Fed Goes Big
Doug Nolan
This period will be analyzed for decades, if not generations.
For posterity, it’s worth noting that the Fed chose to slash rates 50 bps this week, with the Atlanta Fed GDPNow (Q3) forecast at 2.93%, and August Core CPI up 3.2% y-o-y - after Q2 Non-Financial Debt grew at a seasonally-adjusted and annualized rate of $3.522 TN – accommodating the federal government, as it runs $2 TN annual deficits – with the U.S. posting a massive $267 billion Q2 Current Account Deficit.
The Fed aggressively loosened monetary policy with financial conditions already exceptionally loose, following a “tightening” cycle where financial conditions remained loose throughout.
Some headlines:
“Risk Appetites Rage as Powell Proves Hero in High-Priced Markets.”
“Credit Market Demand Juiced, Spreads Squeezed by Big Fed Cut.”
“Muni Borrowers Set to ‘Shatter’ Bond Sales Records by Year-End.”
“Junk Headed for Seventh Weekly Gain.”
“Fed Is Amplifying Liquidity’s Relentless Rise.”
“Leveraged Loan Sprint Takes Issuance to Highest Since 2017.”
“Companies have sold more than $1.2 trillion of high-grade corporate bonds this year, up nearly 30% from the same point in 2023.”
Marketwatch’s Greg Robb:
“I was wondering if you could go through, you said just at the beginning that coming into the blackout there was like an open thought of 25 or 50, the Fed could move either 25 or 50.
I would sort of argue that when we had those two last speeches by Governor Waller and New York Fed president, John Williams, that they were sort of saying that maybe a gradual approach was going to win the day…
Could you talk - would you have cut rates by 50 bps if the market had been pricing in like low odds of a 50 bps move like they were last Wednesday - after the CPI number came out?
It was a really small probability of a 50 bps cut, does that play in your consideration at all?”
Chair Powell:
“We’re always going to try to do what we think is the right thing for the economy at that time.
That’s what we’ll do.
And that’s what we did today.”
Powell and the FOMC missed a good opportunity to deliver a subtle message to overbearing financial markets:
“We will not always succumb to market pressure.”
Powell:
“This decision reflects our growing confidence that, with an appropriate recalibration of our policy stance, strength in the labor market can be maintained in a context of moderate growth and inflation moving sustainably down to 2%.”
Fine, it’s time to “recalibrate.”
But for a self-described “data-dependent” central bank, it’s a stretch to assert that recent data supported an aggressive cut.
Instead, committee members were likely rattled by August 5th (the week following the July 31st “hold” meeting) market instability.
Suffering self-doubt from habitual missteps, this Fed is keen to avoid blame for a market accident.
It would have been prudent to launch an easing cycle with 25 bps, though my overarching concern continues to be the Fed’s flawed analytical and policy frameworks.
Powell:
“Longer-term inflation expectations appear to remain well anchored…”
That’s arguably the case for consumer price inflation, but expectations for ongoing asset price inflation are deeply ingrained.
Faith that the Fed will backstop the markets has crystallized.
Truth be told, asset inflation and Bubbles pose greater risk to financial, economic, social, and geopolitical stability than rising consumer prices.
After all, the “GFC”/“great recession” and Great Depression were the fallout from major Bubble collapses.
China’s deepening crisis is also the consequence of Credit and asset Bubbles that inflated in an environment of well-contained consumer price inflation.
I’m troubled that the Fed continues to send the message that it will do whatever it takes to suppress market instability and prevent recession.
Efforts to thwart market, economic and Credit cycles are doomed to fail.
It may appear a successful strategy for a while, but the process ensures deep structural maladjustment.
Repeatedly postponing corrections and adjustment comes with a steep price to financial and economic stability.
I was reminded Wednesday that the Fed succumbed to Wall Street pressure and began reflating its balance sheet in September 2019, a quarter where GDP growth accelerated to 4.6%, and system “repo” assets surged $309 billion.
By year-end, Fed assets had expanded $400 billion, administering additional propellant to already overheated leveraged speculation.
An intense bout of de-risking/deleveraging required a speculator community (including the big “basis trade” players) bailout as the Fed launched its March 2020 pandemic crisis response.
Circling the wagons around its maximum employment and stable prices “dual mandate,” the Fed’s traditional overarching responsibility for safeguarding financial stability could be showcased on an episode of “Mysteries of the Abandoned.”
The S&P500 ended the week with a 20.8% y-t-d return.
The NYSE Computer Technology Index (XCI) has returned 33.7% so far in 2024, the Philadelphia Utility Index (UTY) 29.9%, the KBW Bank Index (BKX) 22.7%, and the Nasdaq Composite (CCMP) 20.2%.
It’s worth noting that high yield CDS prices closed the week (309 bps) at the lows back to January 2022, when the policy rate was near zero.
Investment-grade CDS traded down Thursday to September 2021 levels (47.5). JPMorgan CDS traded at October 2021 levels.
Junk bond yields are down 95 bps q-t-d to 6.96%, the low back to April 2022.
Investment-grade yields have dropped 81 bps to a two-year low of 4.67%.
The Fed had no way to know that its 2019 QE restart would exacerbate fragilities going right into a global pandemic.
But our central bank should be sensitive to stoking leverage and speculative excess in the current environment of highly elevated risk, including political and geopolitical.
