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Volcanos, Bitcoin and remittances: A Tongan lord plans for financial security

A former lawmaker from the island nation wants to use Bitcoin to secure his country’s financial security.
A former member of the Tongan Parliament is behind a proposal to make Bitcoin (BTC) legal tender in the tiny Pacific nation…

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A former lawmaker from the island nation wants to use Bitcoin to secure his country’s financial security.

A former member of the Tongan Parliament is behind a proposal to make Bitcoin (BTC) legal tender in the tiny Pacific nation of Tonga, following in the footsteps of El Salvador. It’s due for a vote in Parliament in May and the early signs are encouraging.

Mataʻiʻulua ʻi Fonuamotu, Lord Fusitu’a told Cointelegraph that plans are in motion to use state-run volcano mining facilities to create wealth in Tonga. 

Tonga has 21 volcanoes. “That means one volcano for every 5,000 people.” He owns one volcano himself through his family’s hereditary land rights.

The proposed Bitcoin mining operations would use the geothermal energy of the volcanoes to generate power. 

“It takes two megawatts of electricity to service 5,000 people. So 40,000 megawatts will service the entire national grid. Each volcano produces 95,000 megawatts at all times leaving much to spare,” says Lord Fusitu’a.

“We will give every family hash huts. But, this is only 20,000 units, as there are only 20,000 families.” 

He suggests each volcano can generate $2,000 of Bitcoin each day, to be “gifted” to each family by the Tongan government.

For an Island of 120,000 people, economies of scale matter and the average person stands to benefit greatly.

Family Bitcoin hash huts:. Source: Lord Fusitu’a

Tonga needs $26 million for the cabling to build the operation, but the World Bank said Tonga didn’t have the collateral for that funding. 

Nevertheless, Tonga managed to raise the money through a Least Developed Countries grant. Given Lord Fusitu’a's influence in local politics — and the fact he claims to own a volcano himself — he might just pull it off. 

Lord Fusitu’a also claimed to have negotiated a gratis offer of the mining tech, but he has not revealed the terms of the deal. Chinese companies such as Bitmain have much market share in this space. It is also possible that refugee mining operations from China’s recent ban could be headed to Tonga. For now, that remains a mystery.

“For a nation-state, the math doesn’t change. The optimal state is for a state to have its own mining.”

Related: Tonga to copy El Salvador’s bill making Bitcoin legal tender, says former MP

Who is Lord Fusitu’a?

Once a barrister before he was a politician, Lord Fusitu’a is a member of the Tongan nobility.

Tonga is the only country in the South Pacific with a remaining indigenous monarchy. While it is a member of the Commonwealth, this was done so by choice in 1970. Tonga has never been colonized, despite pressures from imperial nations throughout history.

Lord Fusitu’a decided to step down as MP in November 2021 after recovering from operations for serious medical conditions and living in New Zealand for three years, especially with Tonga closing its borders due to COVID-19. However, his cousin has taken his seat in the Tonga Parliament, so according to Lord Fusitu’a, his domestic legislative agenda remains intact.

Two clinical deaths due to injury have informed his ambitious agenda at the Global Organization of Parliamentarians against Corruption, which includes anti-corruption legislation and gender empowerment and climate change policies. 

When he spoke to Cointelegraph, and as is common since a series of surgeries, he is shirtless and covered in tattoos (a Tongan word corrupted by Captain Cook) that depict a millennium of his clan’s tattoo history.

Lord Fusitu’a has been a “Bitcoin only guy” since 2013, but “don't let the exterior fool you:” He began coding when he was eight years old. 

It was his time stuck in hospital when he couldn’t speak or swallow and could only read when he reaffirmed his passions. Re-reading every printed word about Bitcoin.

Lord Fusitu’a is very visible in Bitcoin circles online where he waxes lyrical about why his country, which relies so heavily on remittance payments, should pursue Bitcoin adoption. 

It’s the soundest money ever devised. It’s the combination of digital scarcity and decentralized distributed ledger. The most democratic egalitarian money on the planet. It’s sound money, the most pristine asset ever devised. It has a 200% appreciation year-on-year. As a store of value, it’s the apex creditor asset.”

