The Fed Isn’t Rushing to Create a Digital Currency. 4 Reasons Why, According to One Analyst.

2 Key Reports on Digital Assets

Washington Policy Weekly Update
BTIG
Oct. 8: Two coming reports should provide some insight into the regulatory policy landscape for digital assets: 1) the Federal Reserve’s digital payments paper in October, which is expected to provide an update on its central bank digital currency (CBDC) efforts, and 2) a stablecoin report from the PWG [President’s Working Group] by early November. On the Fed’s report, our expectation is that it will be a largely academic release that outlines both the promise and peril of a Fed-backed CBDC without explicitly committing to either design or a course of action in the future. As for the PWG’s stablecoin paper, we expect a fair framing of the benefits (e.g., faster/cheaper payments, financial inclusion) with potential drawbacks (e.g., risk of runs leading to fire sales of reserve assets), as well as a number of policy recommendations.

Our sense is that the Fed’s digital payments/CBDC paper is likely to be released first, and press reports suggest the release is imminent. Ultimately, we believe that the Fed will continue its work on CBDCs, but we sense reticence regarding the effort and don’t expect tangible progress in the near term. We offer the following points in support of this view: 1) there are questions regarding the need for a CBDC given that the Fed is expected to launch its real-time payments system, FedNOW, in 2023; 2) a CBDC would result in a sizable amount of bank deposits shifting to cash, which would have negative implications for bank funding bases, loan growth, and borrower costs; 3) BPI, a leading bank trade group, warned that CBDCs could limit the Fed’s capacity to effectively advance monetary policy; and 4) any effort to advance a Fed-backed CBDC would likely require Congressional approval, which is unlikely in the near term. We will continue to track relevant CBDC developments given the potential market implications, but we do not expect tangible near-term action on this front.

—Isaac Boltansky

Implications of Natural-Gas Crisis

Industry Update
Wells Fargo
Oct. 7: There are three things we believe the energy world (along with industrial and retail consumers) are learning firsthand with the current gas crisis. One, the world is going to need a lot more natural gas/liquefied natural gas (oil and natural gas liquids, too). Two, renewable-power sources need a greater reserve margin than they currently offer, or fragility and price volatility will only increase. Three, planned base load power (coal, gas, oil, nuclear) reductions/retirements ought to be moderated versus the aggressive “by some date certain” plans that have been dominating power grid transformations. If these three items aren’t addressed, one unintended consequence is likely to manifest in declining support for the Energy Transition (ET).

The ET isn’t the sole factor to blame/credit for what is unfolding in global gas markets. Broader demand growth and the effects of Covid lockdown/recovery also have starring roles. However, the ET is important and is the long-lasting factor in our view. Energy systems have historically been constructed and operated so that a sufficient reserve margin exists to handle both routine and unplanned extreme events. The historical view was, better to pay for a reserve and avoid outages. Could it be that one of the reasons many renewable power sources are described as cheaper than traditional fossil fuels is because they do not include a reserve/avoid outages implicit (much less explicit) fee?

—Roger D. Read, Lauren Hendrix Walker

Food-Price Inflation Soars

Hot Charts
National Bank of Canada
Oct. 6: The risks of a stagflation scenario are increasing. Global supply-chain constraints are currently being exacerbated by an energy shortage and the soaring cost of carbon-emission permits in many OECD economies. And this at a time when China is recalibrating its industrial policies. This confluence of factors is looking more and more like a supply shock reminiscent of the early 1970s, when soaring production costs idled industrial capacity and lowered potential GDP for many quarters.

As if this weren’t already bad news for inflation, we now have to contend with soaring food costs. Earlier this week, the United Nations reported that its Food Price Index (FFPI), which tracks the international price of a basket of food items, is already up 30% in 2021 from its 2020 annual average, the largest increase in 47 years. The FFPI adjusted for inflation is currently at its highest level since the early 1970s. This is a particularly troubling development for emerging markets, where food accounts for a large share of the consumption basket. Remember that EMs now account for about 60% of global GDP. Clouds are forming over global economic growth forecasts for 2022.

—Stéphane Marion

Investor Optimism Sags

Market Comment
Phases & Cycles
Oct. 6: One of the best ways to determine where we are [in shifting markets] is by looking at the level of optimism or pessimism of North American investment newsletter writers. Investors Intelligence has been producing this data for more than 50 years. It has proved to be a very useful gauge of investor sentiment.

As of Oct. 5, 40.4% of independent newsletter writers were optimistic (down from 46.5% the prior week) and 22.5% were pessimistic (relatively unchanged). This is the lowest level of optimism since May 2020. That was two months after markets started rebounding from the Covid lows on March 23, 2020. Presently, optimism is lower than it has been during normal market conditions.

Optimism bottoms when markets bottom. Optimism plummeted during the 20% selloff in December 2019 and the 35% Covid selloff in March 2020.

—Dave Harder

Value-Investing Opportunities

Equity Insights
Putnam Investments
Oct. 6: One component of our investment strategy is relative value—focusing on the valuation of a company compared with businesses in the same sector. What is the market underappreciating that makes a stock attractive relative to its peer group? This concept may have been lost on many investors in the early months of 2021, when we saw an emphasis on cheapness over quality. This tends to happen with a recovery trade at the start of a new cycle. Enthusiasm about an economic rebound leads investors to flock to the cheapest stocks, often with little regard for company fundamentals. Notably, this “cheapness rally” left behind higher-quality companies that became undervalued and presented a few opportune entry points.

This reinforces our belief in the importance of defining value daily. Once a year, the Russell 1000 Value Index is reconstituted, identifying a value universe of companies with lower price-to-book ratios and low growth rates. However, company fundamentals can change considerably over the course of 12 months; 2020 was a textbook example. In the June 2020 rebalance of the Russell indexes, for example, healthcare stocks shifted to the growth index following their outperformance over the previous 12 months. In the next index rebalance this past June, faltering performance sent healthcare stocks back into the value benchmark. Much more frequent analysis—we suggest daily—of the value universe is necessary to uncover the most compelling stocks, many of which may not currently be part of a value benchmark.

—Shep Perkins, Darren A. Jaroch, Lauren B. DeMore

Email: [email protected]