouts on the libertarian right. But the US is pretty united about this from a government perspective.
It’s just not from a business perspective. And that’s fine. You can have that discordance. But businesses need to understand main street and Congress feel very differently about these issues than they do.
TN: Yeah. So one last question on this. Unless Albert, Tracy, you guys were going to come in, but do you think we’ll see publicly traded American companies disposing of their China units with say a Hong Kong IPO?
I mean, I know this is an old idea, but better than nationalization, at least they can get some value of it. And I think of like a GM or something like that, right? It’s a huge business for them. So they could potentially either have that nationalized or they could make it public on the Hong Kong stock exchange or something.
So do you think we’ll see more of this? Young Brands is the one that everyone knows about from ten years ago or whatever, but do you think we’ll see more of this? And if people don’t do it now, is there a danger of a rush to the exits in say twelve months?
ISF: I think that’s an excellent point. Ping on, which is a major shareholder of HSBC, suggested HSBC break up into two different banks, one headquartered in Hong Kong to focus on China market and one of the rest of the world.
And companies like Boeing, which has an airplane business that I think it’s something like 14% to 18%, goes to China, specifically the Chinese Communist Party and then has a very important government contracting business which is increasingly at odds with its relationship with the Chinese Communist Party and need to start considering these issues.
I think you’re right also on the timing, these things take a lot of time and companies are very private with them for obvious reasons. So if they’re considering them now and we’re going to see announcements on it and it doesn’t require that much scrutiny from Cyphius or the Beijing’s regulatory Agency or other Beijing other Chinese agencies, I can see these things happening.
I think if companies are starting to think about it now, it’s probably too late. I think years process. But in the same way that nobody wants to talk about war, nobody wants to talk about spinning off their China assets.
TN: Right. But you either do it now or it gets nationalized. Or you do it for $0.10 on the dollar in a year or two years.
ISF: I think you’re exactly right. And Tony, we should write something on this, and I think this is a good time to talk about this issue.
Albert Marko: Okay. There are other issues. Capital flight out of China, even if you decide to list in Hong Kong, is like, where’s the money going to come from? It’s not going to come from the west. Even the Chinese are starting to take their money out into Singapore and Macau and anywhere else they can get it out of at the moment.
But I agree with Isaac on 90% of what he’s saying. I don’t think that war, Taiwan is even a remote possibility in the next ten years, to be honest with you. The pilot bureau, Xi is inspired politburo. It looks scary. There’s no question about that. And the Western companies need to take a look at that because it reminds me of the Nazis from the 1930s.
Now, I’m not talking about what the Nazi crimes were, but just the mobilization of the country and the nationalization of corporations and then starting to boost the economy internally. It’s most likely going to start happening, and they will nationalize companies that they see are instrumental for their vision going forward.
TN: Yes. I mean, honestly, I don’t know why anybody related to SAIC Shanghai automotive. Why would that not become the property of SAIC? If they’re really taking this nationalist bent, that’s a real risk, right? I think so. Any of these guys really need to pay attention and really start to evaluate what is their path going forward? What is their path for Chinese staff? What is their path for foreign staff there? What is their path for IP that’s shared between those units? These are real head scratcher questions.
Okay, Isaac, thank you so much for that. This is so insightful. I’d love to spend 2 hours with you on this, but we’ve got to talk about tech earnings.
So, Albert, tech earnings are super bad, right? Super bad.
AM: Super bad is an understatement.
TN: Yeah. Horrific. It’s a tech wreck, all that stuff. So we can talk about what missed and kind of we all know what’s missed. That’s been analyzed over the last 24 hours or say a few days or whatever. But I guess what I’m most interested in tech is staffing.
So the vacancies in the US. Workforce has been a big issue for the Fed. Okay. And I’m showing right now on the screen that the Meta’s stock price from $350 all the way down to I think it was $97 yesterday, just over one year. It’s incredible, right?
So a lot of these tech firms have been over hiring. They’ve been putting out job wrecks for things that they where they just want to target one person and they don’t really want to target the job and all this stuff. They’ve almost been hiring based on their valuation rather than their revenues. So in terms of those productivity metrics, do you think we’ll start to see headcount reduction in tech? Or they’ve been saying, hey, we’re just going to slow down our hiring.
So do you think they’re going to stick to only slowing down their hiring? Or do you think we’re going to see this kind of tech halt and kind of shrink the tech workforce?
AM: Oh, absolutely. You got to shrink the tech workforce. But that’s not going to come till after midterms. I mean, nobody wants to be in the line of sight of Biden’s firing squad over firing 10 thousand people just before midterms happen. But afterwards you will. Probably after Christmas, you’ll actually start seeing quite the number of job layoffs in the tech industry.
TN: Every time I’ve worked with a tech related firm, the pink slips come literally the week before Christmas.
AM: Yeah, you know what I mean? I don’t think that people understand how bad these tech earnings are. Right. We can note Facebook and Amazon and whatnot, but they had tailwinds of inflation of an extra 10% because CPI, they say 8%. It’s really like 20%. So they had an extra 10% baked into their earnings that people don’t really catch. Right? And even with that, they’re down 30, 40%.
Amazon lost 25% in two days. Amazon. These are just astronomical. Which is a solid company. I love Amazon. I don’t have any… Company. Yeah, it is a solid company. And I like Amazon, I like the tech, I like the delivery service. And everything they do is correct. But I mean, realistically, they were, them and along with another dozen tech names were so over inflated for the last two years because the market just kept pumping up to just the high heavens that this was just I mean, it was an easy call that tech had to come down.
And on top of that, tech is based on zero rates. We’re not going to see zero rates for years.
TN: Right, that’s fair. Okay, so, you know, one of the hedge funds, I can’t remember who, was pushing Meta or Facebook now, I guess, again, to cut 20% of their workforce. Do you think something like that is possible?
AM: And it sounds like a lot, but given what’s happened with their valuations, do you think a 20% cut is possible? Do you think more or less is possible? And 20% is a lot. Usually when you have over 12%, you start looking at a company as going into bankruptcy. That’s one of the signs that you look at. So 20% is way too much. I don’t think that’s going to happen. Maybe seven to 10% staggered over the next few years.
TN: Okay, that’s fair. But I mean, they hire a huge number of people. What that would do to wages in tech would be immediate, right? $300,000, 22-year-old dev, that would be gone.
AM: Well, yeah, that cuts into the state’s budgets also because they take those tax revenue and whatnot. The other thing that we should talk about is China’s mix with the tech industry. I mean, now that the US congress, like Isaac was saying, is actively trying to prevent companies to go over there, I don’t know where tech earnings are going to come from. I just don’t see it. They’re taking away massive market share. They’re taking away supply chains and semiconductors and everything. I don’t see any silver lining in tech for the next two, three years.
I think they need to run size their organizations and really focus. Plus there’s more competition in the ad market, so you’re not going to see ad rates necessarily rise from here for some time.
So, yeah, I think there’s a lot of headwinds. I actually have to get Isaac’s opinion on this one is no one is talking about the tech industry in China competition with American companies in countries like India. Right? Because you have Chin Data and a couple of other countries that are massive and makes generate a ton of cash out of there.
And nobody’s talking about the competition level in India between the two. And I don’t know if you’ve heard anything, Isaac, but like, that’s something that I wanted to start looking into.
ISF: I think that’s an excellent point, is it doesn’t get nearly enough attention. And the market for the rest of the world for most of these companies is larger than the market for the US and China combined. There are a lot of contested spaces, especially in countries like India, Brazil, Indonesia.
And I think the lens through which we should see it is the political battle between the US and China because both countries are really pushing all of these third countries to be more sympathetic towards their way of view because so many of these tech companies can be hobbled by regulations. We see that with Huawei. We see that a lot in India where there’s a lot of distrust for Chinese tech companies, a lot of restrictions on the ability of Chinese tech companies to operate.
And so it’s protectionist, but it’s good political warfare for both sides to be making these arguments in countries around the world. And it is good business for these companies to be spending heavily on government affairs in all of these companies, in all of these countries and figuring out how they position their relationship with the government, whether it be the Chinese government or the US.
AM: Yeah, and that’s something I actually criticized the Biden administration that they’ve been so hard on India about using Russian tech and Russian oil. It’s like, come on, you guys got to be a little bit pragmatic here. You know what I mean? They’re stuck between a rock and a hard place with China and Pakistan.
TN: True.
ISF: I think that’s a great I mean, they buy huge amount of weapons from Russia, and they buy those in large part to defend against China.
TN: Yeah, very good. Okay, great. Thanks for that, Albert.
Now, Tracy, let’s move on to crude inventories. I’ve got a Tweet up where you talk about there was another draw this week.
And we saw a draw on global inventories. As we have inventory drawdowns, we have OPEC supply contracting by what, about 1.2 million barrels per day, something like that. Russian crude sanctions starting. We also have with the SPR, it was interesting to see the US became the third largest exporter of crude, I think last week or something, with over 5 million barrels per day because of the SPR draw.
So we know global industries are low, but when does that start to bite? I feel like the easy answer is well, after the SPR stops, right? What more to the story is there?
TS: I mean, I think it really depends on where you are. I mean, we’re already seeing the SPR. Those draws are kind of dwindling down, right? We’ve gone from about seven, 8 million barrels per week to 3.5 million. Even though that’s still a lot. That’s been part of the reason why we’re exporting, because we kind of, first, we were drawing down sour crude because that’s really what US refiners need. But at some point, that’s almost gone, so we had to start releasing sweet crude, and we can’t do anything with those barrels. And so they are making their way to China, they are making their way overseas.
And that’s why our exports have increased over the last few months there. In particular, we’re kind of seeing an uneven balance where we’re seeing global inventories are drawing, still drawing, right? US inventories are drawing, by all intents and purposes. I mean, we had, what, a 2.8 million build, but we also had a 3.5 million SPR release and an adjustment factor of 15.8 million barrels. Technically, we are drawing. And really, if you include the SPR, we had a draw of 5.9 million barrels total crude plus products this week.
But we are seeing what’s interesting is we are seeing Japan. Their stocks are actually going up because they’re stockpiling mad right now. So they’re buying everything from everybody. It’s stockpiling, and they were giving subsidies for companies to buy that in their SPR. So Japan kind of had a different kind of way of looking at things and the rest worlds just dumping. But they’re literally stockpiling.
China did stockpile for a while, but really their SPR is down, obviously, from the 2020 highs. They’re not stockpiling as much. But with China, I know that there are many problems going on there, but if they increase those import quotas for the Teapots, then we’re going to start seeing them by a lot.
TN: By Teapots, you mean the small refinery?
TS: Is just correct, because they’re talking about possibly raising those import quotas. But we won’t really find that out until December, and that’ll be for into 2023.
TN: Okay, so just a question on both, well, in Japan, first of all. With the yen at these dramatic lows, they’re stockpiling and it’s hugely expensive for them. It’s not just kind of incidental decision, this is a really intentional decision for them to stockpile. So are they partly, do you know, are they partly stockpiling
on geopolitical concerns?
TS: Yes, absolutely. I believe so. And all around, because we really saw them that sort of started to kick off in March after Ukraine invasions. Same with LNG, right? They’ve always been huge importers of LNG, the world’s largest, but they’re importing even more because they’re kind of seeing what’s happening in Europe right now and they don’t want that to happen to them.
AM: I think it’s a little bit more than that. Also, I think that they see that we’re probably even got cues from the US that Japan is going to be a manufacturing hub to try to pick up the slack from China. So I think they’re preparing for that in 2023, 2024. And on top of that, the price of oil right now, that’s still discounting China not stimulating because once China stimulates, the demand is just going to skyrocket.
TN: Okay, all three of you guys want to ask about that China stimulus. So you guys all know China Beige Book, and they’ve been saying everyone’s really foolish for thinking China is going to stimulate, and they’ve been saying that for something like six months. Right? And I hear a lot of people say, oh, they’ll stimulate after the Party Congress. I said that too, and we still haven’t seen that. Do we think that we’re going to see stimulus in China, say, before Chinese New Year, which is what, February?
ISF: I would say absolutely not. I think the real stimulus for the Chinese economy, too, will be less a government led infusion of capital and more a relaxation of COVID concerns.
And I think that’s going to be a lot more likely after Spring Festival than after the March Congress because, A, you have the appointment of the premiere, you have some important events there, but you also don’t have to worry about mass contagion with hundreds of millions of people wanting to travel.
So I think the base case for the opening of the economy and then potentially economic inflation is after the Congress, after Spring Festival. And who knows, it’s very hard to predict, but that would be my best guess for that.