“But, if you’re a remittance-dependent country like El Salvador or Tonga, it’s life changing immediately. For hyperinflation ravaged countries like Nigeria or Venezuela, where you need a wheelbarrow of currency to buy a loaf of bread […] it could be a survival mechanism for four billion poor people,” he said.

The plan

Fusitu’a explained his four-part plan for changing the way Tonga operates its economy to Cointelegraph. 

The plan consists of financial education for Tongans about Bitcoin remittance payments, making Bitcoin legal tender, setting up Bitcoin mining operations in Tonga and creating Tongan Bitcoin national treasuries.

A key part of the plan revolves around fiscal education for Tongans whose economy is most heavily dependent on remittances.

Lord Fusitu’a says he is tired of families in the developing world losing so much of the badly needed income from middlemen when sending remittances home.

About 40% of the Tongan national economy is built upon remittances sent back to the country from its diaspora of almost 300,000 overseas workers, according to Lord Fusitu’a. They send money back to the island population of about 120,000. As more than double the population lives in the Tongan diaspora, remittances are crucial to the national economy.

He claimed that Tonga’s “GDP in 2020 was $510 million, 40% of that is just over $200 million. So, 30% of that, or $60 million, is fees alone to Western Union.” 

Lord Fusitu’a argues that feeless Bitcoin transactions would provide a 30% uptick for everyone on remittances, as the Western Union charges villagers 30% commissions, though a calculator on Western Union’s site suggests a fee of nearly three Australian dollars for transferring a 100 Australian dollar transaction.

However, Lord Fusitu’a says that this does not account for the fact that:

“The $2.90 on $100 shown on the website does not show that there’s a minimum fee of around 10–25% on ALL remittances, depending on where you’re sending from that’s not shown on the website. When your average remittance from El Salvador or Tonga is $50–$100, that’s a lot of your remittance. It also doesn’t show that you’ll be charged the forex slippage for the purchase of Australian dollars, its conversion into Tongan pa’anga and purchase of the TOP.” 

Tonga has already begun the financial literacy and “how money works” education programs in 2021, and teams were sent out for community outreach. What does the “how money works” discussion look like? Simple:

“People understand the three hours of travel and the $20 return fare bus ticket. Waiting in line at a Western Union to pay the high remittance fees. The $70 dollars that is at the counter instead of the $100 they thought they would get. And then there’s the beggar’s tax, as beggars sit outside. Three hours each way back to the village, makes a nine-hour day, you come home tired, hungry and having lost remittance fees and bus fares just to get $40-50 of your original $100 wire transfer.”

Related: Crypto remittances see adoption, but volatility may be a deal breaker

Importantly, there’s a high rate of mobile-first internet adoption in Tonga.

“A cell phone with an internet connection can change lives immediately,” Lord Fusitu’a says. For the unbanked, “a cellphone and warm wallet is their first participation in any financial system ever.”

Non-Know Your Customer wallets like Moonwallet can help those that don't have IDs. “It’s not about Bitcoin Bros, this is a viable mechanism for the billions of unbanked poor people globally. $200 billion of $700 billion lost in fees in annual remittances globally hurts the average family.”

Also, in 2005, Tongan instituted a consumption tax (GST) of 15%, rather than an income tax, which further penalizes the poor. If Bitcoin is adopted then more money in the pockets of average Tongans — and less for Western Union — will also benefit government coffers through the consumption tax.

Lord Fusitu’a also provides Bitcoin fundamentals talks weekly in the Tongan language.

The legal tender bill

Lord Fusitu’a looked to El Salvador’s bill for Bitcoin as legal tender before its release and seeks to pass “pretty much a carbon copy.”

Tonga’s bill has been ready to go since July 2021 and would make Bitcoin legal tender alongside Tonga’s currency, the paʻanga. 

Like article 7 of El Salvador’s controversial Bitcoin Law, the bill would make Bitcoin mandatory to accept if proffered.

The bill will be tabled at the next session of parliament in May 2022. To pass, it will require the approval of a parliamentary majority of at least 14 of the 26 members. 

