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Opinion: Powell has lost his North Star, and the Fed is flying blind

The Fed risks raising interest rates too much as the compass spins wildly

STAN HONDA/AFP/Getty Images
Stars appear to rotate around Polaris, the North Star, in this time exposure of the Kitt Peak National Observatory near Tucson, Ariz.

Federal Reserve Chairman Jerome Powell is in an unenviable position. Folks expect him to fine-tune interest rates to keep the economy going and inflation tame but he can’t make things much better — only worse.

Growth is nearly 3% and unemployment is at its lowest level since 1969. What inflation we have above the Fed target of 2% is driven largely by oil prices and those by forces beyond the influence of U.S. economic conditions — OPEC politics, U.S. sanctions on Iran, and dystopian political forces in Venezuela and a few other garden spots.

When the current turbulence in oil markets recedes, we are likely in for a period of headline inflation below 2%, just as those forces are now driving prices higher now.

Overall, long-term inflation has settled in at the Fed target of about 2%. The Fed should not obsess about it but keep a watchful eye.

Amid all this, Powell’s inflation compass has gone missing. The Phillips curve, as he puts it, may not be dead but just resting. To my thinking, it’s in a coma if it was ever alive at all.

That contraption is a shorthand equation sitting atop a pyramid of more fundamental behavioral relationships. Those include the supply and demand for domestic workers and in turn, an historically large contingent labor force of healthy prime-age adults sitting on the sidelines, the shifting skill requirements of a workplace transformed by artificial intelligence and robotics, import prices influenced by weak growth in Europe and China, and immigration.

…click on the above link to read the rest of the article…

St Louis Fed Discloses More Free Money: A Carry Trade in Liquidity

Not only do banks earn free money on excess reserves, they can borrow money and make guaranteed free money on that.

The Federal Reserve Bank of St. Louis discusses the Carry Trade in Liquidity.

The IOER [interest on excess reserves] has been the effective ceiling of other short-term interest rates. The figure above compares the IOER with overnight rates on deposits and repos.

As we can see, the IOER has mostly remained above these two rates, implying that (at least some) banks have been able to borrow funds overnight, deposit them at the Fed and earn a spread, in essence engaging in carry trade in liquidity markets.

Interest Rate on Excess Reserves

How Much Free Money?

Fed vs ECB

While the Fed has been busy giving banks free money by paying interest on excess reserves, banks in the EU have suffered with negative interest rates, essentially taking money from banks and making them more insolvent.

If the goal was to bail out the banks at public expense (and it was), it’s clear Bernanke had a far better plan than the ECB.

Ten Years After the Last Meltdown: Is Another One Around the Corner?

Ten Years After the Last Meltdown: Is Another One Around the Corner?

September marked a decade since the bursting of the housing bubble, which was followed by the stock market meltdown and the government bailout of the big banks and Wall Street. Last week’s frantic stock market sell-off indicates the failure to learn the lesson of 2008 makes another meltdown inevitable.In 2001-2002 the Federal Reserve responded to the economic downturn caused by the bursting of the technology bubble by pumping money into the economy. This new money ended up in the housing market. This was because the so-called conservative Bush administration, like the “liberal” Clinton administration before it, was using the Community Reinvestment Act and government-sponsored enterprises Fannie Mae and Freddie Mac to make mortgages available to anyone who wanted one — regardless of income or credit history.

Banks and other lenders eagerly embraced this “ownership society”’ agenda with a “lend first, ask questions when foreclosing” policy. The result was the growth of subprime mortgages, the rush to invest in housing, and millions of Americans finding themselves in homes they could not afford.

When the housing bubble burst, the government should have let the downturn run its course in order to correct the malinvestments made during the phony, Fed-created boom. This may have caused some short-term pain, but it would have ensured the recovery would be based on a solid foundation rather than a bubble of fiat currency.

Of course Congress did exactly the opposite, bailing out Wall Street and the big banks. The Federal Reserve cut interest rates to historic lows and embarked on a desperate attempt to inflate the economy via QE 1, 2, and 3.

…click on the above link to read the rest of the article…

Choking On the Salt of Debt

Choking On the Salt of Debt

Life After ZIRP

Roughly three years ago, after traversing between Los Angeles and San Francisco via the expansive San Joaquin Valley, we penned the article, Salting the Economy to Death.  At the time, the monetary order was approach peak ZIRP.

