Big One Incoming

The 3M/10Y bond yield inversion is the second longest ever. The longest yield curve inversion preceded 1929. Two other long ones preceded 1973-1974 and 2008, two of the worst bear markets after the Great Depression. The Other long one came ahead of the early 1980s back-to-back recessions, the worst recession since the Great Depression at that point. The current market has the qualities of the 2000 tech top mania speculation in tech and crypto, it has valuations on par with 1929 and 2000, along with curve inversion on par with markets that collapsed from valuations far lower. This might finally be the start of something that will dominate history books for a century.

Replacement of American Workers by Foreigners Hits Extremes

 ZeroHedge: The Real Shocker In Friday's Jobs Report: 1.2 Million Native-Born Workers Lost Their Jobs, And Were Replaced With 668K Foreign-Born Workers

Meanwhile, the number of foreign-born workers (i.e., immigrants) surged by 668K to a record 30.396 million

About 156 million people are employed in the labor force. About 1 out of 5 are foreigners and this isn’t counting illegal aliens who might run into the tens of millions. The total swung by 1.8 million people last month alone, or more than 1 percent of the workforce.

If an invasion of foreigners was good for the country, USG should be running massive budget surpluses as foreigners build companies and pay taxes. The opposite is the case: data from the Center for Immigration Studies shows foreigners use welfare at far higher rates than natives. Cities such as New York, Chicago and Los Angeles are now having political meltdowns over experiencing a small fraction of what Texas, Arizona and other border states experienced for decades. Many of these states were already on the brink of bankruptcy. They do not have the resources to deal with the problem.

It also isn’t really a result of busing from border states so much as the waves of illegal aliens finally overwhelming the United States. There isn’t enough housing, there aren’t enough doctors, there aren’t enough schools, there’s nowhere near enough money for tens of millions of new welfare cases adding to the burden of a rapidly aging society already going into inflationary-collapse over entitlement spending. If natives are quitting or losing jobs and being replaced with cheaper foreigners, they all qualify for welfare. The country is moving backwards, rapidly into Third World status.

Very short-sighted and clueless people think this is good for the country. It’s going to end up being good like atomic cornflakes, margarine and mRNA vaxxes. Unlike many problems, this one won’t get cheaper after people realize what happened. The country will first experience massive economic hardship. Only then, when natives suddenly cannot find jobs or have to take huge pay cuts amid rising inflation, or see their welfare benefits cut as is already happening in cities such as Chicago, will they realize they’ve been hoodwinked. Then we spin the roulette wheel and find out what form the dictatorship takes and how long it lasts. Even if its democratic, the man who emerges from this mess will rule as FDR and Lincoln did. Political enemies will be jailed., either the current regime hanging on or a new regime punishing the current one. Immigration will probably go negative for a time and then hit a number close to zero, staying there for a century or more.

The U.S. has been in similar situations before, but it was never pushed to this extreme. Foreign born population was high enough to warrant a major reduction or even near total ban on immigration back in 2000. Policy has gone in an extremist direction since then. The three prior periods: heading in the 1770s, the 1850s and the 1920s. Two out of three sparked wars and the third came ahead of World War II. Nothing good is coming in the short-term.

Inflation-Adjusted Possibilities

If the Fed can't or won't stop inflation, the inflation-adjusted losses on the market indexes may erase the entire 40-year bull market. A drop to the 1966 inflation-adjusted DJIA seems like a lock to me in any major bearmarket. It is about a 69 percent loss down to the 1500 area onthe S&P 500, the 2000 and 2007 topping area (I used DJIA for any data before the 1980s because it was the most watched index then), that I think can be hit in nominal terms during a front-loaded bear market. The longer a bear takes to unfold, the more losses will be made up of lost purchasing power. That might sound nuts, but consider the CPI-adjusted low in 1982 matched where the DJIA was in 1947.

The CPI is about 300 right now. What if the CPI hits 500, about 60 percent inflation, over a decade. Multiply the CPI by 30 to get 15,000, matching the inflation-adjusted peak in 1966. Zero inflation-adjusted gains not including dividends. You may point out the dividend gains aren't too shabby and you're right, that's a lot of compounding. However, we are looking ahead. Do you want to suffer that loss while only collecting about 1.6 percent yield on the S&P 500 Index? Also, bonds can compound too. If inflation rises, 10-year treasuries will be paying substantial interest, possibly as much as the 8-percent investment return target many investors and institutions default to.