September 19 – Bloomberg (Christopher Condon):
“Federal Reserve Governor Michelle Bowman said cutting interest rates by a half percentage point this week risked signaling the US central bank was declaring victory over inflation too early.
‘The committee’s larger policy action could be interpreted as a premature declaration of victory on our price stability mandate,’ Bowman said… ‘I believe that moving at a measured pace toward a more neutral policy stance will ensure further progress in bringing inflation down to our 2% target.’
Bowman became the first Fed governor to dissent against an interest-rate move since 2005, when she voted against her colleagues’ decision to lower rates by 50 bps…”
Brief comments on all the inflation happy talk: Inflation’s significant retreat from peak 2022 levels has been a global phenomenon.
Supply chain normalization has certainly helped.
Faltering Chinese domestic demand and booming exports are playing a significant role in weakened goods prices.
But focusing more on domestic factors, services inflation remains sticky.
August Services PMI Prices Paid rose to (a 29-month high) 55.7 and ISM Services increased to 57.3.
Shelter price pressures have also been persistent, with the recent drop in mortgage borrowing costs likely to support home prices.
An aggressive Fed elicited an interesting global bond reaction.
Ten-year Treasury yields rose nine bps to 3.74%.
Perhaps it was coincidental, but deficit-challenged UK and France bonds led to the downside.
Gilt yields surged 14 bps to 3.90% (BOE holds rates steady), with French yield up 13 bps to 2.97%.
Few discuss the most salient inflation dynamic: today’s elevated risk to price shocks.
There is a remarkable confluence of potential inflationary shocks, including tariffs, trade wars, actual military wars, and climate change, to name the most obvious.
Labor markets remain tight, with ongoing upward wages pressures underestimated.
There is also newfound dollar weakness that could underpin higher import prices, along with the potential for inflationary shock treatment for China’s deflating Bubble.
Speculative markets are notoriously short-term fixated.
So there’s little surprise that mounting geopolitical risks are now disregarded.
And with our economy no longer critically dependent on Gulf oil, Middle East developments these days garner scant market concern.
The media is so focused on domestic politics that this week’s troubling events barely made the news.
September 20 – New York Times (Liam Stack, Euan Ward, Aaron Boxerman and Michael Levenson):
“Israeli fighter jets bombed an apartment building in Beirut’s densely populated southern suburbs on Friday in what the military called an attack on Hezbollah militants, including a senior commander who was wanted in the deadly 1983 bombings of the U.S. embassy and U.S. Marine Corps barracks in Beirut.
The Israeli military’s chief spokesman, Rear Adm. Daniel Hagari, said the senior commander, Ibrahim Aqeel, had been killed, along with ‘around’ 10 others from Hezbollah’s elite Radwan unit, who were meeting underneath the residential building…
The strike marked an escalation in Israel’s bloody conflict with the militia and fueled fears among Lebanese, Israelis and diplomats that Israel is driving closer to a full-blown war with Hezbollah, even as it continues to fight Hamas in Gaza.”
September 20 – New York Times (Patrick Kingsley):
“Exploding pagers on Tuesday.
Detonating walkie-talkies on Wednesday.
An unusually intense barrage of bombs on Thursday.
And a huge strike on southern Beirut on Friday.
Israeli attacks on Hezbollah… this week constitute a significant escalation in the 11-month war between the two sides.
For nearly a year, Israel and Hezbollah have fought a low-level conflict, mostly along the Israeli-Lebanese border, that has gradually gathered force without ever exploding into an all-out war.
Now, Israel is attempting a riskier playbook.
It has markedly increased the intensity of its attacks in an attempt to force Hezbollah to back down, while raising the chances of the opposite outcome: a more aggressive response from Hezbollah that devolves into an unbridled land war.”
The U.S. is at the cusp of being pulled into a regional conflict that could easily spiral out of control.
Loose conditions have created heightened shock vulnerabilities.
Gold jumped $44 this week to an all-time high $2,622, while Silver rose 1.5% to $31.18.
What important messages are the appropriately named precious metals sending, with Gold up 27% y-t-d and Silver rising 31%?
Seems reasonable to assume they’re warning of looming inflationary surprises.
The metals market recognizes that the Fed and global central bankers are trapped by Bubble fragilities, performing as they should when the Fed aggressively eases monetary policy, despite financial conditions being loose, Credit growth strong, and markets precariously speculative.
Likely more than inflation, Gold and Silver are discounting the increasing likelihood of acute market instability – perhaps an unfolding crisis of confidence in financial assets.
I don’t think we’ve seen the end of “AI/tech” Bubble vulnerability, or de-risking/deleveraging generally.
As the Fed stoked market excess, the BIS – the central bank to central banks - weighed in this week in their September Quarterly Review, “Carry On, Carry Off.”
September 19 – Bloomberg (Alice Atkins):
“The Bank for International Settlements is warning the financial system is prone to repeat episodes of volatility like the one that rippled across markets this summer when a popular hedge fund strategy collapsed.
As central banks across the world withdraw liquidity, investors will be forced to reduce leverage and review risk strategies, the BIS said in a report...
The unwinding of so-called carry trades is the most recent example of the potential consequences of that transition.
‘We should be under no illusion.
This is not the first and will not be the last turbulence in markets,’ said Claudio Borio, head of the monetary and economics department at the BIS...
‘It is part of the bigger picture, the inevitable withdrawal symptoms that markets suffer as they transition away from the extraordinary period of exceptionally low interest rates and ample liquidity.’”
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