Inflation in America

A three-decade high in inflation sows concerns about America’s recovery

How a broad pickup in prices puts pressure on the Fed to raise rates

If an average American decided that last month was high time to buy a new sofa and then spent his evenings drinking beer on it, he would have been lucky. 

Both the furniture and the brew cost a little less than a few weeks earlier. 

Unfortunately, that same American may have been painfully aware that just about everything else—his rent, the petrol for his car, his food and even that new leafy plant next to the sofa—cost a fair bit more. 

The best level for inflation, economists joke, is when people do not notice it. 

In America it is becoming very noticeable. 

In October the consumer-price index rose by 6.2% compared with a year earlier, the highest rate in more than three decades (see chart 1).

As inflation has accelerated economists and officials have debated whether it is a transitory phenomenon—reflecting overstretched supply chains—or a more persistent problem. 

It is far more than an academic debate. 

If inflation is short-lived, the right move for the Federal Reserve would be to look through it, aware that jacking up interest rates may do more harm than good. 

If, however, inflation is stubbornly high, the central bank is duty-bound to tame it. 

The big jump in prices in October tilts the debate in favour of “Team Persistent”, as some have taken to calling it, and puts pressure on the Fed.

To be sure, a big chunk of America’s headline inflation is still attributable to the lumpy post-pandemic recovery (see chart 2). 

Gasoline costs, for instance, are 50% higher than a year ago, tracking the surge in oil prices. 

Used cars are 26% dearer than a year ago, with a semiconductor shortage leading to slower production of new cars and more demand for second-hand vehicles. 

And prices are rising globally, from Australia to Britain.

Nevertheless, optimism that supply kinks would be ironed out by now has vanished. 

Inflation is even hotter in America than in other countries because of the strength of the rebound there, with stimulus payments fuelling demand. 

Price pressures are getting broader. 

A gauge of core inflation, stripping out volatile food and energy prices, rose by 4.6% year-on-year in October, more than twice its trend rate of the previous quarter-century. 

Increasing rents suggest that elevated inflation will continue well into 2022. 

With wages also rising at their fastest in years, concerns are mounting about a feedback loop, in which higher salaries beget higher inflation.

In truth there ought to be little chance of a wage-price spiral in America. 

A sharp narrowing in the fiscal deficit will constrain growth in the coming quarters. 

And, crucially, investors still expect the Fed to take decisive tightening action if necessary, which is why longer-term bond yields have not moved much. 

Last week the Fed announced that it would start reducing its monthly asset purchases, the first step to unwinding its ultra-loose policies implemented at the height of the pandemic.

Several prominent banks have moved forward their forecasts for rate increases. 

Goldman Sachs, for example, had previously expected the Fed to wait until 2023; now it expects two increases next year, starting in July. 

But the uncertainty around all these expectations is much greater than in normal times. 

The Fed itself has consistently underestimated inflationary trends over the past year, so its shift to tightening may end up being uncomfortably abrupt.

Politically, this is treacherous territory for President Joe Biden. 

His week had got off to a great start with the passage of America’s biggest infrastructure-investment bill in decades, giving him something to crow about. 

On November 10th, shortly after the inflation data were published, he instead chose to adopt a defensive posture. 

“Inflation hurts Americans’ pocketbooks, and reversing this trend is a top priority for me,” he said. 

His administration is trying to clear some of the backlogs at ports, which would help retailers stock their shelves more quickly, perhaps easing some of the pressures. 

Mr Biden also noted that the price of natural gas, a big contributor to inflation in October, has dipped in recent days.

Yet inflation is, ultimately, out of Mr Biden’s hands. 

The government can only do so much to paper over global shortages. 

Knowledge that the Fed may feel compelled to raise rates before too long will offer Mr Biden little consolation. 

Historically, growth cycles tend to come to an end when the central bank tightens policy, so today’s price pressures may augur economic disappointment a little farther down the road. 