Game Over

Repo is inverse with XLF, not on XLE.

If California Didn't Exist, Austrians Would Have to Invent It

Clownifornia delivers another lesson in central planning and interventionism gone wrong. Retail sales spiked in October when California issued a stimulus check. Retail sales fell in November.

If America chose a pet rock for president, it would be a successful term because the pet rock would not intervene. Unfortunately, there are bad policies that do constant intervention that must be unwound, but a pet rock would come up with no stupid ideas, which it seems is the only thing the Baizuo ruling class can come up with.

Stability is the Problem

The one aspect of this bear market that is misunderstood: stability was the problem. The market right now is in a mild bear market. Most bear markets aren't mild, they eventually get worse. Time-wise, the bear market is moving slowly, which suggests a larger magnitude bear move. The economy is holding up well, credit risk still hasn't broken out yet. People want to blame the Federal Reserve and they do deserve blame for pouring gasoline on the bubble. They deserve blame for quantiative easing because they suppressed volatility for more than a decade. Yet they didn't shut down the global economy and spend trillions as a response.

All of which is to say, there's no way this was going to end well. The Federal Reserve's rate hikes are arguably having very little effect on the markets and in hindsight, will merely be a symptom rather than a cause. Suppressing volatility is like adding dry wood to a forest floor year after year, while preventing all forest fires. Eventually, all it takes is a spark for a forest-killing fire. The governments of the world started helicopter dropping gasoline in 2020. Western governments and China haven't stopped.

Frozen Baizuo 2023 Edition

ZH: New England's Power Crisis Set To Return, Regulator Warns

New England's power grid could be several cold snaps away from the start of an energy crisis that reappears whenever temperatures dip because of the state's heavy reliance on natural gas generation, delayed/blocked expansion/upgrades to energy infrastructure, and lack of grid diversification.

Average temperatures across Massachusetts started to slope down in mid-August. Temperatures are between 55-60 degrees Freigheight, indicating the heating season could be just weeks away.

Another serious issue is the controversial US law, the Merchant Marine Act of 1920, more commonly known as the Jones Act. This law helps ensure the US merchant marine fleet remains busy by only allowing US vessels to transport goods from one domestic port to another, barring foreign vessels.

This means New England can't receive LNG shipments from the US Gulf because the US shipbuilders don't build LNG carriers. So LNG facilities in New England have to rely on foreign shipments -- adding to the complexity of the region's issues.

Bizarro Markets Again

The markets are nowhere near pricing in a world where 15% of Europe's GDP goes into energy payments. Think about how the world financial markets behaved in 2000 and 2008 when about 3 percent of GDP was lost. The effects are enormous because that 3 percent isn't spread evenly over the economy. Sectors such as manufacturing can see double-digit declines in sales and profits. Now think about 5 times as much spending being shifted. Think of it this way: imagine the US had to shut the entire healthcare sector. All the hospitals, biotech firms, Band-Aid manufacturers, doctor, nurses and administrators, it's all gone. Or consider federal spending is about 23 percent of US GDP. European consumer spending on non-necessities will fall to near zero.

There is a bullish case here: Europe blinks. The financial markets could easily rally 10 percent on that news. How that shakes out with oil prices and inflation would take time.

The bearish case is they don't blink. I'd wager almost none of this risk is priced in because it's extreme risk. Every multinational consumer company might see sales tumble towards zero if this plays out in the worst way possible. This would cause a Great Depression 2.0 because debt would default or the ECB prints enough such that the currency absorbs the losses. I have no idea where EURUSD could go in that scenario, but 50 cents is probably on the optimistic side.

Baizuo Found Dead After Fact Checking Meme

We are reaching levels of reputational collapse that shouldn't be possible. An obviously fake story was fact-checked because in 2022, the average voter might believe a story about the Washington Post calling for the cancellation of elections to save democracy. This hits on so many levels. The public assumes the media are the authoritarians? Possibility that the media itself is so stupid that it is fact-checking jokes? It's own sideso malinformed by mainstream media that it requires these fact checks? However you spin it, the implication is a reputational fatality for media.

