#121: Understand Lags Understand the Markets

S2N Spotlight

I find it remarkable how the human mind often struggles to understand lag effects. I’m not entirely sure why that is, but it’s something I’ve observed over time. Perhaps impatience is an inherent character trait that plays a role. However, I also believe that our difficulty grasping derivatives or engaging in abstract thinking contributes to this challenge.

Take a look at the bottom x-axis, where the change in the effective Fed Funds rate during a tightening phase is reflected along with the change in Net Interest Expenses for the private sector on the vertical y-axis. I got this chart from Alfonso from Macro Compass. As you can see with the upward-sloping line, the higher the Fed rate, the more one pays in interest from before the tightening. It seems obvious.

Now look where the current 2021–2023 red dot is sitting. We are experiencing a decrease in Net Interest Payments for the private sector. The reason is because many borrowers locked in rates at historically low levels for lengthy periods. The other reason is that the government is running record budget deficits, pumping liquidity and wealth to households and businesses.

This is the main reason the US economy and many other global economies have managed to continue their economic progression despite much higher rates. The big question is whether rates will come down sufficiently in time for debt that is rolling over. I am not going to make a prediction other than to say that watching how businesses and households interest expenses track, is probably one of the most important metrics to keep an eye on.

S2N Observations

If you live in Australia and know nothing about mining, you will still have heard about Iron ore. Iron ore is Australia’s largest export, contributing around AUD 150 billion in export earnings annually, representing over 40% of Australia’s total export revenue. It also dominates the mining industry, which contributes approximately 10% of Australia’s GDP.

Australians often refer to Australia as the lucky country. It really is a beautiful and wonderful country, and our pride in our ability to compete per capita on the world sporting stage has been boosted by the Paris Olympics, where we came in 4th in the medal standings.

Over the years, I found it near impossible to find data to plot a chart. The below chart of the iron ore future traded on the CME shows you how the lucky country saw iron ore prices rise strongly after the Global Financial Crises and the Covid Pandemic. If I look at the chart below, I see very weak price action. I wonder if the lucky countries luck is about to run out?

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