Mr Biden, a teetotaller, cannot even soothe his sorrows with a modestly cheaper bottle of lager.

Accident-Prone End-Game Dynamic

Doug Nolan

Bloomberg Television’s Jonathan Ferro (November 12, 2021): 

“You wrote a scathing piece in the Financial Times this week. I want to start with a quote from it: ‘Failure to act promptly would turn the Fed’s increasingly discredited ‘transitory’ characterization from one of the worst inflation calls in decades to also a big policy mistake with widespread and unnecessary damage.’ Mohamed, I want to start with that single piece there: ‘One of the worst inflation calls in decades.’ Why do you think it’s this bad?”

Mohamed El-Erian: 

“Because they didn’t show humility at the beginning of the process… 

There are lots of structural changes going on in the post-pandemic economy… post immediate shock. 

You can’t simply dismiss them as transitory. 

You’ve got to respect the fact that behaviors change. 

And they just didn’t have the open mindset enough to see that. 

So, they got stuck in this narrative and they held on to it for too long, and the result of which is they’re looking at inflation that is much higher than they ever expected; they’re looking at inflation that is much broader than they expected; and they’re looking at inflation that is going to last even longer than they expect even now. 

So, it’s going to go down in history as one of the worst inflation calls by the Federal Reserve.”

The Consumer Price Index (CPI) was reported up a stronger-than-expected 0.9% for the month of October, pushing the year-over-year increase to a distressing 6.2% - the strongest gain since November 1990. Up 0.4% for the month, Core CPI rose 4.6% y-o-y (high since July 1991). 

It’s worth noting that heightened inflationary pressures in 1990 were fueled by a fleeting spike in crude prices ahead of the first Persian Gulf War. 

Crude prices spiked from $16.50 in early-July to above $40 by November, only to trade back below $20 by February 1991. 

CPI jumped from July’s 4.8% y-o-y to 6.3% in November. 

Saddam’s military promptly crumbled, with the crude oil and inflationary spikes proving transitory. 

CPI was below 3.0% y-o-y within a year.

The New York Fed’s November survey of one-year Household Inflation Expectations jumped 0.4% for the month to 5.7%. 

Ignoring the summer of 2008’s ($140 crude-induced) spike to 5.1%, this month’s 4.9% reading of University of Michigan Consumer One-Year Inflation Expectations was the highest since 1981. 

Weighed down by inflation concerns, Consumer Expectations sank five points (21 points in 5 months!) to 62.8, the low since 2011. 

Producer Prices (PPI) gained 0.6% during October, with PPI up 8.6% y-o-y.

November 12 – Associated Press (Christopher Rugaber): 

“Americans quit their jobs at a record pace for the second straight month in September, while businesses and other employers posted a near-record number of available jobs. 

The Labor Department said… 4.4 million people quit their jobs that month, or about 3% of the nation’s workforce. 

That’s up from 4.3 million in August. 

There were 10.4 million job openings, down from 10.6 million in August… 

The figures point to a historic level of turmoil in the job market as newly-empowered workers quit jobs to take higher pay that is being dangled by increasingly-desperate employers in need of help. Incomes are rising, Americans are spending more and the economy is growing, and employers have ramped up hiring to keep the pace. 

Rising inflation, however, is offsetting much of the pay gains for workers.”

Chinese Producer Prices were reported up a stronger-than-expected 13.5% y-o-y, their hottest inflation in 26 years. 

Germany posted y-o-y consumer inflation of 4.6%, the highest in decades, with aggregate euro zone inflation at 4.1%. 

Brazil’s inflation rose stronger than expected, while Mexico reported a 6.24% y-o-y CPI increase. 

Surging inflation is a global phenomenon.

The week had the feel of an inflection point in terms of market perceptions of both inflation risk and central bank inflation neglect. 

Global bond markets had rallied last week on concerted central bank dovishness. 

There was heightened concern this week that inflationary pressures will run unchecked. 

