Doug Noland: $10 Trillion In Nine Months

Federal Reserve Assets surged $120 billion last week to a record $7.363 TN. Fed Assets inflated $3.593 TN, or 95%, over the past 66 weeks. M2 “money” supply surged $228 billion in this week’s report to a record $19.226 TN – with a 66-week gain of $4.255 TN (28%). Overheated markets have become wholly enchanted by this frightening monetary inflation.

In early rules-based versus discretionary central banking debates, it was long ago recognized that discretion came with the risk of one misstep leading invariably to a series of only greater policy mistakes. This is the story of the contemporary Federal Reserve – from Greenspan to Bernanke to Yellen and now Jerome Powell. Policy doctrine has become progressively in the clutches of a runaway financial Bubble.

The Fed was out digging a deeper hole this week – an err compounded by Chairman Powell’s press conference dovish overkill. We’re in the throes of a period of precarious Monetary Disorder. This is apparent in Credit data and the monetary aggregates, throughout the financial markets and, increasingly, in housing markets across the country.

Financial conditions are precariously loose. Yet virtually everyone is convinced extremely loose monetary policy is appropriate considering the economic hardship being suffered across the United States. This thinking – utter reverence for monetary and asset inflation – has become only more perilous during the pandemic.

Powell responded to a question on elevated equities prices: “Asset prices is one thing that we look at… We published a report a few weeks ago on that… And I think you will find a mixed bag there… With equities, it depends on whether you’re looking at PE’s or whether you’re looking at the premium over the risk-free return. If you look at PE’s, they’re historically high. But… in a world where the risk-free rate is going to be low for a sustained period, the equity premium, which is really the reward you get for taking equity risk, would be what you’d look at. And that’s not at incredibly low levels, which would mean that they’re not overpriced in that sense. Admittedly, PE’s are high, but that’s maybe not as relevant in a world where we think the 10-year Treasury is going to be lower than it’s been historically, from a return perspective.

December 14 – Bloomberg (Rich Miller): “U.S. financial conditions are the easiest they’ve been in more than a quarter century as stock markets scale new heights on hopes of an end to the Covid-19 pandemic, according to an index compiled by Goldman Sachs… The index, which dates back to 1990 and also takes account of the value of the dollar and interest rates, reached its loosest level ever last week. That came as financial markets have boomed, thanks to unprecedented support for the economy from the Federal Reserve and Congress.

Evidence of egregiously loose financial conditions is everywhere. The Fed’s ballooning balance sheet. Unprecedented system “money” and Credit growth, along with the largest quarterly Current Account Deficit ($179bn) since 2008. Dollar weakness and the rapidly inflating cryptocurrencies. Record stock prices – across market indices from the S&P500 to the small caps. Massive ETF inflows. 
There are myriad indications of conspicuous speculative excess: The Nasdaq100’s 47% y-t-d return, with a P/E of about 40. Individual company valuations with no basis in reality (i.e. Tesla’s $660bn mkt cap). A booming IPO marketplace. The SPAC phenomenon. Surging retail trading volumes (“Robinhood Effect”). The booming options-trading marketplace – retail and institutional – and, more specifically, the manic popularity of call option speculation. The blowup of hedge fund short-only and long/short strategies – with the Goldman Sachs Most Short Index surging 43% since the end of October and over 200% from March lows (up 53% y-t-d). Historically narrow corporate bond spreads (and low CDS prices) – in the face of major and mounting Credit impairment throughout the economy (households, corporations, state & local govt, etc.). Record investment-grade and high-yield corporate debt issuance. Booming private-equity and M&A.

In his press conference, Powell admitted the economy has proven more resilient to Covid spikes than the Fed would have anticipated. Clearly, economic activity has been bolstered by loose financial conditions, resulting booming equities and debt markets, and unmatched fiscal stimulus. But prolonging this addictive stimulant is fraught with risk. These risks do resonate with some Fed officials, with Robert Kaplan providing a voice of reason.

December 18 – Wall Street Journal (Patricia Zengerle and Eric Beech): “Reserve Bank of Dallas President Robert Kaplan said Friday that he believes it will be time for the central bank to start pulling back on its bond-buying stimulus efforts when it is clear the economy is recovering strongly. ‘I’m going to deliberately stay away from a timetable,’ Mr. Kaplan said… However, Mr. Kaplan said that as 2021 moves forward and vaccines to treat Covid-19 roll out, if the Fed is ‘making substantial progress on our dual mandate goals, I do think it would be healthy and very appropriate to begin the process of tapering our asset purchases.’ …Mr. Kaplan said he remains concerned extended periods of bond buying could bring problems. ‘These purchases, if they go on for longer than they need to, I worry that they have some distorting impact on price discovery, that they encourage excessive risk taking, and excessive risk taking can create excesses and imbalances that can be difficult to deal with in the future.’”

Abruptly redeploying QE in September 2019 – despite an increasingly speculative backdrop pushing stock prices to record highs (and with unemployment at multi-decade lows) – was a hefty blunder. QE should be recognized as a dangerous tool to be employed only in the event of systemic illiquidity precipitated by powerfully destabilizing de-risking and deleveraging (popping of a Bubble).

A measured QE response was appropriate in March. It is categorically inappropriate today – and arguably a dereliction of the Fed’s duty to safeguard system stability. Rather than supporting an unstable system’s adjustment to a changing financial and economic backdrop (as in 2008 and March), QE today directs powerful liquidity flows to already over-liquefied and highly speculative markets. Instead of accommodating deleveraging, $120 billion monthly QE at this late-cycle phase stokes speculative leveraging and only deeper structural maladjustment.

