Is China the Biggest Market Risk? With Jeff Snider

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1:24And now to the top analysis of today's markets.

1:40Is China the biggest market risk? Hi, everyone. Welcome to this extended Real Vision Daily Briefing. With me today is Jeff Snyder, host of the Eurodollar University. Hi, Jeff. How are you? Great, Maggie. How are you? I'm doing well. It's great to have you back on. We were just joking right before we came on air that it's been really busy. And it certainly seems like that, especially the last couple of weeks. I mean, the August lull is a myth. We know that. But we've seen a lot of movement. It feels like a lot of anxiety building beneath the surface. So we look like, I mean, the stocks have been bouncing around today.

2:16They were mixed. They were lower. And they still look like they're going to, again, end at the lows of the day, a little selling into the close. But it's really been the bond market where you've seen that worry show up, the 10-year yield now at 424. I'm not sure exactly where it closed, but it's going to be pretty close to that, 427. What's going on? Why have we seen such a big move in the Treasury market? Well, both Treasuries and stocks are reacting to potentially more hawkish Federal Reserve policy, right? because in the stock market in particular, ever since we went through the banking crisis in March and April, the narrative has been, Jay Powell's done.

2:58The FOMC, they've gotten as far as they can go. Now the economy is going to fall off, maybe a mild recession. So there's no way the Fed can hike any more rates. And then it got into that Goldilocks position where we thought, OK, the Fed's done, but there might actually not be a recession at all. And stocks rallied on that. Bonds were sort of agnostic about it. And now we're in a position where, OK, maybe the economy appears to be too strong. Not only are we going to avoid a recession, at least that's the narrative, that's going to force the Fed to get back into the rate hikes. And if you think rate hikes are the reason why stocks were lower, if you think rate hikes are going to impact bonds, then you're going to sell both of those instruments.

3:38So we've kind of gone through the entire circle here, the entire circuit here. We went from no more rate hikes is good. We're not going to have a recession to, oh, maybe we're going to we're not going to have a recession such that we're now going to have more rate hikes again. And it's impacting sentiment. And then you throw on top of it, there's so much uncertainty about what's going on with consumer prices, what's going on overseas. It's really a confusing period. In fact, maybe it's one of the more confusing periods we've had over the last couple of years. And the last couple of years have been known for being particularly ambiguous and confusing.

4:09So we're all in a pickle. And by the way, we've heard that almost across the board from everyone that's been coming on our platform. And these are people who've been in the business for decades, who've traded all sorts of crises in the past. A lot of people saying this is one of the most challenging macro environments they've been in. So let's sort of break that down into some bite-sized pieces. First of all, on the inflation front. So, yeah, you're right. It's like no landing. Uh-oh, wait. Actually, the U.S. consumer is so resilient, this is going to mean higher for longer, maybe hikes, maybe a return of inflation.

4:44Is that a narrative that you think is going to happen? Is that how you see it playing out? Well, that's how I think most people see it playing out. And that's certainly what the Federal Reserve is worried about, because for them, consumer prices are all about two things. That's expectations and the Phillips curve, neither of which have anything to do with inflation. But at least that's what the Federal Reserve actually believes. And so for them, it makes sense that they would be sending more hawkish signals because they have been expecting a real material slowdown, especially after March and April, credit crunch developing and all that.

5:16And you look at recent statistics, I mean, they're kind of soft. The payroll reports weren't great, but it's hardly the stuff that you would consider as hardcore recession or even close to recession. The unemployment rate's lower again. So as far as the Fed is concerned, the Phillips curve is still in play. And the longer that it goes, then they believe that gets into expectations. So for the Fed, they're thinking, yeah, we need to hike rates. But as far as what's really going on with consumer prices, there's any number of forward-looking indications, which suggests there's no risk at all of that happening.

5:49You look at producer prices around the world, which not only are solidly deflationary, not just in the US, but more so overseas, there is a very good and close relationship between, say, a PPI and a CPI. Maybe there's a little bit of a lag there. But the deeper into deflation producer prices go, the more we know that consumer prices are going there. And furthermore, we know why producer prices are becoming deflationary. It's because the economy, even though maybe it's not showing the signs that the Federal Reserve would like to see, it is actually weakening under the surface. So the Fed looks at the Phillips curve, the unemployment rate, and worries about expectations.

