Central Bank Collusion
In the early days of central banking, none of the central bankers really knew what they were doing, because there wasn’t any policy or procedures to follow. One could make that same argument today, expect central bankers now have mandates that they hope to achieve. While history has proven their inability to meet their mandates, it hasn’t kept them from trying. Even in the early days, central bankers throughout the world would meet to discuss monetary policies in hopes to create a global policy that would benefit everyone. Collusion among the central bankers has led to the creation and bursting of massive asset bubbles, and evidence shows that central bankers are back at it again.
In the late 1920’s, before the Great Depression, central bankers were in collusion with their monetary policy in order to get gold out of the United States. This happened because the world was on the gold standard and without gold, a country couldn’t print very much money. As we have learned through past updates, a constricted money supply leads to a constricted economy. This was a problem for most of Europe, as their economic growth was being limited by their lack of gold and inability to print more money.
After World War I, the United States found itself with a disproportionate amount of gold, which turned out to be a problem for the Federal Reserve. While European nations were starving for gold, the Fed was trying to ways to keep our gold from causing rampant inflation. The central bankers at the time decided that if the United States raised interest rates then money, and gold, would flow to Europe where interest rates were lower.
As history would show, this plan didn’t work. As the Fed raised interest rates, more money flowed into the U.S. stock market. The world took the Fed raising rates as a sign of economic strength and the stock market bubble continued to get bigger. The Fed continued to raise rates in hopes that the money flow would stop, but it didn’t. As money flowed in from overseas, so did the gold, which meant the money supply and the economy for most of Europe were contracting.
To stop the flow of gold going to the United States, European countries were forced to raise interest rates. This, among other things, would trigger a global depression, unlike anything that had been seen before. Later in life, those same central bankers would admit that all their efforts to stabilize the global economy had left it in worse shape. And to think, the central bankers of the world are back at it again.
After eight years of holding interest rates at 0%, in December 2015 the Bernanke led Fed voted to raise interest rates months before Yellen would take over as Chairman. The Yellen led Fed would again raise rates in December 2016, March 2017 and June 2017. While further rate hikes are uncertain, many experts have questioned why the Fed has continued to raise rates despite weakening economic data.
The answer has to do with the U.S. dollar. When the dollar is strong relative to other foreign currencies it is cheaper for Americans to buy foreign goods. When the dollar is weak, it is cheaper for foreigners to buy American made goods. This is why a country that is struggling economically will deliberately devalue their currency so they can export their way to prosperity. By devaluing their currency, they make their products cheaper for Americans and other countries to buy.
With the United States showing signs of finally emerging from the 2008-09 recession, global central bankers likely colluded to keep the dollar strong. A strong dollar would keep oil prices low and allow foreign countries to export to the United States. Assuming the U.S. economy continued to grow and the demand for cheap foreign made goods increases, the plan could work.
But in December 2016 the dollar index peaked and has since fallen approximately -10%. This shouldn’t be happening because the dollar should rise as the Fed raises interest rates. A rising dollar is a sign of confidence. In the meantime, the Euro has risen against the dollar, although I can come up with several reasons why this doesn’t make any sense. What does make sense is that the European Union (EU) does want a strong dollar so they can export out of their economic problems. This is the point in the story where the strength or weakness of the dollar comes into play.
When the U.S. is appreciating in value or rising, it has the effect of tightening the money supply. This happens because when something is appreciating, more people want to hold onto it. As a result, fewer dollars will circulate and the money supply will contract. But when the dollar weakens, as it has been since December 2016, it has the opposite effect. A weakening dollar eases the money supply, which is why we haven’t seen a big drop in the money supply despite the amount of bank lending contracting at a rapid pace. Even as the Fed has attempted to tighten the monetary conditions, the weakening dollar has kept financial conditions rather loose.
The big loser is the Euro (EU currency) that has been appreciating against the dollar, making conditions tighter in Europe while the European Central Bank (ECB) has kept their monetary policy extremely loose. The problem for the European Union is that their economy is starting to show signs of life, just at the point where the recent appreciation in the Euro is going to start causing problems. This puts pressure on the Fed to continue raising interest rates and to start unwinding their $4.5 trillion bond portfolio to give the European Union some relief. What I find interesting is that the Fed may be forced to continue to tighten the monetary policy at a time when the U.S. economy may not be able to handle tighter monetary conditions.
Suddenly you start to see this as a redo of the late 1920’s policy mistakes that caused the Great Depression. Today the central bankers want a strong U.S. Dollar in hopes that demand from the United States can pull the rest of the world’s economies out of this slump. With the dollar weakening, it puts pressure on the Fed to tighten more, in attempt to get the dollar to rally. If those policies fail and the dollar continues to weaken, it puts pressure on the ECB and other central bankers to raise rates in hopes to weaken their currencies. When everyone is raising rates at the end of the weakest growth cycle in history, you can accurately guess what’s coming next: a massive global recession.
Video Topic of the Week
Brief commentary on the different market sectors.
Chart of the Week – Federal Surplus or Deficit as % of GDP
The Fed has a great recession indicator and it tripped in 2015.
Portfolio Shield™ Update
Latest investment detail report for September is linked below. A temporary website with a video and answers to frequently asked questions is up. See link below.
