The Irish Lumper

May 3, 2020 – Weekly comment

Exactly a year ago I was in NYC for a grand benefit staged by a friend as part of County Mayo Days.  I was also invited on Saturday May 4 to an event at the Irish Hunger Memorial by new friends Corina and Siobhan.  The Hunger Memorial is at Vesey and North End Avenue in Battery Park, a few blocks from the 9/11 memorial. There, the ruins of an original stone cottage from Mayo were reconstructed on a hill of wild grasses.  Strewn on the site are rocks from every county in Ireland.  For a minute, it’s easy to forget you’re in New York City.  Perhaps especially so on that day as it was a cool overcast morning under a slight drizzle.  The modern part of the memorial is tucked under the west side of the hill.  There the walls are engraved with proverbs and quotes of Irish poets.  “Hunger will break through a stone wall.”   

The Great Hunger was caused by a blight of potato crops in Ireland in the mid-1800’s.

By the early 19th century, however, the potato had begun to show a tendency toward crop failure, with Ireland and much of northern Europe to experience smaller blights in the decades leading up to the Great Famine. While the effects of these failures were largely ameliorated in many countries thanks to their cultivation of a wide variety of different potatoes, Ireland was left vulnerable to these blights due to its dependence on just one type, the Irish Lumper. When HERB-1, which had already wreaked havoc on crops in Mexico and the United States, made its way across the Atlantic sometime in 1844, its effect was immediate—and devastating.

Last week, problems related to the COVID virus affected meat-packing plants in the US, threatening reduced supply.  As Bloomberg reports there’s a downside to efficiency, as “…part of the issue is that a few big companies dominate the industry through a handful of extremely high volume plants, the result of years of consolidation.”  

Modern society has become governed by efficient and concentrated international supply chains and products.  In essence, it’s the problem of the Irish Lumper: dependence on just one variety with beneficial qualities.  “…Since potatoes can be propagated vegetatively, all these lumpers were clones, genetically identical to one another.” Clones.  Like corporate managements and the political class.

It’s clear that in the short term, vast amounts of demand will be cut, overtly reflected by the example of Buffet dumping Berkshire’s airline stocks.  There will be bankruptcies and the jobless rate, which is obviously soaring, will take a long time to come back down, perhaps never reaching the historic lows achieved recently in the US.  However, associating inflation with low joblessness and low rates has proven to be an error.  Similarly, there are now those who think inflation can’t possibly come back due to demand destruction and idle capacity.  However, as a weekend Bloomberg article notes, some aren’t so sure. “Such contrarians wonder if an environment of ultra-loose monetary and fiscal easing, commodity shortages, frayed supply chains and braking globalization might be fertile ground for surging consumer prices.” 

In the aftermath of the GFC there was significant monetary and fiscal stimulus, but much of it was drawn out over years.  At that time, I thought inflation was sure to follow.  Wrong.  I would note that many concluded the exact same outcome.  In November 2010 a group of influential economists and investors sent an Open Letter to Ben Bernanke published in the WSJ regarding QE: “The planned asset purchases risk currency debasement and inflation…”

