That's Our Story...
Doug Nolan
Powell:
“I would say the January number, which was very high, the January CPI and PCE numbers were quite high.
There's reason to think that there could be seasonal effects there.
But nonetheless, we don’t want to be completely dismissive of it.”
“But I take the two of them [January and February CPI] together, and I think they haven’t really changed the overall story, which is that of inflation moving down gradually on a sometimes-bumpy road toward two percent.
I don’t think that story has changed.”
“…The story is really essentially the same, and that is of inflation coming down gradually toward two percent on a sometimes bumpy path.”
“We’ve got nine months of 2-1/2% inflation now, and we’ve had two months of kind of bumpy inflation.”
Powell’s dovish mindset was not limited to the inflation backdrop.
The NYT’s Jeanna Smialek:
“But so strong hiring in and of itself would not be a reason to hold off on rate cuts?”
Powell:
“No, not all by itself no…
You saw last year very strong hiring and inflation coming down quickly.
We now have a better sense that a big part of that was supply side healing, particularly with growth in the labor force.
So, in and of itself, strong job growth is not a reason for us to be concerned about inflation.”
Powell:
“We don’t think that the inflation was not originally caused, we think, I don’t think, by mostly by wages.
That wasn’t really the story.”
It’s a challenge to have confidence that Powell and the Fed have a sound understanding of the nature of second round inflation effects.
Markets rallied immediately on Chair Powell’s opening statement.
In a passage verbatim from the January 31st statement, Powell followed,
“The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably down toward 2%,” with the market pleasing,
“Of course, we are committed to both sides of our dual mandate, and an unexpected weakening in the labor market could also warrant a policy response.”
With market exuberance running sky high, it’s not the optimal environment for reinforcing the notion of a Fed cocked and ready to unleash easier monetary policy.
In a team meeting after the January 31st meeting, I made the comment, “Powell is not that good at this.”
He repeatedly made what I viewed as gaffes, providing highly speculative markets pretext for believing Powell was more dovish than he actually was.
No more benefit of the doubt.
Powell and the Fed surely recognize the backdrop, yet they continue to deliver the music Bubble markets are eager to dance to: No more rate increases.
The path to 2% inflation remains on track.
The committee prefers to get going on rate cuts.
Ongoing economic growth and tight labor markets are not impediments to easing.
And its assessment of the balance of risks has shifted away from inflation to potential labor market weakness.
Markets today are convinced the Fed will respond hastily to fledgling risks, albeit in the financial markets, softening labor or economic weakness.
Moreover, no degree of market excess will factor into Fed policy.
Market financial conditions matter profoundly to the Fed when they’re tight, but hardly matter when they’re loose.
There was a telling exchange on Bloomberg Television between the release of the Fed Statement and Powell’s press conference (documented for posterity):
Bloomberg’s Jonathan Ferro:
“The biggest risk based on what we know so far?
What is the biggest risk?
Waiting too long to cut or cutting too soon?
Mohamed El-Erian:
“The biggest risk it faces is being overly tight – and pushing this economy into recession when there’s no reason for it to go into recession.”
Ferro:
“So, holding too long.
How would you define holding too long?
Going beyond June?
Going later this year?”
El-Erian:
“Going later and not doing two to three cuts.
Being hawkish.
It’s a different Fed.
Entering into this inflation shock that they got, they tended always to be on the dovish side.
The inflation shock that they got has reminded them of the seventies.
And that’s something they do not want to repeat.
So, the balance of risk if they are wrong is that they’re too tight rather than too loose.”
Ferro:
“You’re all [the panel] making me feel a little uncomfortable, because you all agree with each other…
There’s going to be a lot of people watching this that just think, ‘hang on a minute.’
There’s a huge contradiction in all of this.
You’ve [the Fed] revised higher inflation.
Revised lower unemployment.
You’re looking for a faster economy.
And your projection for rates stays unchanged.
That sounds super dovish – and, I would say, displays a real tolerance for above-target inflation, with equities at all-time highs and Credit spreads very, very tight.
Why are we wrong when people come on this program and say, ‘we are sufficiently restrictive.’
In fact, some people come on this program and say significantly so.
Where is the evidence of that, based on what we’re seeing this afternoon?