Do Californians Know They Live in A Desert?

Part of climate change hysteria is driven by Americans who live in deserts and don't know it. SF Chronicle: Mono Lake was supposed to have been saved from going dry. Now, the ‘white stuff’ forces a reckoning

The drought bearing down on Mono Lake and the rest of California picks up on a two-decade run of extreme warming and drying. It’s a product of the changing climate that has begun to profoundly reshape the landscape of the West and how people live within it.

Nope. You live in a desert.

Phys.org: Ancient Southwest marked by repeated periods of boom and bust

This is particularly important as droughts of just five or ten years were enough to prompt major shifts in the small niches where Pueblo people grew maize, their major crop.

The niches, said Kohler, were "woven together with a web of ceremony and ritual that required belief in the supernatural" to ensure plentiful rain and good crops. When rains failed to appear, he said, the rituals were delegitimized.

"Then there's a point where people say, 'This isn't working. We're leaving,'" he said.

That starts a period of exploration in which people look for new places to live and develop new ways of living, followed by a period of exploitation in a new niche with different behaviors and values.

"There's a new period of wealth creation, investment in architecture and culture change," said Kohler.

The researchers said the first period of exploitation, known as Basketmaker III, took place between 600 and 700 A.D. It ended with a mild drought and was followed by a period known as Pueblo I, in which the practice of storing maize in underground chambers gave way to storage in rooms above ground.

The researchers think this represents a shift from unrestricted sharing of food to more restricted exchanges controlled by households or family groups. The period ended around 890 with a slightly larger drought.

The exploitation phase of the Pueblo II period ran from 1035 to 1145 and was marked by large shared plazas and great houses—what we would today call McMansions—in the Chaco Canyon area south of Mesa Verde, Colo.

"We're talking some of the largest—actually, the largest—prehistoric masonry structures in North America north of Mexico," said Kohler. "These things are huge."

Wood for roofs had to come from 50 to 75 miles away, requiring an unprecedented level of coordination. The mix of large and small buildings also suggests a more hierarchal social structure with someone in charge.

Climate change is a big deal when you live in a place that has adequate rainfall and water supply for a few hundred years and then turns into a dry desert. Ignoring the reality of this cycle moves a society from one in deep trouble facing serious climate problems to one that exterminates itself with energy and economic policies that facilitate mass distribution of Darwin Awards.

Chile Kicks Off Nationalization Stage of Nationalism Wave

Resources will become more scarce as more countries go down this path. Mining Journal: Chile Constitutional convention votes to nationalise mining

Chile’s Environmental Commission of the Constitutional Convention has approved a rule for inclusion in the new constitution to nationalise the exploitation and exploration companies of strategic assets, which includes lithium, copper and precious metals assets. The norm would result in, “passing to the national domain all the assets of said companies and their subsidiaries related to their activity in national territory. … The exploration and exploitation mining concessions constituted in favour of these companies will cease immediately once the nationalisation takes effect,” the document reads.

Included in the law is no compensation for lost assets.

Very few countries run state industries efficiently. What happens most of the time is the nationalized industry is inefficient. It needs increased capital, but cannot obtain it on the world market. In the current world situation, China will probably be happy to colonize Chile's resource sector. Otherwise, as happened in Venezuela, the country will go down the tubes as one of its main sources of wealth is systematically destroyed by a parasitical ideology.

For the rest of the world, the result is higher resource costs. If they do not print money and create inflation in response, the result will be slowing growth, recession and stagnation until substitutes are found. Copper won't be replaced outright, but as the price rises, projects that use it will cease, and where it can be substituted it will be. Over time, countries will make do with less of whatever resources has become expensive. In this case, the green revolution is rapidly dying, although most of the West doesn't realize it yet because they're blinded by an apocalyptic religion.

The other trend to note is nationalism. Nationalist socialism, nationalist populism, nationalist capitalism and so on are rising. The nationalists will defeat the globalists.

What Should the Federal Reserve Do?

Surprise the market with a 50 bps hike,m citing economy weakness. No dovish rhetoric,no pivot, merely watching to see if the economy takes inflation down on its own. This will trigger a squeeze that will temporarily push up inflation a bit. Powell uses Jackson Hole to jawbone it down. Then raise anotehr 50 bps or 75 bps if necessary in September. Stocks will be about where they are now.

