Doug Noland: It’s About Jobs, Jobs, Jobs

I’m sticking with the view that we’re in the end game to these multi-decade experiments in finance and monetary management. I understand how $3.0 TN in Fed purchases buys some bond market tolerance. But multi-Trillion federal deficits will not be a one-year phenomenon. The Federal Reserve has accommodated a massive expansion of Treasury securities at ridiculously low yields. Does the Fed really believe it could then accommodate rising inflation without a market backlash? Do they appreciate how an unexpected inflationary surge would wreak absolute havoc in highly leveraged markets and economies?

The Wall Street Journal referred to a “a milestone” – “a major shift in how [the Fed] sets interest rates by dropping its longstanding practice of preemptively lifting them to head off higher inflation.” The New York Times went with “a major shift in how the central bank guides the economy, signaling it will make job growth pre-eminent and will not raise interest rates to guard against coming inflation just because the unemployment rate is low.” 

The Financial Times underscored a note from Evercore ISI economists: ‘They view the shift as ‘momentous and risk-friendly’, saying it ‘takes the world’s most important central bank beyond the inflation targeting framework that has dominated global monetary policy for a quarter of a century’.” “A revolutionary change to its monetary policy framework” that “could have profound consequences for the price of pretty much everything,” was how it was viewed by the Financial Review.

August 28 – Australian Financial Review (Christopher Joye): “On Thursday night the world’s most powerful central bank – the US Federal Reserve – ushered in a revolutionary change to its monetary policy framework because it believes it has consistently missed its core consumer price inflation target. This new regime, which will allow the Fed to keep borrowing rates lower for longer, and tolerate periods of what would have been unacceptably high inflation, could have profound consequences for the price of pretty much everything. It also reveals the central bankers’ essential conceit: that they don’t want markets to clear, or asset prices to gravitate to their natural levels, in the absence of extreme policymaking interference.”

For the most part, equities took Powell’s Jackson Hole speech in stride. Stocks rose – but they pretty much rise whenever markets are trading. Understandably, bonds were a little edgy. Ten-year Treasury yields rose six bps on the announcement to 0.75%, a 10-week high. Investment-grade corporate debt was under notable pressure. The iShares Investment Grade Corporate Bond ETF declined 0.8%, trading to the low since July 1st (down 1.1% for the week).

There is certainly an element of “the emperor has no clothes” in all this. We know from experiences in Japan, the U.S. and elsewhere that central banks don’t control the inflation rate. The shift to an “inflation targeting” regime was ill-conceived from the start. Rather than admit to mistakes, the global central bank community will continue frantically digging ever deeper holes.

Can we at least admit that inflation dynamics have evolved momentously over recent decades? Could we accept that technology innovation has led to a proliferation of new types of products and related services – profoundly boosting supplies of high-tech, digitized and myriad online products? There has also been the seismic shift to services-based output, altering inflation dynamics throughout economies. Moreover, “globalization” – especially the capacity to manufacture endless low-cost technology components and products globally – has fundamentally changed the inflation axiom “too much money chasing too few goods.”

The above noted factors have placed downward pressure on many prices, altering traditional inflation dynamics and rendering conventional analysis invalid. This contemporary “supply” dynamic has worked to offset significant inflationary pressures in other price levels (i.e. healthcare, education, insurance, housing, and many things not easily produced in larger quantities) – putting some downward pressure on consumer price aggregates (i.e. CPI).

Moving beyond the obvious, can we contemplate that ultra-loose monetary policies work to exacerbate many of the dynamics placing downward pressure on consumer price aggregates? Clearly, the historic global technology arms race is a prime beneficiary – but cheap money-induced over-investment impacts many industries (i.e. shale, alternative energy, autonomous vehicles, etc.). I would further argue monetary-policy induced asset price Bubbles are a powerful wealth redistribution mechanism with far-reaching inflationary ramifications (CPI vs. price inflation for yachts, collectable art and such).

Let’s be reminded that central bank monetary management traditionally operated though the banking system, where subtle changes in overnight funding rates influenced lending along with Credit conditions more generally. Central bankers these days continue to expand this momentous policy experiment in using the financial markets as the primary mechanism for administering policy stimulus.

Why is it reasonable to believe that monetary policy specifically aiming to inflate securities markets will somehow simultaneously ensure a corresponding modest increase in consumer prices? It’s not. As we’ve witnessed for years now – and rather dramatically over recent months – such a policy course foremost fuels asset market speculative excess and price Bubbles.