Where is the evidence, Mohamed?”
El-Erian:
“So, the evidence was given to you earlier by Kathy [Charles Schwab’s Kathy Jones], which is if you just look at one price, which is where the policy rate is relative to where core PCE is, that’s where you get restrictive.
But I agree with you, if you look at financial conditions as a whole, these are very loose financial conditions.”
Mohamed El-Erian is one of the preeminent market and economic commentators of this era.
Having closely followed his analysis for years, I don’t recall a period where I had such issues with the substance of his views.
He is today part of this consensus Wall Street narrative that lacks coherence.
How can one assert that the Fed is “sufficiently restrictive,” when financial conditions remain extraordinarily loose?
What is the basis today for stating that the biggest risk is the Fed not cutting rates two or three times this year?
With “everything Bubble” speculative excess at this stage of the cycle posing momentous systemic risk, there’s a notable lack of “straight talk” from the Wall Street punditry.
It is today’s most pressing issue, and they’ve had ample time to craft a response.
Explanations – from Wall Street and the Fed – why policy is today restrictive are feeble at best.
Axios’ Neil Irwin:
“How do you assess the state of financial conditions right now and, in particular, do you view the kind of easing financial conditions since the fall is consistent and compatible with what you’re trying to achieve on the inflation mandate?”
Powell:
“So we think there are many different financial conditions indicators, and you can kind of see different answers to that question.
But ultimately, we do think that financial conditions are weighing on economic activity, and we think… a great place to see it is in the labor market where you’ve seen demand cooling off a little bit from the extremely high levels, and there I would point to job openings, quits, surveys, the hiring rate, things like that are really demand.
There are also supply-side things happening, but I think those are demand side things happening.
We saw, that’s been a question for a while, we did see progress on inflation last year, significant progress despite financial conditions sometimes being tighter, sometimes looser.”
Could there be a more telling response?
The most pressing issue of the day for the Fed and global central bank community - and subject matter Powell knew would be top of mind at the press conference.
Markets going nuts, and that’s the best he’s got: cooling (“a little bit from extremely high levels”) demand for labor?
It all just lacks credibility, turning uncomfortably reminiscent of Alan Greenspan’s artful dodging.
Bloomberg:
“All-Tolerant Powell Sends Wall Street Bulls Into a Buying Frenzy.”
The S&P500 jumped almost 1% on Powell’s press conference, with the Nasdaq100 rising 1.4%.
Gold surged $29 in Wednesday trading – and traded first thing Thursday above $2,200 for the first time.
Trading below 61,000 early Wednesday, Bitcoin shot to 67,000 on Powell.
It’s gone beyond dovish.
FT: “Bullish Jay Powell Sticks to Federal Reserve’s Rate-Cutting Script.”
“The story is really essentially the same…” “I don’t think that story has changed.”
Powell might as well have said, “That’s our story, and we’re sticking to it.”
Yet the “story” has changed.
Since the Fed’s December “dovish pivot,” the S&P500 has jumped 17.2%.
The Semiconductor Index surged 25.3%, and the NYSE Arca Computer Technology Index 19.0%.
Nvidia has almost doubled (98%), with Meta up 52%, Micron 41%, and Netflix 36%.
Investment-grade spreads (to Treasuries) dropped from 1.04 to 0.88 – outside of a couple months in 2021, the narrowest since March 2007 (20-year avg. 1.49).
High yield spreads collapsed from 3.63 to 2.92 – that, excluding the six months beginning in June 2021, are the narrowest since July 2007 (20-yr avg. 4.93).
“The tightest spreads on AA bonds since 2005” and “Single B Spread Index Makes New 16 year Low.”
March 20 – Bloomberg (Michael Gambale):
“There are no companies looking to sell debt in the US high-grade bond market on Federal Reserve decision day…, after sales broke $500 billion on Tuesday.
Bond sales reached $501 billion, the fastest pace ever, according to… Bloomberg…, well ahead of the $342 billion average over the last five years.”
Gold prices have rallied $185, or 9.4%, since the dovish pivot to $2,165 – trading this week to an all-time high $2,221.
It was a big week for central bank meetings.
Notable decisions included the Swiss National Bank’s surprise rate cut, and a dovish pivot by the Bank of England.
