By Benjamin Picton, Senior Macro Strategist at Rabobank
The 1990s are back in vogue. It seems like everywhere I go now, I see people wearing high-waisted mom jeans, grunge band t-shirts or channelling Princess Dianna’s sneakers and tube socks look. I’ve even noticed that people who were too young to watch it when it first aired now have a strange fondness the TV show ‘Friends’. Local pubs host trivia nights full of Gen Zs who know all about ‘the one with the [whatever]’ and can tell you all about Phoebe Buffay’s back catalogue. I wonder if this trend might be a harkening back for a simpler and happier time of security, self-confidence, rapidly rising living standards and a sense that war was all but abolished? I see similarities to the trad types who consciously live as if it is still the 1950s.
Whatever the motive, it’s clear that the world of today isn’t at all like the 1990s. The unipolar moment has expired, living standards are increasingly stagnant and the West now seems unsure of both it’s economic formula (dealt a near mortal blow in 2008) and its cultural inheritance. There IS an element of back to the 90s in some areas though. Specifically, Brent crude prices pushed back above $90/bbl last week, and managed to consolidate above that level into the close on Friday. That’s the highest weekly close since November last year, and is made all the more remarkable by the fact that the Dollar spot index has also been on an incredible bull run. On Friday the DXY index recorded its highest weekly close since late February.
Usually when the Dollar is so strong, you would expect commodity prices to be falling. But the announcements from Russia and Saudi Arabia to extend their respective production cuts until the end of the year are clearly putting a lot of pressure on a market that was already stretched. Our own energy analyst, Joe Delaura, has been bullish on the prospects for crude oil for months, and prices are now trading fairly close to his forecasts. Joe points out that rig counts are still falling in the USA, and investment in both new hydrocarbon supplies and alternative energy sources like renewables are facing headwinds from much higher interest rates (to say nothing of the ESG headwinds for hydrocarbons). With this confluence of factors already pressuring crude oil prices higher, one really has to wonder what is going to happen when the US Government gets around to refilling the strategic petroleum reserve that Joe Biden ran down to the lowest levels since the early 1980s in the leadup to the midterm elections. That’s a lot of latent demand waiting to come into the market.
Surging crude oil prices is one thing, but arguably an even greater problem are the widening crack spreads that we are now witnessing. The spread between crude and refined products has been widening out as unseasonably hot weather in Europe impacts on refinery capacity utilization, and the cuts to Russian and Saudi supplies force refiners to source lighter crude supplies that are less suited to the production of diesel. In this context, the recent struggles of German industrial output might be for the best, because the market for transport fuels on the continent is incredibly tight and spilling over into other regions. That’s bad news for farmers, miners, construction, and anyone trying to run a logistics business.
While crude prices were heading back to the 90s, so were bond yields (in a way). Yields on the US 10y finished last week at 4.26%, and have opened firmer again this morning. This is now approaching the sorts of levels that were trading around the time that Bill Clinton was busy getting impeached. Despite the lift in yields, curve steepening took a bit of a break last week as markets bid up the short end on the back of a punchy ISM services number and resilient weekly jobless claims figures. Even so, it’s worth pointing out that the 2s10s Treasury curve has steepened by almost 40bps since early July and has to steepen another 210bps or so to get back to a ‘normal’ spread. Clearly we’re at some kind of critical juncture in the rates cycle, and the only question now is whether steepening will come in the form of a lower short end, or a higher long end. If it’s the latter, that sounds like a US 10y at close to 6.5%!
On that score, unofficial Fed mouthpiece Nick Timiraos published an article in the WSJ over the weekend declaring that ‘An Important Shift in Fed Officials’ Rate Stance is Underway’. Timi says that gone are the days of the majority of central bankers preferring to err on the side of tightening too much, and therefore committing a policy error that plunges economies into recession and/or financial crisis. The new orthodoxy is to be less aggressive, and take more of a wait and see approach that will see the Fed Funds rate unmoved in September after 525bps of cumulative tightening since March of 2022. Naturally, there is more than one way to skin a cat, and Timiraos suggests that the alternative to this new philosophy of a lower peak that lasts longer (what Huw Pill might call the Table Mountain approach) is a more aggressive tightening trajectory followed by rapid cuts when it becomes clear that a policy error has been committed. This is the ‘Matterhorn’ approach seemingly favored by hawks like Loretta Mester and Christopher Waller, but this is a minority view and Mester isn’t a voter this year anyway. So, does that mean “rate cuts soon” is a non-starter and the Greenspan put is finally dead?
Timiraos mention of potential “financial turmoil” is interesting, because the ‘hold-to-maturity’ losses in Treasury bond portfolios that kicked off the mini banking crisis this year are still with us, and going further into the red every day that the 10y yield heads higher. My colleagues have recently spilled some ink on European M1 money supply turning negative, and another fault line now may be opening up as BOJ Governor Ueda intimated over the weekend that Japan could soon reach the point where inflation is judged to be sufficiently sustainable to begin lifting the policy rate out of negative territory. The BOJ is the last holdout of the major central banks still supplying liquidity to world markets, so if they get serious about tightening as well, what does that mean for asset prices, yields and financial stability? It’s little wonder that other central banks are starting to second guess themselves if the last shock absorber is soon to disappear, especially since there is little prospect of China riding to the rescue as it has done in the past.
Speaking of fault lines. We haven’t yet touched on the events of the G20 meeting over the weekend, which saw the US upgrade it’s relationship with old foe Vietnam to a ‘Comprehensive Strategic Partnership’ and Australia do the same with the Philippines. Markets seem to be interpreting the summit like an episode of Seinfeld (a show about nothing), but we disagree. Global Strategist Michael Every will have more to say about this in tomorrow’s Daily, but for now suffice it to say that as much as we might wish it was the 1990s, Great Power competition, energy transition, banking crises and plague suggest the present day has more in common with the 1890s.
