The macro portion of this report focuses on rates, gold, the dollar, OPEC+, and China.
The bitcoin portion focuses on the miner migration and the current opportunity in some publicly-traded North American bitcoin miners like Marathon Digital Holdings (MARA).
On a global scale, daily new cases of COVID-19 are starting another leg up, and deaths attributed to the virus appear to be bottoming out:
Chart Source: Worldometer
There is a promising outcome happening in the UK, though. Their case counts are up, but their attributed deaths remain extremely low.
Chart Source: Worldometer
Treatment methods are better now that doctors have had time to figure it out. Most folks who want the vaccine in the UK have received it, many people have already had the virus, and variants over time may spread faster but less lethally. I’m not a medical expert, so mainly I can only track the numbers.
Indonesia and Malaysia have been in broad lockdowns recently. The spike of cases and deaths in India has subsided, but now that spike is in other countries in Southeast Asia instead.
Malaysian deaths attributed to the virus, via Worldometer:
Indonesian deaths attributed to the virus, via Worldometer:
The same is true for Thailand, with a spike in attributed deaths. Those three countries are interesting places for contrarian/value investors to look at the moment. When they begin getting over the peak of the virus, their markets should be well-positioned for recovery after their lackluster start to 2021.
Meanwhile, Japan is moving forward with the Olympics without spectators, which basically eliminates the economic benefits of hosting the Olympics. They put in the costs but now won’t get the tourism revenues.
Rates and Inflation
Long-duration Treasury yields have declined in recent weeks. They remain well below both the reported year-over-year inflation rate, and the 10-year forward inflation breakeven rate. The forward breakeven inflation rate is the difference between the yields of inflation-protected Treasuries and normal Treasuries, which ostensibly represents the Treasury market’s forward inflation expectations.
For the first time in US history, the high end of the junk bond market is yielding below the current inflation rate, and only 0.91% over the 10-year inflation breakeven rate.
In other words, the Treasury market is saying “current inflation is 4.99%, but we think inflation will average 2.22% over the next ten years, and we’re willing to hold Treasuries at a 1.37% yield and therefore gradually lose purchasing power during the decade based on our expectations”. The junk bond market is also extremely complacent with record low yields, quite sure that default risk will be below.
Some of this is being attributed to slower growth expectations, as fiscal stimulus wears off and we move past some of the easy base effects. Another factor could be the market discounting the possibility of the debt ceiling not being extended for a while. The US debt ceiling suspension expires at the end of July, which will limit the new issuance of Treasuries and cause the Treasury Department to take extraordinary measures of shuffling its books around, until the debt ceiling is increased.
The caveat, of course, is that the Fed is the biggest buyer of Treasuries at this time, including the inflation-protected kind, so the measurement of bond yields has become a target and thus is only mildly informative about economic prospects. In addition, the Fed briefly bought corporate bonds during the heart of the pandemic shutdowns to help with liquidity while fiscal policymakers provided financial assistance to help with solvency, which gave the market the indication that if there were to be another crisis, policymakers might step in again to help with corporate solvency and liquidity.
This problem of Treasury rates no longer being particularly predictive is something I’ve been discussing since early 2020, and focused on in my post back in 2020 in our TradeRoom. Here’s an excerpt from that issue:
Historically, the bond market has been the “smart money” because it is largely driven by institutional investors rather than retail investors. It tends to be more focused on near-term math than on emotion or long-term projections, and as such tends to front-run the equity market, at least in terms of major transitions.
As a key example, an inversion of the Treasury yield curve (10 year yield minus 3 month yield) has preceded the past several U.S. recessions with a useful lead time, and with no misses or false positives. In other words, the Treasury market consistently front-runs what the Federal Reserve will do with regards to interest rates, in reference to prevailing economic data.
Here is the Treasury yield curve, with recessions shaded in gray:
Chart Source: St. Louis Fed
In simplistic terms, bond investors pile into long-duration Treasuries when they expect slower economic growth and lower inflation, and move out of them if they expect faster economic growth and higher inflation.
During this dis-inflationary cycle over the past four decades, economic growth rates and inflation levels tend to be rather correlated. So, the bond market either says growth and inflation are pointing up, or growth and inflation are pointing down. We haven’t seen a notable stagflationary period (high inflation with low growth) since the 1970s (although I do lean in that direction as a risk for the 2020s).