Nine members of parliament are hereditary lords who “vote in a block” and supposedly “always” follow Fusitu’a’s lead as the only lawyer and barrister in parliament. Three other elected members have exposure to Bitcoin. Needing only two more of fourteen votes would seem to make a successful majority vote plausible.

Lord Fusitu’a expects there to be a natural uptick in remittances from the Tongan diaspora when and if the bill is passed into law. Bitcoin remittances back to Tonga have already seen an increase in 2021, he mentions.

It is pegged to five currencies keeping it artificially low to protect its exports of mainly produce, but this makes imports expensive. 

Related: El Salvador: How it started vs. how it went with the Bitcoin Law in 2021

Bitcoin National Treasuries

The final part of Lord Fusitu’a's four-point Bitcoin plan is building Bitcoin’s national treasuries as a hedge against inflation. The lord’s thoughts on Bitcoin’s utility have informed this decision that is controversial in traditional economic policy.

“Emerging markets traditionally hold theirs in ‘melting at 5% per annum’ USD, ‘devaluing at 2-6% per annum' gold and ’negative yielding since 2008’ U.S. bonds. We do this also. Had we moved our $700 million national treasuries into BTC in March 2020 they would have been worth $22.5 billion by February 2021.”

“With a 2020 GDP of $510 million, $22.5 billion is equivalent to 45 years of Tongan economic productivity earned in 11 months,” he says, adding, “When Nayib Bukele teases on Twitter that he’s ‘buying the dip,’ what he means is he’s moving his national treasuries from those three dead man’s assets into BTC with each purchase.”

Bukele has been criticized for his decisions, but part of this criticism stems from the nature of his governance. Lord Fusitu’a’s track record of participation in multinational groups suggests he is more amenable to working with international organizations to secure his country’s economic future.

What’s ahead?

But, if it’s so obvious, why don’t other countries follow his logic? “They see the logic but it takes the money from legacy finance,” Lord Fusitu’a says.

Another Pacific Island, Palau, is rolling out a stable coin on Ripple’s XRP. “Are they crazy? Their approach is more palatable because partnerships with XRP with Ripple include legacy finance rails.”

The international monetary policy risks are still there for Tonga. In October 2021, the Internal Monetary Fund released a report acknowledging that crypto ecosystems could replace official currencies in “unbanked” emerging economies unless regulators ensure financial stability. But, perhaps that showed that the IMF was paying attention to Tonga.

On both the legal tender and the Bitcoin mining plans, Lord Fusitu’a is optimistic. The “Bitcoin community likes seeing the underdog win.”

Like many in crypto land, Lord Fusitu’a is either a genius or a great showman. Or both.

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Spread & Containment

Will Powell Pivot? Don’t Count On It

Will Powell Pivot? Don’t Count On It

Authored by Lance Roberts via RealInvestmentAdvice.com,

Stocks are rallying on hopes that Jerome Powell…

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Will Powell Pivot? Don't Count On It

Authored by Lance Roberts via RealInvestmentAdvice.com,

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’

  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency

  • *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS

  • *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES

  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg

  • FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.

  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard

  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch

  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch

  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”

Summary

We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

Tyler Durden Wed, 08/10/2022 - 08:05

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Spread & Containment

Will Powell Pivot? Don’t Count On It

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For…

Published

on

Stocks are rallying on hopes that Jerome Powell and the Fed will stop increasing interest rates this fall, pivot, and start reducing them next year. For fear of missing out on the next great bull run, many investors are blindly buying into this new Powell pivot narrative.

What these investors fail to realize is the Fed has a problem. Inflation is raging, the likes of which the Fed hasn’t dealt with since Jerome Powell earned his law degree from Georgetown University in 1979.  

Despite inflation, markets seem to assume that today’s Fed has the same mindset as the 1990-2021 Fed. The old Fed would have stopped raising rates when stocks fell 20% and certainly on the second consecutive negative GDP print. The current Fed seems to want to keep raising rates and reducing its balance sheet (QT).

The market-friendly Fed we grew accustomed to over the last few decades may not be driving the ship anymore. Yesterday’s investment strategies may prove flawed if a new inflation-minded Fed is at the wheel.