 

Our boy ZIRP has passed away. Mr. 2.2% effective has taken his place in the meantime. [PT]

We found the absurdity of zero bound interest rates to have parallels to the absurdity of hundreds upon hundreds of miles of blooming crop fields within the setting of an arid desert wasteland.

Given today’s changing financial conditions, namely the prospect of a sustained period of rising interest rates, we have taken the opportunity to refine our analysis.  What follows is an attempt to bring clarity to disorder.

The natural starting point for the topic at hand is from a place of delusion. That is, the popular delusion that central planners can stimulate robust economic growth by setting interest rates artificially low. The general theory is that cheap credit compels individuals and businesses to borrow loads of cash – and consume.

Over a sample size of five to ten years, say the growth half of the business cycle, central bankers can falsely take credit for engineering a productive economy.  Profits increase.  Jobs are created.  Wages rise.  A cycle of expansion takes root.  These are the theoretical benefits to an economy that central bankers claim they impart with just a little extra liquidity.  In practice, however, this policy antidote is a disaster.

Without question, cheap credit can have a stimulative influence on an economy with moderate debt levels. But once an economy has reached total debt saturation, where new debt fails to produce new growth, the cheap credit trick no longer works to stimulate the economy.  In fact, the additional credit, and its flip-side debt, distorts prices and strangles future growth.

…click on the above link to read the rest of the article…

Yes, Something Broke

Yes, Something Broke

In this missive, we are just going to focus on the “WTF!” moment of this past week. In order to do this properly, I need to start with last week’s missive where we asked the question “Did Something Just Break?” In that article we addressed very specific concerns about interest rates and the problem they were going to cause.

Speaking of rates, each time rates have climbed towards 3%, the market has stumbled.”

Chart updated through Friday.

“If you note in the chart above, a short-term ‘warning signal’ has been triggered which suggests that if rates remain above 3%, stocks are going to continue to struggle. The last time this occurred was in May when rates popped above 3%, stocks struggled and bonds outperformed.”

We also updated the pathway analysis for the highest probability outcomes over the next couple of months.

Chart updated through Friday – pathways remain unchanged

While the majority of the pathway’s accounted for a continued corrective, consolidation, process through the end of the year. It was Pathway #3 which came to fruition.

“Pathway #3: The issue of rising interest combines with a break in the economic data, or another credit-related event, and sends the market heading back to test supports at 2800 and 2750. This would likely coincide with a more severe contraction in the economic data which is not an immediate threat. Nonetheless, we should always consider the risk of an unexpected, exogenous, event. (10%)”

The recent sell-off coincides with the rising concerns of higher rates coupled with deterioration in economic growth heading into 2019. To wit:

“As such, our best initial take is that yesterday’s repricing of US growth was an overdue gut-check following last week’s monetary and oil supply shocks.”

…click on the above link to read the rest of the article…

Peter Schiff Explains “What Happens Next” In 47 Words

Outspoken critic of The Fed and one of the few that can see through the endless barrage of bullshit to how this really ends, has laid out in a tweet “what happens next”…

Likely sequence of events:

1. Bear market;

2. Recession;

3. Deficits explode;

4. Return of ZIRP and QE;

5. Dollar tanks;

6. Gold soars;

7. CPI spikes;

8. Long-term rates rise;

9. Fed. forced to hike rates during recession

10. A financial crisis without stimulus or bailouts!

h/t @PeterSchiff

The Fed’s Easy-Money Policies Aren’t Helping Income Growth

The Fed’s Easy-Money Policies Aren’t Helping Income Growth

inequality1.PNG

Back in August, Bloomberg interviewed Karen Petrou about her research on quantitative easing and the Fed’s policies since the 2008 financial crisis. What she has discovered has not been encouraging for people who aren’t already high-income, and in recent research presented to the New York Fed, she concluded “Post-crisis monetary and regulatory policy had an unintended but nonetheless dramatic impact on the income and wealth divides.”

This assessment is based on her own work, but also on a 2018 report released by the Minneapolis Fed.1  The report showed that both income and wealth growth in the US have been much better for higher-income households in recent decades

Notably, when indexed to 1971 (the year Nixon ended the last link between gold and the dollar) we can see the disparity between the top wealth groups and other groups:

income_wealth.PNG

 Petrou continues:

What did we learn [from the Minneapolis Fed report]? This new dataset shows clearly that U.S. wealth inequality is the worst it has been throughout the entire U.S. post-war period. We also know now that the U.S. middle class is even more “hollowed out” than we thought in terms of income, with any gains made by the lower-middle class sharply reversed after 2007.

