ANDREAS STENO LARSEN: Hi everyone, and welcome to the Real Vision Daily Briefing. I'm Andreas Steno, the senior editor at Real Vision, sending to you live from Copenhagen, Denmark, the 7th of July. It's been another action-packed day with Boris Johnson resigning as the Prime Minister in the UK from the early morning while equity markets have rallied again, begging the question whether the markets have already bottomed.
I'm super pleased to be joined by one of the best people I know in finance, Jeff Snider, also known as Mr. Eurodollar. Jeff is the chief strategist for Atlas Financial. Jeff, a warm welcome to the show.
JEFF SNIDER: Hi, Andreas, thanks for having me. Good to see you.
ANDREAS STENO LARSEN: Likewise, Jeff. I know you follow markets and the economy closely, Jeff. We had jobless claims coming in high again this week pointing to a weakening labor market. We had recent trade balance data suggesting that imports and hence demand has waned in the US. Give us your top-down view of where the economy is heading over the next couple of quarters here.
JEFF SNIDER: Well, Andreas, I think you're right, that's the place to start is what is the labor market going to look like? Because that's what the Federal Reserve's looking at is in terms of judging its rate hikes. Obviously, the unemployment rate, Phillips Curve, all that stuff. But really, where's the actual underlying economy going?
Jobless claims have bottomed out a couple months ago, they're rising, they're not surging by any means. And they're at an incredibly low level, weekly level, seasonally adjusted. But still, it's that direction and the persistence of that direction that gets our attention that maybe we've reached an economic turn. And it's not just jobless claims, either.
There's other labor market data. We'll see tomorrow with the major payroll reports whether it follows through but the ISM numbers, both manufacturing and non-manufacturing, their employment components are below 50. The non-manufacturing in particular was 47.4. So, quite a bit below 50, both of them the lowest they've been since 2020. So, there's some forward-looking indications that maybe there's some definite softening going on in the labor market.
Also, we got to think about the household survey, the other unappreciated twin to the establishment survey, that one dropped precipitously for the month of April, and then only partially rebounded in February. Even though the household survey tends to be very noisy month to month, what you end up with is a two-month drop in the household survey, which is indicative of the possibility that, hey, maybe something has changed in the labor market.
We also saw a softening in the ADP numbers, which they're not going to produce for June, I think July, they're not going to come back until August as they redo their methodology. But there's any number of indications that at least suggests weakening in the labor market, again, we'll see tomorrow whether or not that's because it's gotten worse or whether it's continuing to follow through. But that's a good place to start. And at least in terms of the US part of the global economy, are we seeing the economy start to shift.
ANDREAS STENO LARSEN: The debate on whether the Federal Reserve will pose a pivot towards the end of the year has been a hot potato in recent weeks in markets. If we assume that they will actually pull some pivot, what would be the trigger, the labor market or inflation?
JEFF SNIDER: Both I think. I think when you look at-- the curves have been pretty much increasingly confident that this is going to happen. And the reason that the curves are saying this is because on the one hand, you have economic weakness, on the other, you have a bunch of warning signs that consumer prices, maybe outside of energy and gasoline are really starting to soften or are ready to soften. You have retailers talking, signaling they're going to do liquidations and discounting in some of their goods, because inventories are way too high, especially given some trends in consumer spending and consumer demand which aren't very favorable.
So, it could be a combination of rising unemployment at the same time as decelerating consumer prices, which again, the Fed has said we're going to focus exclusively on CPIs. I think they want to send that message to the public. But I think the markets are right that eventually, especially if CPI start to come down, they're going to go right back to focusing on the unemployment rate, especially if the unemployment rate starts to go up, any material fashion, as well as any sustained move in the unemployment rate. They're going to pause and pivot.
And I think the market is increasingly confident. Nothing's ever certain. There is no 100% in finance looking forward. But it's increasingly very confident, the markets are increasingly very confident that this is going to happen and probably sooner rather than later.
ANDREAS STENO LARSEN: You have brought a bunch of great charts with you today, Jeff, for the show, and the first chart refers to the exact Eurodollar future that you indirectly referred to. The inversion of the Eurodollar curve has worsened a bit over the past month or so, meaning that dollar LIBOR rates in for example, 2020 are priced at lower levels than the dollar LIBOR rates towards the beginning of 2023. Why is that happening? And why is it important in your view?
JEFF SNIDER: Why is it important is because the Eurodollar futures market as you just stated, Andreas, is it's one of the most fundamental marketplaces, one of the most misunderstood as well as ignored or dismissed or people don't even know it exists. Yet, it has historically been validated time and time again. We saw, for example, Eurodollar futures inversion in June of 2018 at a time when nobody was thinking the Fed was going to stop back then, yet the market was increasingly hedging against this very scenario, where the economy would turn in the wrong direction, inflation would never materialize back at that time, and that the Fed was going to have to pause its rate hikes and then eventually cut them, as it actually did.