Of course, you can ignore the realities of today’s high inflation and take Jim Cramer’s ever-bullish advice.

When the Fed gets out of the way, you have a real window and you’ve got to jump through it. … When a recession comes, the Fed has the good sense to stop raising rates,” the “Mad Money” host said. “And that pause means you’ve got to buy stocks.

Shifting Market Expectations

On June 10, 2022, the Fed Funds Futures markets implied the Fed would raise the Fed Funds rate to 3.20% in January 2023 and to 3.65% by July 2023. Such suggests the Fed would raise rates by almost 50bps between January and July.

Now the market implies Fed Funds will be 3.59% in January, up .40% in the last two months. However, the market implies July Fed Funds will be 3.52%, or .13% less than its January expectations. The market is pricing in a rate reduction between January and July.

The graph below highlights the recent shift in market expectations over the last two months.

The graph below from the Daily Shot shows compares the market’s implied expectations for Fed Funds (black) versus the Fed’s expectations. Each blue dot represents where each Fed member thinks Fed Funds will be at each year-end. The market underestimates the Fed’s resolve to increase interest rates by about 1%.

Short Term Inflation Projections

The biggest flaw with pricing in predicting a stall and Powell pivot in the near term is the possible trajectory of inflation. The graph below shows annual CPI rates based on three conservative monthly inflation data assumptions.

If monthly inflation is zero for the remainder of 2022, which is highly unlikely, CPI will only fall to 5.43%. Yes, that is much better than today’s 9.1%, but it is still well above the Fed’s 2.0% target. The other more likely scenarios are too high to allow the Fed to halt its fight against inflation.

cpi inflation

Inflation on its own, even in a rosy scenario, is not likely to get Powell to pivot. However, economic weakness, deteriorating labor markets, or financial instability could change his mind.

Recession, Labor, and Financial Instability

GDP just printed two negative quarters in a row. Some economists call that a recession. The NBER, the official determiner of recessions, also considers the health of the labor markets in their recession decision-making. 

The graph below shows the unemployment rate (blue), recessions (gray), and the number of months the unemployment rate troughed (red) before each recession. Since 1950 there have been eleven recessions. On average, the unemployment rate bottoms 2.5 months before an official recession declaration by the NBER. In seven of the eleven instances, the unemployment rate started rising one or two months before a recession.

unemployment and recession

The unemployment rate may start ticking up shortly, but consider it is presently at a historically low level. At 3.5%, it is well below the 6.2% average of the last 50 years. Of the 630 monthly jobs reports since 1970, there are only three other instances where the unemployment rate dipped to 3.5%. There are zero instances since 1970 below 3.5%!

Despite some recent signs of weakness, the labor market is historically tight. For example, job openings slipped from 11.85 million in March to 10.70 in June. However, as we show below, it remains well above historical norms.

jobs employment recession

A tight labor market that can lead to higher inflation via a price-wage spiral is of concern for the Fed. Such fear gives the Fed ample reason to keep tightening rates even if the labor markets weaken. For more on price-wage spirals, please read our article Persistent Inflation Scares the Fed.

Financial Stability

Besides economic deterioration or labor market troubles, financial instability might cause Jerome Powell to pivot. While there were some growing signs of financial instability in the spring, those warnings have dissipated.  

For example, the Fed pays close attention to the yield spread between corporate bonds and Treasury bonds (OAS) for signs of instability. They pay particular attention to yield spreads of junk-rated corporate debt as they are more volatile than investment-grade paper and often are the first assets to show signs of problems.

The graph below plots the daily intersections of investment grade (BBB) OAS and junk (BB) OAS since 1996. As shown, the OAS on junk-rated debt is almost 3% below what should be expected based on the robust correlation between the two yield spreads. Corporate debt markets are showing no signs of instability!

corporate bonds financial stability

Stocks, on the other hand, are lower this year. The S&P 500 is down about 15% year to date. However, it is still up about 25% since the pandemic started. More importantly, valuations have fallen but are still well above historical averages. So, while stock prices are down, there are few signs of equity market instability. In fact, the recent rally is starting to elicit FOMO behaviors so often seen in speculative bullish runs.