The Treasury five-year “breakeven rate” of market inflation expectations spiked 29 bps to a Friday intraday high 3.18% (before ending the week at 3.12%). 

Friday’s rate was the highest in data from 2001. 

The Treasury 10-year “breakeven rate” jumped 17 bps to 2.72% (Friday’s 2.76% intraday high was a record in data back to 1997).

November 11 – Bloomberg (Alexandra Harris): 

“The U.S. Treasury market has become a minefield over the past month. 

As bond traders around the world try to force central banks to respond to elevated inflation rates, unusually large price swings have taken their toll. 

Signs have emerged of a vicious cycle in which reluctance to participate in the market impairs liquidity, making large price swings even more likely. 

As measured by Bloomberg’s U.S. Government Securities Liquidity Index, trading conditions in Treasuries are the worst since March 2020, when the pandemic spurred massive central-bank intervention around the world. 

The index measures deviations in yields from a fair-value model. 

As for expected volatility, the ICE BofA MOVE Index for U.S. bonds is near the highest since April 2020.”

Two-year Treasury yields began October at 0.27% and ended the month at 0.50%. 

Dovish central banks sparked a short squeeze, with two-year yields closing last Friday at 0.40%. 

Inflation angst had yields back to 0.51% to close this week, as wild volatility engulfs short-term rate markets. 

Five-year Treasury yields jumped 17 bps this week – after sinking 13 bps last week. 

In what must be quite a hedging challenge, benchmark MBS yields surged 16 bps this week, following the previous week’s 11 bps drop.

The rates market ended the week pricing in 2.5 rate hikes by the end of 2022, up from last Friday’s 1.79. 

Importantly, markets have begun to deemphasize the dovish policy stance, focusing instead on deteriorating inflation dynamics. 

This problematic loss of central bank control bodes poorly for market stability, with elevated risk of a disorderly market adjustment.

And speaking of disorderly market adjustments… The Shanghai Composite rallied 1.4%, with the growth-oriented ChiNext Index up 2.3% this week. 

Chinese developer bonds recovered, as “Chinese Property Stocks Soar Most in Six Years…”

November 11 – Bloomberg: 

“China’s efforts to limit fallout from China Evergrande Group’s crisis are gathering steam. 

A series of articles published in state media in the past few days signal support measures are on the way to help developers tap debt markets, potentially easing a liquidity crunch that began with Evergrande’s meltdown five months ago. 

Stocks and bonds of property firms jumped for a second day on reports that regulators may adjust rules so that real estate firms can sell debt in the domestic interbank market. 

Another report showed state-owned enterprises are pushing for the right to increase borrowing for mergers, which could make it easier for them to scoop up struggling developers. 

State-run banks meanwhile boosted lending to the sector last month, state media reported.”

There’s no conundrum surrounding the market’s disregard for the ongoing historic Chinese developer bond collapse. 

Beijing has been expected to intervene when the situation gets bad enough. 

They certainly wouldn’t tolerate things spiraling out of control. Well, things were looking really bad earlier in the week.

In a major ratcheting up of crisis dynamics, instability jumped from the developer “Periphery” to the “Core,” engulfing what had been perceived as the most financially sound and stable developers. 

Friday’s closing prices (and yields) are not indicative of the week’s chaotic trading.

Country Garden, China’s largest developer, saw its bond (2025) yield close Friday at 5.43%, down from the previous week’s 7.80% close. 

This yield began September at 3.25%, largely ignoring the Evergrande implosion. 

In a spectacular market dislocation, Country Garden yields spiked to 9.5% in Monday trading and to as highs as 10.74% in Tuesday mayhem.

Vanke (#4 developer) bonds (2029) traded Wednesday to 4.56%, up over 100 bps in four sessions. 

This yield was just above 3% in mid-September. 

Vanke CDS, having traded below 100 bps in September, surged 152 bps this week to a record 252 bps. 

Longfor (#6) yields surged almost 100 bps to 4.70%, with its CDS this week spiking 188 bps to a record 285 bps. 