If you're going to manipulate markets, might as well manipulate them all the way. Stress relieving rallies are necessary if they have in their mind to "go all the way" and lift the Fed funds rate above the CPI if necessary. The current pace is pointing to a crash that will force the Fed to choose destructive QE again or allowing something like a 2008 market crash to proceed without any help.

PPI Surges, Depression Incoming

Market Ticker: FIIIIRE! (PPI)

It gets worse in the intermediate category, which I remind you takes six to 12 months, minimum, to work through the system to the store shelf.

For comparison, here is 2008:

He is not wrong in what he says, but the example of 2008 shows that price increases don't have to make it through to the consumer. If instead demand collapses, these high costs will turn into losses for the businesses. 

The average price for oil in July is $105 through yesterday, down nearly 10 percent. Not enough to really dent inflation yet, but a start. The drop to the low $90s the past two days could double the percentage drop if it holds through the month.

Oil has topped though, and the pattern has a target of $65. Consider how bad things will be for $65 oil in the middle of a war with a government intentionally jamming oil prices as high as possible.

Will the Federal Reserve Destroy the World in Two Weeks?

When people using different models come to the same conclusion as myself, I pay attention:

I'm overdue on updating the fed pivot indicator, and frankly it's showing we have arrived already

We are at the point where the fed would usually halt rate hikes and begin easing again

As they gear up for 75bp in a couple weeks, they would be knowingly blowing up the system pic.twitter.com/u20NsnvhNH

— TheHappyHawaiian (@ThHappyHawaiian) July 11, 2022

He's using debt financing for government. I look at it from the view of inverted yield curves and the breakout in the U.S. dollar versus the yen in particular. Here's the spread between the 10-year and 2-year yield. Back to the line where rate cuts begin.

Here's the same chart with the effective funds rate (DFF on FRED) inverted.

This makes me very nervous:

If I was in Powell's shoes, I'd be scared of hiking 75 bps and the market interpreting policy as hawkish. The markets are on a knife's edge. In 2018, the Fed reversed course and stopped a stock market decline. I'm not sure they can reverse a collapse in the yen if they knock that domino over. Crashes beget crashes:

Coming into 2022, the Fed was trapped because the market would crush stocks and bonds whether they hiked or not, therefore they had to hike. Now they are in a different trap. They have a new threat: deflationary collapse. 

If they hike too slowly and the CPI stays high, they may have to hike more later. My hunch is recession will kick in eventually and solve this risk. Still, if it is a risk, it is a manageable one. They could signal hawkishness in September if August gets too inflationary for their tastes, but my hunch is any bounce in speculation and commodities will burn out in a couple months at most. 

If instead they push global markets into a major crisis, they will have to backtrack on tightening at all. They also might have to do it within days, weeks at most. That will harden the idea that the Fed is trapped for good and can never hike rates or has no idea what it is doing, setting up a repeat of 2022's decline as soon as whatever animal spirits they stir up fade away.

My view: the Fed has a lot of leeway on what constitutes a pivot. Markets are now pricing in a 75 bps hike with the gamblers betting on a 100 bps hike. This looks like lunacy to me given developments in commodity and currency markets, plus incoming economic data. Odds of a 50 bps hike were at 50 percent a month ago (before the market priced in more hawkishness). Since then commodities have cratered, gold-copper screams deflation, U.S. dollar is breaking out again and Fed models show a recession and rapid disinflation. Everything is telling me 75 bps will be a coup de grâce for inflation and financial markets.

At this point, a 50 bps hike would both be economically excessive in my opinion, but also perhaps necessary given Fed guidance. It would cause a "dovish" reaction in markets. If the Fed plays the markets, then 50 bps looks like the right number. Or the Fed could deliver 75 bps as expected, but signal a far more dovish footing for September, perhaps even no hike being on the table if the "data warrants" with the Fed statement discussing the rapid cooling in various markets. Whatever they do, they are at high risk of overshooting on the hawkishness and should consider how they want to climb down. A slower pace of hikes is the obvious choice because it leaves open the possibility of more hikes.