Indeed, the report concludes: “…half of all American households have less wealth today in real terms than the median household had in 1970.”

A closer look at income data also suggests that income growth has been especially anemic since 2007. Using data from the Census Bureau’s 2017 report on income and poverty, we find that incomes for the 90th percentile are increasingly pulling away from both the median (50th percentile) income and from the 20th-percentile income.2

income_percentile.PNG

 The household income for the 20th percentile increased 70 percent since 1971, while it has only increased 20 percent at the 20th percentile.

…click on the above link to read the rest of the article…

Albert Edwards: “Equity Investors Are Facing The Four Horsemen Of The Apocalypse”

Even SocGen’s Albert Edwards was surprised at how quickly his latest predication was validated.

Recall that 3 weeks ago with the 10Y yield at 3.10%, with Edwards looking at the surge higher in 10Y Yields the SocGen strategist pointed out that the break in the 10y above 2.8% was not the key level that could mark the end of the secular bull market, but rather it was the 3.05% zone as shown in the chart below.

Commenting on this breakout, he said that rates might surge further and addressed whether this would mean the end his “Ice Age” thesis. As he noted, if investors “get the wrong side of a new multi-year bear market in government bonds, all investment  portfolios will be shredded to ribbons as bonds are the cornerstone of most equity valuation models”.

Fast forward to today when in his latest note he writes “let me be totally honest: I was most surprised that the US 10y yield managed to smash through its multi-decade downtrend last week, mainly due to the fact that the CFTC data showed that speculators had already built unprecedented large short positions. It seemed that every man, woman and child was already bearish and so who was left to sell? Well clearly someone was! One thing that helped tip bond prices over the edge and take yields up to 3¼% was the fundamental support from stronger than expected economic data (see chart below). ”

Another factor for the latest breakout in yields which pushed the 10Y interest rate to fresh 7 years highs was the previously discussed economic exuberance by Fed Chair Powell who managed to convince markets that they were still too sanguine on their expectations on interest rates, “and the futures strip ratcheted up another notch towards the Fed dots.”

…click on the above link to read the rest of the article…

“This Is The Tipping Point”: One Bank Is Calling For A 30% Market Correction

While some believe that it is the level (or stock) of the 10Y yield during a rate rout that determines the resulting revulsion toward equities, while others claim that it it speed of the sell off (the “flow” angle) that matters, the reality is that the higher rates rise – whether fast or slow – the less attractive risk assets become (in a recent analysis, Bank of America calculated what the great un-rotation “magic number” is for yields).

And while violent interest rate repricings certainly have an impact on risk assets – if only over the short-term, until rate vol normalizes – as today’s market action confirms, a more comprehensive theory suggests that the US dollar (the world’s reserve currency) and US interest-rates (world’s risk-free-rate) cycle play a vital role in determining changes in asset prices and the global economy, especially after the gold standard was abolished in 1971.

In a new note from Nedbank’s Neels Heyneke and Mehul Daya, the strategists explain why they believe “we are approaching historical thresholds”, where tighter monetary conditions in the US have traditionally been the “straw that breaks the camel’s back” for the equity market and economic growth, and why “this time should be no different.

To begin, Nedbank defines US real interest rate as the spread between the US 10-year bond yield and the natural rate of interest (r*). The Laubach-Williams r* estimate is basically the real short-term interest rate at which the US economy is at equilibrium, i.e., where unemployment and inflation are at the 2% target. This allows to determination of monetary conditions in the US relative to the underlying economy.

…click on the above link to read the rest of the article…

 

Rising Interest Rates Start Popping Bubbles — The End Of This Expansion Is Now In Sight

Rising Interest Rates Start Popping Bubbles — The End Of This Expansion Is Now In Sight

Towards the end of economic expansions, interest rates usually start to rise as strong loan demand bumps up against central bank tightening.

At first the effect on the broader economy is minimal, so consumers, companies and governments don’t let a slight uptick in financing costs interfere with their borrowing and spending. But eventually rising rates begin to bite and borrowers get skittish, throwing the leverage machine into reverse and producing an equities bear market and Main Street recession.

We are there. After a year of gradual increases, interest rates are finally high enough to start popping bubbles. Consider housing and autos:

Mortgage Rates Up, Affordability Down, Housing Party Over

The past few years’ housing boom has been relatively quiet, but a boom nonetheless. Mortgage rates in the 3% – 4% range made houses widely affordable, so demand exceeded supply and prices rose, eventually surpassing 2006 bubble levels in hot markets like Denver and Seattle.

