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SVB - IS THAT REALLY THE END OF THE HIKING CYCLE?

The Pro-Labour, Anti-Capital cycle continues in my view

With the failure of Silicon Valley Bank (SVB), there is a widespread view that the Federal Reserve is done with its rate hiking cycle. Certainly, the bond yields of long dated Treasuries and JGBs have fallen in recent weeks.

This may be true, but I think this more muscle memory from the GFC, than a true reflection of the likely inflation and interest rate market outlook. For new subscribers, there are many detailed explanations in older posts, but in essence I am arguing that in 2016, we saw a political change, that began to favour workers over corporates. That is it became political unacceptable to put all the burden of economic adjustment on workers and wages. In fact policy is now geared to raising “real wages”, which means tighter monetary policy, and policy geared to ending speculation. The destruction of Chinese property developers was one feature of this, and I would say the demise of SVB is another. The end game for me is something like the 1970s, with strong commodity prices and higher interest rates as wage inflation gets out of control. We are still early in that trade, if correct.

The recommended trade for this view is long GLD/Short TLT. On Friday as TLT rallied 3 percent, GLD also rallied 2%. The GLD/TLT pair did no inflect deflationary in anyway.

If you are tin-hat, armchair twitter, look at me style substack writer, you may well wonder how GLD/TLT faired in 2007/8 period. Well I show it below. Actually, gold did well until late 2008, and then you wanted to be long bonds, and then back into gold.

So you might be looking at this and thinking this is random. But actually, the market is not random in this case. What I would argue is the market is sending a very clear signal, its just that you are not ready to receive it. What is the market saying? It is saying that China, not the Fed, is the market and government that sets global inflation trends. But not via construction, or auto and luxury sales, but via food (please see my food inflation posts for more detail). As mentioned in 2016, China move pro labour, and has been more successful at raising wages than other nations in recent years. China now has higher food prices in the US, and is large importer of food. So unless China devalues, food inflation will remain an issue globally.

Why is this an issue? Well politicians are very simple creatures. They just want to get re-elected. If people are worried about food inflation, then pressure will be on central banks to get food inflation down, with the easiest way to do this is via tight monetary policy and strong currencies. So over the last year, food inflation has been strong.

And to counter this, the Fed has pursued a strong dollar, tight monetary policy regime.

The problem is that it has not caused China to devalue. And with China exiting Covid restrictions, and the war in Ukraine continuing, the failure of SVB is going to have no effect on food inflation. In anything, US dollar weakness will make things worse.

Discussion about this video

User's avatar
A Walking Gentleman's avatar

I thought it was funny, maybe not in hindsight.

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Russell Clark's avatar

close enough!

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A Walking Gentleman's avatar

Been an interesting last 96 hours. Scaled out of Short TLT last week and added Long Gold. Will rebalance when ECB action what they need to do with a looming European banking crisis.

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AM's avatar

Might be a noob question but how much do central bankers care about gold?

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Russell Clark's avatar

They don't- but they do care about food. Gold is a proxy on that... and much easier to hold

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Aaron Pek's avatar

Another noob question.. what exposure does TLT represent? I thought it was dollar, but in another comment you mentioned you'd be worried if TLT and dollar moved together?

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Russell Clark's avatar

All questions are good questions. TLT US is a fund that mimics the performance of US treasuries with a maturity of over 20 years. What is useful about this is that long dated treasuries can give you large "capital gains" if market expectations of inflation and interest rates fall. If a bond has a maturity of 25 years, and its yield falls from say 4% to 3%, you get a 25% capital gain (roughly speaking). TLT allows you do that in a liquid ETF. In times of stress, TLT has been more liquid than actual treasuries (blame clearinghouses for that).

If TLT rose this means the market expects that the interest rates to be lower for the foreseeable future. In this case, if the dollar also rose, it would be a sign that that interest rates everywhere would also be lower, and we were heading to a very deflationary environment. If the dollar fell, its meant the rest of the world is fine, and the weaker dollar will actually be inflationary for the US. A weak dollar shows that any problems are likely to be confined to the US.

Does that make sense?

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Aaron Pek's avatar

Yes it does, thank you!

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Feral Finster's avatar

My pure SWAG is that SVB will be bailed out, as this allows the Fed to kick the can down the road without having to give up on its goals of furthering Empire and crushing labor, while rich people cannot be allowed to lose money.

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Russell Clark's avatar

Not sure SVB is getting bailed out... but a bunch of tech start ups are getting their deposits back....

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Feral Finster's avatar

Same difference. It accomplishes the purposes I listed above. The Empire can continue the war, labor can be brought to heel, and rich people given the perquisites due their elevated station.

They can't call it a "bailout" as that word has negative connotations and may lead to a questioning of the administration and its policies.

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Clement's avatar

What would lead you to change your mind Russell?

If wheat/corn prices stop rising anymore?

If unemployment in the US > 6%?

Surely the Fed has it limits too.

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Russell Clark's avatar

I would get much more nervous is the dollar rallied when TLT rallied.. but with falling yields you get a powerful inflation signal from markets, which fits in with my view that monetary policy is needed to restrain inflation, not promote it...

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Clement's avatar

Does the stabilisation of energy commodities in particular change your view?

Even wheat now is back to its pre-2022 levels.

From a technical perspective, given the base effects, commodity prices will now be taking away from inflation rather than aggravating it.

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Cyril's avatar

This move in rates is getting insane... The vol too... Maybe just FOMO buying based on March 2020 muscle memory, but it feels more like a Volmaggedon/CHF de-peg/GME/etc. type squeeze... Some funds/institutions getting caught short?

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90s Random Consultant's avatar

Is the larger/premium miners a good enough position to have the call on gold or it's imperative to have the right call to be in $GLD

I go back and forth on this and like the miners for the 3%+ yield they off per quarter

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Russell Clark's avatar

I prefer GLD to miners... particularly as gold looks expensive to energy... if energy prices rise a lot, gold miners do not do well

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Cyril's avatar

I tend to agree my base case is the violent repricing of rates we're seeing is premature, I think authorities will spin the SVB failure as idiosyncratic and isolated and the Fed will stay the course for the time being (we'll find out in 2 weeks I guess) and not pivot. However, while SVB seems to have been poorly managed and all the doomsday talk seems more like PTSD from 08-09 than a realistic assessment of the situation, it does show the stress on the system. I'm not a believer in another widespread US banking crisis, but to me it does seem to show that there is a significant risk of a bigger credit/liquidity event down the road (might not be one big thing... may be the economy dying from a thousand cuts...). How do you assess that risk? You've said previously that you don't expect a recession, but if you expect other failures, in banking or elsewhere, surely in a highly leveraged system that raises the risk of an eventual recession?

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Russell Clark's avatar

SVB price action reminds me of Chinese property developers price action. Equity holders got smoked, but with rising wages, it made little "macro" difference. Social media (including substack sadly) is geared towards predicting crisis. I just the trend is higher in GLD/TLT, with whipsawing action as market hope that rates get cut....

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HWE's avatar

👍🏻

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HWE's avatar

Interesting comment about new subscribers. Behind the Balance Sheet by Steve Clapham said the same thing earlier this week. I find that really weird. Both of you were on the Grant Williams podcast, but a while back.

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Russell Clark's avatar

Looks like the surge in net interest subscribers cause a flow to me as he used some of my clearinghouse work back in the day

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A Walking Gentleman's avatar

Хорошая презентация, товарищ

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Russell Clark's avatar

Are you trolling me?

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