August 6 – Cautious stability returned to Wall Street overnight, and I say cautious because confidence that the rout is over remains low. Stock futures bounced modestly overnight, while the VIX trades near 32. The dollar index bounced to trade near 103.1 this morning as Treasury yields rebounded as well. Yields on 10-year Treasuries are trading near 3.83%, while yields on 2-year Treasuries are trading near 3.93%, so we’re getting a bit of the yield inversion back again. Crude oil prices are weaker on lingering economic worries, albeit with an eye to escalating tensions in the Middle East as traders brace for possible multiple days of retaliatory strikes on Israel from Iran, which may then result in a response from Israel. Grain and oilseed prices were again lower overnight, but we’ve seen them rally against negativity in the outside markets in each of the past two sessions.
Perception and reality are the two forces constantly at work in the markets. There’s the reality of the fundamentals, and the perception of reality. The danger in any volatile market is that perceptions can rule the day to the point where they start to shape, and then to define reality. The perception across the air waves the past several trading days has been that Wall Street was throwing a temper tantrum because the Fed failed to act soon enough, followed by a weak jobs report on Friday that reinforced recession fears. The reality, as I mentioned yesterday, is that the Fed gave the markets everything that they wanted on Wednesday, and that the jobs report – while soft – was not a recessionary jobs report. Austin Goolsby, one of the more dovish members of the Federal Open Market Committee, said as much on Monday.
Another reality largely went overlooked. We reported last week that Japan made a significant move to hike its benchmark interest rate last Wednesday, as the U.S. FOMC was in the middle of its two days of policy meetings. It surprised investors by making its largest rate hike since 2007, raising it to its highest level in 15 years, while ending eight years of negative rates. It also suggested that more hikes may be coming this year, while also committing to reducing its purchases of debt certificates, which would also be expected to support higher rates. I wrote on Wednesday of the danger of it raising rates too quickly, which could bring a lot of money home to Japan at the expense of the U.S. financial markets. Japanese investors are the largest foreign holders of U.S. debt certificates, while also being large owners of U.S. equities.
It's known as the "carry trade." Investors borrowed against the yen at negative interest rates to purchase the dollar so that they could invest in U.S. Treasuries and equities. Nobody knows exactly the volume of carry trades that may be unhedged, but it is believed to be massive. Furthermore, there are indications that the unwind is just getting started. The average U.S. consumer knows little of “carry trades” or their impact on the U.S. markets. They just know that they’re being hit with headlines of a crash on Wall Street, and that they’re seeing their 401K’s shrink. That shrink in the wealth effect tends to lower consumer sentiment, which can end up reducing consumer discretionary spending if it goes on long enough. That in turn can lead to lower retail sales, leading to layoffs at stores and factories, and the cycle begins to perpetuate itself. That’s how perception can end up defining reality, instead of the other way around. That then becomes the danger in our current situation.
The sharp drop in the dollar led to a notable surge in the value of the yuan in recent days, giving Chinese authorities some cover for stimulus, which they have started to do. But China has bigger problems long-term. China reported the lowest number of marriages in 12 years in the first half of this year, as just 3.43 million couples were married in the first six months of the year, down 12% from the previous year’s pace, and just one-quarter of the marriages seen 10 years ago. This puts China on pace to see the lowest number of marriages this year since 1980. Why is this significant? Lower marriages are expected to lead to an even sharper decline in the birth rate, since only married couples are allowed to have babies in China. The birth rate is already below the death rate in China, with its overall population declining by 2.08 million people last year. This will accelerate the population decline, which makes sustaining economic growth even more challenging long-term.
Corn and soybean yield models crept higher this week. The corn condition scores slipped, but not as much as they normally do in early August, while soybean ratings went contra-seasonally higher. Buying returned again to the grain and oilseed sector on Monday, as it has each day since StoneX released its customer survey-based estimates that came in above trend – but below levels feared by the trade. The market had priced in expectations for much-above trend yields. That’s still possible if August is favorable for grain fill, but that may not currently be the case. Additional private survey-based estimates are expected to shape perceptions in the days ahead.