Declining yields, tightening yield spreads, and rising asset prices are inflationary. If anything, recent market stability gives the Fed a reason to keep raising rates. Ex-New York Fed President Bill Dudley recently commented that market speculation about a Fed pivot is overdone and counterproductive to the Fed’s efforts to bring down inflation.

What Does the Fed Think?

The following quotes and headlines have all come out since the late July 2022 Fed meeting. They all point to a Fed with no intent to stall or pivot despite its effect on jobs and the economy.

  • *KASHKARI: 2023 RATE CUTS SEEM LIKE `VERY UNLIKELY SCENARIO’
  • Fed’s Kashkari: concerning inflation is spreading; we need to act with urgency
  • *BOWMAN: SEES RISK FOMC ACTIONS TO SLOW JOB GAINS, EVEN CUT JOBS
  • *DALY: MARKETS ARE AHEAD OF THEMSELVES ON FED CUTTING RATES
  • St. Louis Fed President James Bullard says he favors a strategy of “front-loading” big interest-rate hikes, repeating that he wants to end the year at 3.75% to 4% – Bloomberg
  • FED’S BULLARD: TO GET INFLATION COMING DOWN IN A CONVINCING WAY, WE’LL HAVE TO BE HIGHER FOR LONGER.
  • “If you have to cut off the tail of a dog, don’t do it one inch at a time.”- Fed President Bullard
  • “There is a path to getting inflation under control,” Barkin said, “but a recession could happen in the process” – MarketWatch
  • The Fed is “nowhere near” being done in its fight against inflation, said Mary Daly, the San Francisco Federal Reserve Bank president, in a CNBC interview Tuesday.  –MarketWatch
  • “We think it’s necessary to have growth slow down,” Powell said last week. “We actually think we need a period of growth below potential, to create some slack so that the supply side can catch up. We also think that there will be, in all likelihood, some softening in labor market conditions. And those are things that we expect…to get inflation back down on the path to 2 percent.”

Summary

We are highly doubtful that Powell will pivot anytime soon. Supporting our view is the recent action of the Bank of England. On August 4th they raised interest rates by 50bps despite forecasting a recession starting this year and lasting through 2023. Central bankers understand this inflation outbreak is unique and are caught off guard by its persistence.

The economy and markets may test their resolve, but the threat of a long-lasting price-wage spiral will keep the Fed and other banks from taking their foot off the brakes too soon.

We close by reminding you that inflation will start falling in the months ahead, but it hasn’t even officially peaked yet.

The post Will Powell Pivot? Don’t Count On It appeared first on RIA.

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Economics

Market Rally Has Some High Hurdles To Clear  

One of the most exciting races in all of track and field is the 110-meter-high hurdles, a fierce event that requires extreme focus, grit and determination…

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One of the most exciting races in all of track and field is the 110-meter-high hurdles, a fierce event that requires extreme focus, grit and determination to succeed in clearing all 10 hurdles without hitting one, which can easily compromise victory.

Back in 1981, Renaldo “Skeets” Nehemiah owned the track and field world as the first man to run the 110m hurdles under 13 seconds, clocking a 12.93. As a member of the Virginia Tech University Track & Field team during 1981 (Class of 1982), I had the privilege of meeting Skeets in the infield at an all-conference meet at Florida State University stretching out before the men’s 880-yard relay.

He had already torched the field in the 110 highs and was going to run the anchor leg for the Terrapins in the 880 relay. As I watched him take the baton, it was if his feet never touched the ground. He ran his leg in 19 seconds flat, an unofficial world record time for a 220 split.

It is always fun to share a memory about meeting someone who is very special and very humble, but it also makes for an abstract metaphor by which to compare to what I believe the market faces in the next several weeks ahead — a series of high hurdles to clear before it gets to what could well be the year-end handoff to a record-setting finish.

Not only did the market put up a good fight to avoid dipping below its lows in June, it made up a decent portion of year-to-date losses during the month of July. Led by the all-important big-cap technology sector, growth stocks came back into fashion as the expectations of reduced inflation and fewer rate hikes took hold of investor sentiment.