Interestingly, the marketplace even turned on government-backed Poly Real Estate (#2). 

After trading below 2% in mid-September, (2024) yields surged 60 bps this week to 2.94%. 

Perhaps the wildest move of the week was achieved by government-backed Sino Ocean, whose yields, after closing the previous week at 7.79%, traded as high as 32% on Tuesday before ending the week at 9.62%.

Fears again this week pointed to mounting systemic risks, manifesting in higher CDS prices for China’s major banks. 

Bank of China CDS jumped as much as seven to 70 bps, matching highs from the mid-October systemic scare. 

Trading at four-week highs, Construction Bank of China CDS rose as much as 7 to 71.5 bps. Industrial and Commercial Bank of China CDS were up eight mid-week to 72 bps, and China Development Bank CDS rose four to 66.5 bps.

There was also this week a noteworthy jump in China's sovereign CDS prices. 

After closing last Friday at 49 bps, China CDS jumped to almost 57 bps during Wednesday trading. 

This was the high since the mid-October spike, where China CDS traded as high as 60 bps – and up from about 32 bps on September 16th.

November 8 – Bloomberg (Richard Frost): 

“Kaisa is showing that Evergrande was just the tip of the iceberg when it comes to the challenges facing China’s real estate industry. 

Kaisa is putting up 18 projects in Shenzhen for sale, with a total value estimated at about 82 billion yuan ($13bn), according to reports… 

That’s after the company said it was facing ‘unprecedented pressure on its liquidity’ and missed payments on high-yield consumer products it had guaranteed. 

With more than $11 billion of dollar bonds outstanding, Kaisa is the nation’s third-largest dollar debt borrower among developers.”

November 11 – Financial Times (Thomas Hale and Hudson Lockett): 

“A bout of selling this week in junk bonds issued by riskier Chinese property developers has sent their borrowing costs soaring to the highest level in a decade and imperilled companies’ ability to access an important funding source… 

‘The downward spiral for Chinese developers is the result of a massive liquidity squeeze,’ said Paul Lukaszewski, head of corporate debt for Asia-Pacific at Abrdn. 

‘Few companies can survive for long in environments where they cannot access their internal cash or external financing.’”

Beijing is no doubt becoming increasingly nervous. 

The developer bond collapse turned disorderly, eliciting supportive comments from China’s state media and PBOC officials. 

There was a spectacular short squeeze in developer shares and bonds, but it’s difficult to believe the situation won’t continue to deteriorate. 

China is very early in its real estate bust. 

I doubt Chinese citizens understand the seriousness of the situation. 

Published apartment prices have remained stable, despite the acute liquidity squeeze, which will force heavy discounting of unsold units.

China’s October Credit data were out this week. 

At $250 billion, the growth in Aggregate Financing was 6.5% below estimate and down sharply from September’s $455 billion. 

October (1st month of the quarter) is typically a seasonally weak period for lending, with the month’s growth up 14% from October 2020. 

Aggregate Finance expanded $4.72 TN over the past year, or 10.0%.

At $129 billion, New Loans were less than half September’s $260 billon, but were above estimates. 

Over the past three months, New Loans were 4% below comparable 2020. 

Corporate Bank Loans dropped to $49 billion (from Sept’s $154bn), yet were ahead of the year ago $37 billion. 

Corporate lending over the past three months was 13% ahead of 2020, with six-month growth 23% above comparable 2020. 

Corporate Bank Loans were up 11.4% y-o-y, 25.3% over two years, 39% over three and 68% over five years.

Consumer Loans dropped to $73 billion, down from September’s $123 billion - but ahead of the year ago $68 billion. 

Over the past three months, Consumer Loan growth was 19% below comparable 2020. 

Six-month growth was down 21% from comparable 2020. 

Even with the slowdown, Consumer Loans were up 13.1% y-o-y, 30% over two years, 50% over three years and 117% over five years – in mortgage lending excess that will come back to bite.