TN: I think that’s really solid. What do you think about that?
AM: Yeah, I think COVID Zero policies are going to be still in place until March. There’s no question about that. I think stimulus happens around the same time that they think that inflation is under control. I think that’s pretty much their driver at the moment, because if they stimulate price of copper and oil and everything in the country is going to go to the moon and they know this. So I think it really depends on inflation. What the US can do to tame it.
TN: So when do you think they’ll think that inflation is under control?
AM: I think close around March after the US. And also the end of quantitative tightening and whatnot. So it’ll probably be a coordinated effort.
TN: Okay, so Tracy, if they just let go of the lockdowns, what does that do to crude demand?
TS: Well, definitely we obviously start to see that rise because they’re locking down millions of people at a time, you know what I’m saying? An entire city, and not for a couple of days. We’ve seen some cities lock down as long as two months.
So I think as soon as they start relaxing that we’re definitely going to see demand come flooding into the market.
And again, China hasn’t really been stockpiling this whole time during this, which they have a little bit from their lows, if you look at their SPR, but not a lot. Not as much as everybody thinks they are. Everybody thinks they are because oil prices are lower and they like lower oil prices. But really, comparatively speaking to how they purchased in the past, the SPR hasn’t been as much as most people think.
AM: Okay, do you think that they could be? First of all, I don’t trust the data of China. I don’t have anything.
TS: Well, what we can see from satellite systems, right? We have no idea what their underground storage looks like or anything of that nature. But what we can tell and what we can track, what’s actually going into the country.
AM: Do you think that they can hide that in tankers on the sea for a while?
TS: Yeah, absolutely. I mean, they’ve been known to do that before. Absolutely. They’ve used Myanmar,
AM: Singapore also, I believe.
TS: Well, Singapore is a little bit harder to hide just because it’s so huge and so many people are tracking vessels there. So they kind of like to kind of stay away from there when they’re kind of trying to hide stuff.
But definitely, I mean, they’ve, you know, hidden purchases from Venezuela through Singapore, through other ports in that area. From what you can see from the best guess. From the best guess, what you can see, what you can tell what satellite services have picked up, like Kepler or whatever.
TN: OK, let me kind of close up with this question. So I just filled up with gas in the US last night and I posted this price in Texas is $2.95. So I’m sure you’re all jealous. I said, will this be 30% higher by the end of the year? Because post election, SPR releases stop, other things? Do you expect gasoline to rise, say, as much as 30% before the end of the year since SPR release and other things are stopping? Or do you think we’re kind of in this zone that we’re going to be in for a little while?
TS: Well, I think that generally this is kind of lower demand season anyway, right? I mean, usually typically we don’t see prices really start to rise again until about mid December, just seasonally speaking, right before the holidays. Christmas in particular, and everybody goes on vacation, et cetera, et cetera.
But I think, I don’t know. 30% might be a lot for this year, but definitely for next year we’re going to have some problems because they took that last 10-15 million barrels and they pushed that out for December, so we’ll still have some releases then.
So I think they did that it was actually 14 million barrels that are left and so they did push those out until December. So they’re kind of going to triple it out in order to kind of control prices.
TN: Okay, so the selection bias for people telling me that I was right is wrong.
TS: I think it’ll probably depend on where you are in the country, you know, depending on the state. Yeah, absolutely. I mean, if you’re in the Northeast, you’re going to have a huge problem, right, because they have the same issues going on that Europe. They don’t have any pipelines, they don’t have any storage, and they don’t have any refining capacity.
So this winter, especially with the diesel shortage, you’ll probably see the highest gasoline prices, obviously in California and then the Northeast will be the next higher.
TN: And I just want to say to everybody, I’m not promoting the gasoline price as a reason to move to Texas. I mean, it’s all scorpions and rattlesnakes and really terrible bagels here, so please don’t move here. It’s just an incidental benefit of living in a place that’s a pretty rough place to survive.
So anyway, guys, thank you so much. Isaac, really invaluable. I don’t think we’re going to gotten this perspective from anybody else on earth, so I really appreciate the time that you spent with us.
Albert. Tracy. Thank you, guys. I always appreciate your point of view. So thanks very much. Have a great weekend. Thank you.
Investors were not impressed by results from Meta and Alphabet leading to a sell-off in tech stocks on Wall Street. We speak to Tony Nash, CEO of Complete Intelligence, to find out how results from Apple and Amazon set to come out soon might impact overall market sentiment.
Transcript
BFM
This is a podcast from BFM 89.9, The Business Station.
BFM
BFM 89 Nine. Good morning. You’re listening to the Morning Run. I’m Shazana Mokhtar with Keith Kam. It’s 7:06am on Thursday, the 27 October a rather overcast Thursday morning. For now, perhaps we’ll see the sun come out a little bit later. As always, we’re kickstarting the morning with a look at how global markets closed overnight.
BFM
It was a bit of a mixed day for what generally red though the Dow Jones on Wall Street, the Dow Jones ended marginally higher, that’s 0.01% barely changed. S&P 500 was down 0.7%. But the action was on the Nasdaq that closed 2% lower because of disappointing results from Meta and Alphabet. We’ve just got to wait for the Apple and Amazon results that will be out tonight US time. So we’ll be discussing that tomorrow. Early in the day, Asian markets were generally green. The Nikkei was up 0.7%, the Hang Seng was up 1%. The Shanghai Composite and Singapore’s STI, they were both 0.8% higher. And back home the FBM KLCI closed 0.7% up.
BFM
For some thoughts on what’s moving international markets, we have on the line with us Tony Nash, CEO of Complete Intelligence. Good morning, Tony, thanks for joining us today. Now, notwithstanding overnight results, global equities led by US stocks have extended gains over the last week, avoid by the expectations that peak inflation has been reached. What do you think? Are they being too sanguine about inflationary pressures?
TN
I don’t necessarily think they’re being too sanguine. There are cases to be made that housing prices and wage growth have turned the corner. Goods price inflation has likely peaked, but there doesn’t necessarily mean that we’ll see prices decline. Regardless of what’s happening in the inflation environment. The Fed is going to raise rates in November, likely by 75 basis points and again in December. So the Fed typically lags inflation on both sides on the way up and on the way down and so they’re likely going to over tighten. Markets have largely factored in a 75 and 50 basis point hike over the next two months. So are they sanguine? I don’t know. I think if we start to see inflation really take a downward turn, then it could be a very good thing for all of us.
BFM
But Tony, the 75 basis point expected hike by the Feds comes at a time when a lot of analysts are also expecting recession to hit the US sometime sometime next year. Would there be some reassessment as we go along?
TN
Well, we’ve already had kind of negative economic growth for half a year, so we do need to see jobs come down. And with the tech earnings coming out, as you guys mentioned in the news segment, we expect tech companies to announce some pretty major layoffs before the end of the year.
BFM
Let’s get into that a little bit, Tony, in terms of tech results, I mean we did see Meta overnight, we’ve seen how Microsoft also came in below market expectations. What do you think this tells us about the direction of the tech sector moving forward, especially with this environment of rising interest rates and a looming global recession?
TN
Yeah, well, tech companies have overhired. They were hiring based on valuation, not necessarily based on revenue. And so now that their valuations have come down, they have excess staff and they need to clear the decks. And the productivity within the technology sector, although it sounds a little weird, the productivity is pretty low because they’ve had too many people. So as these companies come out and give pretty sad earnings reports, there’s going to be pushback from investors that they need to lay people off, and that will come out in the next couple of months. So we’ll see some of that. Now, if you compare that to, say, companies like Coca Cola and GM who beat the street, those companies have been able to pass on cost rises to their customers, so they’ve factored in cost rises to their price. Now, many of those companies saw volumes decline, but price rises more than made up for the volume decline. So they’ve beat expectations by raising price, in many cases by double digits.
BFM
Tony, we’re expecting Amazon and Apple results to come out tonight, and what we’ve seen from the previous results have sort of, well, dampened market sentiment, if you may, what are your expectations going forward?
TN
Yeah, I don’t think they’re going to be stellar results. I think Amazon had this, at least in the states, they had this kind of second prime day a couple of days ago to goose sales revenues for the quarter, which tells me that things are not stellar at Amazon, and so there are signs that things aren’t working out. The new iPhone is kind of a yarn for a lot of people, so it’s not necessarily pushing out. And so I think the expectations are for pretty mediocre results. So if they report in excess of expectations, then tomorrow will be a fantastic day in markets. But I don’t think that’s necessarily likely at this point.
BFM
All right, something we’re going to be keeping an eye on. Another thing to keep an eye on is the slew of indicators that are going to be coming out. We’ve got US GDP, durable goods, and initial jobless claims numbers. Which indicator are you paying the most attention to in terms of being a gauge of how well the economy is going?
TN
Yeah, one of the things that I always tell people to be careful of with some of these macroeconomic numbers is things like GDP. What’s being announced is what’s called a preliminary release. So they kind of have a sketch of what’s happening in the economy, but it’s not detailed. So when these GDP announcements come out and it’s the first release, it’s not really accurate. And those things can change by 50% or more in some cases. So GDP is not really something I look to. It’s kind of a headline, but it doesn’t really mean a whole lot.
TN
Durable goods is interesting because that tells me that people are investing in things, buying things that last a long time so that they can deliver new services or new products in, say, three to six months time. So that would tell me people are looking forward. So if durable goods is a bad number, then it tells me people are really just trying to take care of today and not investing in the future.
TN
Jobless claims. I don’t know. Sometimes it’s meaningful, sometimes it’s not. I think the sentiment around jobless claims is overhyped. The Fed is definitely watching jobless claims because they want to see wages and jobs come down. So with jobless claims, it’s one of those good news and bad news types of things. So we’re kind of hoping for a poor jobless claims so that the Fed can kind of tick off the box and say, mission accomplished.
BFM
Tony I just want to pick your brains on this. We’ve seen three straight days of market gains on Wall Street and this morning, or rather last night for you or today for you. We’ve just seen a reversal of that. Is this an indication that maybe fortunes might be changing going forward?
TN
I think it’s a good question, and I think it’s hope that the Fed is changing course. And I think regardless of what comes out, say, this month, and I think probably next month, I don’t think the Fed is going to change course. They were caught flat footed. They said that inflation was transitory, they messed up, they’re embarrassed, and they’re going to make people feel it. And people are going to lose jobs and homes and all sorts of things because regional Fed governors don’t want to be embarrassed again. So I think at least over the next two months, they’re probably not going to change course. They’re going to continue to tighten. I don’t think there’s been a dramatic change in everything. I think this is a little bit of hope, and I think it is some earnings that have been reported that are better than expected. But I think in general, people are being very cautious about trades they make.
BFM
Tony let’s end the conversation with a look at oil prices. They are taking a breather on news that US stock bells have risen. How will that translate in terms of energy prices as the Northern Hemisphere moves into winter?
TN
Yeah, the SPR, the Strategic Petroleum Reserve release, it’s put a lot of volume in the market in recent months. And of course, that’s lowered crude prices and it’s lowered the price of refined products. So after the election, and it’s no secret we expect the SPR releases to decline dramatically. And we’ve talked for a few months about how we expect crude prices to kind of spike towards the end of the year. And that would be spikes in crude prices and downstream products like, say, petrol. So we do expect that to happen in the North American market, kind of in Q4 and through Q1 out of the effects of that SPR release wear off.
BFM
And meanwhile, OPEC has also forecasted that China’s oil demand will decline by 60,000 barrels per day. Is that something that you see could cap further spikes in prices?
TN
It could. I mean, 60,000 barrels isn’t a lot, but it could. I think if China were simply to end COVID Zero, it would really drive consumption of crude. So OPEC must expect further dampening of the economy in China, and that’s no surprise. I mean, China is really having a hard time right now, and whether or not they can come back in ’23 is questionable, so it’s no surprise. But 60,000 barrels a day really isn’t a lot, and I don’t think it would affect prices dramatically.
BFM
Tony, thanks as always, for speaking with us this morning. That was Tony Nash, CEO of Complete Intelligence, giving us his take on some of the trends that he sees moving markets in the days and weeks ahead.
BFM
Yeah, so we did see Meta shares plummet 17% on week fourth quarter forecast. And earning miss. It basically came up well short of Wall Street’s expectations. Earnings per shares earnings per share was $1.64 versus a $1.89, which was what was expected. Revenue was at $27.7 billion. Daily active users did meet expectations at 1.98 billion users, and the monthly active users came in at 2.96 billion versus 2.94 billion.