Over the past couple cycles, equity investors have caught on to bond investors being smart money, and have referenced the yield curve or other moves in the bond market as potential leading indicators of what might happen to equities going forward.
However, what happens if the Federal Reserve intervenes in the Treasury market? Can we still rely on what Treasury yields are telling us, if the Federal Reserve is the biggest buyer of Treasuries, and uses a combination of forward guidance and ongoing purchases to stabilize yields and ensure liquidity in that market?
Ever since the September 2019 repo rate spike, and especially during the pandemic fiscal stimulus period in 2020, the Federal Reserve has turned to deficit monetization, meaning it creates new dollars to buy Treasury securities, using primary dealer banks as intermediaries.
Here is the Fed’s holdings of Treasury securities:
Chart Source: St. Louis Fed
If we draw the line at the beginning of Q4 2019 for a clean starting point, which was a couple weeks after the repo spike, there has been a little under $4 trillion in net Treasury security issuance since then, and the Federal Reserve has accumulated about $2.2 trillion in Treasuries, which is more than half of the net issuance.
In fact, the Fed accumulated more Treasuries since the beginning of Q4 2019 than the entire foreign sector accumulated over the past eight years since 2012.
So, we’re eating our own cooking; the U.S. Federal Reserve is the biggest buyer of U.S. federal government debt, and they print new dollars to do so.
What should we do about this fact? Does this throw off market signals about what the bond market is telling us, since the “bond market” in reference to actual private bond investors is less than half of the recent Treasury demand, while a semi-government institution is more than half of Treasury demand, against a backdrop of record Treasury supply for the largest fiscal spending environment since World War II?
I would say so.
The closest model we have for this type of bond/inflation dynamic is the 1940s, when the Fed intervened to ensure that Treasury rates remained low regardless of what the prevailing inflation level was.
At this time with so much Fed intervention, the bond market is still somewhat useful for sensing near-term rates of change in economic prospects, but not great for judging inflation magnitudes, default risk, or other important variables.
The Dollar Index
The US dollar index continues to be firm. It hasn’t had higher highs yet but it has been holding pretty steady at elevated levels in this recent June/July rally, although it does recently seem like it could roll over again:
Chart Source: Trading Economics
The dollar remains one of the most important macro variables. It has had a sizable inverse correlation to risk assets over the past five years, ever since it became strong in 2014/2015, and especially as the US net international investment position became very negative. Here’s the Fed’s version of the dollar index (which is similar to the dollar index but not identical) compared to the S&P 500:
Chart Source: St. Louis Fed
The spectacular S&P 500 bull run of 2017, and strong global synchronous economic growth, coincided with a year of significant dollar weakness.
Then, the Fed began quantitative tightening, and the dollar bottomed and started strengthening again. During that time, from early 2018 through mid-2019, the S&P 500 was in a choppy sideways consolidation as the dollar strengthened.
In the fourth quarter of 2019, the Fed reversed course on quantitative tightening and started doing quantitative easing again, due to the overnight repo spike of September 2019. The dollar then had a short bout of weakness during the fourth quarter of 2019 as the Fed expanded its balance sheet, and the S&P 500 rallied to new highs.
Then in 2020, COVID-19 hit China and then spread globally. Economic shutdowns began, and international trade collapsed. The dollar spiked up so hard that the foreign sector had to sell some Treasuries to get dollars, causing disruption in the Treasury market. A combination of Federal Reserve action (massive QE, re-introduction of swap lines, and other measures to address the global dollar shortage) along with US fiscal stimulus, weakened the dollar considerably for the next three quarters of 2020. Risk assets, including the S&P 500, shot back up to new highs.
In recent weeks, the dollar has been firming up. The S&P 500 has gotten a bit more volatile, and equity breadth has broken down. Stocks that are more closely tied to the economy, like banks, commodity producers, and industrials, have faced significant stock price weakness. Big Tech, on the other hand, caught a bid and has been one of the few areas able to rise.
This is important to monitor, because if the dollar starts to break out to the upside, it’ll be a significant headwind against risk assets, with maybe a few secular growers like Amazon and Facebook able to push upwards but many other stocks finding trouble.
However, until the dollar index breaks over 94, that scenario is not quite in play. Right now, the dollar is still range-bound rather than breaking down or breaking up.