The latest stronger-than-forecast data from the labor market and manufacturing sector has the Atlanta Fed raising its gross domestic product (GDP) estimate to 1.4% from the -1.9% that I posted just a week ago in this column. That’s a notable swing of 3.3% to the good! And, with over 80% of S&P 500 companies having posted second-quarter sales and earnings that exceeded estimates, the market found some good footing upon which to build.

The first hurdle that will heavily impact market sentiment will be when the Consumer Price Index (CPI) and Producer Price Index (PPI) reports for July are released. While food and energy prices have come down, the costs of rent, professional services and skilled and hourly workers have probably increased. The market has been betting heavily of late that inflation has peaked, where any numbers that come in above consensus will take bond yields higher and stock prices lower as expectations of more Fed interest rate hikes will likely hurt investor sentiment. There is an important week ahead.

Investors shouldn’t be complacent about the market’s newfound lovefest with the change in narrative about the economy skirting a recession. There are deep problems in other major economies around the world. While inflationary forces in the United States will likely begin to diminish as the year progresses, the same cannot be said for Europe, which faces stubbornly high prices for natural gas, food and other shortages.

Europe is facing a grim winter of record inflation, if there is no relief in the price of natural gas. Russia has now stated it is slashing the supply of gas through the Nord Stream 1 pipeline to just 20% of capacity to pressure Germany and the European Union (EU) to stand down in their support of Ukraine. Top EU officials say Russia is “blackmailing” Europe and “weaponizing” its gas supplies. Moscow has repeatedly denied the accusations.

Japan’s economy is the third-largest in the world and faces the same challenges of inflation and a weakening global economy that could pressure its export-dependent economy. Japan is adding an additional $2 trillion to its mountain of debt, now at 230% of GDP. That percentage of debt to GDP is the highest in the world. The Bank of Japan has almost no choice but to keep bond rates low to be able to service debt. But as a result, the yen has lost more than 20% of its value in the past year.

For decades, the yen was considered a safe-haven currency, but now it shows what can happen when a nation’s debt soars to where it compromises the currency in a country that faces an aging society, a declining birthrate, labor shortages and highly restrictive immigration laws. Supply chain snarls and more bouts of COVID-19 only compound a very difficult set of economic conditions.

China has its own set of stiff headwinds. Its slumping property market and shadow banking industry are under serious stress, with the government having to orchestrate broad refinancing measures to avoid widespread bankruptcies. The country will be hard pressed to meet its year-end GDP goal of 5.5% if it continues to wage full lockdowns against COVID outbreaks. Data showed the world’s second-largest economy slowed sharply in the second quarter, missing market expectations with just a 0.4% increase from a year earlier.

And capital outflows from Chinese bonds and equities continued for a sixth straight month with the United States threatening to delist major Chinese ADRs due to regulatory and disclosure violations. Tensions with the United States due to its support of Taiwan are also a possible flash point that is keeping capital away from those markets. A view of the China Large-Cap iShares ETF (FXI) shows a very troubling pattern where that market could test the 2008 low, marking a 14-year period of stagnant market conditions.

Sadly, Hong Kong, once the shining Asian light where East meets West, has seen its equity market retreat 40% from its 2018 highs after China’s pseudo-takeover. The Hang Seng Index now trades at the same level as in 2007. This week, videos of Chinese tanks on streets to disperse agitators fuming at not being able to withdraw funds from their bank accounts have gone viral as the government now grapples with growing civil unrest. So much for the great China experiment.

And the war in Ukraine only adds further uncertainty to this set of big challenges for the global economy. Because the United States accounts for roughly 25% of total global GDP, it is considered a safe and investible market for now, as economic conditions are stable, while the U.S. dollar and the labor market are strong. This is a big reason capital from around the world is seeking shelter and opportunity in the U.S. bond and equity markets. 

There is still an incredible amount of uncertainty with inflation, interest rates, energy prices, commodity prices and geopolitical situations that could flare up at any time. As some of these metrics become more clear in the month ahead, investors will gain much-needed insight into these and other risks that will determine whether the recent gains will hold and build, or whether another retest of some lower level for the market is in order.

The post Market Rally Has Some High Hurdles To Clear   appeared first on Stock Investor.

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