But this week mortgages hit 5% …

… and people have begun to notice. Here’s an example of the resulting media coverage:

Mortgage rates top 5 percent, signaling more home price cuts

Some of us out there still remember when the average rate on the 30-year fixed mortgage hit 9 percent, but we are not the bulk of today’s buyers. Millennials, now in their prime homebuying years, may be in for the rude awakening that credit isn’t always cheap.

The average rate on the 30-year fixed loan sat just below 4 percent a year ago, after dropping below 3.5 percent in 2016. It just crossed the 5 percent mark, according to Mortgage News Daily. That is the first time in 8 years, and it is poised to move higher. Five percent may still be historically cheap, but higher rates, combined with other challenges facing today’s housing market could cause potential buyers to pull back.

…click on the above link to read the rest of the article…

 

Beijing Eases Policy, Yuan Slides Towards 10-Year Low

On Sunday, the Bank of China cut the level of cash that banks must hold as reserves. The Yuan continued its slide.

Shares in Asia stumbled in early trade on Monday as investors waited with bated breath as China’s markets prepare to reopen following a week-long holiday and after its central bank cut banks’ reserve requirements in a bid to support growth.

Investors will be focused on markets in China, following a decision on Sunday by the People’s Bank of China (PBOC) to cut the level of cash that banks must hold as reserves in a bid to lower financing costs and spur growth amid concerns over the economic drag from an escalating trade dispute with the United States.

Reserve requirement ratios (RRRs) – currently 15.5 percent for large commercial lenders and 13.5 percent for smaller banks – would be cut by 100 basis points effective Oct. 15, the PBOC said, matching a similar-sized move in April.

Trade War

China said it would not devalue the yuan in response to a trade war. Actions speak louder that words.

The CNH is once again dangerously close to the PBOC’s redline of 7.00, with 3-month USD/CNH points, which have reached their highest this year, suggesting that a breach of that level is increasingly probably and implying a CNH yield of around 2% above equivalent USD 3-month rates. At the same time, the 1-year forward is also flirting with 1,000 pips, another signal that traders see a weaker yuan. The rate of appreciation in the forward curve this month is the quickest since June, when the U.S.-China trade war crossed the Rubicon.

…click on the above link to read the rest of the article…

The Global Distortions of Doom Part 1: Hyper-Indebted Zombie Corporations

The Global Distortions of Doom Part 1: Hyper-Indebted Zombie Corporations

The defaults and currency crises in the periphery will then move into the core.

It’s funny how unintended consequences so rarely turn out to be good. The intended consequences of central banks’ unprecedented tsunami of stimulus (quantitative easing, super-low interest rates and easy credit / abundant liquidity) over the past decade were:

1. Save the banks by giving them credit-money at near-zero interest that they could loan out at higher rates. Savers were thrown under the bus by super-low rates (hope you like your $1 in interest on $1,000…) but hey, bankers contribute millions to politicos and savers don’t matter.

2. Bring demand forward by encouraging consumers to buy on credit now.Nothing like 0% financing to incentivize consumers to buy now rather than later. Since a mass-consumption economy depends on “growth,” consumers must be “nudged” to buy more now and do so with credit, since that sluices money to the banks.

3. Goose assets based on interest rates by lowering rates to near-zero. Bonds, stocks and real estate all respond positively to declining interest rates. Corporations that can borrow money very cheaply can buy back their shares, making insiders and owners wealthier. Housing valuations go up because buyers can afford larger mortgages as rates drop, and bonds go up in value with every notch down in yield.

This vast expansion of risk-assets valuations was intended to generate a wealth effectthat made households feel wealthier and thus more willing to binge-borrow and spend.

All those intended consequences came to pass: the global economy gorged on cheap credit, inflating asset bubbles from Shanghai to New York to Sydney to London. Credit growth exploded higher as everyone borrowed trillions: nation-states, local governments, corporations and households.

While much of the hot money flooded into assets, some trickled down to the real economy, enabling enough “growth” for everyone to declare victory.

…click on the above link to read the rest of the article…

“Waiting For The World To End” – Bond Rout Bodes Badly For Exuberant Equity Investors

It was a tough week for stock market investors but the primary driver of the chaotic crumble in small caps and tech stocks was not one of the usual suspects and even for those who consider themselves ‘hedged’ or balanced it was the worst week in 7 months.

The blame for this blight on Americans’ wealth was placed squarely on the shoulders of the bond market and its violent and high velocity lurch higher in yields.