Beijing faces a precarious balancing act. 

A historic Bubble collapse has commenced, with producer price inflation running at a 26-year high. 

It’s unclear that cutting rates and bank reserve requirement, while showering the system with liquidity, would significantly alter the trajectory of China’s bursting apartment Bubble. 

Excess liquidity, however, will surely find its way into inflating producer and consumer prices.

It’s been my view that the prospect of a faltering Chinese Bubble has provided crucial underpinning to global bond markets confronting accelerating inflation.

It’s always the case that liquidity will seek out inflation. 

Inject enormous liquidity when securities prices have attained a strong inflationary bias, and you’ll fuel a mania. 

Adding liquidity when price levels throughout the economy have gained strong momentum will propel an inflationary cycle.

I believe it matters that China’s Bubble is faltering in a backdrop of powerful global inflationary dynamics. 

At least in the near-term, the likelihood of the bond-pleasing deflationary scenario appears much reduced compared to a year or even six months ago. 

Perhaps that’s part of what has lately lit a fire under the “breakeven rates.” 

Up another $46 dollars this week, gold prices have also heated up. 

It appears global central bankers have begun to lose control of bond yields. 

If yields begin reflecting inflation realities, bond markets have an arduous adjustment period ahead.

Returning to the Fed’s worst inflation call in decades. 

The developing global financial crisis has been decades in the making. 

Contemporary central bank doctrine is fundamentally flawed. 

Using the securities markets as the primary mechanism for system stimulus – for Credit growth and financial conditions more generally – ensures speculative excess, over-leveraging and Bubbles. 

Coddle speculative markets at the system’s peril.

The Fed is trapped. 

They’ve been trapped for a while, but it essentially didn’t matter (in the age of open-ended QE) so long as consumer price inflation remained well-contained. 

That era has run its course. 

Speculative market Bubbles are these days dependent on persistently low rates, liquidity abundance and extremely loose financial conditions – a backdrop that is now quite problematic in terms of stoking the perilous confluence of manic blow-off Bubble excess and surging inflation. 

It was always going to end badly. 

Markets are exhibiting an erratic, Accident-Prone End-Game Dynamic.

The pandemic stimulus has backfired in emerging markets

Aggressive monetary and fiscal intervention added nothing discernible to developing countries’ recovery

Ruchir Sharma 

People visit an amusement park in Pasay City, Metro Manila, Philippines. The country under Rodrigo Duterte was among the heaviest spending emerging markets © Lisa Marie David/Reuters

From the start of the pandemic, many emerging nations watched the US and other large developed countries “go big” on economic stimulus, and wished they could afford to follow. 

It turns out they were lucky if they couldn’t and wise if they chose not to.

Emerging markets that stimulated most aggressively got no pay-off in a faster recovery, owing in part to the downsides of overindulging. 

The big spenders tended to suffer higher inflation, higher interest rates and currency depreciation, at least partly cancelling out the sugar high of stimulus.

Scanning data on the top emerging and developed markets for a statistical link between the scale of their 2020 stimulus programmes and the strength of the ensuing recovery, I found none. 

Even after correcting for the deeper downturns, which often produce a higher bounceback in growth, aggressive monetary and fiscal stimulus added nothing discernible to the recovery.

This disconnect was sharpest in emerging markets, from China to Chile. 

Dividing the top emerging markets into the most and least aggressive spenders, the heavy spenders typically suffered weaker recoveries. 

Throughout the second quarter this year, the median recovery in the big spenders amounted to 12 per cent of gross domestic product, compared with 19 per cent in the light spenders.

Among the heaviest spending emerging markets were Hungary under Viktor Orban, Brazil under Jair Bolsonaro and the Philippines under Rodrigo Duterte — all populist governments. 

Each of these nations spent at least 16 per cent of GDP on stimulus, including both new government spending and asset purchases by the central bank.

At the top of the big spender list by far is Greece, which was demoted in 2013 from the developed to the emerging markets amid a run of financial mismanagement. 