And finally, for the first time since 2016, there’s a positive policy rate in Japan.
March 19 – Bloomberg (Toru Fujioka and Sumio Ito):
“The Bank of Japan scrapped the world’s last negative interest rate, ending the most aggressive monetary stimulus program in modern history, while also indicating that financial conditions will stay accommodative for now.
The bank’s board voted 7-2 to set a new policy rate range of between 0% and 0.1%, shifting from a -0.1% short-term interest rate…
The BOJ also scrapped its complex yield curve control program while pledging to continue buying long-term government bonds as needed, and ended purchases of exchange-traded funds.”
It's entertaining to ponder why the Fed has its head stuck in the sand (disregarding loose conditions).
Some speculate it might be because of the massive federal debt load and spiraling debt service costs.
I tend to believe the Fed is petrified by the specter of repo and money market instability and associated risks of disorderly deleveraging.
Could the Fed and global central bank community fear potential ramifications of Bank of Japan monetary policy normalization?
Might the Fed be worried by the stress rising Treasury yields and the dollar place on a highly indebted world and levered global bond markets?
Tuesday’s BOJ shift (almost) went off without a hitch.
It was one historic nothingburger.
A mere 10 bps increase, with talk that a second mini-baby-step might have to wait until this fall.
And while the BOJ may have announced the end of yield curve control (YCC), the central bank explicitly stated its bond-buying program would be ongoing.
The yen suffered a 1.1% Tuesday smack-down, right back to near 33-year lows.
It wouldn’t be surprising if the Ueda BOJ had waited diffidently for the Fed and global central bank community to have begun pivoting toward policy easing, believing such a backdrop would help mitigate “normalization” risks.
They outdid their central bank brethren in waiting way too long to get started.
March 20 – Reuters (Rae Wee and Tom Westbrook):
“Japan’s era of negative rates may be over, but some investors are convinced that low rates are not, meaning bets against the yen are back despite the Bank of Japan's first hike in 17 years.
While the BOJ move… marked a monumental shift, it stuck to its dovish tones and said it expects to maintain ‘accommodative financial conditions’.
That sent traders scurrying back into popular yen 'carry trades', driving an already battered yen yet lower.
‘Japan still remains the lowest interest rate among the G10,’ said Shafali Sachdev… at BNP Paribas Wealth Management.
‘So, with event risk out of the way this is almost seen as an opportunity to re-enter carry positions.’
In a carry trade, an investor borrows in a currency with low interest rates and invests the proceeds in a higher-yielding currency.”
Mini-baby-step rate increases every few months aren’t going to cut it.
They won’t anytime soon meaningfully narrow today’s extraordinarily wide – and alluring - interest-rate differentials.
Meanwhile, higher for longer Fed policy isn’t offering the battered yen any help either.
And I recognize why the BOJ, fearful of a destabilizing spike in JGB yields, would telegraph ongoing bond purchases.
But that only ensures liquidity excess and heightened risk of disorderly currency devaluation.
It just all adds up to a problematic backdrop for the Japanese currency.
Perhaps the Fed was hoping its dovish pivot would take pressure off the likes of the yen, renminbi, and levered EM bond markets.
But signaling rates cuts in an environment of such loose financial conditions could easily backfire.
For one, loose conditions extend late-cycle “Terminal Phase” excess.
Surging asset prices, spending, and investment - with attendant labor tightness and pricing pressures - boost odds of the Fed holding pat through 2024.
A dovish pivot with markets in the throes of a stock market and AI mania is also problematic.
At the epicenter of the AI boom, policy promoting Bubble excess benefits the U.S. currency.
Similarly, booming U.S. corporate debt markets are a magnet for speculation and global flows – again bolstering the dollar.
I’ve long assumed global government finance Bubble excess would end with turbulent currencies.
After all, irresponsible governments and central banks eventually confront global currency market retribution.
Unhinged Treasury debt growth, massive Fed monetization, and destabilizing market backstops and interventions put dollar stability at risk.
Reckless Beijing directed Credit growth, banking system ballooning, a historic apartment bubble, and epic structural maladjustment create a perilous backdrop for the renminbi.
And Japan’s negligent monetary experiment with negative rates, massive BOJ monetization, and market manipulation risk a yen collapse.