And again, the inversion took place at a time when nobody was talking about that. Similarly, you go all the way back to 2006, Eurodollar, futures curve inverted, which was a warning sign that something was going wrong in the monetary financial system in such broad fashion that even though the Fed said we're not going to stop hiking rates, we're not going to lower them, the Eurodollar futures market got ahead of what became the global financial crisis and the great recession.
And the same thing had happened in 1999 and 2000, Eurodollar futures inversion predated what became the dotcom recession. So, it's a historically validated signal. And in addition to that, what Eurodollar futures actually refer to, as you said, three-month LIBOR, which is supposed to be set by the Federal Reserve, what the market does is looks out in the future and says, okay, the Fed is going to do one thing, where the Fed wants to do one thing, which today accounts for the steepness in the front of the curve, because the Fed says it's going to raise rates.
And then beyond that, the curve is assessing what the Fed will be able to do, regardless of whether it wants to do it or not. And so, the market is pricing. And this is not just some small, tiny, little niche market. This is one of the biggest, deepest, most sophisticated markets where trillions upon trillions of fixed income positions around the world are being hedged via this vehicle. So, it's something you really need to pay attention to. And when the market begins to hedge for the potential and really serious potential, given the shape of the curve, for lower interest rates in the future than they are today, or will be in the near-term future.
That's something you really need to stand up and look at because again, these trillions upon trillions at risk being hedged in this manner tells you that something is bothering the global monetary and financial system to such an extent that has distorted the curve. As you said, Andreas, these curves are just ridiculously inverted at this point. And they've really changed a lot over the last couple of weeks.
ANDREAS STENO LARSEN: Yeah, if we look at the Eurodollar futures curve, it obviously at least partly reflects the future pricing of the Fed Funds Rate. But there was also a layer of liquidity considerations beneath the surface of the Eurodollar futures curve. Can you please unpack these liquidity considerations for the audience here?
JEFF SNIDER: Well, a lot of it has to do with the fact that what is the liquidity system look like today, and then piling on what it looks like down the road, because in one sense, what governs interest rates, monetary rates, whether or not it's the Fed or just market rates is liquidity. Because if there's a liquidity problem, then we're going to know at some point that interest rates are likely to go lower through time. And one of the ways that happens is you have a liquidity crisis or a liquidity impediment or some structural problem, where the system does not function or will not be able to function in the way it has before.
In some ways, the longer end of the Eurodollar futures curve is like the long end of the yield curve, and that it factors in liquidity characteristics, inflation versus deflationary potential. And when you see the Eurodollar futures curve, in particular, upside down and inverted in the way that it is currently, that's a sign that the market is, again, it's hedging against something. And as you said, Andreas, that something likely contains a liquidity component to it. So, the market is getting ready for something to change the Fed's position likely this year.
These are all about probability distributions. You don't take the curve or the prices of the contracts literally, but the way the curve is shaped currently, the market is expecting the Fed to do a couple more rate hikes, likely a couple more rate hikes, and then something will happen probably has to do with liquidity, which will change the Fed's mind and get interest rates moving on a downward track over time.
That's really what the curve has been saying. Ever since December of last year, this is not something that just showed up. The inversion started December of last year, and the curve has only become more and more inverted, and more importantly, where that inversion begins, which has signaled the market more and more concerned about the immediacy, as well as the particular depths and scope of the dangers involved.
ANDREAS STENO LARSEN: If we look at the actual numbers priced into the Eurodollar futures curve right now, we have March 23 trading around 3.5%. And then we have March 24 trading substantially below 3% already, signaling a quite substantial rate cutting cycle, commencing from the Federal Reserve sometime through 2023. Is this one of the firmest signals that you've seen from the Eurodollar curve historically?
JEFF SNIDER: Yeah, and that's what really is concerning is that we don't usually see the Eurodollar, even when it is inverted, you don't usually see it this inverted, and then the shape it's taken, where it's almost like there's something weighing on the middle of the curve, particularly in that part. And what's really, I think, most concerning is how the other side of the inversion, the longer side of the inversion has moved up too, which is a recession signal.
But if you put it in the historical context of, say, 2018, 2019, this is far and away above that, and it's starting to look more like-- and I hate to use a comparison, but it's starting to look more like 2006, early 2007. I'm not saying we're repeating 2008, but I think the market is hedging against the possibility that severe liquidity problems, which-- let's face it, we may already be seeing some of those already. And so, it's not just hedging against future risk, it's hedging against maybe current reality too which may account for one reason why the curve is so ugly and distorted right now.
ANDREAS STENO LARSEN: I guess the two of us Jeff can easily agree that the Eurodollar futures curve is interesting, but why should the average Joe care about the Eurodollar futures curve?
JEFF SNIDER: Because of what it signals. It's not about its correlation with other market classes or assets or anything like that. It's what it tells us about, first of all, the monetary system, as well as the potential risks to the global economy and as we know, asset classes like stocks and others, there's a close correlation between macroeconomic conditions and how stocks fare. So, if you were sitting there in December of 2021, last year, and the Eurodollar futures curve began its inversion, you thought, well, maybe now's the time to start lightening up on risk positions, because the market is starting to look at the potentially serious downside case, such that it is distorting the Eurodollar futures curve.