It spent the equivalent of 67 per cent of GDP, apparently for naught. 

Like Hungary, Brazil and the Philippines, Greece got an unexceptional recovery, close to the emerging market average of about 16 per cent of GDP.

Why is stimulus showing unclear benefits, and even backfiring in emerging markets? 

The impact of stimulus in any one emerging country may now be overwhelmed by factors unique to the pandemic, including the global impact of huge stimulus in the US and other developed countries, and the continued fight against the virus. 

Research by Goldman Sachs found a tight link between growth and both lockdowns and vaccines: the stricter the lockdown and the slower the vaccine rollout, the bigger the hit to growth.

Moreover, overspending often backfires, particularly in developing nations. 

They lack the financial resources and the institutional credibility to ramp up spending without unbalancing the economy, and end up getting punished by global markets.

Over the past year, in the heavy spending emerging markets, inflation has run above 5 per cent, nearly a point faster than in light spenders; bond yields are up more than 142 basis points, versus 43 points in light spenders. 

Currency values have drifted down, while holding steady in light spenders. 

Based on IMF forecasts, the government deficit at the end of 2021 will also be slightly higher in heavy spenders, at nearly 7 per cent of GDP, versus 6 per cent in light spenders.

Comparing emerging markets on an index of these factors — inflation, currency, interest rates and deficit — highlights where the backfire effects are most pronounced. 

The heavy spenders that scored worst include Hungary, Brazil and the Philippines. 

Light spenders that scored best include Taiwan, South Korea and Mexico.

The logic of stimulus campaigns may have more to do with politics than economic conditions. 

In keeping with their government traditions, East Asian nations tended to be light spenders, Latin American nations tended to be heavy spenders. 

Emerging or developed nations that suffered the sharpest downturns did not necessarily roll out the biggest stimulus packages.

The developing world has faced these choices before. 

Many emerging markets went into the crises of the late 1990s in weak financial condition, were forced to reform rather than spend their way out of trouble, and reining in deficits and debt set them up for a boom in the next decade. 

By 2008 they were flush, and many responded to the crisis that year by spending and borrowing heavily, which contributed to one of the worst decades on record for emerging economies.

Nations that spend in haste are often forced to repent at leisure. 

Those that attempted to “go big” during the pandemic probably got less added growth than they imagined and considerably more trouble, in the form of higher deficits and debt, which will leave them with less ammunition to fight the next battle.

The writer, Morgan Stanley Investment Management’s chief global strategist, is author of ‘The Ten Rules of Successful Nations’ 

How the Fed Played Us—And Cornered Themselves as Recession Signs Mount

By Matthew Piepenburg

With the possible exceptions of Bill Martin and Paul Volker, history will one day confirm that the Fed is precisely what Thomas Jefferson warned: A parasitical banker’s-bank that will do more damage within its host nation than a foreign army standing on its shores. 

Here’s the story of how the Fed played us.

The Fed’s more recent history of just plain dishonesty, manipulation and market favoritism at the expense of economic realism and free market price discovery opened with patient-zero Greenspan and then remained embarrassingly consistent via the identical policies of Bernanke, Yellen and Powell.

For years, we have shown this with data rather than drama.

The latest and most obvious evidence of form over substance and words over truths from the Eccles Building is the Fed’s desperate inflation narrative as well as inflation conundrum, which boils down to this:

If the Fed doesn’t tackle the real rather than “transitory” inflation problem (i.e., by raising rates), the bond market tanks; however, if the Fed tries to raise rates to save bonds, it kills the stock market.

This, of course, is a conundrum, forcing the Fed, as one commentator observed, “to ride two horses with the same a$$.”

Ultimately, however, we all kind of know how that can end…

Two Sides of the Same Mouth

But as we discover below, the Fed’s solution to this conundrum is to do what the Fed does best: Spin, obfuscate and fib.