There’s a strong case to be made that this dynamic pulls finance into the securities markets at the expense of more balanced investment spending throughout the general economy. Moreover, increasingly aggressive policy support (i.e. zero rates, QE and other emergency operations) over time exacerbates speculative excess and associated market distortions. As I posited last September when the Fed employed “insurance” rate cuts and QE with markets at all-time highs, it was throwing gas on a fire.

For now, damage wrought to Fed credibility is masked by record equities and bond prices. In the wanting eyes of the marketplace, the “inflation targeting” regime is mere pretense. Bernanke didn’t punt on the Fed’s “exit strategy” due to consumer prices. Below target CPI was not behind Yellen’s postponing policy normalization in the face of strengthening booms in both the markets and real economy. And Powell didn’t abruptly reverse course in December 2018 because of lagging consumer price pressure, just as CPI had nothing to do with last fall’s “insurance” stimulus measures.

Any lingering doubt the Federal Reserve has adopted a regime specifically targeting the securities markets was quashed with the $3 TN liquidity response to March’s downside market dislocation.

It’s tempting to write, “when future historians look back…” My ongoing commitment to weekly contemporaneous analysis of this is extraordinary period is fueled by the proclivity for historical revisionism (and the associated failure to learn from mistakes). Just this week a Financial Times article stated the Fed’s last September stimulus measures were in response to trade war worries – neglecting to mention the decisive role played by late-cycle “repo” market instability.

That said, I do believe skilled analysts will look back and point to the destabilizing impact of prolonged ultra-loose monetary policies stoking speculative finance, distorted asset price Bubbles, and general Monetary Disorder. The fixation on consumer price indices slightly below target in the face of such historic Bubbles will be a challenge to justify.

I have argued now for a long time that Bubbles and associated maladjustment are the prevailing risks – not deflation (as argued by conventional economists). And the greater Bubbles inflate the greater the risk of collapse unleashing deflationary outcomes.

The Fed has been undertaking a policy review for the past year, with the outcome seemingly preordained. But to announce preference for higher prices and tolerance for persistent above-target inflation in the current backdrop is not without risk. At $7.0 TN, the Fed’s balance sheet has ballooned sevenfold in twelve years. A traditionally conservative central banker would never take a cavalier approach with inflation after an almost $3.0 TN six-month increase in M2 “money” supply.

I’m sticking with the view that we’re in the end game to these multi-decade experiments in finance and monetary management. I understand how $3.0 TN in Fed purchases buys some bond market tolerance. But multi-Trillion federal deficits will not be a one-year phenomenon. The Federal Reserve has accommodated a massive expansion of Treasury securities at ridiculously low yields. Does the Fed really believe it could then accommodate rising inflation without a market backlash? Do they appreciate how an unexpected inflationary surge would wreak absolute havoc in highly leveraged markets and economies?

The Treasury yield curve steepened markedly this week. With 30-year Treasury yields jumping 18 bps to an 11-week high 1.50%, the spread to 3-month T-bill yields rose to 141 bps (wide since June 9th). Ten-year Treasury yields rose nine bps this week to 0.72%, with benchmark MBS yields gaining nine bps to 1.44% (6-wk high).

The dollar index declined 0.9%, nearing the low since May 2018. The Bloomberg Commodities Index jumped 2.3% to the highest level since March. Gold increased 1.3%, and Silver jumped 3.4%. Yet gains were notably broad-based. Copper rose 2.9%, Nickel 4.6%, Aluminum 2.0%, Coffee 5.8%, Corn 5.5%, and Wheat 2.6%. WTI Crude gained 1.5%, trading this week at the high since March.

Equities continue to go nuts. The S&P500 gained 3.3% to an all-time high, increasing y-t-d gains to 8.6%. The Nasdaq100 jumped 3.8% to a new record, boosting 2020 gains to 37.4%. It was another brutal short squeeze week, with popularly shorted stocks again outperforming. The Bloomberg Americas Airlines Index surged 14%, and the J.P. Morgan U.S. Travel Index jumped 8.8%. The NYSE Financial Index rose 4.3%, and the NYSE Arca Computer Technology Index advanced 4.2%. Tesla surged another 8%, pushing its market capitalization to $412 billion.