6:25And so there's a lot of people who think inflation is in danger of being reignited by a tight labor market and expectations. when there's a lot of other data which goes in the complete opposite direction, including producer prices, which are telling us that things are really getting serious underneath. So if there is a lead from producer prices to going up in the data yet, what some folks are looking at, they'll say, okay, well, all the good news from that energy deflation, the drop in energy prices is already made its way through. and now you're kind of moving into the winter. You haven't seen prices go down.

7:06They've kind of bottomed. So we're going to see potentially a resurgence in energy. We still have a war in Ukraine. A lot of the things that drove energy up in the first place are still in place. We've drained the SPR. You know all the arguments. So if anything, you're going to have energy start to feed back into inflation and you're going to have a problem. You don't see that as a concern? Well, I think that's an old narrative. That was the idea that in the early stages of disinflation at the end of last year, moving into this year, it was entirely energy, which was kind of funny to begin with, because that's all we heard in 2022 was that oil prices and energy were inflation.

7:43Then it becomes oil prices are disinflation. We're just going to ignore that. We're not going to pay attention. But over the last several months in particular, really since May, what we've seen in producer prices and to a certain extent, a substantial extent in consumer prices, is that it's not just energy prices. I'll give you a couple examples. The European PPI, which has been down pretty substantially over recent months, the core PPI has been down even more in the last couple of months, by the most since 2009. In the last U.S. CPI report for the month of July, what we saw was the core rate, the core CPI rate for the second straight month was disinflationary.

8:22It was modestly positive. I think it was 0.16 % month over month for two months in a row. And the reason was because when you strip out energy, food, and shelter prices, the rest of the CPI was actually fractionally negative for the second straight month. So it isn't just energy prices. And though energy prices are rebounding, especially gasoline, which we all know, and that's going to feed through part of the CPI bucket, part of consumer prices, There are the rest of consumer prices that are becoming more and more disinflationary, if not deflationary outright. Services is another one. The less CPI, services, less rent.

9:01They've been disinflationary basically all year. So I don't think it's just energy and gasoline that we need to worry about. It's the rest of the CPI bucket that's going in the opposite direction from oil and energy and gasoline. So if that's the case, is the economy as strong as we think it is if we're seeing these deflationary forces? What are they keying off of? Yeah, I think that it's the opposite. I think the economy is in much worse shape than we're seeing in the mainstream economic numbers. GDP is a good example. GDP was much better than expected in the second quarter in real terms. But you look at it in nominal terms, what you see is it's been slowing way down.

9:43It just hasn't filtered into the rest of the statistics yet. The labor market seems to be incredibly resilient. The unemployment rate is still at a really low number. The payroll reports are still hanging in there. But we've heard anecdotes. We've seen data that this cycle more than any other cycle, and this happens every cycle, businesses are hoarding labor. They're not resorting to layoffs and firing people because of the experience of the last several years. They don't want to let go of people. So they're experiencing problems in their own businesses, but it's not translating into the main recession indicators that most people associate with a recession, the Federal Reserve included.

10:21It's not showing up in the unemployment rate because businesses are cutting hours. They're shifting people from full-time to part-time, but they're not engaging in the mass layoffs like they probably would have if we were in a more typical cycle, which goes back to what you said from the beginning here. One of the reasons why it's the most uncertain macroeconomic climate in quite some time is there are all these unique factors that are combining to make it really difficult to really put your finger on it and say, this is exactly what's happening. And here's all the data spread out that points to only one conclusion.

10:55It's really ambiguous because you have all of these unusual processes that are taking place. But when you step back and look at it from a high level, despite the unemployment rate, despite the labor market numbers, look at producer prices, you look at market positions and things like that, even though the yield curve, interest rates are backed up a little bit, you have to ask, why aren't they backing up a whole lot more if we were in danger of an actual restart to the inflation process? So there's enough indications out there to suggest that, yeah, the soft landing, that's nowhere near a foregone conclusion.

11:28And you're undercutting or you're not really appreciating the risks that are becoming, in my view, more and more visible all the time. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing. Have you ever wanted to trade Bitcoin but haven't dared try? With Plus500 Futures, you can trade crypto without the hassle of opening a wallet. With just a few clicks, you can register and start practicing with their free and unlimited demo. See a trading opportunity? You'll be able to trade it in just two clicks.

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12:39Not all applicants will qualify. Plus500, it's trading with a plus.

