(Premium) FICC in Focus – September

What do we want to own?

That’s the question we ask ourselves every day. Stocks? Bonds? Commodities? Crypto? Cash? The answer doesn’t have to be like flipping a light switch. It’s not like we want to be all in on stocks on Monday, then all in on Treasurys by Tuesday afternoon. Instead, the answer to “What do we want to own?” evolves slowly over time. Our minds gradually change as new evidence comes in, and our decisions follow those slowly-formed opinions.

Stocks have been the place to be since last fall. There’s not much argument about that. In recent weeks, though, the tide seems to have turned in favor of other asset classes. Commodities are leading the way. Check out the ratio of the Invesco DB Commodity Fund (DBC) vs. the S&P 500 below. We’ve broken the downtrend line, momentum just reached overbought territory for the first time all year, and the ratio crossed above the 200-day moving average. It’s a bit early to definitively call this the start of a new uptrend, but at the very least, this year-long downtrend has weakened considerably.

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Waiting on Silver

We keep waiting on silver to take a leadership role.

Prices for silver and gold tend to be highly correlated, but silver tends to move in greater magnitudes. As such, when precious metals are rising, we expect silver to outperform. That’s what we’ve typically seen during gold’s best runs. These days, silver refuses to lead.

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(Premium) FICC in Focus – August

We’re experiencing a bit of déjà vu this month.

It seems like we’ve traveled back in time to 2022, when only two things seemed to matter: interest rates and the US Dollar. Those familiar foes have returned to the fore of the investment landscape, pressuring stock prices along the way.

Each time interest rose last year, the S&P 500 fell. And each time rates offered a reprieve, stocks rallied in relief. Look at how closely the two moved together:

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Checking in on Energy Prices

The bears fumbled their opportunity.

Crude oil was vulnerable below $73. It even dropped as low as $63 one morning, before buyers stepped in to defend it. Now, prices are back above the first key level of resistance. That doesn’t mean we want to be aggressively buying oil here – at least not until we get above $83 and really show signs that a new uptrend is in place – but we can have confidence that the immediate threat of lower oil prices is now in the rearview mirror.

That’s what we wrote about crude two weeks ago in our Energy sector note. Since then, oil prices have continued to surge. We gapped above the 200-day moving average for the first time in almost a year, leaving sellers gasping for breath in the rearview mirror.

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(Premium) FICC in Focus

We keep waiting on silver to take a leadership role.

Prices for silver and gold tend to be highly correlated, but silver tends to move in greater magnitudes. As such, when precious metals are rising, we expect silver to outperform. That’s what we’ve typically seen during gold’s best runs. These days, silver refuses to lead.

Towards the end of last year, precious metals prices surged, with gold jumping from near $1600 to above $1800 by January. Similarly, silver jumped 30% from its October lows over that time. Gold prices continued to rise with the new year. Silver did not.

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(Premium) FICC in Focus: Metals Meltdowns, Uninteresting Rates, and Some Eye-Catching Developments in Currencies

The Federal Reserve held rates constant at this month’s FOMC meeting, an unsurprising outcome after the latest CPI report showed price pressures continuing to moderate. The quarterly Summary of Economic Projections showed that the median Fed participant sees two more quarter-point hikes by year-end. That would imply a terminal rate of 5.50%- 5.75% for this cycle, and the highest Fed Funds rate in 20 years.

Jerome Powell spent this week reinforcing his view that more hikes are on the way, but the recent decision to not raise rates after doing so at every meeting for more than a year is a clear signal that this hiking cycle is nearing its end. Modest changes to the terminal rate aren’t the same as what happened in 2022, when the Fed went from talking about one 0.25% hike at year-end, to implementing the fastest tightening cycle in 40 years. Here’s a brief recap of the timeline for those that have blocked last year’s turmoil from their minds:

Of course, inflation could always surprise us by reaccelerating. (We aren’t economists, after all, and, even if we were, we’d probably be terrible at predicting the path of future activity. The latest GDP report proved that even predicting the past can be quite perilous.) If it does, the Fed may well respond by tightening policy to a level that no one expects.

For now, the market is discounting the likelihood of that scenario. Inflation was a problem for asset prices last year because higher inflation meant higher interest rates, and higher rates meant a stronger US Dollar. We shared with our subscribers many times an overlay of Treasury yields, the US Dollar Index, and the S&P 500 index, pointing to how tightly correlated the 3 were.

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Gold Breakout on Hold

Just a few weeks ago, it looked as though gold would finally reach new highs. Alas, the breakout was not meant to be – at least not yet. May saw gold fail once again at 2100.

In the near-term, 1950 is the most important level. That price marked reversals in the fall of 2020 and again earlier this year. The principle of polarity suggests this former resistance level should now offer support, and bulls could make another run at those highs.

And each time buyers push prices up toward that resistance, they absorb more overhead supply. At some point, there won’t be any sellers left, and this consolidation should resolve in the direction of the underlying trend. How high could the metal go on a breakout above 2100? Above 3000. That’s the 1794% Fibonacci retracement from the 1990s decline. Prices have respected these retracement levels all the way up: The hiccups in 2006 and 2008 occurred near Fib levels, the ceiling from 2013-2019 was the 684.4% retracement, and right now, were stuck below the 1109% retracement. It would make a lot of sense to go up and touch the next one. That might even be a conservative expectation – prices rallied a lot more after the 2004 breakout.

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(Premium) FICC in Focus: Interest Rates and Commodities Warn of Recession

Jerome Powell and his friends raised rates for a tenth consecutive meeting yesterday. That wasn’t a surprise. Neither was it surprising when Powell laid the groundwork for a pause in hikes, removing language from the prior meeting’s press release that indicated additional policy firming would be necessary, and replacing it with more flexible language that highlights the Fed’s data dependence going forward.

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Are Lower Rates Still Good for Stocks?

It’s starting to look as though interest rates have peaked, thanks in large part to the failure of Silicon Valley Bank.

In the weeks prior the banking crisis, every piece of economic data pointed to stubbornly high inflation and a tight labor market. That was the story driving Treasury yields higher all throughout 2022, and the latest batch of data pushed 2 year Treasury yields to the highest level since 2007.

In the weeks after the failure, though, 2 year rates have given back those gains and more.

Yields have fallen across the curve. Ten year Treasurys are breaking down to their lowest levels since last September.

Based solely on what we’ve witnessed over the last year, that would be a bad thing for the Dollar and a good thing for stocks. All throughout 2022 and into this new year, we watched as higher rates and a stronger Dollar pushed equities lower (and vice versa). Look at how closely the three moved together.

Will those relationship hold forever, though? Of course not. In fact, they’ve already begun to weaken.

The correlations between equity prices, rates, and currencies have rebounded from multi-decade extremes to something that more closely resembles an average.

Why might that be? Blame bank failures again.

Throughout 2022, lower rates reflected softening price pressures and bolstered hopes that the Fed could softly land a hot economy. Fears of a deep recession are the focus today. Deposits are flowing out of banks across the country and into money-market funds, and that disintermediation will force banks to pull back on credit issuance. Credit crunches often lead to deep recessions – a scenario which could force the Fed to lower rates.

But recessions just aren’t great news for stock prices, whether rates are coming down or not.

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