This means talking hawkish yet remaining dovish when it comes to keeping the liquidity spigot fully open to an otherwise fully-Fed-dependent equity and credit market.

Or in plain speak, this means publicly “tapering” the QE money printing with words while replacing that liquidity with hidden but otherwise consistent acts of alternative liquidity from, inter alia, the Standing Repo Facility (SRF) and FIMA swap lines.

Ackman’s Mistaken Battle Cry

Recently, hedge fund manager Bill Ackman made a presentation to the New York Fed recommending an immediate and meaningful taper along with equally meaningful rate hikes.

Needless to say, the equally recent and much-headlined (though hardly meaningful) Fed “tapering” from $120B/month to $105B/month was an open farce, just as a Fed balance sheet rocketing toward $9T hardly suggests that our securities markets can ride on their own without central bank training wheels.

After all, a bottle of whiskey a day is hardly less of an addiction than a bottle and glass a day of whiskey…

Such ongoing rather than “tapered” accommodation hardly suggests that our market is anything but a broken vehicle surviving exclusively on the artificial support of (and addiction to) a deadly monetary experiment in which trillions of currency-debasing and inflation-generating dollars are produced with a mouse-click with each passing (and compounding) month.

Clearly, Ackman, like so many Wall Street dragon-slayers, is worried about cancerous inflation, as it makes a mockery of bonds whose yields can’t outpace inflation’s cruel bite—hence his valiant call for a rate hike, the 85% chance of which has already been priced into the market.

But Mr. Ackman, like Mr. Market, is forgetting a few, well…risks and realities in his otherwise forceful presentation: Namely, the Fed can’t afford to raise interest rates above inflation rates.

Damned If They Do, Damned If They Don’t…

Yes, inflation is a major risk normally worthy of a rate reaction/hike, but unfortunately, there’s nothing normal at all about the current debt reality.

Central bankers have put us and themselves into a fatal corner regarding rate hikes that boils down to: “Damned if they do, damned if they don’t.”

Like so many spoiled hedge fund managers and retail investors who came of age in a world where money was effectively free for a select few, Ackman has gotten used to fiscal fantasy to the point where it’s part of his financial sub-conscious.

In this way, he’s forgotten one sad but simple fact: We can’t raise interest rates higher than inflation rates.


Because as a debt-soaked nation as well as debt-driven market, we are too broke to pay the rate piper unless we do so with inflated (i.e., debased currencies).

Thus, the Fed can pretend to worry about inflation while it simultaneously and deliberately seeks more of it.

As I’ve said elsewhere, negative real rates are the only option going forward.

The shameful debt pyre/pile that has grown along with Ackman’s net worth in the preceding decades makes a rate hike less of an option than it is a bullet to the heart of an artificial market.

In other words, the reality of our debt pile makes inflation (and more rather than less liquidity) far more necessary than the experts would want us to otherwise believe.

I would remind Mr. Ackman, for example, that even Uncle Sam has to pay interest on his debt—and it’s at an embarrassing as well unprecedented (not to mention unsustainable) level.

Specifically, Ackman and others need to remember that even at the 5000-year, all-time low-rate fantasy environment in which the Fed has placed us, there was and is not enough tax revenues coming in to pay even the interest expense alone on the insane debt levels currently owed.

Forcing rates higher, as Ackman recommends, would only make those interest expenses even more comically unpayable than they already are.

Thus, any public taper (i.e., removal of printed/QE liquidity) and rate hike would need to be (and will be) immediately offset with new liquidity in the form of FIMA swap lines, the SRF and new SLR exemptions allowing toxic banks to employ more rather than less deadly leverage.

In short, and notwithstanding “taper” tough-guy talk from the Eccles Building, the needed, as well as inflationary and currency-debasing liquidity, will come from somewhere.

If not, the VIX and USD will shoot to the moon and stocks will sell toward the basement.

But here’s the rub…

If the Fed won’t deal with inflation via a literal rather than figurative elimination of liquidity, stocks will continue to rise but bonds will spiral as liquidity-driven inflation eats away at their already negative yields.