In the current case, huge sums of fiscal stimulus have been instantly unleashed with the CARES act in the amount of $2.2 trillion or 10% of GDP, with more on the way.  In the eight YEARS from 2007 to 2015, the Fed’s balance sheet expanded from $870B to $4.5T, an increase of just over $3.6T.  In the eight MONTHS from Sept 2019 to April 2020, the balance sheet has exploded by nearly the same nominal amount, $3.76T to $6.65T.  M2 has had an eight week increase of $1.73 trillion to $17.2T.  Yesterday’s Bloomberg article notes an “…asymmetric response during the financial crisis, when CB’s cut rates and started quantitative easing, but governments reined in budgets.”  In the 2008/09 episode, money primarily flowed into efforts to save banks and the financial architecture.  The outcome wasn’t the inflationary response of ‘too much money chasing too few goods’ but rather ‘too many investment funds chasing too little yield’.  This dynamic squashed inflation.  The Fed successfully pushed the market out the risk curve, perhaps aided by boomers focused on retirement income.  In recent years, I suspect the general public wasn’t particularly informed nor did they care about corporate buybacks.  However, that issue has bubbled to the surface.  The financial engineering outgrowth of the GFC will likely be stymied during this go-around.
Now, money is flowing directly into the economy, not just financial institutions.  All sorts of supply chains will be duplicated and domesticated.  Inventory on hand will become more important.  Less global trade will result, but my guess is that companies and even consumers may now weigh ‘certainty’ of supply vs the ‘price’ thereof.  Though the economy is now primarily service-based, the extra layer of health safety will increase costs.  As Wilbur Ross said in his awkwardly tone-deaf manner in late January, “It should help manufacturing and jobs return to the US.”  Having experienced the oil price plunge in the last two months, year-over-year inflation comparisons are likely to significantly expand by Q4 2021.  Of course, it’s not all about oil, but still worth noting that after a significant bounce this week, CLM0 settled 19.78, CLZ0 at 28.59 and CLZ1 33.81. (The increase from Dec’20 to Dec’21 is 18%).  A slower growth world with more friction (of every sort) and less security will almost certainly lead to price pressures.

Where is this thesis emphatically NOT reflected?  In back month Eurodollar contracts.  In the past week, back month Eurodollar contracts made all-time highs.  Reds (2nd year forward) had never settled at the 9975 strike, but on Wednesday that’s exactly where the first red, EDM21, settled.   The high in the first green in 2012 was 9952.  On Friday it was 9968 (EDM22).  The previous high in the first blue was 9923, now 9956 (EDM23), and in the first gold, 9868 to current 9940 (EDM24).   

The question might be, with central banks in accommodative overdrive, why should there be any expectation of change?  The trend is for lower rates.  Kocherlakota was just out last week making his asinine argument for negative rates.  Well, two and a half months ago, SPX also made an all-time high.  When sentiment begins to change, it can happen in a hurry.

I’ll end it with a comment from perhaps the biggest bond bull and consistent (and consistently correct) deflationist around, Lacy Hunt.  The last Hoisington Quarterly Review is once again mostly about the prospect for lower growth and declining inflation.  However, it included this caveat, a warning about MMT, for the first time:  “Having the Treasury sell securities directly to the Fed could do this [make the Fed’s liabilities legal tender]; the Treasury’s deposits would be credited and then the Treasury would write checks against these deposits.  If this change is enacted, rising inflation would ensue and the entire international monetary system would be severely destabilized and the US banking system would be irrelevant.” 

“Evolutionary theory suggests that populations with low genetic variation are more vulnerable to changing environmental conditions than are diverse populations.”

Concentration giving way to diffusion.  Commoditization morphing into diversity.  Supply retrenching from global to local.  Higher price pressures. 


Three month libor plunged 30 bps this week, from just over 84 bps on April 24 to just over 54 on Friday.  However, EDM0 net change was from 9960 a week ago to 9963 on Friday, with the intervening high at 9968.  The market is now signaling that libor compression has run its course.  Interest rate volume eased as the week progressed and implied vol in treasuries declined, with implied vol on TY around 4%, lower than the level of early Feb before stocks peaked. VIX has also declined, but popped off the lows on Thursday into Friday as stocks resumed a sell off.  VIX ended at 37.19, up 1.26 on the week. Importantly treasury vol did NOT respond positively to equity weakness; a signal that perhaps treasury yields have bottomed.

UST 2Y21.220.0-1.2
UST 5Y36.136.70.6
UST 10Y59.163.94.8
UST 30Y117.1127.710.6
GERM 2Y-70.6-76.0-5.4
GERM 10Y-47.3-58.6-11.3
JPN 30Y43.442.7-0.7
EURO$ M0/M1-13.0-9.04.0
EURO$ M1/M25.54.0-1.5
CRUDE (1st cont)16.9419.782.84

Posted on May 3, 2020 at 10:28 am by alexmanzara · Permalink
In: Eurodollar Options

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