Yields rose across the curve on the back of strong US economic data and hawkish comments from Federal Reserve Chairman Powell, forcing equity investors to reevaluate the higher rate environment.

To be sure, the absence of uncertainty has been bewildering given the fact that the US government’s budget deficit has swelled, contributing to the country’s debt load, now at $21.5 trillion. Meanwhile, corporate America has gone on a borrowing spree to take advantage of near-record low rates. In fact, according to Bloomberg, excluding financials, S&P 500 companies have more than doubled their borrowings to $5 trillion over the past decade.

“There are a lot of people waiting for the world to end because of this bond market,” said Brad McMillan, chief investment officer for Commonwealth Financial Network, which oversees $156 billion.

“Low rates will keep going forever — a lot of justification for high valuations is based on the assumption. That assumption is largely broken.”

And, as Bloomberg  notes, prophesies of doom are everywhere.

There’s billionaire investor Stan Druckenmiller, who says our “massive debt problem” will ignite a crisis.

Oaktree Capital’s Howard Marks warns that public and private debt will be “ground zero when things next go wrong.”

And Citadel’s Ken Griffin sees a credit binge ending badly.

…click on the above link to read the rest of the article…

The Federal Reserve’s Rising Interest Rates Are A Ticking Time-bomb For U.S. Economy

The Federal Reserve’s Rising Interest Rates Are A Ticking Time-bomb For U.S. Economy

One of the worst things for an over-heated and extremely leveraged economy is rising interest rates.  So, with the recent 2-2.25% interest rate, big trouble is on the horizon,  Also, with higher interest rates, the U.S. Treasury will have to fork out even more money to service its debt.  In just a little more than two years, the U.S. Fed Funds Rate jumped by nearly 2%.

This is indeed a big change for the Federal Reserve’s “economic stimulation policy” as it kept interest rates below 0.25% since January 2009.  And with extremely low-interest rates, nearly zero, it allowed the United States to more than double domestic oil production.  Unfortunately, this newly created oil supply has come at a huge cost.  It has created another big mess which I call the U.S. Shale Ponzi Scheme.

But, before I get into details of this article, I wanted to let my readers and followers know that the lack of articles this week was due to a freak storm that impacted our area.  We had a mini-tornado or a micro-burst that touched down in our local area which caused a great deal of destruction, mostly to trees and bushes.  In a little more than 10 minutes, upwards of 100 mile per hour winds uprooted, snapped and destroyed a large number of trees on our property.

Interestingly, there was only minor damage done to one home in the adjacent neighborhood.  The homeowner’s wooden porch and garage tin roof were ripped off, and part of the roof is still hanging 30 feet up in one of our trees.  So, I have been quite busy not only cleaning up the mess on my property, but also helping my neighbor.  I will say, the good thing that came out of all this destruction is how our neighbors came out together to help out.

…click on the above link to read the rest of the article…

The “VaR Shock” Is Back: Global Bonds Lose $880 Billion In One Week

Markets were in turmoil, S&P futures were locked limit down as traders panicked, the establishment political system was in chaos and global bond portfolios were about to suffer a near record $1.2 trillion in losses in just a few days.

All this took place in the hours and days following Donald Trump’s November 8, 2016 election as a Value at Risk (or VaR) shockwave spread around the globe over fears Trump would ignite an inflationary conflagration that would undo years of unorthodox monetary policy, sending interest rates soaring and crashing stock  markets.

In retrospect it didn’t happen, and as the initial shock from the political revolution in the US fizzled, bond buying resumed and the VaR shock of 2016 faded as an unpleasant memory.

Or rather, it didn’t happen then, because fast forward a little under two years, when the realization that something may is profoundly changing with the US economy has unleashed the latest global bond market Value at Risk, or VaR shock, when in just the span of three days as interest rates blew out both in the US and across the world…

some $876 billion in aggregate bond market value was lost, the biggest weekly drop since the Trump election VaR shock, and wiping out one year’s worth of mark to market profits as the aggregate value of global bonds tumbled to $48.9 trillion, the lowest going back to October 2017.

The immediate catalysts have been extensively discussed here in recent days: a record non-manufacturing ISM, a surprisingly hawkish speech by Fed Chair Powell in which he warned that rates “may go past neutral” and, topping it off, another strong nonfarm payrolls report. Meanwhile, European bonds have tumbled on renewed fears about Italian politics while Emerging Markets have been routed as a result of the strong dollar which in turn has squashed local bonds.

…click on the above link to read the rest of the article…

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