The inventory issue has been bubbling for a couple of months, but only recently – the last week or so – has a deflationary impulse surfaced in the markets. Most all commodities are in correction mode, with the Bloomberg Commodity Index down more than 10% since June 9, as metals, energy and agricultural commodities have all fallen significantly from their highs. Even cotton has had a series of limit-down day in the futures market. When speculators first realized that faster inflation was inevitable, the natural response was to plow into commodities, and the Bloomberg index had soared as much as 43% since the start of December. But now those gains are being unwound.
Apart from orders for durable goods, which the Commerce Department said Monday rose a greater-than-forecast 0.7% in May, the economic data has been deteriorating. The Federal Reserve Bank of Atlanta’s widely followed GDPNow Index, which aims to track the economy in real time, is showing no growth for this quarter. The Dallas Fed’s survey of manufacturing intentions released on Monday dropped its lowest reading since the early days of the pandemic in May 2020. The “deflationary pulses” that Burry referenced may be happening now. It seems very likely that the Consumer Price Index report for June, scheduled for July 13, will come in comfortably below the 8.6% recorded in May. To believe otherwise would require ignoring a mountain of economic data.
In previous inflationary periods, the Fed had to boost interest rates above the rate of inflation to bring inflation down. That may not be the case this time. As laughable as it may seem, there may still actually be a transitory element to current inflation that was a function of quantitative easing, government spending and pandemic hoarding. Now that all these factors are going in reverse, inflation may slow. And if inflation slows, it is likely to be very positive for both the stock and bond markets. The current bear market was predicated on the idea that the Fed was stuck in that they had no option than to raise rates to the point of forcing the economy into a recession if it wanted to get inflation back under control. And the economy may indeed have been forced into recession, albeit prematurely.
Commodities may be entering a very deep correction as a consequence. Everyone knows that a lot of “hot money” has poured into commodities, making it a very crowded trade. The “pain trade” would be for the recent drop in these markets to continue – and that may be just getting started based on the latest economic data.
So, if Burry is speculating that the Fed may pause rate hikes, when would that be? The Fed has said it wants to see “progress” on slowing inflation before it pulls backs, and presumably that means more lower CPI readings for a couple of months. It’s possible that policy makers could pause as soon as their meeting in the second half of September, and in this context, “pause” may mean a 25 basis-point rate hike instead of a 50 or 75 basis-point increase.
Could the rate hike campaign end with a target federal funds rate of 2.5%, up from the current range of 1.50% to 1.75%? Yes, but only if there is clear evidence that the economy has entered a recession. It seems like it will. Ironically, that would be positive for the capital markets. To an outside observer, this makes no sense — stocks rally in a recession? Sure, because the stock market discounts future events to the present. The stock market priced in a recession about six months in advance, and will price in an expansion about six months in advance.
In this framework, US Treasuries look cheap, especially shorter-dated maturities. Two-year note yields got a bit carried away, rising to near 3.5% from around 0.25% this time last year. Eurodollar futures show traders are pricing in rate cuts in the not-too-distant future.
Burry, who gained fame as one of the few who predicted the collapse in the subprime mortgage market that led to the global financial crisis, isn’t saying anything terribly original. There are some market participants who share his views. But when he says something, it tends to carry additional weight given his past successes. The inventory tweet is a small part of the picture, and while the recession talk has become so pervasive that it’s become a bit cliché, the data is…