Energy, Currency, & Deglobalization Pt 2; Market Reacts to Jackson Hole
The second in a two-part series on the changing world order, its impacts on the global economy, and the future of central bank monetary policy. Plus, an update on the Fed's Jackson Hole conference.
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Today’s issue is the second leg of our two-part issue, “Energy, Currency, & Deglobalization.” For subscribers who have not yet read yesterday’s issue, please read that first for context on the topics and issues discussed previously.
As we covered the brewing geopolitical tensions and developing energy crises in Europe in yesterday’s issue, let's cover some of the possible second order effects, as well as outline our short-term and long-term market outlook, with quotes from the ever-insightful Zoltan Poszar from his latest piece “War and Industrial Policy.”
Before diving back into the big ideas from Poszar, let’s review the market moves today following Federal Reserve Chairman Jerome Powell’s speech at Jackson Hole.
As Powell began to speak, global markets began to sell off sharply, with equities quickly making new lows, as bitcoin followed in tandem while the dollar rallied. Shown below are the three respective charts (with DXY inverted). For now, it’s all one trade (more on this later).
Among the most interesting developments in recent weeks has been the divergence between the bond market and the equities market, as yields across the curve continued to push higher in tandem with equities, which is not a relationship that is expected to last.
All else being equal, higher yields equal higher discount rates and borrowing costs, and when the largest market in the world (bonds) is selling off significantly, equities can only swim against the tide for so long.
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The repricing in yields was in part due to the rise in Fed Funds expectations in 2023, with a significant amount of repricing taking place over the course of recent weeks towards higher rates for longer. In fact, that was one of the key talking points in Powell’s speech today.
The Fed has been fairly transparent about their intent to raise interest rates to combat inflation, and today was no different.
Powell even went further today, so much as to admit “pain” is likely to be felt by households and businesses,
"While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses” - Jerome Powell
As said in our July Monthly Report: “Long Live Macro,”
“The story of 2022 has been the inflation-induced monetary tightening that has occurred across financial markets. In an attempt to fulfill their dual mandate of price stability and full employment (more on this later), the Federal Reserve has embarked upon one of the fastest hiking cycles in history.”
The combination of tightening monetary policy globally coupled with a structural energy shortage has led to the dollar strengthening against other fiat currencies materially.
“A strong dollar is in the process of completely upending the global economy. While there are certainly exogenous factors that are causing the economic pain points such as shattered supply chains following COVID-19 economic lockdowns (which were incredibly strained following unprecedented levels of monetary and fiscal stimulus in 2020/2021) and the Russia/Ukraine conflict which has thrown global energy and commodity markets in flux, a strong dollar only increases pressure on foreign nations in terms of meeting their dollar-denominated liabilities, while increasingly harming U.S. domestic industry.” - “Dollar Go Up: Global Macro Headwinds Intensify, 7/15/22”
Let’s return to the excellent work of Zoltan Pozsar before further examining the likely path for financial markets and Fed policy:
“Globalization is not a bank in need of a bailout. It’s in need of a hegemon to maintain order. The systemic event is someone challenging the hegemon, and today, Russia and China are challenging the U.S. hegemony. For the current world order and its trade arrangements and network of global supply chains to survive the challenge, the challenge must be squashed quickly and decisively, in the spirit of the Powell Doctrine.
“But Ukraine and Taiwan aren’t Kuwait, Russia and China aren’t Iraq, and ‘Top Gun 2’ isn’t the same movie as ‘Top Gun’ … Think about what Tim Geithner said about how to deal with crises like the Asian financial crisis or a herd of short sellers questioning the solvency of the U.S. banking system. In today’s context, Russia and China are basically the ‘short sellers.’”
To be able to attempt to outcompete Russia and China, the U.S. desperately needs to reshore domestic manufacturing. This not only takes time, but plenty of raw materials and infrastructure, all of which are inflationary. Yes, the Fed is attempting to destroy demand (at the margin) to combat inflation, but during “wartime,” industrial policy and economic sovereignty take importance.
“I get it why the U.S. wants to invert time. But we can’t win by slowing progress. We’ll also have to progress by building, and that’s where industrial policy comes in: as an investor, you care about the inflationary consequences of Russia and China challenging the U.S. hegemon. Where inflation goes, policy rates go, or if not, financial repression is an issue.”
“Either way, you care, especially if you are a bond house or if you depend on fixed income. These are the scary times when the ‘euthanasia of the rentier’ is a risk. To ensure that the West wins the economic war – to overcome the risks posed by ‘our commodities, your problem’; ‘chips from our backyard, your problem’; and ‘our straits, your problem’ - the West will have to pour trillions into four types of projects starting ‘yesterday’:
(1) re-arm (to defend the world order)
(2) re-shore (to get around blockades)
(3) re-stock and invest (commodities)
(4) re-wire the grid (energy transition)
“I think that the above four themes (re-arm, re-shore, re-stock, and re-wire the electric grid) will be the defining aims of industrial policy over the next five years. How much the G7 will spend on these items is an open question, but given that the global order is at stake, they will likely not be penny pinching. If Tim Geithner were in charge, he’d put ‘a lot of money in the window’ to show who’s in charge.
“And hopefully it will be like that … and if so, any investor will have to be mindful that the above to-do-list is:
interest rate insensitive
uninvestable for the East
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