The inventory problem has been bubbling for a few months, but it was only recently – about the last week – that a deflationary impulse surfaced in the markets. Most commodities are in correction mode, with the Bloomberg Commodity Index having fallen more than 10% since June 9, with metals, energy and agricultural commodities all falling significantly from their highs . Even cotton has seen a series of lower limit days in the futures market. When speculators first realized that faster inflation was inevitable, the natural reaction was to turn to commodities, and the Bloomberg index had climbed as much as 43% since the start of December. . But now those gains are disappearing.
Aside from durable goods orders, which the Commerce Department said Monday rose 0.7% in May, more than expected, economic data has deteriorated. The Federal Reserve Bank of Atlanta’s widely followed GDPNow index, which aims to track the economy in real time, showed no growth for the quarter. The Dallas Fed’s manufacturing intentions survey released on Monday fell to its lowest level since the early days of the pandemic in May 2020. The “deflationary impulses” Burry referred to could be happening now. It seems very likely that the June Consumer Price Index report, due July 13, will be comfortably below the 8.6% recorded in May. To believe otherwise would be to ignore a mountain of economic data.
In previous inflationary periods, the Fed had to raise interest rates above the rate of inflation to bring inflation down. That may not be the case this time. As laughable as it sounds, there may still be a transitory element to current inflation that was a function of quantitative easing, government spending and pandemic hoarding. Now that all of these factors are reversing, inflation could slow. And if inflation slows, it should be very positive for stock and bond markets. The current bear market was based on the idea that the Fed was stuck in the fact that it had no choice but to raise rates to the point of forcing the economy into recession if it wanted to control the ‘inflation. And the economy may indeed have been forced into recession, albeit prematurely.
As a result, commodities could enter a very deep correction. Everyone knows that a lot of “speculative money” has been poured into commodities, making it a very crowded trade. The “pain trade” would be for the recent decline in these markets to continue – and that may just be beginning based on the latest economic data.
So if Burry is speculating that the Fed might suspend rate hikes, when would that be? The Fed said it wants to see “progress” in slowing inflation before it recedes, which likely means weaker CPI readings for a few months. It is possible that policymakers will take a break as soon as they meet in the second half of September, and in this context, “pause” could mean a rate hike of 25 basis points instead of 50 or 75 basis points.
Could the rate hike campaign end with a target fed funds rate of 2.5%, up from the current range of 1.50% to 1.75%? Yes, but only if there is clear evidence that the economy has entered a recession. It looks like it will. Ironically, this would be positive for capital markets. To an outside observer, this makes no sense – stocks rally in a recession? Of course, because the stock market discounts future events to the present. The stock market has forecast a recession about six months in advance and will forecast an expansion about six months in advance.
Against this backdrop, US Treasuries look cheap, especially at the shorter maturities. Yields on two-year notes edged up a bit, rising to nearly 3.5% from around 0.25% at the same time last year. Eurodollar futures show traders expecting rate cuts in the not too distant future.
Burry, who became known as one of the few to predict the collapse of the subprime mortgage market that led to the global financial crisis, says nothing very original. Some market players share his point of view. But when he says something, it tends to carry extra weight given his past successes. The inventory tweet is only a small part of the picture, and while the talk of the recession has become so pervasive that it’s become a bit cliché, the data is there and it’s likely to happen.
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This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Jared Dillian is the editor and publisher of Daily Dirtnap. Investment strategist at Mauldin Economics, he is the author of “All the Evil of This World”. He may have an interest in the areas he writes about.
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