At least one Fed official sees the risk. Esther George today (PDF): Tightening Monetary Policy in a Tight Economy

The main role of the Federal Reserve is bailing out the banking system, not controlling interest rates. It mostly follows the market, and it ignored the market screaming inflation in 2021. It waited too long to hike rates and the economy is doing the work of raising rates and killing inflation for them. It's no surprise that recession fears are here so soon because the Fed should have started hiking rates at least 15 months ago when inflation was obviously manifest and financial assets were still in a speculative frenzy.

It is rare to say, but here a Federal Reserve official gets it. The Fed can communicate hawkishness while dialing back the speed of hikes. See if market forces start taking inflation down for them. The 1970s were a mess because the Fed cut rates in the recessions. If the economy is going into recession and commodities continue selling off, rates are probably already too high. Inflation will come down on its own without any push from the Fed. 

Contra 2021 screaming inflation, markets are screaming caution and deflation here. Maybe it's a momentary fit of madness and will pass. The Fed can't afford to take that risk though. If the markets are right, they're saying something very large could break. Better to wait and see, then to be the impetus for triggering a global meltdown.

Lockdowns All Over Again

The people who were stupid enough to believe in lockdowns believe these energy policies have to do with war and Russia. They don't. Darwin Awards for everybody!

HAMBURG GERMANY IS REPORTEDLY PLANNING TO RATION HOT WATER ***

— The_Real_Fly (@The_Real_Fly) July 4, 2022

Why the Dollar Soars With Oil

The Sounding Line: Where Did Germany’s Trade Surplus Go and Why?

Well, today the data officially confirms that Germany’s [trade balance] turned negative in May for the first time since reunification (1991).

When people talk about the dollar dying, they're talking about the euro. Rising energy will kill the euro. The U.S. consumer and businesses will be hurt, but money that would have gone into buying Chinese imports will instead go to buying oil and gas from Texas, Oklahoma, South Dakota, Pennsylvania...

Known Versus Unknown & Brandon in the Bunker

All the way down in the first half, at least until April or so, bullish investors were saying "everything is priced in." Day after day I would see sentiment indicators showing extreme bearishness. I ignored these because the market was not bearish, precisely because these bottom callers were constantly coming out of the woodwork. Additionally because they were almost always using data sets that only covered the previous bull market. 

"Everything is priced in" also doesn't work when mood changes because nothing is priced in. At the peak of the Nasdaq in November 2021 and S&P 500 Index in early January, nothing was priced in. When mood changes, the news flow turns negative. Not only is bad news not priced in, but more bad news is coming, day after day, week after week.

If a larger rally unfolds this summer, it will happen because two conditions will be satisfied. First, investors are sufficiently pessimistic such that they've priced in much worse news than is coming. This upcoming earnings season could be that. I wouldn't bet on it, but it is possible. Evidence would be provided by a bad earnings report by a major such as Apple resulting in a gain in the stock price. The other catalyst will be actual positive news, be it a Fed pivot (likely positive in the short-term only) or legitimately good news such as peaceful developments in Ukraine.

The downside scenario is that the market simply doesn't understand how bad the situation is here and ever more negative news continues rolling out. There's some risk there with Western governments behaving like Hitler in the bunker. The Biden admin has modeled for $200 oil and $10 gasoline, which would unleash a depression the likes of which hasn't been seen since the 1930s. I think that outcome is unlikely, but I also see no sign that the government cares in the slightest. These are the same people who did the lockdowns after all. Assuming they're sadistic people trying to maim and kill their own citizens has been a fairly good predictor of their policy choices. Becoming too political with economic and market forecasts is always a losing move, but then I've never in my life or U.S. history seen a government this destructive. I assume at some point they'll cry uncle on some issue, but they haven't yet. Here's the latest headline: Biden proposes limited drilling leases off Gulf of Mexico and Alaska

Administration officials said fewer lease sales — or even no lease sales at all — could occur, with a final decision not due for months.

The most bearish thing about the markets and economy right now is the Biden administration. They are making everything far worse than it needs to be. I honestly thought they would have done something positive by now, thus I've been moving "USG doing something good" from the unknown column to the known column, but in the negative.