BFM
I mean, Meta is contending with a broad slowdown in online ad spending, challenges from Apple’s iOS privacy update and increased competition from other players like TikTok. It’s getting more expensive to run the company as Meta’s costs and expenses rose 19% year over year to $22.1 billion. And that’s something that Tony alluded to earlier, the fact that they’re likely going to see more layoffs moving forward. Tech companies have just been on a hiring spree that they cannot afford at this point. And I bet the WhatsApp outage the other day didn’t help a Meta’s fortunes either, at least in terms of its reputation and image. It could see a lot of people try to migrate elsewhere from using WhatsApp as their main communication source to another platform that is more stable, perhaps.
BFM
I must say we could wait until to see what happens towards the end of the year. Well, November actually, just next month when the midterm elections come, and we see if there’s any pick up in usage then.
BFM
That’s true. All right, it is 7:18 in the morning. We’re heading into some messages, and when we come back, we will be covering the top stories in the newspapers and portals this morning. Stay tuned. BFM 89.9. You’ve been listening to.
BFM
A podcast from BFM 89 Nine, the business station. For more stories of the same kind, download the VFM app.
In this episode, we’re joined by our special guest, Simon Mikailovich from the Bullion Reserve, along with regular guests Tracy Shuchart and Albert Marko.
First, we looked at systemic risk in the case for hard assets with Simon. When we look at recent events like the BOE intervention in the long-term gilt market, where does he think the next systemic risks could come from? Is it developed more market (European) debt?
Also, Simon discussed how we should be looking at the gold market now. Why is there a divergence between physical gold at the retail level and institutional demand for gold derivatives?
Next, we went into a little bit on OPEC cuts with Tracy. OPEC cut supply by 2m BPD. Everyone has talked about this. We’ve spoken in earlier episodes about a price spike in oil later in Q4, partly owing to SPR releases stopping or slowing. Is this even likelier now? Some US legislators are pushing a bill to break up OPEC. Is that even remotely possible?
And then finally, we took our first look at US midterms. Democrats now control both House and Senate. That’s a huge advantage for Joe Biden. For many reasons – inflation, crime, etc – Democrats are in trouble for November’s midterms, but will they lose control of both the House and the Senate? Albert discussed that in this episode. We’ll cover more of this in the coming weeks, but we want to have a starter conversation here.
Key themes: 1. Systemic risks and the case for hard assets (Gold) 2. OPEC cuts = Q4 Crude price whipsaw? 3. US Midterms 4. The Week Ahead
This is the 37th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Tony Nash: Hi, everyone, and welcome to The Week ahead. I’m Tony Nash. This week we’re joined by our special guest, Simon Mikailovich from the Bullion Reserve. Simon, thanks so much for joining us. We really appreciate it. We’re also joined by Tracy Shuchart and Albert Marko.
We’ve got a lot to dig into this week. The first we’re looking at is systemic risk. And the case for hard assets? We’ll dig into that quite a bit with Simon.
Next, we’ll go into a little bit on OPEC cuts with Tracy. You’ve all heard about it, there’s no secrets there, but what do we expect for crude prices in Q4?
And then finally we’ll take our first look at US midterms. I think we’ve got a lot to talk with Albert about over the next few weeks before US midterms, but we’ll just do a quick dive in this week.
So before we get started, please take a look at our product, CI Futures. It’s a forecast subscription product. It’s $99 a month. We cover a few thousand assets over a twelve month horizon, economics, currencies, commodities, equity indices. So please take a look at that. The URL is on the screen. Thanks a lot for that.
So, Simon, welcome and thanks for taking the time on a Friday. I know there’s a lot going on in markets, so it’s a huge compliment for you to be here. I want to ask about systemic risks, something you tweet about quite a lot. And we put a tweet, one of your tweets on screen.
You talk about the BoE commits to ensure unicorn in every pot. And this happened a couple of weeks ago, the Bank of England. And I’m really curious, when we look at events like the BoE intervention in the long term guild market, where do you think the next systemic risks could come from? And I guess, more specifically, do you expect those risks to come from developed, more developed markets or emerging markets or does it matter?
Simon Michailovich: First of all, it’s a very difficult subject because obviously you can spend hours and hours talking about it. It’s like the existential problems of our time. And I know we’re also going to talk about gold and systemic risk. What I think I’d like to do is I’d like to have a little parable that kind of explains, I think, or illuminates the situation that we’re in generally. And the dichotomy that may exist, I think exists between markets and life out there.
And terrible comes from very appropriately named for the Times from Russia With Love, which is Ian Fleming’s story, one of the James Bond books. And just to set up this quote that I’m going to read to you, the situation is that James Bond is absconding with a Russian decryption machine on a train and it’s supposed to be met somewhere down the line by the British intelligence agents. And he’s accompanied by a much wiser and older head of station from Istanbul whose name is Kareem Bay.
And Kareem advises him to get off the train immediately because there’s existential danger. They’re being hunted and Bond wants to see this gamble through. And so Kareem tells him a little story which I’d like to read to you which I think kind of explains more or less or answers a question about systemic risk and generally what’s going on between the markets and events that we’re all observing through press but may not necessarily fully understand or yet appreciate their implications.
So what Kareem tells him, he says “you’re a gambler. To me, this is business, to you this is a game.” And then he puts a hand on his shoulder and he says, “this is a billiard table. An easy, flat, green billiard table and you hit your white ball and is traveling easily and quietly towards the end. The pocket is alongside. Fatally, inevitably you’re going to hit the red and the red is going to go into that pocket. It is the law of the billiard table, the law of the billiard room. But outside the orbit of these things a jet pilot has fainted and his plane is dining straight at that billiard room or a guest main is about to explode.
It already has actually, in the real life with Nordstream or lightning is about to strike and the building collapses on top of you and on top of the billiard table. Then what has happened to that white ball that could not miss the red ball and to the red ball that could not miss the pocket. The white ball could not miss according to the laws of the billiard table.
But the laws of the billiard table are not the only laws. And the laws governing the progress of this train and of you to your destination are also not the only laws in this particular game.
And so the point is that for 40 years, the markets, the financial system and the economy has gone along with that, have lived by the laws of financialization, by the laws of the billiard room and of the billiard table and other laws that are outside the real economics more famine, pestilence, inflation have not entered into the equation. And so within the framework of the billiard table there is no, for example US Treasuries do not have credit risk. US dollar does not have counterparty risk. Banking deposits are safe, 100% safe. That’s by the laws of the billiard table. That’s by the laws of the markets.
So essentially this bubble, the everything bubble that the credit bubble that we have been in for x number of years. All the problems inside this bubble were nominal problems related to nominal values in financial markets. And those values can be fixed by creating additional money, by creating additional credit, by creating conditions, by providing liquidity. What cannot be fixed inside this bubble are real problems like energy shortage, like supply chain disruptions, like World War, like the fact that a significant number of other countries are suddenly developing their own ideas as to economic policies and monetary policies and other policies that they want to pursue.
Whereas our system has come to depend on the US dollar as a source of cheap financing without any limits and without any constraints on our ability to create credit, create money, pay the bills, however much, in any quantity at any time. So when you ask me about systemic risks, what I would say is that systemic risks are coming from outside this framework and are not yet fully understood inside the framework.
Which is why, for example, the dollar is on a tier relative to other currencies. And the phrase that’s used to describe it is it’s the least dirty shirt? What is not being said in that statement is how dirty is the least dirty shirt? Has it been already worn for ten days and all the other ones for 20 days, or is it just been worn for ten minutes? That’s my point. So how healthy is the healthiest course in the soap factory? That’s the question, right?
TN: And I guess the question about systemic risk, which is almost unanswerable. But when these things break, do they usually break gradually or do they usually break all at once? Is that an answerable question?
SM: Well, they break gradually and then all at once. Just like the famous also overused quote from Hemingway how do you go broke slowly and then all at once? Obviously you can think of this phenomenon as a confidence collapse. Now, confidence collapse is not a problem in itself. It’s a consequence of other problems where the preponderance of the evidence and preponderance of the mental recognition reaches a certain critical mass, where in the physics it’s called phase transition.
Like for example, boiling water, which looks the same whether it’s half boiling or almost boiling. And then suddenly you see the bubbles, you see the churn, and it almost happens in moments, but it didn’t happen in the moment. It’s been heating up for a while. So that’s how I would describe it. And
TN: this is all great, I guess, if we have a doomsday clock, are we like really close to midnight or are we kind of approaching midnight? And it’s something that will come at some point I know that’s kind of an ambiguous question, but does it feel to you like we’re really close to midnight or can we put it off for a little bit?
SM: Well, I would answer it this way. I think the proverbial train has left the station. The crisis is now underway. Okay? The crisis, geopolitical crisis, military crisis, supply chain crisis, economic crisis, and financial crisis. All of the… And political crisis. You’re going to talk about elections. So all of these events, and by crisis I mean a moment of high danger, again develops similarly to boiling water. Crisis itself, once it starts, it means the heat is now in real time, is going up. The boiling point has not yet been reached. How long does it take to reach it? It depends on the intensity of the flame. Right. So that we cannot gauge. But what we can gauge is that the process has started and it can accelerate or decelerate as it goes, but I don’t think it can stop suddenly.
TN: Right. And a US president using the word Armageddon in a fundraising speech half a dozen times this week doesn’t really help lower the boiling point.
SM: It does not help lower the boiling point. It does not help. And frankly, I think that people are not paying much attention to what happened with this Nordstream explosion. But this is the first act of sabotage on an international against an international supply chain infrastructure, which I think is going to have dramatic consequences ultimately, because it changes the rules of the game. Sure something unthinkable becomes feasible.
Albert Marko: Just real quick. I agree with Simon on the systemic risks. And the fact is the Fed policies have completely ignored geopolitical issues, political issues, supply chain problems. I mean, they keep going on this tear about raising rates is going to bring down inflation, but then they put themselves in doom loop because the demand is going to come back faster than the supply damage that they’re creating.
So, yeah, Simon is correct that the systemic risks are there and getting worse and that’ll see any chance that they can be alleviated in the next six months. I’m skeptical that ongoing rate rises or rapid rate rises is going to have an impact on inflation given… Wait till they end QT in the next couple of months and continue on with rate hikes thinking that’s going to fix things. It’s not. It’s not. It’s whistling past the graveyard. It’s way overused. But that’s what we’re doing.
TN: So before we move on to other things, I want to ask you about gold. Okay, Tracy, kindly put out some questions for you last night. And we got some responses from some Twitter users and this Twitter user @Spudlink1, asked, “if gold doesn’t rally in this environment, how could conditions possibly get more perfect than the last three years? Is gold dead?”
So, very poignant question, but what are your thoughts on that?
SM: So my thoughts on that are very simple. Gold itself. Gold is not a company. It doesn’t release results. It’s not like things are going better or worse. Gold is the same gold. So the price of gold and the prospects of gold are not determined by gold itself or anything that it does, but it is determined by supplying demand, which is human driven. So it’s human perception and human behavior.
So why is gold not behaving like certain people like this gentleman expect it should? That’s because what this gentleman thinks and what few of us think is not accepted as received wisdom by the vast majority of investors. That’s not consensus.
So the fact that these are perfect conditions for gold is absolutely not consensus because by the rules of the billiard table inside the billiard room, gold is not seen at the moment as a safe haven. The dollar is because the dollar is fiat gold. Now, fiat of gold is no gold. But inside this framework that we’ve been in for 40 years, it has been and so demand for gold, you don’t need to take my word for it. I mean, you can just look at the ETF flows like GLD publishes ETF laws and you can see that money is not flowing into gold.
So demand from investors for gold is anemic in an environment where some of us think it should be robust. But that’s because we see certain things and we believe that there’s tremendous systemic risk and market large does not believe it.
Again, you don’t need to take this as the only example. You can look at the Treasuries, they’re trading, I mean for something percent with the percent inflation. Well, why is that? Well, because the breakeven rate, which is market expectation of future inflation, the curve, the forward curve shows that rates are actually positive and getting more positive because inflation is supposed to drop to 2-3% imminently. Well, is it going to? Well, that’s conventional wisdom is that it will. So that’s one thing.
The other thing I would say is when people say that gold is dead, I mean, it’s an American century theory because gold is essentially a reserve currency. It has outperformed all other currencies, reserve currencies but gold. So let’s say in dollar terms gold is down like 6% year to date, but in yen terms it’s up 18%. In pound terms it’s up 13%. In Europe, in Swiss Franc, all of the DXY components, currencies, DXY, Canadian dollar in all of those currencies, gold is up.
