Welcome to the subscriber-only Odd Lots newsletter. Every week, Joe Weisenthal and Tracy Alloway bring you their thoughts on the most interesting developments in markets, finance and economics.
Here’s what Tracy’s watching
The idea of the Federal Reserve hiking rates “until something breaks” has become something of a mantra in markets. The problem is some stuff is already beginning to shatter, it’s just all taking place outside of the US.
Here, for instance, is Japan intervening to bolster the the yen for the first time since 1998, when it was in the grips of the Asian Financial Crisis.
And here’s sterling plunging against the greenback after the UK unveiled a mini-budget featuring regressive tax cuts for high-earners and companies.
While most of the move in cable clearly had to do with the questionable economics of the new Conservative leadership (more on that from Joe below), you can’t ignore the role of the strong dollar here. It also pushed down the euro, which fell below $0.98 for the first time since 2002.
And of course, we know that a stronger dollar has sparked havoc in emerging market economies, which often have dollar-denominated debt and import commodities that are invoiced in US currency.
Speaking of commodities, the dollar has been breaking things there too. As Odd Lots guest and the author of the Commodity Context newsletter Rory Johnston tweeted, there’s a whole lot of dollar dynamic in the oil price this week given the absence of much other news. The global benchmark Brent is now down more than 30% from above $123 a barrel in June.
In bringing down prices of commodities, the strong dollar is ruining one of the last remaining hedges for investors trying to offset higher inflation.
That’s a feature rather than a bug for a Fed that’s been adamant that stocks need to come down in order for monetary policy to actually tighten financial conditions. But make no mistake, the dollar is a wrecking ball swinging at the global economy and investors’ portfolios right now.
Here’s what Joe’s watching
The big news today, as Tracy mentioned above, is the surprise tax cuts planned by the UK government. Markets are going haywire because it’s pretty standard stuff that when the main problem you’re trying to deal with is inflation, the last thing you’re supposed to do is fiscal loosening.
If anything, tax hikes probably make more sense here. But elected officials never like to do tax hikes, which gets to the case for central bank independence in the first place — unelected policymakers who can impose “pain” that elected officials would be loathe to exact themselves.
Anyway, the policy moves being made in the UK made me think about a recent comment from Credit Suisse’s Zoltan Pozsar during our recent live episode about the future of the US dollar.
Pozsar argued that policymakers are used to crises of “basis,” i.e. some kind of spread that needs to be closed, which can be solved by throwing more money at the problem. But the problem of inflation is a different one.
Here’s the whole comment from Pozsar, which is worth reading in full:
“Let me just offer one observation, which is that, you know, everybody likes to talk about the fact that, well, maybe we are in a bond bear market and Wall Street is so young nobody has seen rising interest rates. So we don’t know how to trade it. A version of that is that we haven’t seen an inflation episode so we don’t know how to think about inflation … There’s a basis that creeps in always. And it’s always as simple as somebody throws balance sheet at it, and the basis closes. This crisis of the price level, this inflation crisis, is a very different ballgame. It’s not as simple as raising rates because the world doesn’t work like that. It’s not as simple as doing QT because the world doesn’t work like that. So I think this is a real test. And so I think this is a very particular moment in time. You know, this notion that the Fed can deliver 2% price stability is probably the reason why FX reserve managers, over long periods of time, started to diversify away from bills to two-year Treasuries, five-year Treasuries, 10-year Treasuries, because it’s a good store of value. And it’s an idea, and we will see if that’s indeed the case or whether we are going to settle in a period where 2% is not attainable. And maybe 4% at some point is the new target. Or maybe we’re just going to be bouncing around between five and 10. I don’t know. We have seen something like what happened in the 70s, but we haven’t seen anything that, you know, happened a hundred years ago, 1914, 1948, all these things. So my impression, talking to clients, is everybody thinks about the spike in inflation charts as if it’s another basis. Okay. You know, we are used to thinking about crisis because we had crises of basis, you know, a FX rate and a market rate, a cross currency basis, a LIBOR/OIS, a cash Treasury-futures basis, AAA CDOs versus AAA Treasuries.”
You have parties that have built their identities around tax cuts (conservative ones, typically) and others that have built their identities around subsidies and welfare expansion (left, liberal ones typically) and it’s not obvious that either has the muscle built up to address today’s set of imbalances.
And it’s not just the UK either. California is giving out inflation relief checks. Conservatives in Canada are talking about tax cuts and so forth.
And again, while some may take solace in the idea of central bank independence and the fact that they can hike rates into all this, there’s also good reason to be skeptical that rate hikes are the best tool to address the factors driving inflation today.
On the podcast this week
This week we were mostly about crypto (don’t worry, there are some more macro episodes coming out next week). We continued thinking about stablecoin regulation, this time speaking with Tim Massad, the former Commodity Futures Trading Commission chairman under President Obama. Tim is fantastically thoughtful when it comes to financial regulation in general, so the episode is well worth a listen. You can also read the transcript.
We also caught up with Christine Kim, a researcher at Galaxy Digital, to talk about “The Merge,” Ethereum’s long-awaited switch from proof of work to proof of stake. The episode is here and the transcript over here.
We asked Christine for some book recommendations. She says she’s currently reading “The Cryptopians” by Laura Shin. She also suggests “Kings of Crypto” by Jeff Roberts and “Project Hail Mary,” which she describes as one of her favorite science fiction books.
Here’s what we’re reading
- Get used to startups trying to reinvent housing.
- Which country produces the essential metals for clean energy?
– The case for Joe Manchin’s vision of energy permitting reform.
- What was the Volcker Shock, really?
- What FedEx means and doesn’t mean for the economy?