Ongoing macro analysis continues to be a balance between liquidity interventions and recession probabilities.
Problems in leveraged commercial real estate and unprofitable tech firms (including private equity) continue to mount. These are the most sensitive sectors to interest rates.
On the other hand, the recent upturn in liquidity, and ongoing strength in sectors like travel, restaurants, and defensives (healthcare, utilities, consumer staples, and profitable tech) continue to hold up well.
As we have discussed in the live trading rooms, the US Domestic liquidity remains moderate for now, and likely for the next couple of months. This domestic liquidity index consists of the Federal Reserve balance sheet, minus the Treasury General Account, minus reverse repos.
The Federal Reserve balance sheet portion of domestic liquidity inched down last week, after two massive upward weeks due to loan activities.
We have discussed the liquidity topic multiple times over the last few weeks. My base case is sideways liquidity for a while, meaning the balance sheet will likely remain above the recent low point, but not screaming higher right away unless some further crisis happens that necessitates it. On a longer timeline, I expect it’ll need to head up again, but not necessarily in the next couple months.
The Treasury General Account portion of domestic liquidity had a big drawdown last week, and is now getting rather low. When the TGA draws down, it’s pro-liquidity for the financial system, all else being equal.
I expect that here in April it will be a net increase for the TGA due to tax season, but after that, the trend is generally down until the debt ceiling is raised. And due to how poorly most assets performed in 2022, capital gains taxes payable in April for the 2022 tax year are likely to be very weak.
Purchasing managers indices are pointing upward in March, from recessionary levels.
The more-reliable but slower-updating ISM numbers were mildly up for February to 47.70 from 47.40 on January and dropped down for March 2023 down to 46.30.
The six-month September 2019 to February 2020 period continues to be worth being familiar with in terms of market and economic dynamics. In that period, the Federal Reserve ran the banking system into a liquidity problem, stopped reducing its balance sheet, began trending its balance sheet sideways, and various economic indicators were bouncing up from near-recession levels. It continued that way until COVID lockdowns struck in March 2020. You can see the bounce in PMI on the charts above in late 2019.
Overall, I think we are in a similar dynamic now. Liquidity and economic indicators are likely to trend sideways-ish for a bit. As we look out further, perhaps into the second half of 2023, a U.S. recession is a significant possibility depending on what policymakers do.
Getting into the Commodities and Geopolitical world makes sense from here. There was a flurry of commodity/currency and some geopolitical agreements over the past week
- -China purchased LNG imports from the French energy supermajor Total (TTE) using yuan for settlement, from the United Arab Emirates. This milestone is pretty significant, considering that it’s occurring with a non-pariah state (e.g. not Iran or Russia or Venezuela).
- -Meanwhile, Brazil and China agreed to drop the dollar for currency exchange, which reduces friction for Brazil and China to trade in their own currencies. Brazil is one of the biggest commodity exporters and China is the biggest commodity importer while exporting a lot of electronics and manufactured goods, so they do a lot of bilateral trade.
- -Additionally, Brazil’s central bank released numbers last week showing that the yuan has flipped the euro as the second-largest currency in their foreign-exchange reserves. Until 2018, Brazil had no yuan in its central bank reserves, and this past quarter has 5.37% exposure to it. They only have 4.74% euro exposure. The majority is in dollars, but that’s likely past its peak percentage.
- -The Shanghai Cooperation Organization includes much of Asia as members, and along with BRICs is a rival international coalition comparable to the G7. The SCO includes full members, observing members, and dialogue members. Saudi Arabia has now joined as a dialogue member, which is noteworthy, given Saudi Arabia’s long-lasting security agreements with the United States.
- -At the same time, Saudi Aramco agreed to begin construction on a new $12 billion refinery in China. They also made a set of Chinese refinery stake acquisitions, and overall have tightened their energy partnership with China.
When analyzing non-petrodollar energy and trade agreements, analysis tends to be very polarized.