So gold is outperforming financial assets, stocks, equity is down 23%, Nasdaq is down whatever it is, 33% or 34% here today. Gold is down 6%. So it’s outperforming financial assets and an underperforming US dollar because US dollar is gold by the rules of the billiard table and the guest line has already blew up, but maybe the plane has not yet hit the room.
And so as long as that’s continuing, everybody’s playing by those rules where there’s no credit risk in the dollar. So if there’s no credit risk in the dollar or in Treasuries, in US sovereign obligations, then by the dent of that reasoning, getting any kind of coupon beast getting no coupon, if you factor out credit risk and market is not factoring in credit risk, I think the credit risk is tremendous. And obviously people who are asking and wondering how come gold is not surging, they think there’s credit risk. But that’s a minority opinion. That’s a simple answer to that question.
TN: And that is fantastic. Thank you so much for that. This is an amazing perspective because I think there is a lot of cynicism around gold in the markets today around kind of popular chatter. And it’s so great to get this perspective.
AM: Tony, I mean, I’ve been a big critic of gold for a long time. However, in this scenario, I even have to admit that if you want to arbitrage for dollars, especially in other currencies and FX’s, gold is the only real way to do it. And the longer that the Fed makes errors in policy, there’s no question that people are going to start resorting to gold just as a hedge.
SM: My only warning to people is gold is a commodity that’s sort of it’s an industrial commodity in physical form. So, of course, all the paper gold exposure has counterparty risk. Physical gold does not have counterparty risk, but physical gold is a manufactured product. And manufactured product borrows coins.
By the way, the premiums on coins are surging, and it’s doubled this summer since the beginning of the summer. So manufactured products, they’re supply chains, they’re manufacturing facilities that produce them. They can work 24 hours a day, but three ships, but they can’t work faster than that.
So just like with toilet paper, it all works until suddenly there’s a surge in demand. Then there’s no toilet paper in your supermarket. It’s the same thing with gold. It’s available until everybody wants it, at which time, by definition, it’s not available because the inventory and supply chain is geared towards test demand, not towards surging demand. So as soon as demand surges, it disappears.
So you buy insurance when you can, not when you think you really need it, because you’re not the smartest guy or person you know, other people achieve the same reach the same conclusion at the same time. And so everybody wants insurance at the same time.
TN: You’re the only guy I’ve ever heard who compared gold to toilet paper in a positive way. Yeah. Okay, let’s move on to crude from one physical quantity to another. Tracy, we talked about OPEC in recent weeks. We talked about crude prices in recent weeks.
And with the OPEC announcement, the supply cut announcement this week, I want to revisit our discussion from a couple of weeks ago about crude prices in Q4. We talked about the possibility of a whipsaw effect for crude prices in Q4. What’s your thoughts on that? Do we see that happening?
Tracy Shuchart: Well, I think what we’re… First, I kind of wanted to touch on this 2 million barrels because it’s not actually a 2 million barrel cut, right? Because the group hasn’t been producing a quota all year, basically. So we’re running at a 3.58 million barrel shortfall, really, which happened in September. And so if we take a look at the cut distribution, yes, the five countries that are producing at or near quote, which are Iraq, Kuwait, Saudi Arabia, UAE and Russia, yes, they are shouldering most of that burden. But when you net everything out, it’s really closer to like 1.25 million barrels. So I just kind of wanted to clear that up because it’s really not 2 million.
Going into Q 4, what we have to pay attention to is, one, the ending of the SPR, which if they keep releasing it, eventually it will drain. But so far it should end in November, which is going to immediately take four to 7 million barrels off the market because that’s kind of what they’ve been releasing per week on average. Then we also have to look at China and their COVID lockdowns trying to come to an end because they’re looking for 5.5% GDP by end of year, which is not going to happen.
TN: Well, it’ll happen.
TS: Well, on paper it’ll happen. Statistically it’ll happen. But we are starting to see a little bit of firmness in mobility data in traffic and airlines. What I’m also looking at is they are talking about lifting export quotas. If they do that, that means they are going to have to purchase more crude barrels because it would be a significant increase. Those are kind of the things that I’m.. Going into Q4, in other words, I think the pressure is definitely to the upside rather than the downside, just looking at what is coming online potentially that could propel this market higher as far as… I mean, we’re already in a structural supply deficit, so it’s not going to take a lot for this kind of freak out.
TN: Post US midterms, post CCP meeting, post SPR, post other stuff. Right.
TS: And then December 5, we have to see if EU actually follow through with their oil and product embargo for Russia. So also another thing that would take more barrels off the market.
TN: Right. So I’ve also heard, I think you may have said it where this OPEC meeting, and what we’ve seen over the past few months is really OPEC changing their orientation to Asia and really forgetting about the west. Is that real? Are you seeing that, in fact, or is that just kind of a myth?
TS: Well, no, I mean, if you look throughout the last few years, I mean, China and Russia basically compete, sorry, Russia and Saudi Arabia basically compete for China’s fitness. So off and on, one of those countries has been their biggest suppliers. So this is not new where the focus is towards Asia, especially because over the last few years, the west is pursuing green policies and trying to stay away from that. And so where they can sell barrels like you see Saudi Arabia or you see OPEC in general raising their OSP to Asia consistently, right. Because they can capture above markets for their barrels. That’s not really a new phenomenon.
TN: Well, China’s perpetuating green policies, too, right. Kind of wink wink, supposedly as they build out coal plants and other things. But I think what I find interesting is Europe and the US are kind of begging for more energy and OPEC is saying, no, we’re going to cut back. I think the headline is more important than the fact the 2 million is more important than the 1.25, because that’s what really moved markets in the immediate term. But China had really bought all their crude already by, say, April or something, right? And so they had fixed all that stuff, the prices for the year in kind of second quarter. So this doesn’t at least for now, it doesn’t really affect them. It won’t affect them until early next year or something like that. Is that fair to say?
TS: Well, unless in Q4 they raise these export quotas, then it’s going to matter because that’s still on the table for discussion next year. This is kind of a last-minute thing. And so that’s definitely something that I’m watching if they actually follow through with that. Right?
TN: And also with purchases in a dollar equivalent, whether it’s not US dollar, whether or not it’s US dollar, these are extraordinarily expensive barrels compared to what they could have gotten in Q2. So something has to change for them to want to buy the volumes that they bought. And then if they’re buying at the same time the US is trying to refill the SPR, that creates even more pressure on the market. Is that fair to say?
TS: Yeah, absolutely. In fact, our SPR barrels are going to China, right? Right.
TN: So, Tracy, what are we missing? I mean, we’ve heard all this chat about OPEC over the last couple of days. What’s the nugget that you feel like people are missing?
TS: I think as prices have come down, I think everybody has been forgetting we are still in a structural supply deficit. Even though prices were coming down, they were down to extraneous reasons like recession fears and not as many Russian barrels off the market as initially anticipated. But really, the market structure hasn’t changed, nor has the supply problem. Right. Let me add another question there. I want to ask about refining capacity. What are we at now with refining capacity? We need more refining capacity. 90 something. We’re currently we’ve been between 90 and 95% of our refining capacity, which is crazy because I’m actually surprised that we haven’t seen more heart breakdowns. They’re not built to Google at 95%.
TN: So we have a hurricane goes through Louisiana, cuts out some refineries for a week. What does that do?
TS: Well, that would be a little bit of a relief for crude prices, right? Because you shake it with the barrels. But that’s going to take your product prices through the roof, and your current tax rates are going to go through the roof.
TN: And what’s the lag on that? What’s the tail on that?
TS: That really depends on how long the refinery is offline for. Right. Whether it’s a week or two, that’s fine. But if we start going into, like Katrina, where you’re going in months, then that’s going to be longer. Problem.
TN: Okay, very good. Thank you for that. And as we talk about gasoline, it becomes very political at some point. And Albert, as we go into we’re deep into the midterm season right now, and I’ve got a couple of graphics from Real Clear Politics looking at the House and the Senate races in the US.
And it looks like it’s very competitive in the Senate. The House, it seems like Republicans are doing very well to reclaim the House, but it seems like the Senate is really competitive at the moment. Can you walk us through that?
AM: Yeah, well, simply, the Republicans will easily take the majority. Redistricting alone will give them 20 seats, which is the majority, and then you start looking at any Democrat that one with 2% or less across the country is probably going to lose. So I think that will probably end up getting 250 seats in the House of the GOP. So I think that would end up being like 185 for the Democrats, which is important because you need a buffer to avoid any messy infighting the Senate becomes difficult because the Republicans have kind of weak candidates in Oz, in Pennsylvania, and Walker in Georgia.
If those two candidates were stronger, it would have been a slam dunk, but it’s not at the moment. Nevada looks like it’s trending towards the GOP, which is a big, big problem for the Democrats at the moment. If they lose Nevada, they’ll probably end up losing Arizona. And if they lose Arizona, it’s going to be a one or two seat GOP majority.
TN: Okay, and so what does that do? Okay. We covered Pennsylvania, right? You said it’s potential
Republican but not strong. Georgia potential, but not strong. Arizona is leaning that way. Nevada is leaning that way. Wisconsin is Wisconsin.
AM: Wisconsin and North Carolina are solid Republican.
TN: Okay, so then what does that mean for the second half of the Biden administration?
AM: Not good things. Hearings all over the place, from Hunter Biden’s antics to Biden’s pipeline policies, environmental policies that’s affecting the economy at the moment. Border crime, elections, election integrity, I mean, you name it, it’s going to be all over the news. So it’s just not good for the Biden administration. I expect them to keep on going with executive orders because there won’t be anything that he can pass.
TN: Okay, very interesting. Now for the people not in the US. Most Americans view legislative gridlock as a good thing, right? I mean, it’s a good thing for business when we have legislative gridlock. So this is not necessarily a bad thing for US government. There will be a lot of talk about can’t pass a budget, can’t get extensions on certain things, and that’s just drama that comes every year. But legislative gridlock is not necessarily a bad thing for American business. Is that fair to say?
AM: It’s not. You’re absolutely correct about that. However, actually, with Biden insisting on producing executive orders for his own policies and the treasury, with the Allen just acting insane, in my opinion, god knows what they’re going to sit there and pass. If you can’t pass something legislatively, they’ll do it via budgets. That’s fine. But it sets a terrible pressing going. Forward because we’re well past that, Tony. We’re well past that president. We’re well past that.
TN: Okay, great. I want to cover this over the next couple of weeks as we lead up to the election. So I just want to give people a taste of what we can talk about. So if we don’t mind if you guys don’t mind, let’s just go around and I’d love to know what you guys are looking for in the week ahead. Tracy, do you want to get us started? Then Simon will go to you. And now what are you guys looking for for the week ahead?
TS: Obviously, I’m watching the energy markets right as we get closer and to see what sort of policies the US is going to or the current administration is going to try to pull out of a hat to derail oil prices in front of Midterms. They’ve been talking about fuel bans, fuel export bans. They’re talking about actually trying to pass the no peck bill again. They’re also talking about actually seizing assets of Saudi Arabia, which they do own, motivo, which is the largest refinery in the US. Which is paramount to all out oil war. So closely watching the administration and how they’re going to move forward with energy policy.
TN: is this Venezuela thing real? Will they dial back the restrictions on Venezuela to get Venezuelan crude?
TS: Venezuela produces 7000 barrels per day and literally most of that goes to China to pay debts. There’s nothing more you can squeeze out of Venezuela.
TN: Okay, that’s good to know. So that’s fake news. All right. Okay. Simon, what do you see
going into the week?
SM: Well, a week is not my reference, in my opinion, but I think that the most important thing people should be watching are international geopolitical developments because I believe we are in a world war. It sounds very dramatic. War usually is assumed to be bomb flying, but there are other forms of enforcing essentially will on other people and economic, financial, political, ideological, cyberspace,
space, outer space these days.
So I think the most critical thing to watch are developments like with Tracy’s talking about confiscation of Saudi refinery. I mean, that’s an act of war. That’s an act of economic war. So this is where I think a lot is going to come from. And the other thing I would watch very carefully for the types of developments like what we saw with Gilts in UK just overnight, things happen. Like for example, the repo lines right now are in excess of 2 trillion. I mean, in 2019, the first blow up, they went in with 30 billion. So this is a crisis that’s continuing and it’s being bailed out by the Fed.
So I would watch all these excess, telltales of all these excesses and watch for ripples on the surface to make sure to identify if something is really breaking. Like you said, when is it going to come? Well, is the water starting to boil? That’s what I want…
TN: Real quickly, do you get the sense that at least in the US, they’re trying to hold this back until midterms and then we’ll start to see a bunch of bad news come?