I question whether the BOJ appreciates today’s realities.
A refusal to narrow interest-rate differentials while imposing artificially low bond yields is a recipe for currency crisis.
And the same week that the yen suffers a 1.6% drop, China’s renminbi posts its largest loss (0.45%) in ten weeks.
March 22 – Bloomberg:
“China’s tentative loosening of its vise-like grip on the yuan unleashed a slide in the currency and pulled down its Asian peers along the way.
The onshore yuan dropped the most in more than two months after the authorities set a weaker-than-expected daily fixing, fueling speculation they would tolerate further losses.”
For the past two months, Beijing has tightly pegged the renminbi to the dollar.
Currency pegs are generally not indicative of underlying strength and stability, and this tight peg succumbed Friday.
Busted currency pegs are known to unleash uncertainty and instability.
With ongoing massive Credit growth and a banking system increasingly at risk from a deflating apartment Bubble, China’s currency is vulnerable.
It would not be surprising to see yen and renminbi fragility feeding off each other, with resulting dollar strength triggering contagious EM currency weakness.
March 20 – Reuters (Roushni Nair):
“The Bank of Japan is expected to hike the interest rate in either July or October, though an October hike is considered more likely, as it would give the BOJ around half a year to evaluate the impact, Nikkei newspaper reported…
Additional hikes are of course on the table,’ a BOJ source told Nikkei.
An October hike would give the BOJ more time to evaluate how ending negative rates affects prices and the economy, the newspaper reported.”
I don’t expect the currency market to grant the BOJ a six-month grace period to figure things out.
To not let this CBB get further out of hand, I’m including a few news excerpts worthy of contemplation (with the briefest of comments).
March 19 – Reuters (Yoruk Bahceli, Nell Mackenzie, Harry Robertson and Dhara Ranasinghe):
“Hedge funds are piling into the euro zone's $10 trillion government bond market, scenting opportunities as funding needs surge and the European Central Bank retreats. The funds are buying a large share of government debt sales, providing a source of much-needed capital, traders and officials say.
Yet the lightly-regulated investors often load their bets with bank debt, tying their fortunes to lenders…
Interviews with more than a dozen sources, including senior traders and treasury officials… show that hedge funds have become increasingly entrenched in the bloc's debt market.
Hedge funds accounted for a record 55% of European government bond trading volume on Tradeweb last year, up from 36% in 2020, displacing other financial firms to become the dominant players for the first time…
Three traders estimated that hedge funds have been buying between 20% to more than 50% of auctions in some instances.
Another trader, who requested anonymity, said hedge funds buy around 35% at auctions on average, up from roughly 20% five years ago.”
Historic leveraged speculation is a global phenomenon, raising the odds of an inevitable global de-risking/deleveraging episode.
March 16 – Financial Times (Kate Duguid):
“When hedge fund billionaire Ken Griffin told an industry conference this week that the US bond market was due some discipline, he was voicing the concerns of many investors about the impact of the government’s huge spending and debt issuance plans.
US government spending ‘is out of control’, he told the Futures Industry Association’s gathering...
‘And unfortunately, when the sovereign market starts to put the hammer down in terms of discipline, that can be pretty brutal.’
But while there may be good reasons for so-called bond vigilantes — hedge funds and other traders that punish free-spending nations by betting against their debt or simply refusing to buy it — to turn their attention to the Treasury market, analysts say they have so far failed to materialise.”
Drug dealer decrying the lack of enforcement of drug laws.
March 20 – Reuters (Stephen Nellis):
“Intel is planning a $100-billion spending spree across four U.S. states to build and expand factories after securing $19.5 billion in federal grants and loans - and hopes to secure another $25 billion in tax breaks.
The centerpiece of Intel's five-year spending plan is turning empty fields near Columbus, Ohio, into what CEO Pat Gelsinger described… as ‘the largest AI chip manufacturing site in the world’, starting as soon as 2027…
The funds provided by Biden’s plan for a broader chipmaking renaissance will go a long way to help Intel mend its wounded business model.”
Ultra-loose conditions coupled with historic AI/semiconductor/home shoring booms, along with major renewable energy and power grid investment and strong housing construction – and one has the ingredients for economic overheating.
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