Will Powell do ‘whatever it takes’?

Monday, 19 August 2019
Adelaide, Australia
By Bernd Struben

  • What’s an ayatollah to do?
  • In the mailbag — ‘When the zombies start to die’

When I think of Jackson Hole Wyoming, two things spring to mind.

First, the outstanding natural beauty of the place. It’s where I saw my first — and to date only — wild moose. And the ski resort of the same name offers some of the longest and most challenging runs in the US.

Not to knock Victoria’s Falls Creek. But Jackson Hole’s 4,139 feet (1,262 metres) vertical drop from top to bottom is more than five times what we get Down Under. And we won’t even mention the annual snowfall disparity…

The second — and more relevant — thing that comes to mind is that the small resort town plays host to the US Fed’s annual Economic Policy Symposium.

That date is almost upon us again. The big wigs from the Federal Open Market Committee (FOMC) alongside Fed Chairman Jerome Powell are meeting there on Thursday and Friday.

Powell, as you know, has been taking a bruising from Donald Trump. First, for having the audacity to raise interest rates last year. Then for being stubbornly slow to bring in the first rate cut this year. And delivering only a paltry 0.25% cut last month at that.

With that background in mind, and central banks across the world waking up to the limits of their powers, they’ve at least gotten off on the right foot with this year’s title, ‘Challenges for Monetary Policy.’

Indeed.

Analysts are already tripping over themselves in a rush to explain what’s at stake. But it’s pretty simple really.

Global markets have been juiced by cheap money since central banks began slashing interest rates and buying bonds (quantitative easing) in the wake of the 2008 global financial meltdown. Lured by easy money, households, corporations, and governments loaded up on ever more debt.

Highly indebted emerging nations may offer some of the most intriguing growth opportunities. But they’re also most at risk. Not that any market is safe.

Any hint that we’ll need to service these mountainous debt piles with interest rates that aren’t close to zero or actually negative is enough to send investors stampeding for the exits.

Just think back to the latter months of 2018. Following a series of small rate rises by the US Fed, with promises of more to come in 2019, US markets tanked by roughly 20%.

The ASX 200 did a little better, losing ‘only’ 13.5% from 30 August until 24 December. Since then, following on a dovish change in tune from Powell, the ASX 200 is up 16.5%. Even after the past two weeks’ losses.

Investors have already priced in a 0.25% September rate cut with 100% certainty. But if Powell wants to please bossman Trump — and be rewarded with more than a tepid, short lived stock market rally — he’s going to have to dig deeper.

That could well come in the form of a 0.5% cut. But more likely it will be in the words he uses. Hints of future rate cuts will be bullish for stocks. As will any mention that the Fed could restart its quantitative easing programs…having only just put its quantitative tightening on hold.

What equity investors are really hoping is for Powell to channel ECB chief Mario Draghi’s infamous 2012 speech. If he comes out and says the Fed ‘will do whatever it takes’ to drive this business cycle into uncharted territory, you’ll want to have some money in growth stocks.

Of course, even the most favourable comments from Powell won’t be enough to stop a market rout if China sends its People’s Armed Police force into Hong Kong. And as covered last Tuesday, that remains frighteningly likely.

Now a look at the rebounding markets.

Markets

Over the weekend, the Dow Jones Industrial Average closed up 306.62 points, or 1.20%.

The S&P 500 closed up 41.08 points, or 1.44%.

In Europe the Euro Stoxx 50 index finished up 46.30 points, or 1.41%. Meanwhile, the FTSE 100 gained 0.71%, and Germany’s DAX closed up 150.07 points, or 1.31%.

In Asian markets Japan’s Nikkei 225 is up 131.65 points, or 0.64%. China’s CSI 300 is up 1.66%.

In Australia, the S&P/ASX 200 is up 59.87 points, or 0.93%.

West Texas Intermediate crude oil is US$55.25 per barrel. Brent crude is US$59.07 per barrel. (More on oil below…)

Turning to gold, the yellow metal is trading for US$1,509.62 (AU$2,226.58) per troy ounce. Silver is US$17.10 (AU$25.22) per troy ounce.

One bitcoin is worth US$10,322.60.

The Aussie dollar is worth 67.80 US cents.

What’s an ayatollah to do?

With Hong Kong’s democracy protests and the US-China trade war stealing the show, poor Kim Jong-un just can’t manage to grab global headlines like he used to. That’s despite the almost weekly displays of fancy fireworks he’s been setting off over the Sea of Japan.

Even Boris Johnson is having trouble staying on the front pages. And that’s with his self-imposed 31 October Brexit deadline coming on fast.

Then there’s the West’s festering rift with Iran. What’s an ayatollah got to do to scare the bejesus out of global energy markets? More, it seems. A lot more…

At US$55.25 per barrel WTI crude is trading right in the middle of my US$50–60 price forecast for 2019. That’s, obviously, as expected. At this price most US drillers are well into the profit zone. And record production out of the US continues to keep a lid on prices.

But a hot war pitting the West against Iran could still shut down the vital Strait of Hormuz to tankers. That risk is as real now as it was six weeks ago. And it would likely see crude top US$100 per barrel almost overnight.

Yesterday Gibraltar opted to release the impounded Iranian supertanker, commandeered by the Brits in early July. The ship’s been reflagged and renamed, and still carries its load of oil. It’s now heading east, towards Syria, which was reportedly its original destination.

If the Iranian tanker does attempt to deliver its load to Syria in violation of UN embargos that would surely aggravate tensions. And the next war of words could be punctuated by artillery fire.

