“When all the experts and forecasts agree — something else is going to happen”, Bob Farrell

Financial Events

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In January, “everyone knew” that inflation was about to take off, and that the US$ was going to collapse. Last week, the great Bob Farrell’s Rule No 9 proved its worth, yet again. US interest rates fell sharply and the US$ bottomed for this cycle.

The two charts above tell the story – because they are long-term, and aren’t confused by day-to-day or week-to-week “noise”:

Interest rates and inflation: The 10-year rate peaked at 1.76% at the end of March, and has been in steady decline ever since. And last week it fell very sharply, from 1.59% to 1.45%.

All the experts are still expecting the “return of inflation”. But in reality, as great analysis by my ICIS colleagues Tom Brown and Will Beacham confirms, today’s increase is a short-term phenomenon, caused by short-term supply chain chaos:

“Container freight rates on major routes around the world are spiking to historic highs as coronavirus-related port gridlocks in China cause further disruption to supply chains which were already stretched…

“The port issues have also exacerbated the cooling effect that lockdowns and infection surges seen elsewhere in the world during the year have had on exports from China.”

China is the manufacturing capital of the world. So its dramatic rise in Producer Price Inflation from -3.7% in May 2020 to 9% in May 2021 has inevitably increased Consumer Price Inflation in the West.

But supply shocks work their way through the system in the end. And by raising prices, they lead to demand destruction. Most people only have a certain amount of discretionary cash after paying essential bills – and if prices have risen, then they have to cut back.

That is what is happening today for consumers’ two most important purchases – houses and cars (h/t Joe Weisenthal), as the University of Michigan consumer expectations surveys show. Headlines may focus on today’s record prices, but consumers are voting with their wallets.

We have 30-year lows for house buying conditions, and post-Crisis lows for auto conditions. Both are almost certain to go lower before they bottom.

The US$. The dollar also turned on a dime last week, as interest rates fell. It trades in a wide range as the chart shows. But last week it hit the bottom of its post-2007 range, and rallied very sharply from a low of 90.3 to close at 92.2.

This is likely to prove very bad news for many commodities, including oil. The hedge funds’ favourite paired trade is to sell the dollar and buy commodities, or vice versa:

  • The dollar is the world’s reserve currency, and commodities are generally priced in dollars
  • A weaker dollar therefore makes commodities cheaper, and vice versa
  • With the dollar rising, commodities are therefore likely to come under major pressure

Financial risks will also rise, as borrowers outside the USA have often borrowed in dollars. Now they will have to repay the loan in more expensive dollars relative to their local currency.

As the charts show, stock markets have gone exponential over the past year, suggesting a confirmation of Farrell’s Rule No 5.

“The public buys the most at the top and the least at the bottom.”

They have essentially become a casino, financed by ever-growing amounts of debt. May’s margin data was the highest on record at $862bn. And who can forget the Dave Portnoy phenomenon, with his 3.5m Twitter followers and motto “stocks only go up“?

Markets may well have “one last hurrah”. But the 6 charts above suggest we might soon need to recall the wisdom of Farrell’s Rule No 4:

“Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”

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