12:49That's so interesting because it's really contrary because we actually went from soft landing, which was pretty market friendly to like no landing. That's what that's what this coinciding with this kind of rethink of rates. In fact, we had former U.S. Treasury Secretary Larry Summers speaking in the media somewhere in an interview saying he thought 10 year yields could average 4.75 % for a while. This higher for longer, Fed isn't done. That's the real risk. Well, the markets are thinking the opposite because you look at forward rate markets and they're still pointing for lower rates ahead. Whether it's the near-term forward spread, SOFR futures, or in Europe, Uriber futures, the European bond curves, just the inverted yield curve.

13:33We're still looking at lower rates. We just don't know when. And so there's a form of recency bias that creeps in here because you think, OK, we've been talking about recession for how long now? And it hasn't happened. So it can't possibly happen. If it was going to happen, it would have happened by now. And because it didn't happen by now, it's not going to happen. And that's a form of bias. That's not actually looking at the situation because the markets, they continue to point to lower interest rates ahead. We just don't know at what point that's going to show up or at what point the economic data or the economy itself is going to be unambiguous, where it's at the point where we all say this is a recession.

14:12And by the way, that's not atypical. Most recessions aren't night and day. It's not like you go from expansion to contraction all at once. You go through a prolonged period where the economy looks like it's going to slow down. You're not really sure where it's going to stop. And then maybe it gets into recession. Maybe it doesn't. Then all of a sudden, everybody agrees, OK, this is the recession. Think of 2008, for example. There were still arguments about whether we would have a recession weeks before Lehman Brothers happened. In the summer of 2008, there was a robust debate about what was going on in the economy when we were already eight months into what was the worst recession up until recently.

14:50So this is typical stuff in these types of periods. And I think, as we said before, it's even more difficult this time because we have more unusual factors to consider than normal. It's understandable why people will be almost polar extremes. People like Larry Summers and the Federal Reserve saying, we need to be really concerned about inflation here. When all the markets are looking at lower interest rates over next year, the years ahead, persistently low interest rates, which are nothing like inflation and nothing like a normal healthy environment or a soft landing, more of a messy transition between where we are today and where that long-run future would look like.

15:32Yeah. So Trillian is asking, what do you make the ongoing bear steepening? And do you think the 10-year yield can reach 5 % in the fall? So is the market mispricing the U.S. economy right now? I think what we're seeing in the Treasury market in particular is nothing more than just the usual fluctuation. It's been moving back and forth in really a narrow range. We're only basically where we were in last fall in September and October. Despite the fact the Fed has engaged in three-quarters of a trillion dollars in quantitative tightening from its balance sheet just in U.S. Treasuries, There's been how many rate hikes between now and then.

16:08Fitch downgrade. The Treasury is deluging us daily with more paper. Records shorts positions from speculators and Treasury futures. Despite all of that, why is the 10-year only 427 or 428? That's really the question we should be asking. And it's not just the U.S. Treasury market. Look around the rest of the world. Rates are low. They are defying central bank policies. And you have to ask yourself why that is. Is it because we're going into a soft landing? Is it because rates are going to be structurally higher? And the argument usually is, well, the market's just wrong, and the market is starting to realize it's wrong and repricing being wrong.

16:44But when has that ever happened? I mean, the market's certainly not perfect. Curves are never perfect. Nothing ever is. But in every cycle we've been through, the market has a far, far superior record than certainly central banks and mainstream econometric models. So again, you ask yourself, yes, rates are backing up from where they were before, but they really haven't moved all that much. The short-term end of the curve is at 550, yet the 10-year Treasury is more than a full point below that. Why? What is the market actually telling us? So you don't buy this. There are some people who are like, forget that following the inverted yield curves doesn't give the signals that it used to in the past.

17:22Those indicators are broken. You don't buy that. No, we hear that every time. You can go back in history and fish out news articles, economist speeches, Federal Reserve discussions where every single time the curve inverts, they say, this time is different. And this time is never different. It's always the same. And it's funny, you mentioned before, we've been through this back and forth just this year. Remember, we started out, we re-ended last year. We even go back further than that. When the yield curve first inverted in early 2022, It was March and April. The big oil price spiked and curve inverted.