Speaking of which, in an unrelated-related incident, Iranian backed Yemeni rebels are upping their attacks on Saudi Arabia’s oil facilities. Their weapon of choice…a bomb wielding drone. Though the attack did little damage, it highlights the increasingly perilous situation in the region. Both to life and limb. And to the global oil supply.

Saudi Energy Minister Khalid Al-Falih responded to the attack on the Saudi Press Agency website:

Saudi Arabia condemns in the strongest terms this cowardly attack, and affirms that this action of sabotage is a continuation of the series of vulgar attacks targeting the global oil supply chain that including those that were recently launched against oil pipelines in the Kingdom and tankers in the Arabian Gulf amongst others.’

And crude oil prices responded by doing…nothing.

So will OPEC+ do what frictions with Iran have failed? Don’t count on it. As I’ve written here before, OPEC’s glory days are well behind it. And when the cartel agreed last month to extend production cuts into 2020, I told you to keep an eye out for cheating.

Russia, in particular, doesn’t appear to have much appetite for holding back its oil. Just have a look at the chart below:



chart image
Source: Bloomberg
Click to enlarge

Ah, those pesky partners in crime. Always looking to double dip when your back is turned. And in case you thought the Russians were playing their part from May to July, most of that reduction was due to contamination in their Druzhba pipeline.

But it’s not just the Russians cheating on their OPEC commitments.

From Bloomberg:

Iraq, doesn’t seem to be helping much either. Tanker-tracking data compiled by Bloomberg suggest that its crude exports in the first half of August were the highest in three months. Flows out of West Africa also appear to have been robust in August.’

Barring a shooting war with Iran — inshallah — you can see why I’ve been predicting crude prices to head lower into 2020. Oil bulls…take note.

In the mailbag — ‘When the zombies start to die’

Our focus over the past weeks on ever lower — and even negative – interest rates drew a lot of mail.

Some readers are wondering what we believe will be the proverbial snowflake to set off the next financial crisis avalanche.

Like subscriber Graham:

I’ve been subscribing to your interesting site for some time now and feel that I understand the economic situation better than many, seeing as how your views have continually won out over the media views, for one thing.

I am often in Switzerland, and have learned to love mountains, clean rivers, and seeing small businesses dotting every village. Switzerland is now on negative interest, which means that one is paid to take out a loan. Good for me: I have the collateral if things change and so as long as they change slowly enough I can sort it. What I am wondering is, now that money is considered less than worthless, and Central Banks have shown themselves unable to risk the smallest drops of bloodshed, what would be the actual mechanism, the flap of the butterflies wing, that could trigger a meltdown, presumably in or around ’26, in your opinion?

Yours in interested anticipation.’

Thanks for writing in Graham. Rather than me trying to predict the timing, we turn to three of our in-house pros: Phil Anderson, Vern Gowdie, and Selva Freigedo…who’s channelling Harry Dent here.

Here’s Phil’s take:

This is really, really easy for once. The answer is…the same as it’s always been.

A rise in the cost of borrowing.

The rate at which this is, is irrelevant, because asset prices price in whatever the rate is. It’s the rise in the cost of borrowing at the end of the cycle, when land price has increased beyond the ability of working capital to pay the loans back that is critical.

The proof of this is contained in my book, A Secret Life of Real Estate and Banking. Perhaps you’ve read it?

For the exact timing, this is in Fred Harrison’s Boom Bust.

And for an ‘Anderson special’, from the land price low, count forward 168 months to get the cycle peak – that’s the Lord resting on the 7th day.

I am often in Switzerland too. I worked there for a number of years. I came to love the Swiss representative democracy model.

Now here’s Vern’s reply:

I agree with Phil that there will be a rise in cost of borrowing…but come at it from a different angle.

In my opinion, the butterfly is likely to be a corporate or emerging market sovereign default.

For instance if Tesla or WeWork or Lyft defaulted, it would expose this cohort of companies for what they really are…cash-burners fuelled by investors who were sucked in by so-called visionaries with growth stories.

When the zombies start to die, and the defaults start in earnest, then the bond market will start re-pricing the cost of debt…which as Phil says will lead to a rise in the cost of borrowing.

Each individual, company and country has an interest rate threshold level that’s determined by:

  1. level of debt and
  2. income.

The cash burners have a lot of a) and not so much of b). Therefore, their threshold is quite low…rates might move up less than one percent and they’re in trouble.

A high profile default can change sentiment – social mood shifting from slightly positive to slightly negative – and you have a pincer movement of rising rates and falling incomes…leading to a cascading of defaults.

Finally, here’s Selva’s missive:

Harry Dent sees a meltdown much closer than 2026, around 2020.  We are now at a critical point as we head towards a massive debt crisis that will lead to a period of deflation, much like it did in Japan.

Since 2008 when we saw a massive debt crisis and the major central bankers flooded the world with cheap money we have seen debt increase in all areas, particularly government and corporate. The US national debt is at record highs as is corporate debt

But the likely trigger Harry sees here is emerging corporate debt, in particular  from China. Cheap money made it easy for developing countries to rack up debt. We are now seeing a backlash in globalization and a resurgence in protectionism. A China debt collapse will have a huge impact for real estate and the global economy.’

Well there you have it.

A rising cost of debt. A big corporate or emerging nation default. Or China’s house of cards coming tumbling down.

The breeze from any of those butterfly wings could see a meltdown like the world has never known before.

And on that happy note, we wish you a good day.

PS: You can learn more about Vern Gowdie’s advisory service, The Gowdie Letter, here.

And Harry Dent’s Boom & Bust here.

Cheers,
Bernd