SM: Well, for example, they’re releasing strategic petroleum reserve, which is clearly controlling an attempt to control energy prices at the pump, gas prices at the pump. So, yes, I think after the elections we’re going to see some damage break.
TN: Yeah, interesting. Albert, week ahead, what do you got. Your eyes on?
AM: CPI. And I think it’s going to end up coming in hot and all of a sudden you’ll see the dollar surge once again, maybe threatening 120. Then you talk about what Simon is saying about things breaking and building up of a narrative of ending QT, although we haven’t really started it, but it is what it is.
TN: Well, exciting times guys. Thank you so much. Thanks for your time. Thank you very much for all your insights. And have a great weekend. Thank you very much.
It has been a terrible week in markets. It is not looking good for anybody, at least on the long side. A lot of that seemed to change when the CPI number came out. It’s like people woke up and terminal rate is going to be higher and just everything flushes out.
We talked through why the dollar is where it is and how long we expect it to stay there. Brent Johnson recently said that the USD & equities will both rise. And so we dived a little bit deep into that. We also looked at crude.
Crude’s obviously been falling. Tracy discussed how long is that going to last.
We also did a little bit of Fed talk because the Fed meets this week. And we want to really understand when does the Fed stop? After last week’s US CPI print, the terminal rate rose from 4% pretty dramatically. Does QT accelerate?
Key themes: 1. $USD 🚀 2. How low will crude oil go? 3. When does the Fed stop? 4. The Week Ahead
This is the 34th episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Time Stamps 0:00 Start 1:20 Key themes for this episode 2:24 What got us to stronger USD and will it continue to rise? 8:29 Dedollarization 10:23 Intervention in the dollar if it gets too strong? 12:22 Both the USD and US equities will be rising? 14:18 Crude: how low can it go? 18:03 Look at the curves for crude 19:17 Slingshot in December? 20:18 How India and China buys Russian oil and resell 21:33 Restock the SPR at $80?? 22:57 When does the Fed stop raising rates? 29:33 What if Russia, Ukraine, and China don’t lock down anymore? 32:08 What’s for the week ahead?
Listen to the podcast version on Spotify here:
Transcript
Tony Nash: Hi everybody, and welcome to The Week Ahead. My name is Tony Nash. We’re joined today by Tracy Shuchart and Brent Johnson. So thanks guys for joining us, really appreciate the time to talk about what’s going on in markets this week and next week.
Before we get started, I want to remind you of our $50 promo for CI Futures. CI Futures is a subscription platform to get forecast for thousands of items: currencies commodities, equity indices and economics. The currencies commodities equities are refreshed every week. So every Monday you come in for a new forecast, economics forecast every month. That $50 a month promo ends on September 21. So please take a look now go in and check it out and if you have any questions, let us know, we’re happy to answer them. So thanks for taking the time to do that.
So, Brent and Tracy, it has been a terrible week in markets. It is not looking good for really anybody, at least on the long side. And so a lot of that seemed to change when the CPI number came out. It’s like people woke up and we’re like, oh no, the term rate is going to be higher and just everything flushes out, right. And earnings and a bunch of other stuff. So we can go into a lot of specifics. But one of the items that I’ve been really curious about for weeks, if not years, ever since I met Brent in 2018, 19, is the dollar. So we’re going to go a little bit deep into the dollar today.
We’re also going to look at crude. Crude’s obviously been falling. So we’re going to ask Tracy kind of how long is that going to last? And then we’re going to do a little bit of Fed talk because the Fed meets in the week ahead. And I want to really understand kind of when does the Fed stop.
So those are our key themes today.
So, Brent, welcome. Thanks again for joining us. I’d really like to talk through the dollar and we are where we are, which is amazing. And you have seen this years ago. On the screen, I’ve got a chart of our CI Futures forecast which shows a dollar continuing to rise over the next year. We’ve got some bumps in there, but for the most part we see a persistently strong dollar.
CI Futures provides highly accurate commodity, equity, currency and economics forecasts using advanced AI. Learn more about CI Futures here.
So I’m curious what got us here and what will continue to push the dollar higher?
Brent Johnson: Sure. Well, first of all, thanks for having me. I always enjoy talking to you, Tony. The reason I like talking to you is you’ll talk a lot about Asia, but you’ve actually lived there and you actually know what you’re talking about rather than people who’ve just read it in a book. And same with Tracy. So I’m happy to do this and happy to do it anytime you invite me.
But anyway, what’s really going on with the dollar is a function of the fact that it’s not only the Fed and it’s not only the US that has, for lack of a better word, idiotic leaders. The rest of the world does, too.
And I think over the last several years. At least in the retail investment world. There’s been this theme that the Fed is out of control. The government’s out of control. They’re going to spend all this money. The dollar is going to pay the price. And it’s going to get inflated away and go to zero. And the rest of the world is going to do great and we’re going to do poor.
And I understand that view if you just analyze the United States. But the problem is you can’t just analyze the United States because it’s a big world and everything is interconnected. And all of the problems that people have forecast to fall upon the US.
Dollar are currently happening to a greater extent in Europe and Asia. And the budget deficits, the printing of the money, the central bank support, the holding down of rates, all of that applies even more so to Japan and Europe than it does the United States. And that’s really what you’re seeing.
Over the last, let’s just call a year, you’ve seen the yen fall 20% versus the dollar. That is an incredible move for any currency, but it is an absolutely astonishing move for a major currency, specifically the third biggest currency in the world, or some would even argue the second biggest currency in the world. And then you’ve seen the euro over the last year is down 10% or 15%.
So these are very big moves. Again, the reason is because the Fed is raising rates. So on a relative basis, we have higher rates than those two big competitors. And on a relative basis, those two big competitors are doing more monetary stimulus or QE or extraordinary measures, however you want to define that central bank activity.
And you always because the globe runs on the dollar, there is a persistent and consistent bid for the dollar globally. And so it’s really a supply versus the demand issue. Now, everybody always focuses on the supply. Central banks are increasing the currency in circulation. They’re going to print all this money and so therefore the dollar falls or the currency falls. Well, that’s just focusing on the supply side.
But again, you have to remember that all central banks are increasing supply, but the demand is what makes the difference and that there is global demand for the dollar. Now, whether you think there should be, whether you think it’s the right thing, it doesn’t really matter. It just is. That’s the way the system works.
But there is not that same global demand for yen. There’s not that same global demand for yuan, there’s not the same global demand for euros or Reals or Florence or Liras or anything.
And so what you’re really seeing play out is Trifan’s dilemma. And so I’ve spoken about this before. But Trifon’s dilemma is an economic theory that states that if you have a single country’s currency that also serves as the global reserve currency, at some point the needs of the domestic economy for that global reserve currency will come into conflict with the needs of the global economy. And that’s what we have.
We have an inflationary pressure problem in the United States. The Fed is very embarrassed about it. They got it wrong and now they need to do something about it. And they’re bound and determined to try to bring it under control. And so they’re raising rates to counteract that. Well, when you raise rates, you’re tightening the monetary supply. And that’s happening. That’s fine for the US. But there’s many countries around the world that cannot handle that right now.
But that’s what’s happening. And so the needs of the domestic economy are in conflict with the needs of the global economy. And it’s going to be the global economy that suffers more than the domestic economy as a result. It doesn’t mean that the domestic economy won’t be hurt. It just means on a relative basis, you want to be closer to the money than far away from the money. And because we have the global reserve currency, we’re closer to the money.
TN: So it’s interesting when you talk about the dollar versus other currencies, and we often hear people say, oh, CNY is rising as a share of spend, which that’s debatable. But from my perspective, it’s not the dollar that’s kind of in the gladiator ring of currencies. It’s the yen, it’s the euro, it’s the British pound, it’s the aussie dollar, it’s these secondary currencies. They’re going to lose share before the dollar does. Is that wrong?
BJ: No, I think that’s absolutely right. And again, that’s a very good way to put it. I know gladiator walks into the ring and thinks, I’m not going to at least get a few scratches. It’s going to hurt. That’s just the nature of being a gladiator. But what matters is who’s standing at the end of the day, right? And so I think it’s these other currencies are getting hurt by the battle more so than the dollar. It doesn’t mean that we’re not getting hurt. It doesn’t mean it doesn’t sting. It doesn’t mean there isn’t going to be any pain involved. But at the end of the day, if you’re at war, you want to be the last man standing because of the way the system is designed, I believe that that will be the US dollar.
The other thing that I would just quickly point out is a lot of people say, why can’t you see it? It’s very obvious. The rest of the world wants to de-dollarize. They’re putting all of these trade deals in place, the dollars falling as a percent of reserves, etc. And the point I would make is, yes, I do see it. I agree with you the world would like to dedollarize, but it’s much harder to dedollarize than just saying, just because you put an announcement out there doesn’t mean you’re actually going to be able to do it.
I’d like to make the analogy that I’ve said I want to lose weight and get in great shape for 20 years. It doesn’t mean it’s going to happen. It hasn’t happened yet.
But that’s the headline versus reality, right? I just think that’s where we’re at. And the dollar, for better or worse, it’s a rigged game in favor of the dollar. And the US set it up that way is the global hegemon. They set it up that way. Now, it doesn’t mean they’re not trying. It doesn’t mean that the world doesn’t want to get away from it. It’s just very hard to do it.
The last thing I’ll say and I’ll shut up, but the other thing I would say is the process of de-dollarization, even if it is successful, will not be a calm transition. And the process of dedollarization is not necessarily, and in my opinion, not probable to be negative for the price of the dollar. I think the volatility and the lack of liquidity in dollars that would go along with de-dollarization would actually squeeze the price of the dollar higher.
And so it doesn’t matter to me whether de-dollarization happens or not. I think the dollar is going higher for all of these reasons.
TN: I think what’s funny there is people always put de-dollarization in this almost moralistic language. It’s a good or a bad thing. And it’s just not. It just is.
Tracy Shuchart: I just had a question for Brent. I mean, do you see at any point that there’s some kind of intervention on the dollar? The dollar gets too strong because it’s going to crush emerging markets? Do you think there’s any point in which Yellen kind of backs up?
BJ: I do think they will. And that’s why I think the dollar is going to go back to all-time highs before this is all said and done. I don’t think it’s going to be a straight line. It can’t be a straight line without absolute devastation. Doesn’t mean it can’t happen. But I think this is going to play out over several years rather than several weeks. It could play out over several weeks, but I think it will take longer. And the reason I think it will take longer is I think that they will interact or they will get involved, as you’re suggesting, Tracy.
I actually think right now the Fed and the Treasury want the dollar strong. I think they’re using it as a weapon or as a tool. It’s something that can be used very effectively. Again, whether you think it should be used or not, I don’t care. I just think it will be, and I think it is being and so I think that will continue.
But I think the Fed and the treasury, they want the dollar higher, but they want it done in a measured fashion that they can control. If it starts to get out of control, I think that they will rein it in. I think they want some of the other parts of the world to be an economic pain, but I don’t think they want the whole system to collapse. And so my guess is that we’ll get the dollar higher, maybe it goes to 115, 120, and then they’ll do something, it’ll pull back for six months, three months, whatever, and then it’ll get higher again and they’ll come out and do something.
So I think this will be a process, a little bit of a roller coaster, up and down, but I think that the general trend is higher and I think there’s more pain to come for the global economy as a result.
TN: Brent, real quick, before we get onto oil. You sent out a tweet earlier this week that said you think that we’re going to come to a point where both the dollar and equities and US equities are rising. Can you walk us through that just real quickly? I know there’s a very detailed thesis behind that, but can you walk us through that very quickly so we understand kind of what you’re talking about there?
BJ: Yeah, so the first thing I’ll say for anybody who’s just kind of passing through this conversation is that I don’t think this is happening right now. It could happen right now. In the short term, I expect US equities to go lower. I think that’s just kind of where markets are headed.
But as the pain develops throughout the global economy, I think we are going to experience a global sovereign debt crisis. And when the world, the US included, starts selling sovereign debt rather than buying sovereign debt, I think that money will have to go.
Now, some of the money will just be, it’ll just go poof. It’ll be gone. And so that money won’t have anywhere to go but the people who start selling the bonds looking for another place to go, I think the next best place to go will eventually be US equities. And I think US equities will be seen as the new… I don’t want to say new Treasuries.
That’s a little bit hard to say. But on a relative basis, the place where big global capital can go, that is the most advantageous to them. And so I think we will get into a point in the sovereign debt crisis where US equities will get safe haven flows and I think the whole world will potentially be printing more money, right.
