After another week of firmly risk-off conditions, investors need to contend with not only what the intermarket signals are telling them, but also the potential tail risk events that could significantly add to volatility and change conditions quickly.
Japan, in my opinion, is still the canary in the coal mine. The yen continues to fall, the Bank of Japan is likely to act very soon to defend and Asian countries & governments appear to be behind a lot of the gold buying that’s happening right now. All of this points to a situation where confidence has eroded quickly and an imminent currency crisis may be upon us. If the BoJ supports the yen here, it’s probably dumping Treasuries to do it, which puts further upward pressure on long-term yields and starts to destabilize the global fixed income markets. The potential for this entire cycle to implode continues to get higher and a lot of market signals are flashing warnings. If the yen carry trade starts breaking in, the damage could accelerate.
In the United States, it’s getting tougher to make the argument that the Fed will cut interest rates this year (unless political pressures take over) and the inflation numbers this past week support it. At best, I think the disinflationary trend has stalled for the time being and, more realistically, it’s reversing in the short-term. Rising energy prices, of course, have a hand in this, but stickier core inflation is still running at a 4% annualized rate and that’s probably not coming down towards the Fed’s target anytime soon. Oh, and let’s not forget that Iran could strike Israel at any moment and send oil prices rocketing higher, further adding to this pressure. This could be a long slog lower as growth and unemployment slowly shift to reflect the underlying economic fundamentals, but the downside risk is almost certainly outweighing upside potential here.
Keep reading with a 7-day free trial
Subscribe to The Lead-Lag Report to keep reading this post and get 7 days of free access to the full post archives.