The Fed should at this juncture be preparing to “taper” – to commence a gradual process with the goal of policy normalization. It’s certainly no time to rationalize inflated securities (and housing) markets or to downplay what is obvious financial excess. And it is precisely the wrong time to further solidify the “Fed put” while emboldening an already manic Crowd of speculators. The Powell Fed has completely capitulated – and this is anything but lost on the markets. Our central bank has signaled to a frothy marketplace that massive (at least $120bn monthly) liquidity injections will continue indefinitely. It has become paramount to Fed policy to use its balance sheet to sustain market Bubbles to spur economic recovery. It is nothing short of our central bank abandoning its overarching monetary stability mandate.

This deeply flawed policy doctrine has reached a critical juncture: The prospect of massive ongoing QE now stokes precarious late-cycle monetary and Bubble excess – and the longer this persists, the more problematic it will be to pull back from aggressive stimulus. The Fed is trapped, and its credibility is in further jeopardy. Euphoric market perceptions see financial conditions remaining extremely loose for years to come. The nature of current Bubble excess, however, risks an unexpected de-risking/deleveraging dynamic inciting a destabilizing tightening of financial conditions – Fed QE notwithstanding.

Meanwhile, even before inauguration, the Fed has found itself entangled in political gunk.

December 17 – Reuters (David Lawder): “A new potential roadblock to a $900 billion coronavirus economic relief bill emerged in the U.S. Congress on Thursday as some Senate Republicans insisted on language ensuring that expiring Federal Reserve lending programs cannot be revived. One Democratic aide criticized the move by Senator Pat Toomey…, saying it would limit President-elect Joe Biden’s ability to respond to the heavy economic toll of the pandemic… But Toomey wants to ensure that the Fed and Treasury are stripped of the authority to restore pandemic lending facilities that Treasury Secretary Steven Mnuchin will allow to expire on Dec. 31, including the Main Street program for mid-size businesses and facilities for municipal bond issuers and corporate credit and asset backed securities.”

Historic Monetary Inflation is anything but limited to the U.S. After posting in October the weakest Credit growth since February ($217bn), China’s Aggregate Financing bounced back for a $326 billion expansion during November – just above estimates. This pushed y-t-d growth in Aggregate Financing to $5.079 TN – 43% ahead of comparable 2019 and 61% above comparable 2018 Credit growth.

China’s Bank Loans expanded $220 billion, double October’s depressed level, but below forecasts and only 3% ahead of November 2019. At $2.303 TN, the y-t-d Bank Loan expansion was 20.8% ahead of comparable 2019 and 24% above comparable 2018. Outstanding Bank Loans were up 12.8% over the past year; 26.8% over two years; and 84% in five years.

Consumer Loans bounced back for an $115 billion expansion in November, 10% above November 2019 growth. At $1.120 TN, y-t-d Consumer Loans growth was 8% ahead of comparable 2019. Consumer Loans expanded 14.6% over the past year; 32% over two years; 56% over three; and 135% in five years. Corporate Loans expanded $120 billion during November (15% ahead of Nov. ’19). At $1.773 TN, y-t-d growth was 28% ahead of comparable 2019 growth (48% greater than comparable ’18).

Corporate Bond Issuance plummeted during November, confirmation that a flurry of defaults has led to a meaningful tightening of Credit conditions. The $13 billion increase in Corporate Bonds was down from October’s $39 billion and the weakest net issuance since September 2018. Issuance peaked during March and April, with a two-month surge of $294 billion. At $679 billion, y-t-d issuance was 49% ahead of 2019.

Government Bond Issuance slowed somewhat to $61 billion. Year-to-date issuance of $1.167 TN was 75% and 69% ahead of comparable 2019 and 2018. At $6.945 TN, Government Bonds were up 21% over the past year; 39% over two; and 63% in three years.

For the first nine months of the year, China Aggregate Financing expanded an unprecedented $4.535 TN ($504bn monthly). This was 45% higher than comparable 2019 growth, and 67% ahead of 2018. Meanwhile, the Fed’s Z.1 data inform us that U.S. Non-Financial Debt (NFD) surged $5.740 TN during the first three quarters of the year, an increase of 188% from comparable 2019 and 163% from comparable 2018. Combining growth in Aggregate Financing with NFD, China/U.S. Credit expanded an astounding $10.275 TN During 2020’s First Nine Months, double comparable 2019 and 110% greater than comparable 2018 – in one of history’s spectacular Credit inflations.

Money supply data are similarly breathtaking. Through the end of November, China’s M2 “money” supply surged $4.487 TN, up from comparable 2019’s $1.333 TN. Similarly historic, U.S. M2 grew $3.779 TN y-t-d through November. This was up from $900 billion for comparable 2019 (and 2018’s $393bn). Respective China and U.S. “M2” monetary aggregates combined for 11-month growth of $8.266 TN – up 270% from comparable 2019’s $2.233 TN.

Chinese policymakers appear more cognizant of risks associated with ongoing extreme stimulus measures. System Credit growth has slowed from the frenetic $500 billion monthly pace during much of 2020. Regulators have moved to rein in a bubbling corporate bond market, while Beijing and local officials have tightened mortgage finance. Of course, Beijing will move gingerly, mindful of the risk of punctured Bubbles. But I believe there are today much greater risks from Chinese “tightening” than perceived by complacent global markets.

Whether it’s the U.S., China or elsewhere, Bubbles reach a point where risk becomes impossible to control. Excesses, distortions, imbalances and deep structural impairment lead inevitably to financial and economic pain. Looser financial conditions and additional monetary inflation only further destabilize finance and economies – delaying the pain but worsening the outcome.

Original Post 19 December 2020

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