So be sending more liquidity out there. And so I think that liquidity that is generated with little liquidity there is, I think we’ll find its way into the US and the US Dow, big blue chip stocks and I think they’ll go higher. I might be wrong on that, but that’s my working thesis as of right now.
TN: Let’s move on to crude oil. Obviously we’ve seen crude take some hits over the past few weeks and we’ve got a WTI chart on the screen right now.
So how low will crude go? Are we almost there? Are we headed to 65 where it was for a while? And what then pushes it higher?
TS: I don’t really want to forecast exactly where crude is going to go. I definitely think that we could see some more downside, but we have to look at what is weighing on price and sentiment right now. One, there’s more Russian barrels on the market than everybody anticipated.
Two, you’ve got never ending zero Covid China lockdown that haven’t seemed to let up yet. We also have EU recession, right? And then we had 160 million barrels of SPR thrown on the market. And so that’s really weighing kind of on the front end of the curve. Those are the things kind of weighing on sentiment right now. That’s why we’re seeing a lot of weakness.
That said, if we look at the fundamentals of the market, the market is still very tight. We’re still drawing globally. We definitely have a diesel problem that is global. And I think where we start to see kind of a change in this, I think when it comes to the end of October, when the SPR is done this with kind of been looking over the last couple of weeks, had we not had such large SPRs, we would have actually been drawing a regular stock.
So it’s not as if that oil is going piling up anywhere. So I think as soon as the SPR stops, I think after Midterms, because I think this administration is trying to do whatever they can to suppress the price of oil, thus, gasoline. And I also think that we have to see kind of what happens in China after the People’s Party Congress in the middle of October and trying to see what their policy is going to be moving forward.
Are they going to open up? I mean, they’re looking at they want 5.5% YoY GDP by the end of the year,
which…
TN: They’ll hit it. On the nose, we can guarantee that.
TS: But I think they’re going to have to start stimulating the economy a little bit more. And we kind of saw announcement Evergrande is going to start financing more inspection projects and whatnot going into starting at the end of September. So I think we’ll probably see the last quarter if we get a little stimulus and if they back on their policy because, that’s the big thing for oil right now, is that if that demand comes back because they’re down about 2.7% on the year and as far as consumption is concerned.
So I think if that demand comes rushing back, know that’s going to be a huge upside surprise for the market. I think over the long run, oil is going higher, but out looking out into 2023, I just think that’s just the trajectory of it. I’m not calling for $200 oil, anything crazy like that. I just think that we will see higher oil, and I think we’re poised to see higher for longer than the functionality of the market and the fact that we have no capex for the last seven years.
TN: So last month you said to look three to four months out, look at the curves three to four months out to understand kind of what the real oil price was or is going to be. And so that would be two to three months now. So that’s November. December.
TS: Look at those spreads are widening out or not, right. You want to see if we’re moving into more backwardation and even more backward dated market, right? So you kind of want to look at that.
TN: Okay, so I paid $2.88 a gallon for gas at my local last night. We’re the energy capital in the world. Yeah, I’m going to show it off. Anyway, that is kind of coming down. And energy has been the biggest upward factor in some of the inflation issues. That’s good news, at least until the election. Hey, I’ll take it while I can get it, right? And if it heads back up after the election, I think we’re all prepared for that on some level.
So I guess SPR, as he said, election happens, there’s no political reason necessarily to suppress these prices and so on and so forth. So do you expect to see almost a slingshot in, say, December, where things trend higher pretty quickly?
TS: I don’t think we’ll have… I don’t want to call it a slingshot because anything can happen in the oil market. I mean, we’ve seen $7 to $10 in a day before, so that’s not unheard of. But I do think we go higher, especially if you’re looking into the market, is going to get even tighter in December because of tax reasons. December 31 is the tax assessment date for the barrels that you have on hand. So they tend to pull back on production so they can move out inventory as much as they can, so they’re not taxed at the end of the year.
Usually we see a little decline in production anyway in December and the second half of December, we do see prices start to rebound off the seasonal for regular seasonal trend low. Okay, so that would be normal.
TN: Brent, I think you had a question for Tracy on crude markets as well.
BJ: Yeah, I actually had two quick questions. One, I wanted to get your thoughts on the fact that India and China are buying oil at a discount from Russia. And then there’s lots of stories about them selling that oil
on to Europe or other places. And so they’re making that spread. I just wanted to get your thoughts on that and logistically how that actually takes place.
TS: So if you’re looking at India, definitely they are buying discounted crude. What they do is they don’t
resell that to Europe. What they do is they blend it and they sell fuel. So that’s refined. So it’s really hard to trace what’s in… They don’t trace those barrels that way.
So that’s how that oil is kind of emerging back in Europe. It’s really by way of refined products. Now when we talk about China with the gas, really what they’re doing is they’re buying gas right now, literally half off from Russia, and they’re turning around and selling their own gas to Europe for the higher marked up. The gas they already have. So they’re selling the gas they already have? So that’s kind of how that’s working.
BJ: And then the other question I have for you quickly is I was surprised this week when the rumor was floated by whoever floated that they would restock the SPR at $80. It seems like they’re doing everything they can to get the price lower. And then to have that rumor come out and put kind of a floor under it was kind of surprising to me. So maybe nothing more than just the speculation, but did you have any thoughts on that?
TS: Yeah, I mean, basically they put a floor on it. Everybody’s calling it, the Biden put now. But the thing is that it’s all nice and well if they want to do that, they still got enough 60 million barrels that they need to release. And then by the time those contracts go through and you want to refill the SPR, I mean, that’s months away. We’re looking at months and months down the road. And who knows what oil price would be? To me, it was just another try to jaw bone market down lower.
BJ: It kind of reminded me of the ECB where they’re raising rates on one hand, but they’re buying bonds with the other. Biden wants his cap. He’s like got a collar on it. He’s trying to put a cap on it and a foot on it.
TN: Strategy. Let’s move on to a little bit more of kind of the Fed kind of Fed talk. There’s a Fed meeting next week, and when CPI came out this week, the terminal rate really rose very quickly. And that’s when we started to see equities fall pretty dramatically. And we’ve got on the screen right now expectations for the rates coming out of each meeting. So 75 in September, 75 in November, and another 50 in December. That has accelerated the expectations for the Fed by about 25-50 basis points?
When does the Fed stop, basically from where you are now, do you think this continues to accelerate in 2023 or given, let’s say, CPI? Of course on a year-on-year basis it looks terrible. But once we get to November, when CPI really started to accelerate, November 21, do we start to see some of those base effects in a year-on-year basis and the Fed starts to pull back a little bit and go, okay, wait a minute, maybe we’re okay with the plan we have when we stop at say 450 or whatever as a terminal rate.
The other complicating factor will add in there is University of Michigan came out, University of Michigan survey came out on Friday and it’s a bit lower than what was expected. And the Fed has really been looking to University of Michigan, which is kind of a semi-serious survey, but they’ve really used that to justify some of their decisions.
So we obviously have a mixed environment. But I’m wondering, with all of this stuff coming out this week, do we expect the Fed to keep marching pretty aggressively into 2023?
BJ: I’ll take that first. So I actually do expect them to keep marching higher into 2023. And I say that for a couple of reasons, and I’m going to qualify this and say that they will pivot when they have to pivot, but I don’t think they’re going to pivot until they have to pivot. And so I think a lot of people that are predicting the pivot are misunderstanding the Fed’s intentions and perhaps for a good reason. They’ve done a fantastic job of ruining their credibility. So it’s understandable not to believe them.
But in this case, I think you kind of have to believe them. And I’ll tell you why I think you have to believe them. Number one, I think they don’t mind the dollar being stronger. Again, I think that’s kind of policy that I spoke of earlier in conjunction with the treasury.
Number two, I think they want asset prices lower. So the fact that the stock market goes down I don’t think would bother them. I think if the Dow was at 28,000 and the S&P was at 3600, I think they’d say that’s totally fine. I don’t think they have a problem with that as long as it’s not collapsing. Right? Now, if it collapses, then they have to come in. And they will come in, but I don’t think they mind if the stock market is 10% or 20% lower than here.
The third thing I’d say is the Fed central banks in general, they’re always lagging. They’re a reactionary agency. They’re not a predictive agency. We all know that. They can’t predict anything anyway. I’m not sure I want them predicting things, but to me they’re always behind the curve because they always wait until they see it and then they react, right? They come in and they try to save the day. So when things get really bad, then they’ll eventually come in and provide support.
And when things are always too late to tighten as they are now, and then they try to make up for it. So I think they’re going to despite, like you said, the Michigan number starting to come down, Atlanta Feds already slash their GDP. So even though they’re getting these signals that things are slowing down, they’re not reacting to it yet. They will react to it late.
And then the fourth thing I’d say is that I think Powell is mad and he’s pouting, right? Not just Powell, but mainly Powell, but he got all this advice from all his staff and however many staff, PhD staffers they have at the Fed, and they all said inflation is transitory and it’s going to be fine. And then it wasn’t. Right? Now he’s mad.
TN: He’s a lawyer, not an economist.
BJ: And I’m going to do something about it. And if you don’t think that I can bring inflation down, well, then you just watch me, right? And I’ll take my ball and go home. And his ball is interest rate. So he’s taking them higher, and he’s taking them home, he’s taking them higher. And so it come hell or high water, and after the, I don’t know, the chink in their armor or the threat to their credibility that they’ve had over the last year or two, I think the last thing in the world that Powell wants to deal with is the fact that he slowed down or, God forbid, cut rates and then inflation kept going higher.
That would look even worse than waiting for it to crumble, right? So I think for all of those reasons, you kind of have to take them at their word. Again, I’m not saying not unless the markets force them to do it
and the markets might force them to do it. I’m not saying that that’s out of the possibility. The only thing I don’t like saying about this is this is the hole they’re going to hike until it breaks theory, right?
And I agree with that. The thing I don’t like about it is everybody else seems to agree with it now, too. That seems to be the common refrain, is that they’re going to hike until something breaks, and everybody says, yeah, that’s kind of what’s going to happen. Usually when everybody thinks something, it doesn’t happen that way. But as long as equity prices are higher and as long as inflationary prints keep coming in high, I think they continue hiking.
And think about it, inflation could fall by 30%, and it’s still at five or six, which is still two or three times higher than their goal. So is there a path to a pivot? Yes, I think there’s a path to a pivot, but every week, when people come out every week and, oh, they’re going to pivot, they’re going to pivot. I don’t think they’re pivoting next week, and I don’t think they’re pivoting in October unless they have to.
TN: Okay, Tracy, what do you think of that?
TS: Yeah, I absolutely agree. All the data coming in, there’s no way they’re not doing 75 next week. In my opinion. I could be wrong. Somebody will come back. I think that’s pretty much a lock.
TN: Yeah, I think short of, let’s say sometime in Q4, Russia, Ukraine ends, and China says we’re not going to lock down anymore, that would fundamentally change the Feds calculations, right?
BJ: Well, if they weren’t locked down anymore and it pushed demand higher and it pushed prices higher as a result of demand increasing, then to me, that would keep them on their path to hiking. The flip side. And the flip side is that if something breaks in China, and China has to devalue or revalue the yuan in order to deal with the real estate collapse or the internal problems, whatever it is, that could send a deflationary wave to the rest of the world.
So I’m not going to sit here and deny the inflationary pressures that we’re seeing, but I think to a certain extent, people have again dumped themselves into the inflation camp or the deflation camp, and I think we’re going to have periods of both.
I think if you fundamentally understand the design of the monetary system, the threat of a deflationary
wave is always there. But if you don’t admit that the inflationary pressures are here, I think you’ve also got your head in the sand. I’ve said this several times, but I will admit to a big mistake, and that is, for several years, I hated the term stagflation. I thought it was a cop out. I thought it was for people who just couldn’t decide if they were in the inflation or deflation camp. But I think that’s what we have, and I think we have it in spades. I think some assets and some prices are going to continue to rise and be higher, and I think others are going to collapse, and that’s what makes it so hard to deal with.
So to anybody I ever took a shot at for them using stagflation as a cop out, I apologize. I’m with you now. I got that part wrong.
TN: Brent, one of the things I admire about you is you’re not afraid to say you were wrong, right?
BJ: No. I mean, do you mind if I just make a comment on this really quick? I think too often in our business, people will make a call and then they’re just so afraid to change it. Or you’ll make a call, and then somebody else will call you out on it if you got it wrong. At the end of the day, our job is sort of to predict the future. And so anybody who thinks that they can accurately predict the future 100% of the time has the biggest ego in the history of the world.