Weekly Sector Commentary
Broad Market / Economy
The August Nonfarm Payrolls report was much worse than the headline number of jobs created of +156,000 suggests. The prior two months saw downward revisions of -41,000 jobs, meaning fewer jobs were created in the last two months than previously thought. Like prior months, many of the jobs that were created came from the BLS birth-death model that is nothing more than a computer entry of the net number of self-employment jobs that were created or lost. Out of the +156,000-headline number, 69,000 jobs were of those joining the ranks of the self-employed. That leaves a birth-death model adjusted payrolls number of +87,000. As you can see, that doesn’t sound very good. And it gets worse.
The average workweek dropped from 34.5 hours worked to 34.4 hours worked. While that may not sound like a big drop, it’s like a loss of -361,000 jobs.
Wage growth has been stuck at 2.5% year-over-year growth for the past five months, which is well below the Fed’s target wage growth.
From the Household Survey, full-time jobs fell -166,000 in addition to a -54,000 drop in July.
Due to the disruptions from Hurricane Harvey, the September Nonfarm Payrolls report is expected to be 50,000 to 100,000 jobs less than August. At this rate, the payrolls report will be showing negative numbers by year end.
Sentiment is holding around 50%, but the overall sentiment trend remains negative. Stocks won’t sell off at the point until sentiment falls further. Market risk remains to the downside.
The big news this week is with interest rates as the 10-year Treasury yield broke below the 10-month topping pattern it’s been in since the Presidential election. This is interesting because the news, analysts and big money managers all talked about how interest rates were headed up after the election. I said then, as I’ll say again, it was all a ruse to get people to sell their bonds so the big money managers could buy them. This topping pattern is evidence of my narrative.
As bearish as I am on interest rates, I didn’t expect them to drop off this quick. When the U.S. Treasury runs low on money, which it is, interest rates usually rise. Now that the Treasury can borrow money until at least December, that puts further downward pressure on yields. For the moment, sentiment levels are near their prior peak at 80%, suggesting that even a short-term bump in yields is reasonable.
Unless the big money managers are working to drive the stock market down, I expect there to be a bump up in yields, although temporary. A breakdown of this major topping pattern indicates, as I have said before, that yields will make a new all-time low during the next recession. That means the 10-year Treasury yield would need to fall below 1.336%, which is very reasonable considering yields fall -1.86% during the average recession. With the 10-year Treasury yield currently around 2.05%, that means during the next recession we are likely to see yields near 0%.
If yields reach a new all-time low, then U.S. Treasury bonds will reach new all-time highs.
International / Emerging Markets
No major news here either unless you count that the European Central Bank kicked the can down the road on hiking interest rates. There is a potential opportunity in the United Kingdom. An asymmetrical triangle is forming which doesn’t tell us much at the moment, but the break out of this will tell us if prices will continue rising or if this is a reversal. The initial move up, if it breaks to the upside, isn’t big before it runs into resistance, but it could signal that a larger move up is coming.
Even though oil prices fall during a recession, the price chart of oil and gas producers (XOP) is showing that an inverse head and shoulders pattern is forming. It shouldn’t complete for another month, but if it does, there’s an opportunity to catch a move up. A break out above the neckline suggests a +15% move could happen. We’ll track this and see where it goes.
The trade weighted U.S. Dollar Index (/DXY) is trading just below a major multi-year topping pattern. As I mentioned in prior updates, there is a narrative for a rising dollar going into a recession. Perhaps that will happen, but for the moment, the dollar appears to about to continue the second leg of its major descent.
A major decline in the dollar should be Bullish for commodities. So far, that fall hasn’t translated into a boost for agricultural commodities, but we are seeing it finally translate into a boost for the price of gold.
I’m not ruling out a short term move up for the dollar; in fact, sentiment data for the dollar is at 10%, which shows there should be a bounce in the value of the dollar. Momentum data confirms there is a longer term Bearish move for the dollar in play.
As I mentioned last week, prices finally broke out to the upside of a Bearish descending right triangle. A descending right triangle pattern is inherently Bearish, meaning prices should fall when you see this pattern emerge, but it doesn’t always work that way. A better way to word it would be to say that the probabilities are greater than fifty percent that a descending right triangle pattern is Bearish. With that, the only move a person can make is to wait until the pattern has completed and watch the direction of the breakout.
Shortly after the upside breakout, there were DeMark exhaustion signals raised that indicated this upward move was almost worn out. Sentiment for gold is near 80%, which is about as high as gold sentiment gets. Then on Tuesday, nearly right on cue, prices started reversing.
Classical charting techniques suggest an immediate buy upon a breakout move. As I mentioned last week, in more recent times, the breakout move is followed by a retest of the resistance price. Based on the DeMark and sentiment signals, it is reasonable to believe this will happen again.
When the next dip does happen, provided the upside breakout is confirmed our move should be to buy each dip on the next leg up.
Cotton and concentrated orange juice are breaking out due to the hurricanes and wheat sentiment, which was very low, is starting to rise. Just because sentiment starts to rise doesn’t mean prices immediately follow, but if sentiment builds, prices will increase. My view on this space hasn’t changed. I still plan to sell the next rebound unless a falling dollar turns this entire picture upside down.