Bedrock’s Newsletter for Friday 5th of October, 2018
5 October 2018


 Friday, 5th of October 2018

First Friday of October, a month notorious for excitement, if one equates rollercoasters with excitement… This 2018 start sure looks to be a “good one”…


Oil jumped to the highest level in nearly four years as a slowdown in American drilling added to concern over supply losses from Iran and Venezuela. Crude futures gained 2.8% in New York on Monday. As U.S. sanctions dissuaded importers from purchasing Iranian oil, President Donald Trump and King Salman bin Abdulaziz of Saudi Arabia discussed efforts to maintain supplies. Meanwhile, the number of rigs drilling for American crude dropped for a second week, signalling a potential slowdown in output growth. WTI oil traded as high as $76.50 only to edge back to $74.70 as we write. We started the year at $60.10… Quite a pop… Top traders have forecast crude may top $100 a barrel amid speculation that backup supplies are scarce. Even so, BP Plc cautioned that the rally may not be sustainable as escalating trade tensions between the U.S. and China imperil demand. Well, interesting, but not the star of this week…


The Italian government created further turmoil in financial markets on Tuesday morning, after new comments that Rome would be better outside of the euro zone. Claudio Borghi, who leads the economic policy of the ruling Lega party, cast doubt over Italy’s membership of the single currency on national radio Tuesday. “I am truly convinced that Italy would solve most of its problems if it had its own currency,” Borghi said in a radio interview, Reuters reported. 10-year Italian bond rose to 3.40%, its highest level since March 2014 and going beyond the levels seen during a sell-off in May when concerns over Italy’s commitment to the euro zone came to the fore. Yes, a scare for us all, but neither is this disturbing matter our real story…


Federal Reserve Chairman Jerome Powell sees the U.S. economy generating highly optimistic expectations, with the unusual combination of low unemployment and inflation fuelling hopes for an extended expansion. In a speech Tuesday, the central bank chief said the jobless rate is running at 3.9% and inflation is around the Fed’s goal of 2%. Historically, low unemployment has fuelled inflation and sometimes has forced the Fed into hiking interest rates rapidly. “While these two top-line statistics do not always present an accurate picture of overall economic conditions, a wide range of data on jobs and prices supports a positive view,” Powell told economists at a Boston conference. “In addition, many forecasters are predicting that these favourable conditions are likely to continue.” He pointed out that after last week’s Federal Open Market Committee meeting, a reporter asked him if the current conditions are “too good to be true,” which he called “a reasonable question.” “From the standpoint of our dual mandate, this is a remarkably positive outlook,” he said, referencing forecasts from Fed officials, the Survey of Professional Forecasters and the Congressional Budget Office. “Since 1950, the U.S. economy has experienced periods of low, stable inflation and periods of very low unemployment, but never both for such an extended time as is seen in these forecasts,” Powell added. In addition to the low unemployment and inflation, GDP grew at a 4.2% pace in the second quarter and could top 4% again in the third quarter. Consumer and business surveys also are running high, and corporate profits have been growing around 25% this year. He indicated the Fed will continue to raise rates but in the gradual manner that has accompanied the current cycle that began in December 2015. The central bank approved a quarter-point hike in the funds rate last week that brought the target range to 2 to 2.25%. FOMC members indicated another hike before the end of the year, three more in 2019 and likely one more in 2020 before pausing. Powell said the policy is mindful of controlling growth while making sure the recovery continues. On a related issue, Powell said that even if inflation starts to rise, he doesn’t foresee the Fed curtailing the reduction of its balance sheet. The program began a year ago and will see the central bank allow $50 billion in bond proceeds to run off each month starting in October. Powell said the balance sheet runoff is “working very well” and the Fed would be more likely to use rate hikes rather than asset sales to head off inflation. Well, maybe this is this week’s elephant in the room… Or the follow-on words of Powell when he said the central bank has a way to go yet before it gets interest rates to where they are neither restrictive nor accommodative. In a question and answer session Wednesday with Judy Woodruff of PBS, Powell said the Fed no longer needs the policies that were in place that pulled the economy out of the financial crisis malaise. Yes, the “Truth” of the week can be measured in U.S. government debt yields adding to a marked climb higher Thursday, making new multiyear highs as strong economic data continued to tempt investors into riskier assets. The yield on the benchmark 10-year Treasury note, which climbed nearly 12 basis points on Wednesday, hit its highest level since May 2011 early Thursday morning at 3.232%. As of the latest reading, the 10-year rate held higher at 3.21%, while the yield on the 30-year Treasury bond, which broke a new 2018 high Thursday, was up at 3.346%.


Well, the markets seem to sense a true break in the world of very low interest rates. The time has come to be truly weaned off the cheap money proteins… was it brutal? Some might feel so, but in reality, American equities fell by about 1.8% for the NASDAQ, about 0.75% for the DJIA and 0.8% for S&P. But then again, we are at or close to all-time highs… Yes, its true, the discounting factor of future earnings has risen by about 0.20%. Curious, 10 X 0.20% = 2.00% (simplistic approximation!).


Well, should we be scared? At least worried? It might give you that sneaky feeling that it should worry but, let’s take the simplistic algebra one step further- The 10-year note yield moved from say 3.00% to 3.20%. Let’s look at the effect of the discounting bit in the net valuation models and we find that 3.20% discounts a 10-year future by 2.63% more than a 3% factor. And we fell by much less than that… Something else must be added to our brew! No, the missing ingredient is not the imminent Brazilian elections, nor are the Trump trade wars (Yes, NAFTA2 is being organised as we write, in effect reducing Canadian tariffs on US dairy by $70 million. Now THAT is a WOW!!!), We have the question of the US Dollar as the main condiment in the financial soup-of-the-day. The DXY, the trade weighted index of the Dollar has crept back up above 95.50, and then, if the Chinese Yuan were “allowed” to drift down by say 10% against the US$, then much of the ‘Trump Tariff’ would have been offset… In late August, China’s central bank signalled that authorities have no intention of using the Yuan as a weapon in the trade war. Well, maybe… We remain with our painful long-US Dollar view. It is up YTD against most counters, and we believe it still has a way to go.


And for the stock markets? Well, we are expecting Q3 earnings to start flowing this coming week. As customary, we believe that expectations will be beaten. If proven correct again, the equity markets could resume their climb. Yesterday’s tap on the brakes was probably just that, we will coast for a week into the earnings data and are likely to experience another upwards shove into year-end. Well, maybe not for multinationals as much, as a rising US currency costs in FX translation, reducing earnings.


Gold has been trading in a tight range around $1’200/oz and Bitcoin hovers around $6’500. Both could be expensive in the face of rising US$ interest rates… Neither Gold nor Bitcoin bear any interest…


We leave you for your weekend with Bertrand Russel’s quip ‘The fact that an opinion has been widely held is no evidence whatever that it is not utterly absurd.’




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