The reason I don’t mind making predictions is number one. I don’t mind being wrong because I don’t think I’m the smartest guy in history. And if I get something wrong, then I’ll have to deal with it. But this idea that we’re always going to be right and we know everything, it’s ridiculous. So anyway, we’re all speculating at the end of the day.
TN: That’s right. Okay, real quickly, guys, what are you looking for in the week ahead? More the same. More the same disappointment, difficulties, headwind, all that stuff. Until the Fed meeting? Is that what we’re looking for until the press conference?
TS: Yeah, I think we’re the markets will be in limbo, definitely until the Fed. I mean, everybody expects 75. We get 75. Maybe we see a bounce in equity, actually, because it’s already done with, right. There’s no question anymore. So maybe we get a bounce after that.
TN: Slightly less hawkish language than is expected, right?
BJ: I think that’s right. Now we’ve got the potential of maybe 100 basis points, right. So if they come in a couple of weeks ago, although now there’s a path to pivot, they’re probably only going to do 50 basis points in September.
Well, then we got the CPI print and it’s 75. That’s 75 is going to happen. Then a couple of people go hundreds now on the table, right? So now if they only come out and do 75, maybe the market kind of breathes a little bit. At least it wasn’t 100. So my guess is that we would have some volatility leading up to the meeting. Maybe they do 75. Perhaps things get a little bit of a bounce as a breather.
But I don’t think markets are going to change a whole lot between now and the election. I think they’re going to be volatile. I think the Feds are going to keep hiking. And I think Market Powell said it himself. We had the boom and now we have to deal with the pain. This is the unfortunate side effect of what we have to do. So he’s telling you he’s going to cause pain. He just doesn’t want to collapse. So if it starts to collapse, it’s the sad truth.
TN: Guys, thank you so much for your time. Thank you so much. Have a great weekend and have a great week ahead.
Crude and energy are on everybody’s minds, and we spent a lot of the Week Ahead parsing the details. Saudi Arabia came out with some comments about restricting their crude supplies to global markets, and we also have a detailed discussion on the SPR release in the US – when will it end, how will that impact crude prices, etc.
We also discussed Jackson Hole drama and the conclusions of Powell’s latest speech. Powell really didn’t say anything new, so why are equity markets reacting so dramatically?
And will we finally get some stimulus from China’s government? We’ve seen movement in tech stocks and some talks of the stimulus release, but we expect more after the US election.
Key themes
1. Crude oil supply: Saudi/UAE cuts vs SPR
2. Jackson Hole Drama
3. China Stimulus (Finally?)
4. What’s ahead for next week?
This is the 31st episode of The Week Ahead, where experts talk about the week that just happened and what will most likely happen in the coming week.
Tony Nash: Hi, and welcome to The Week Ahead. I’m Tony Nash. This week, we’re joined by Josh Young for the first time. So I want to thank Josh a lot for taking the time to join us. We’ve got Albert Marko and Samuel Rines. We’re lucky to have these three really valuable guests.
Before we get started, I’d like to ask you to like and subscribe to this YouTube channel. You’ll get reminded every week. Give us comments on the show. We always look at the comments. We always respond to the comments. So thanks for taking the time to do that.
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We have a couple of key items this week. First is the crude oil supply. We had Saudi Arabia come out with some comments about restricting their supply. We also have some information on the SPR release in the US. So we’re going to ask Josh to leave the discussion on that.
Obviously, Jackson Hole drama. We’re probably the only people not leading the Jackson Hole today. But there are some meaningful things happening. There are some things happening that are not meaningful, and Sam will talk us through that.
And then when we finally get some China stimulus, I think that’s a real question and Albert will lead us on that.
So Josh, thanks again for joining us. You put out a tweet earlier today about the UAE supporting the Saudi comments on supply restrictions.
Can you talk us through that and help us understand why did that happen and why is that important?
Josh Young: So the UAE is supporting what the Saudis and other OPEC members are doing in terms
of threatening to cut production based on the combination of lower price, as well as their observation that there may be some paper market price manipulation and disconnect from what they’re seeing as the largest sort of combined suppliers in the oil market. And it’s particularly important that the UAE did this because what we saw at Bison was that most of the OPEC members were actually producing their maximum production capacity. And when you produce that maximum, the fields aren’t designed for that. It’s sort of like driving with your foot all the way down on the gas 100% of the time. You’ll break your car and you’ll crash.
And so a lot of these fields and their processing facilities, they’re just not designed to run at this. It’s a theoretical capacity that’s supposed to run for a week, a month, three months, not how they’ve been running it. And so there’s a lot of pressure on a lot of fields in many of the OPEC countries to actually reduce production slightly, so it’s not a surprise.
And we forecast that there would be some discussion of this given the high run rate versus their spare capacity. UAE in particular does have some remaining spare capacity, so what we’re seeing is cohesion within OPEC along with supply exhaustion of the other OPEC members. So it’s actually a pretty big thing, and I don’t think people are really picking up on it too much. Although maybe it’s why oils flat up a little.
TN: With the market down a lot today. Is this something that will start small incrementally and then it will accelerate? Meaning will they cut off a little bit of supply and then over time, maybe they take some fields down for maintenance or something like that, and then you start to see bigger chunks? Is that a possible scenario?
JY: Yeah. Honestly, I don’t know exactly what the path will be. I just know that they see it. We were joking before the show that, hey, maybe they’re following my Twitter feed and a few other people’s been observing these problems with the oil market and sort of weird trading patterns versus very strong physical demand and sort of very strong indicators.
And you see Saudi has a very high price relative to their benchmarks. Right. Their poster price, especially Asia, has been very high and usually that’s associated with price strength, and instead we’ve seen price weakness. So I think they’re very frustrated by that, but they may wait for some other things. So oil prices to fall a little more or some other sort of signal, maybe some small amount of demand destruction to the extent that happens. I think it’s a little hard, just given the Saudi relationship with the US and their sort of hope to maintain a lot of their alliance and their alignment with the west.
So I think they need sort of an additional catalyst. That being said, once they do it, they might… I don’t know if they start small and then go big, or they might just go big. They might just say, hey, we’re cutting by a million barrels a day. We increased by four over the last year and a half, and we’re fully supportive of the market. We might go a lot bigger if necessary, and there’s a disconnect and we’re going to support it.
TN: Okay, so how much of this is related to the SPR release? Is the SPR release having such an impact on prices that the Saudis are kind of fed up with it, or are there other factors?
JY: I actually don’t think it’s related to the SPR release almost at all. It does look like it’s a little related to some of the job owning around a potential agreement with Iran. And there’s a lot of disagreement in terms of how much oil production could come on if Iran came to an agreement with the west and sort of restarted. JCPOA. I’m in the camp that there’s not a lot left to produce and to export. You can see the amount is getting exported to India and various other countries. It’s up a lot from the last time this was floated, six or seven months ago. So whatever that capacity was for Iran to export, it’s less.
But I think it’s partly tied to that because Iran is a regional foe of Saudi Arabia and UAE and several other OPEC countries. So I think it’s a little bit of that. And I think it’s a lot related to the paper market trading patterns and just this really big weird disconnect where you see consumption fine and you see price down and it’s probably messing up your CI Futures forecasting a little because you’re probably tracking the consumption and the consumption is fine and the price is down. And it’s like. Okay. The inventories are down. This is weird. Again, excluding SPR, when the SPR stops releasing, obviously you’d expect price to recover substantially absent a million barrels a day of demand structure.
TN: Is that what you expect when the SPR release is done, that’s late October or something, right, do you expect prices to rise notably?
JY: Yeah. And I think like, the EIA forecast for shale production growth and sort of overall US oil production is just totally off base. They haven’t reset it, even though I think they had like a million barrels a day or something forecast for growth. And I think we’re at sort of 300,000 barrels a day so far this year and pretty flat. And the rig count is not up that much, and the frac stack count is definitely not up enough. So I think there’s sort of this disconnect.
There also in terms of this mark to model from a production perspective versus what’s actually happening in the field. And then you look at it’s not hard to see who the big producers are on the public side and then which ones had forecast growth and how much they’re actually achieving.
It’s really hard to reconcile their forecast for production growth versus what’s actually happening. And we’re really well situated for this because we spend most of our time we talk a lot about macro, we spend most of our time just like looking at individual companies and evaluating them and evaluating their securities. And so I think it’s part of why we’ve had such a powerful voice from a macro perspective, because we’re spending most of our time talking to these companies, looking at the rigs, looking at other services, figuring out the bottlenecks, and looking at some of the local stuff.
And when you do that and you step back and say, these numbers don’t make sense, and the companies are not tracking anywhere close to that. So back to SPR, that matters a lot because we’re not achieving the production that is being forecast. And it seems like a lot of market participants, or at least prognosticators, are just accepting as a given. That means that at whatever point… I’m not saying that the SPR release stops in October. They may continue it, but at whatever point, there is a finite amount of oil there. And we’re hitting tank bottom on some of those caverns that are releasing oil. At some point we just run out or we stop releasing and whatever that point is, absent significant demand destruction in a very deep recession, I think we see a lot higher oil prices.
TN: So in terms of the SPR release, you said, you talk about being empty, this sort of thing. How much do you think are you still thinking kind of October? Are you thinking they’re going to continue, but it would kind of have to trickle out, not at the same rate they had been releasing to date. Right? Because they are short on supply in the SPR.
JY: Yeah, I don’t think it has to trickle out. I think they could produce pretty hard for another month or so, and then it starts becoming more of an issue. But as you get down to it, looks like the numbers around 20% or so for any of the individual storage facilities, and for some of them, it might be a little higher, some of it might be a little lower. You start having issues with contamination as well as just physical deliverability, actually extracting it out.
And I think people take the numbers a little too seriously. And it’s very weird because no one trusts the government about certain things and then other things they just blindly say, oh yeah, it’s right. It’s from, okay, try to reconcile that.
And I think when you talk to engineers and some of the people that have worked on these facilities, their observation is that it’s reasonable to expect less deliverability. But there are enough of the facilities that aren’t drawn down enough that they should be able to supply. I don’t think we’re really hitting deliverability issues yet, but I think we’re likely to start to hit them, let’s say over the next month or so.
TN: Okay. So kind of when we take what you’re talking about and we look at, say, the potential impact of crude prices and refined product prices on inflation and energy prices generally on inflation, seems to me that you’re implying that towards the end of the year we could see those prices rise fairly quickly. Is that fair to say?
JY: It is. But at the same time, gasoline prices are still down a lot. These will start to tick back up the gasoline, which is a big consumer factor, as well as it gets felt through a number of different aspects of the economy. So at least for now, that’s not so much of a risk. But yeah, definitely. Sort of later on in the year, one could expect that.
And one other way to look at that is there’s been a divergence, and I’ve ignored these historically, to my detriment. There’s been a divergence in between the oil price and oil and gas equity prices and oil and gas equities have done a lot better over the last, let’s say, month and a half than oil prices have. And it looks like the equity market is telling us that the companies…
I mean, one, the companies are just very cheap, so I would think naturally they should rise. But the degree of divergence is so much that it seems like the equity market is making a forward looking bet on higher than strip prices in the future. And the forward market and the oil paper market is making the bet that it will be lower.
So there does seem to be a noteworthy divergence that could mean much higher inflation, like you’re saying, but it might also be that shelter matters a lot more and some other stuff matters a lot more, and it might really take diesel rising a lot and gasoline rising a lot to actually shift back into high inflation.
TN: Okay, is that divergence between only upstream companies or is it upstream midstream? Is it the whole stack? What is that divergence? What does that include?
JY: So I’m most focused on upstream. I don’t actually remember whether it also included the pipelines and services. But on the upstream, definitely both the large cap, the XLE ETF that includes Exxon and Chevron and stuff, as well as XOP, which includes sort of independence.
TN: Fantastic. Okay, Josh, that is excellent. Thank you so much for that. On that inflation topic,
let’s move to Jackson Hole. Of course, there’s a lot of breathy analysis of Jackson Hole over the last couple of days, and there will be over the weekend. But Sam Rines, who has the most valuable newsletter that I know of that’s available in America today, covered this week, and there’s a chart that he has in there looking at the meeting probabilities and also looking at the headlines that may or may not come out of Jackson Hole.
Sam, can you talk us through that? And what do you expect some of the conclusions to be?
Sam Rines: Yeah, so I thought it was really interesting. The Fed said nothing all that interesting today. I mean, it might have been a shock to people who weren’t paying attention, but the Fed just reiterated about, I don’t know, 99% of what it’s already said and set it in different words. And Powell said it basically eight and a half minutes. Right. That was the big change. All he did was take a bunch of time out of the speech, condense it and say, we’re not pivoting. They were never pivoting. The pivot was out of the picture at the last meeting. He made that pretty clear during that press conference.