On one hand, there’s been no shortage of “imminent death to the dollar” headlines over the past couple of decades, every time China or some other country makes a currency move of this sort. On the other hand, there are a lot of “there’s absolutely no change for the dollar’s reserve status on the horizon and anyone who says otherwise is a conspiracy doomer” takes as well.
I think the reality is pretty clearly in the middle. Decades ago, China was small compared to what it is now. It’s now the #1 or #2 economy by most metrics, including the largest importer of energy and commodities, and the largest trading partner with the majority of countries in the world. And multiple countries have the incentive to diversify their payments and foreign reserves to minimize their vulnerability to sanctions or asset seizures by any single country.
Around the margins, it seems clear that we’re shifting towards a more multi-polar world in terms of regional powers and currency agreements. China still has capital controls, which makes their currency/bonds broadly unattractive as a reserve asset. However, due to their economic size and trading relationships, they have a significant ability to present an alternative payment and intermediate-term savings ecosystem for various “BRICS” or “BRIICSS” countries. In addition, foreign central banks have been consistently increasing their gold tonnage ever since 2009, which was a reversal of a multi-decade trend from the 1970s to 2009 of dwindling gold tonnage held by central banks.
What this suggests is that around the margins, the percentage of U.S. federal debt held by the foreign sector is likely to decrease. It’s already been on the decline since 2013, as U.S. federal debt kept increasing and foreign holdings of it went sideways:
The red line in the chart above includes both foreign central banks and foreign private pools of capital. Foreign central banks have outright stopped increasing U.S. Treasury holdings for much of the past decade, while foreign private sources still accumulate, just not as quickly as they used to.
In the coming years, we will likely see the Federal Reserve return as a buyer of U.S. Treasuries, due to insufficient balance sheet capacity elsewhere to absorb the ongoing Treasury debt issuance ($1.5 trillion net new issuance per year, and climbing). In the intermediate term, the debt ceiling prevents net new issuance for the next few months, and domestic non-bank entities have some balance sheet space to absorb some more.
Gold continues to show signs of life since my deep-dive gold analysis, with the highest quarter-end close on record, and roughly tied for the highest month-end close. It was a pretty remarkable topic that interest rates are rising nearly 5% now and the dollar index is fairly strong, yet gold is knocking on the doors of all-time highs in dollar terms. There are many analysts, traders and investors claiming themselves as they are professional fundamentalists, but actually using rote correlations is a very common amateur mistake. Just because interest rates are rising, doesn’t mean Gold will be bearish. To have this statement, we first need to dig into the core of the inflation cause and its management.
The precious metal has been consolidating for nearly three years since mid-2020 and is now testing a breakout. I expect it to probably break over $2,000 this year towards clean all-time highs and price discovery, although of course it’s a very finicky market and one can never be sure. The current state of geopolitics and bank problems align pretty well with it.
Technically, Gold looks like it is slowing down in its momentum based on price action. MACD is still pointing to robust momentum, but it is considered lagging behind the price, so I’d rather trust the price action more. I shorted the yellow metal last week before NFP and still holding multiple short trades locked in profit. I remain long-term bullish, but that doesn’t mean we can’t sell the overbought markets to capitalize on good risk-to-reward trading opportunities. Learn more about my trades and strategies in the Private Education & Trading Room!
For completeness, the other yellow metal has been in a $50 consolidation for a long time now:
The longer the Uranium price continues to range, the more attractive will be for me and it will be a topic in our private group.
On our Private section, I have shared a deep-dive analysis for ongiong banking sector crisis, deep-dive analysis and valuation on 4 major banks and update on some of the defensinve stocks we have discussed since last year.
I also shared a multiple trading opportutnies I am taking and preparing for next few months.
This article and analysis is only for information purpose and it should not considered as an investment or trading advice! Please make sure you well understand the risks of trading and investing in financial markets before you take any trading or investing decision.