Ludwig von Mises’ “Crack-up Boom.” The Fed’s new “regime” is major, profound, momentous and more. It’s not the least bit surprising – yet it is nonetheless almost unimaginable to actually witness. The Powell Fed has given up – thrown in the towel. They’ve spent a year essentially crafting rationalization and justification in anticipation of doing little more than executing “money printing” operations for years to come. I have argued they’re trapped – and they have apparently come to the same conclusion. Acute fragility associated with speculative Bubbles and egregious leverage now prohibit any effort to unwind recent extraordinary stimulus, not to mention raising rates or tightening monetary conditions in the foreseeable future.

It’s as sad as it is frightening. Despite the lip service, they’ve deserted the overarching financial stability mandate. Speculative Bubbles are free to run wilder. Leverage – speculative, corporate, federal and otherwise – Completely Unhinged.

Listening to Chairman Powell’s speech, my thoughts returned to Secretary of State James Baker approaching the podium to announce the beginning of the first Iraq war: “The war is about jobs, jobs, jobs.” How would the Bush Administration justify an expensive war in the distant Middle East (removing Saddam Hussein from Kuwait) to the American people? I viewed our government in different light from that moment on.

Chairman Powell: “This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities… The robust job market was delivering life-changing gains for many individuals, families, and communities, particularly at the lower end of the income spectrum.”

August 28 – Bloomberg (Devon Pendleton): “It’s been one of the most lucrative weeks in history for some of the world’s wealthiest people. The net worth of Inc. founder Jeff Bezos topped the once-unfathomable amount of $200 billion. …Elon Musk added the title of centibillionaire when his fortune soared past $100 billion fueled by Tesla Inc.’s ceaseless rally. And by Friday, the world’s 500 wealthiest people were $209 billion richer than a week ago. Musk’s surging wealth expanded the rarefied club of centibillionaires to four members. Facebook Inc. co-founder Mark Zuckerberg, the world’s third-richest person, joined Bezos and Bill Gates among the ranks of those possessing 12-figure fortunes earlier this month. Together, their wealth totals $540 billion…”

The Fed has capitulated on its financial stability mandate as well as the increasingly grave issue of rapidly widening inequality. The Federal Reserve’s culpability for deleterious wealth inequalities and attendant social strife has been exposed. Trapped by financial Bubbles, the Fed will pay only lip service. Actually, it’s worse: Going forward, the Fed will justify precariously loose monetary policies by pointing to its determination to assist the unfortunate.

The entire Federal Reserve system should carefully ponder Powell’s comments following his Jackson Hole speech: “Public faith in large institutions around the world is under pressure. Institutions like the Fed have to aggressively seek transparency and accountability to preserve our democratic legitimacy.”

Bloomberg’s Lisa Abramowicz: “We are getting inflation in certain areas… Certainly asset prices have gotten incredibly inflated and continue to do so on the promise that the Fed will keep rates low. How concerning is this? At what point does this have to make the Fed take stock and raise rates?”

Former New York Fed President Bill Dudley: “I think they are a little bit uncomfortable with the fact that asset prices are so buoyant. But remember that is partly by design. The Fed basically did what they did in March, April, May to try to make monetary policy easy and financial conditions accommodative. And they succeeded. Now as the stock market keeps going up and up and up, that will cause some anxiety about the Fed. But remember, stock markets go up – stock markets go down. The consequences for financial stability have historically actually been pretty modest. We had the stock market crash in 1987. Lots of economists anticipated there’d be a recession. There was no recession. So, I think buoyancy in the stock market is probably less risky to the economy because there’s not a lot of people that use a lot of leverage to own stocks.”

Earth to Dudley: We’re today confronting a deviant financial structure unrecognizable to that from 1987. Have you already forgotten March’s near global financial meltdown? Why did a panicked Fed expand its balance sheet by an unprecedented $3 TN? Why has it capitulated and basically signaled to highly speculative markets that they are committed to looking the other way and just letting things run their course?

I could, once again, invoke the timeworn punch bowl analogy (spiked and overflowing endlessly). It no longer does justice. I was thinking instead of late on Halloween evening when it’s easiest to just fill the big bowl with candies and leave distribution to the trick or treaters. Yet most kids act responsibility, snagging one treat (OK, maybe a couple) and leaving the rest for their fellow treaters. But the thought came to mind of offering a huge bowl filled to the brim with five-dollar bills, with the instruction “Only One Per Family.” It’s a superior metaphor for the Fed’s chosen course – but with the inviting note: “Help Yourself. First Come, First Serve – We’ll Fill the Bowl Whenever It’s Empty.” 

Original Post 29 August 2020

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Categories: Doug Noland