So it’s really interesting to me that there was an actual equity reaction to it. It’s also really interesting
that there was relatively little reaction out of Currencies, relatively little reaction out of global interest rates and only a reaction on the equity front. It was like it was a shock to the equity guys, and everybody else was like, yeah, we need that. So I think that was really the big takeaway was it was a shock to the equity
markets, but everyone who had to be paying attention for the last six months was like, yeah, no big deal.
So Jackson Hole I think one of the things that I had said about it in the newsletter was, you’re not going
to learn anything new. And the only thing that we learned was that Paul was going to say absolutely nothing new and absolutely nothing interesting, and equity markets would still react to it in a pretty meaningful way. The idea that we were going to go to 4% and then stay at 4% was already priced in to Fed fund futures through the end of ’23.
So this whole idea that Powell somehow shocked the market. It’s one of the more entertaining things
today, in my opinion, is just that equity markets were so taken aback by it while you had three or four basis point moves in interest rates across the US curve. And just a big shrug.
To me, the big news today was probably out of Europe where people were potentially discussing 75 basis
point hike from the ECB. The Czech Republic doing an emergency meeting on energy.
There were some more interesting things that happened in the market today, but I think I overlooked in favor of an eight and a half minute speech by somebody just re iterating what he had already said 900 times.
TN: So let’s talk about Europe a little bit, because that’s interesting. I mean, Europe is in a world of hurt, right? We’ve talked about that several times. So what do you think the path for the ECB is from here? Do you think they’re going to hike 75?
SR: No, I think they hike 50. I think 75 is probably a little too aggressive for them. I mean, we were talking about ten basis points three months ago as being something that we thought would be interesting. And now the idea of floating 75, I think that was mostly to defend the currency, right. They knew that there was a known that you were going into Jackson Hole and if you front ran that with the leak that you might go 75, you’re going to defend your currency somewhat against a potentially hawkish Powell. It’s pretty straightforward in terms of defending a Euro at one. So I think that was basically the case. Call 50, maybe 75, I don’t really care. They’re going to hike, and they’re going to hike in a pretty meaningful way, particularly for a place that is already screwed. Right into the recession, right? Yeah.
I think it’s a pretty interesting opportunity to go long the long-end booned and short the Euro. Yeah, we’ve talked about that a few times here and that’s great.
TN: Okay, guys, what else do you have on the, Albert, Josh? Are you guys hearing anything else on US economy or Jackson Hole?
Albert Marko: Sam mentioned about the equity reaction. How much of that is really because
of the low liquidity right now? There’s no traders really out there, no volume out there really, at the moment.
SR: But liquidity works both ways, right? If you have low liquidity, you can rip it. It can get ripped either way. And I think what you saw immediately following his speech was you saw a leg down, then you saw 1% leg down, 1% leg back up, and then a two to 3% leg down, depending on what industry you want to look at. Right. So liquidity works.
AM: But you’re right, nothing was new. That rally that they launched for the weeks prior to that, you expected them to go hawkish after that, what are they going to do? Go dovish and go to 4400, 4500 and look ridiculous? Nothing new came out of this. He’s right about that.
SR: I think there was an opportunity for them to potentially begin to say, hey, we’re going 50s and then 25s, and then we’re going to pause at 4% and we’re going to see how much we’ve ruined everything. There was the potential for that.
But then when you get STIs, you get financial conditions ripping higher, you have meme stocks
coming back into the news. Yeah. The Fed is not going to consider that type policy. If anything, they’re going to look at that and say, hey, it looks like short term neutral is a little bit higher than we thought it was. We need to move a little further and then begin to pause.
So if anything, the equity rally going into Jackson Hole was more problematic for equity markets than people thought.
TN: So do you think some of those 25 expected 25s could be 50s in say, Q4?
SR: I don’t care if they’re going to get to four and then they’re going to stop and they’re going to get to four before they’re going to get to four around December and then they’re going to see what kind of carnage they’ve done. If they haven’t done enough carnage, they go higher. Pause there.
TN: That makes sense.
SR: The pace is probably I would say the pace kind of matters for shock and all purposes,
but in general the pace is kind of meh.
The end is really important and the length of staying at the peak is what is truly the most important thing here. If they’re there for a year and a half and they don’t care about a recession, that’s one thing. If they’re there for six months and cut by 75 because we’re in a recession, then go back, that’s a different thing. But I really don’t care how quickly they get there.
TN: Okay. And the run up to the midterms has no bearing on what the Fed is going to do, is that?
SR: None.
TN: None. Okay. I just hear that from time to time. Well, the midterms are coming, so the Fed
is going to just relax for a few months.
AM: You hear that mainly from me. From my perspective, it’s always been like when I say Fed, I want to say Treasury and Fed together because of Yellen. But sometimes they have those concerns. Like they don’t want the current administration looking bad. I had a midterm. Yeah.
SR: That should sail.
AM: Well, that should sail because just because of the ridiculous antics that they pulled recently with inflation, it’s being ridiculous. So you’re right, that ship has sailed.
TN: Well, I mean, are they ridiculous or not? I mean, inflation has definitely risen and they’ve definitely taken action to offset inflation.
AM: Yeah, they’ve done that in a vacuum because China is not online yet and Europe is a complete disaster at the moment. Right. And we haven’t had a real event to drive oil up into like the 130s, 140s again. God forbid we have a hurricane in like a week that goes into the Gulf of Mexico while Grandhome is sending out letters to all the refiners saying you can’t export anything anymore. There’s plenty of room.
TN: She’s encouraging them. She’s not requiring them. Right?
AM: Yeah. Okay, well, we’ll see about that.
JY: She’s making them an offer that they can’t refuse. So my general take was just like, I’m not a Fed watcher. My general take was kind of stagflation coming out of this. Right? It’s like policy that can’t get too extreme to really like they’re going to try to torch the economy, but they’re also not going to go to a 15 interest rate or anything like that. They’re going to go to a four or whatever, and maybe they’ll go slower or faster.
I think there’s some political motivation there. So maybe they go slower and then they turn on higher after the election. Maybe not. Unclear. Kind of doesn’t matter from my perspective.
What does matter is, like Albert was saying, I think there’s a decent shot that we end up with higher oil prices. We end up with other factors. So, like, there are various drivers that are pushing, especially in the rental market, shelter higher, not lower. And so with persistent inflation in the biggest household bucket, and then with a likely move higher this winter in oil and diesel and probably also gasoline, it’s going to look pretty ugly. And if you have them stopping kind of at four, maybe going to let’s say five or something, but inflation is at ten or nine or whatever, right? Some directionally, really high number. At some point, you just start ticking in where you have negative real and positive nominal, and that’s just hard to break unless they go a lot higher. But if the economy is sucking, that makes it really hard. So that was my sort of general take from what they were saying.
AM: I wanted to come back and ask you about the SPR just real quick about the oil in it. Some of it has got to have degradation, and there’s a lot less barrels there that they can actually release. They might have to stop in end of September. You might start seeing oil rise even before October.
JY: Yes. My base case is not that. My base case is there’s a little bit of contamination, but they’ve managed to reduce that either by not pulling from the caverns that have had contamination historically or by treating the oil or something. My base case is that the oil there is extractable, except they can’t get the last barrel because there’s a certain percentage that needs to be there for the caverns to continue to be
functional, and they’re not going to destroy the storage caverns just to get the last oil. That’s my base case.
But I think there’s a reasonable expectation that there’s less oil there, given the history of contamination and the issues. And they did have a big draw this past week, but prior to that, they had multiple smaller draws. There’s also the crude quality thing, which I’m not really in the crude quality matters camp. I think there’s sort of this bizarre notion that crude, which is mostly fungible, really matters. It did to some extent before you could export oil and before various changes in US refineries.
At this point, it matters a little in terms of getting a couple of dollars, more or less per barrel, depending on transport cost. But I don’t think that’s really affecting the global balance. And I think it’s sort of like
a magic trick, right? It’s like focus on this and not like the thing that actually matters.
And so I’m glad you didn’t bring it up. I guess I brought it up and I just don’t think it matters, though.
TN: Great. Thanks for that, guys. Okay, let’s move on to China. Albert, over the past a week or so, we’ve seen a number of stories saying that China fiscal stimulus may finally be coming.
And we’ve seen some movements, say, in China, tech stocks, these sorts of things. So can you talk us through what you’re seeing with China in the stimulus camping? And why now? They’ve waited so long. Why would it be coming now?
AM: Well, it’s coming out because the policy and the dollar is so high, the Chinese economy is struggling at the moment and they come out with these mini stimulus announcements and there were shots across the bow. I mean, the worst thing right now that the Fed can happen is China stimulating commodities ripping at the moment, that would be absolutely atrocious. Inflation will start going higher and we seen like Josh said a 10% CPI prints coming out and they’re going to be forced to do 75 basis points again. It would throw a wrench in a lot of things and it’s not good if they stimulate it right now.
But after the election, after the US election, they can do what they want to do because they have their own interests at heart at the moment. They cannot let the Chinese economy fall to a point where they can’t recover in the near future.
TN: So what do you see coming out in the near term? This $229 billion bond sale? That was a start, right? So do you see more than that or dramatically more than that coming out? And how quickly do you expect?
AM: Yeah, I expect by January that will have a significant stimulus package coming out. This little SEC audit deal was basically a gift to delay it as much as long as they can.
TN: Okay, very good. And then so you don’t expect a significant amount of Chinese stimulus before, say, December or something like that?
AM: Yeah, before December.
TN: Okay. Sam, what do you think about that? Do you think China stimulus hurts the US?
SR: I really don’t think that the Fed would care or go 75. I mean, it’s commodities, right? And the Fed tries to ignore commodities as much as possible. So yeah, you’re going to get a rip in oil because there’s not enough oil to go around, there’s not enough oil for China and it’s going to coincide with the end of the SPR release. So you’re kind of screwed there.
Copper, all that stuff goes higher. I don’t think the Fed cares. The Fed is going to try to cut that out. Then they’ll pivot core and you’re going to have a really weak Renminbi and you’re going to have probably at least a little bit of a pass through to US consumers on the goods front as you get goods to flow back.
So you could actually see kind of an interesting offset where core goods kind of begins to decline on a Chinese reopen. Commodities rip and you get the, hey look, it looks like core is moving back towards two. We’re not going to have to raise rates as much because we don’t really care about headline, we can’t control oil, we can’t pump more oil.
So I think it’s a weird kind of catch 22 where the Fed is going to have to pivot from talking about headline to talking about core. But I think they’re happy to do it as long as that core is really moving lower because I think they know they’re screwed on energy. They’re in so much trouble in energy, commodities, et cetera, that there’s nothing they can do.
TN: I think you’re right and we’ve needed a weaker CNY for about six, seven months now. So I think it’s about time and we’ve started to see it move, but I think we’ll start to see it move more dramatically soon.
Okay, guys, let’s start looking at the week ahead. Just a quick kind of round the horn of what do you think, Albert, what are you looking for for the coming week?
AM: I’m looking for a little bit of a rally back off these loads here, try to bring it back to 4200. I just personally think that the economy is in trouble, they’re delaying a recession as long as they possibly can, but it’s coming. So I think a little bit of a pump next week and then probably heading back down into September.
TN: Okay, Sam?
SR: Oh, I agree with Albert there. I think the knee jerk reaction today to the Fed is going to be unloud as people begin to look at what really went on in rates. What’s going on in FX. The concentration should be on what’s going on in Europe. And the flow versus the stock problem that nobody seems to be able to figure out. Which is you can stock as much gas as you want in a bunch of caverns in Europe. If you don’t have flow over the winter, your stocks really don’t matter. I think there’s going to be a little bit of a realization that stock versus flow matter more than stocks and at some point you’ve got to figure that one out. So that’s what I’m watching.
TN: Interesting. Okay, Josh, what are you looking for in the week ahead?
JY: Just more information on oil demand. So we’re starting to see reports of surprise, higher oil demand than people would have thought, which coincide with actual reports of oil demand when you look at the raw data. So that should be interesting to see sort of how that gets processed and then sort of how oil price may or may not get suppressed. Again, just as we get more good data points, price should go higher, but it doesn’t seem to want you for now.
TN: Very good. From the energy capital of the Universe in Houston, Texas, Josh Young, Sam Rines.
Guys. Thanks very much. Albert, thanks. Have a great day, have a great weekend and a great week ahead.