17:56And what did everybody say? Nah, this time is different. It means nothing. The economy's just fine. Then we had a whole bunch of really bad stuff happen last September and October. Curves really got inverted and everybody said, uh-oh, here's a recession. Okay, this time we're going to have a recession. And then in January and February, what happened? Everybody went back to the other side of the aisle and said, nope, soft landing. We're going into a soft landing. And then all of a sudden, somewhat out of nowhere for most people's perspective. We had a banking crisis and everybody flipped to the other side.

18:27Oh, yes, there's going to be a recession. The Federal Reserve's models did the same thing. And now what? After First Republic failed and we didn't see the kind of immediate consequences that everybody pictures from a banking crisis, everybody has moved to the opposite direction again. Now we're all back in the inflation soft landing bucket. And so through this back and forth, back and forth, the market curves have been right down the middle this entire time. And again, you have to ask yourself why, despite all of the ambiguity it looks like in the macroeconomic data, markets remain absolutely resolute that from a very technical overview perspective, rates are gonna go down, not up.

19:08And that's not consistent with a soft landing, that's consistent with all the other problems that we've been talking about. Yeah, you're so right in that description. And it makes me think of everyone running on one side to the boat, and it gets really lopsided, then running to the other. And we've seen some of those moves quickly, too. So it's given this sense of real volatility, but super important to kind of pull that lens back. So you mentioned supply. What about all the supply coming? Because that 30-year auction that didn't go well seemed to spark a lot of or contribute to this move higher in yields.

19:39and some people worried about the fact that there are no buyers for treasuries at the long end. This is going to be a problem. And that despite what the Fed does, maybe this is going to put upward pressure on rates to try to attract global capital. What do you make of this supply situation? Yeah, I've lost count of how many years we keep hearing there's too many treasuries. I mean, it's every time. I mean, it's been really since 2009, even before then. But 2009 with the ARA, everybody says there's too many treasuries. And by the way, just to be clear, I agree with them. The federal government needs to be – somebody needs to institute some kind of control.

20:12And I would love it if we would have a return of the bond vigilantes. We need some vigilantes. But the problem is there's enormous insatiable appetite for safe and liquid instruments, which sadly, that's what government bonds provide. I wish there wasn't that kind of link. But the reality is the safe and liquid instruments are government bonds. And because safety and liquidity are prioritized, there's going to be demand for what the government offers. So bond vigilantism is dead, and it was killed by these deflationary circumstances. That's regrettable, but the reality is that's why, despite what Uncle Sam does, despite how much they borrow, rates never skyrocket.

20:52They never surge, no matter how many times we hear they're going to. And they're not going to because supply isn't the overriding concern in the marketplace. The credit profile of the government, sadly, is not the overriding concern. It's safety and liquidity. And that answers the question I asked before. Why are interest rates hanging in where they are? Because people are thinking ahead and saying that safety and liquidity are going to be in high demand at some point in the near-term future. We don't know exactly when that is because you don't put a clock on these things. But at some point in the near-term future, safety and liquidity are going to be in demand.

21:26So Janet can sell her trillion dollars in the third quarter, and it's not going to be that disruptive. And it's funny how that narrative got set by that 30-year auction that you just referenced, Maggie, because the day before it, the 10-year auction was pristine and stellar, but nobody said anything about that. And the three-year before that. Suddenly the 30-year, oh, the 30-year means there's no demand. It's, you know, these quirks, it just, you know, it's, again, it kind of, it fits with the situation. Yeah, and also the narrative that some people have, which you just referenced, which is, yes, there's too much spending.

22:00Yes, there needs to be some sort of relationship and conversation about that. So there are a lot of people who are looking for that ahead of time. And they should. There's no reason the government should be borrowing to the, what are we at, 32 trillion in account? I mean, that's just absolutely mind-boggling awful. But Japan has shown the example. As long as your economy gets stuck in a non-growth rut, the government can do whatever it wants to do. It leads to this long-run self-reinforcing destructive spiral that really takes some kind of effort to get out of. And that's, you know, again, the problem isn't necessarily that bond yields are low.

22:40It's what they're telling us about all of these other things that perversely allows the government to get away with what it's getting away with. And so I understand why people, they emotionally, you know, they really want something to really put a stop to this ridiculousness, the insanity of fiscal deficits. But you're not going to find it in this economic climate from this set of circumstances. As long as safety and liquidity are in demand, that's it. I mean, that's the priority. That's a today problem, not a tomorrow problem. We're going to take another quick break to hear a word from our partners.

23:11We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.