Baizuo Gouge Americans on Gas

Americans are paying, ballpark figure, about $1.50 extra for gas because Baizuo and neocons (barely any Baizuo are neocons, but all neocons are Baizuo) hate Russia. The extra $1.50 in gas isn't harming Russia at all because they're selling oil to India and China at inflated prices. My best guess is that oil would fall 20 to 30 percent if Russia sanctions were lifted. Possibly much more with Fed policy and market trends keep working in the same direction.

I expect the U.S. dollar will weaken as inflation falls because interest rates would fall too, yet the chart below is a good indicator of how far oil prices could drop. A $1.50 plunge in gas prices is a guess, but a conservative one if the sanctions lift.

US Won WW2 With Industry, Will Lose WW3 Without Industry

RUSI: The Return of Industrial Warfare

The winner in a prolonged war between two near-peer powers is still based on which side has the strongest industrial base. A country must either have the manufacturing capacity to build massive quantities of ammunition or have other manufacturing industries that can be rapidly converted to ammunition production. Unfortunately, the West no longer seems to have either.

Presently, the US is decreasing its artillery ammunition stockpiles. In 2020, artillery ammunition purchases decreased by 36% to $425 million. In 2022, the plan is to reduce expenditure on 155mm artillery rounds to $174 million. This is equivalent to 75,357 M795 basic ‘dumb’ rounds for regular artillery, 1,400 XM1113 rounds for the M777, and 1,046 XM1113 rounds for Extended Round Artillery Cannons. Finally, there are $75 million dedicated for Excalibur precision-guided munitions that costs $176K per round, thus totaling 426 rounds. In short, US annual artillery production would at best only last for 10 days to two weeks of combat in Ukraine. If the initial estimate of Russian shells fired is over by 50%, it would only extend the artillery supplied for three weeks.

The US is not the only country facing this challenge. In a recent war game involving US, UK and French forces, UK forces exhausted national stockpiles of critical ammunition after eight days.

Unfortunately, this is not only the case with artillery. Anti-tank Javelins and air-defence Stingers are in the same boat. The US shipped 7,000 Javelin missiles to Ukraine – roughly one-third of its stockpile – with more shipments to come. Lockheed Martin produces about 2,100 missiles a year, though this number might ramp up to 4,000 in a few years. Ukraine claims to use 500 Javelin missiles every day.

The expenditure of cruise missiles and theatre ballistic missiles is just as massive. The Russians have fired between 1,100 and 2,100 missiles. The US currently purchases 110 PRISM, 500 JASSM and 60 Tomahawk cruise missiles annually, meaning that in three months of combat, Russia has burned through four times the US annual missile production. The Russian rate of production can only be estimated. Russia started missile production in 2015 in limited initial runs, and even in 2016 the production runs were estimated at 47 missiles. This means that it had only five to six years of full-scale production.

The U.S. has depleted its reserves of weapons and ammunition, is flushing much needed reserves down the drain in Ukraine, and cannot hope to ramp up and meet Russian weapons reserves even without assuming China starts supplying Russia.

Rapid, and inflationary, reindustrialization is needed if a war is coming.

Federal Reserve Bank of NY Model Projects 2 Years of Recession

The Federal Reserve Bank of New York has a dynamic stochastic general equilibrium (DSGE) model. Now, I will be the first to tell you not to trust in economic models, but that doesn't mean models are worthless. This model projects a wide range of possible outcomes making it fairly useless in some respects. Who cares if in the next two years, economists can project GDP growth will be in a ranges of 3 to 6 percent? The forecast is for growth and given the inaccurcies of forecasting, all the model tells you is growth is likely. The current forecast is far more valuable: it shows a midpoint probability of a two year recession. That tells us there are some serious problems in the economy that express themselves through the model.

Jeff Snider of Alhambra has some discussion here: Sorry Chairman Powell, Even FRBNY Now Has To Forecast Serious and Seriously Rising Recession Risk

The DSGE model is here with discussion and links to explainers if you want more info.

If nothing else, understand this: the Federal Reserve can't print a government that doesn't start a nuclear confrontation with Russia, that doesn't lockdown businesses, that doesn't force experimental mRNA therapy on citizens, the doesn't let criminals out of prison, that doesn't ban trading for oil or fertilizer, that doesn't restrict energy production. If they try to do something via money creation it will result higher prices and accelerated economic decline in these conditions.