The inflation story has run too far ahead of itself. OPEC, China, and the “Trumpflation” narrative, the major drivers of this inflation, are all pausing at the same time. I know that I’ve been flip-flopping like a fish out of water as of late. But that tends to happen around a pivot point. And fortunately the markets have been kind enough to wait for me. I know guys like Jeffery Gundlach and Jesse Felder have been calling for this pivot a bit longer than I. And finally with a lot of struggling, I too agree. So let’s go through it all.
Investors are simply too bearish on bonds.
The Trumpflation narrative is on the verge of coming undone. His own party is prepared to fight him on his key fiscal issues. Which should translate into smaller deficits and lower domestic inflation both of which should push yields lower. To be fair, these are the same congressmen that allowed Obama to rack up $10T of debt in just 8 years. Given enough shoving they’ll likely go along, but that will take time. And time is something this narrative is currently running out of.
OPEC likely needs to prove itself before oil can sustain above $50 a barrel.The market priced in the cut before it happened, but failed to realize what $50+ oil would do for US shale. Rising OPEC production coupled with rising US production is hardly bullish for oil. Inventory builds are massive at the moment. Lower oil prices over the next few weeks should drag down inflation expectations as well.
The PBoC has been tightening liquidity since October. Officials were/are likely worried about rising inflation and decided not to overheat the economy before the new year. They’ll likely turn the taps on in mid January for the Lunar holiday, but till then, deflation and risk off should will be increasing at the margins.
With China tightening till January, OPEC not cutting till January, Trump facing significant political opposition and speculators massive short US treasuries, we could be in for a significant short squeeze in US treasuries.
So if tell you, US yields are set to go lower compressing interest rate spreads between JGBs, the Yen would strengthen. And once you think the Yen is about to strengthen a whole host of trade opportunities become available. Because I’m driving to Texas this weekend (which makes this my last post for the next week), I’ll suggest the most obvious, gold. Gold looks due for a nice bounce.
Actually, I’ll give you another. Once the Fed hikes, and pushes short term rates higher, imagine what the yield curve will do with the long end falling? We could see a much flatter yield curve in just a few short weeks. Bank stocks, the darlings of the FOMO crowd could come under heavy fire.
A real benefit from my constant flip flopping, is that I now have a much better perspective on two sides of the inflation story. At risk of getting ahead of myself, I believe this next move will be nothing more than a counter trend move. I believe that China will once again open the spigot, OPEC and Russia will actually cut production, and Trump? Well Trump ain’t passing so much as a grape salad let alone a massive stimulus bill with the US is growing at 2.5%. US shale may hide the deteriorating US consumer for another quarter or two at most but soon it will be obvious the marginal buyer in the domestic world is no longer there. But at this point, that’s beyond the time horizon of this move.
My biggest concern for this rebound thesis is that the Chinese authorities over estimate the strength of their economy and tighten too much. As a China bear, my bias shows here, but I still think it is something to watch out for. OPEC might also fail to cut, but I doubt it, as they say in the talkies, “there’s no turning back”. Seriously could you imagine how stupid it would be for them to go back now, after US shale hedged a record amount of its production! Odds of that happening are SMALL.
Disclaimer: This blog post is not advice to buy and or sell securities. I am merely informing you of my intentions. If you act on the words of a twenty something millennial over the internet you have only yourself to blame.