And then over time, over the last what is it now, seven months, the curve inversion has only grown worse, which you can relate to any forecasts or any analysis about what the real economy must be doing at that time, and therefore what the risks are to a much broader range of asset classes. So, it's a way to basically calibrate how we view the economy and the markets, and especially through the lens of liquidity and money.
ANDREAS STENO LARSEN: I wanted to play a soundbite for you, as well, Jeff, relating to the discussion on whether a recession is coming or not. It's from a discussion between Gordon Johnson and Michael Green airing on Real Vision these days. And the discussion centers around whether a recession is a good thing or not given the current inflationary environment. So, let's listen to the soundbite and get back to that discussion.
GORDON JOHNSON: The lesson I learned is when the Fed reverses course and says QE infinity back on, we're up, I shouldn't say, we're going to be much more bullish too, we weren't prior, because nothing matters when they do that. And the regulators have said if the stock gets too big, we're not going to regulate. But look, again, I think inflation is a big problem. And I think all these economists saying the Fed can't afford to raise rates, that's ridiculous.
If you look at, I'm going to check my notes here, but if you look at basically interest payments divided by GDP right now, if you look at interest payments of the US government divided by GDP, it's at like the lowest level it's been since 1957. So, they can absolutely raise rates and the US will be just fine. And the problem is, again, if they don't get this inflation under control, it doesn't matter when they start to print again, people just won't be able to afford stuff, and you'll have a revolution. And you'll have riots in the streets.
If milk goes to $20 a bottle, and companies now start to fire people, you're going to see that. We think you're going to start to see a firing cycle as people try to pad earnings, I think you're already seeing that. It's going to be disastrous. So, I think the Fed is serious, I think they're serious, we speak to people who have previously worked at the Fed, they're telling us they're serious. So, I think we're going to go through a period of fundamentals are going to matter again.
And in that environment, I think the things that you and I believe, just the things that we agree on, I think you're going to become much more important, stock picking is going to become much more important, companies who generate money is going to become much more important. And I think in that environment, some of this stuff is going to level out. Some of these companies that shouldn't be operational will go out of business.
And that's a natural healthy thing. Recessions, cycles are natural. Circumventing cycles via money printing is not natural. So, I think this is a good thing.
ANDREAS STENO LARSEN: The entire interview is available for subscribers of the Real Vision platform. Back to the discussion with you, Jeff, Gordon refers to a very firm Federal Reserve, and almost hints that it could be a good idea to get a wash out in the economy to ensure that inflation gets back down. What do you make of that discussion?
JEFF SNIDER: Well, I think the first part, I would definitely agree with, the fact that the Federal Reserve has made it absolutely clear that they've abandoned their dual mandate, and that they're going to focus with singular passion upon consumer prices. And so, that I don't think anybody disagrees with. In fact, the markets agree with it, which is, again, why you see the curves so steep upfront, because the market is pricing in this so-called Fed reaction function, which they've made very clear is all about CPIs.
It's the other part of the curves and the other part of the discussion, where I think you have to really focus, which is the markets are saying, yes, the Fed wants to raise rates aggressively, but it won't be able to. What's not holding the Fed back or what's not holding interest rate back, it's not the Fed's willingness that's going to hold interest rates back, it's the ability to continue raising rates, because prospects for recession aren't just about washing out any consumer price of any leftover consumer price imbalances in the economy.
The recession is itself a deflationary function of the supply shock and maybe the inevitable, I hate to use the word transitory, but the inevitable end of transitory factors. And that's why the curves are the way they are. Because what they're saying is that the Fed is looking at one thing, it changed its mind about transitory famously last fall, and it would have been correct to not change its mind to look at the economy in a very different way. And that consumer prices are on their way to being dealt with, not by rate hikes, not by the Fed, but by the very own imbalances of what's going on with the supply shock.
And as well as some very real coincident deflationary dangers in the monetary system itself, things like collateral shortages and other things, which pile up together to give us these distorted curves and the view of these curves, which is that the Fed wants to raise rates because of its reaction function. But that is not going to be able to, and it's not going to be able to because of the environment that we all are going to find ourselves in or are likely to find ourselves in, in the near-term future.
ANDREAS STENO LARSEN: I perfectly agree that the top priority for the Federal Reserve is now to combat inflation. But talking about inflation, if we look at market pricing over the past, say three, four weeks, I will argue we've seen some signals in in usual inflation hedges such as industrial metals, commodities broadly, in the wrong direction. If you're betting on high inflation, what do you make of the recent market action in the commodity space?
JEFF SNIDER: I think it coincides and corroborates exactly to the problem that we're facing, which is a recession is not a good thing and inflation, it's the recession is the inevitable result of the end of the supply shock, which, again, copper, even oil prices this week that fell so hard and