See what I mean by damned if they do, damned if they don’t?

Doves and Hawks—Squawking in Tandem as the Fake-It Policies Continue

A dovish Fed is thus good for stocks but bad for bonds. A hawkish Fed is good for bonds but bad for stocks.

See the dilemma?

So, what can we expect?

Simple: More faking it and more QE-like liquidity under a different name, specifically, more repo support gone wild, more FIMA swaps and more “permitted” leverage by those very dangerous banks under the Fed’s protection.

The Fed has so thoroughly, negligently, recklessly and stupidly put us and the rest of the world into an insane quandary.

Not Your Ordinary Bond Market—In Fact No Market at All

The grotesquely supported and openly artificial US sovereign bond market (i.e., Treasury market) is not just any bond market.

It’s the largest and most important bond market in the world.

Its published rate acts as the risk-free (yet return-free…) rate for all the additional assets under the Capital Asset Pricing Model (CAPM).

In short, the US Treasury market matters, and the Fed will use the back channels above to “prop” it.

Unfortunately, however, and apparently still unknown to most, is that this bond market is no market at all.

Instead, the Fed simply creates money out of thin air and acts as permanent bidder on U.S. IOU’s that no one wants to buy but the Fed itself.

Since February of last year, greater than 55% of Uncle Sam’s IOUs (i.e., Treasury bonds) were bought by the Fed itself.

More bluntly: The US Treasury “market” is like a lemonade stand in the Alaskan tundra where the only buyers of its unwanted beverage are its owners, who use counterfeit money printed in an igloo to maintain a robust “sales report.”

As a recent Bloomberg op-ed reminded us, the U.S. Treasury market is “a political construct where the Fed dominates trades and sets rates at whatever politically-expedient levels the U.S. government or Fed require.”

Or stated even more simply: The Fed played us, and the U.S. Treasury market is an open sham.

Greasy Tricks, Greasy Sleeves

The Fed can use other liquidity tricks up its greasy, tattered and discredited sleeves to always keep U.S. Treasuries “bought” despite tanking demand for these unloved IOUs.

In addition to the repo pits, swap lines and loosening bank rules, it can even impose yield caps and inevitable yield curve controls.

But in the end, the Fed will do what it always does: Lie, rig and false virtue signal its “war” on inflation.

“It’s Good to be the King”

And by that, I am simply saying the Fed will continue to pour more liquidity (i.e., more fiat/fake money) into the UST market via SRF and other means (i.e., increased short-term bond issuance for money markets) to keep stock markets “accommodated’ while publicly appearing to be hawkish by “signaling” a QE “taper” or rate hike to “fight” inflation, the actual levels of which it will intentionally mis-report (and down play).

Translated even more simply, the Fed will publicly “fight” inflation while privately promoting it and then openly misreport it.

As Mel Brooks might say: “It’s Good to the King—or Fed.”

Thus, as the Fed nominally “tapers,” liquidity will just keep coming in the form of QE by other names.

Un-recovered Addicts

For this reason, we feel liquidity (the kind that kills currencies) will keep on coming, as the banks and markets are now fully addicted to the same.

This, of course, will be good for gold, BTC and stocks, all of which will fare much better than fixed income assets, which, let’s be honest, are just negative income assets when adjusted for persistent rather than transitory inflation.

Meanwhile, the Fed pretends to tackle inflation but deep down seeks more of it in order to get the U.S. out of debt the old-fashioned way—by inflating their way out of it.

Loading Up the Money Markets, Ignoring the Middle Class

The fact that the US Treasury Dept is slashing long-term debt issuance in favor of shorter-term debt for the first time in 5 years just as they were announcing a “taper” was no coincidence.

Instead, it is evidence enough that they are loading up the money markets as an alternative form of QE by another name.

Such pro-inflationary reality hiding behind a tough-on-inflation stance/facade, by the way, is great for markets and just criminal for the real economy and the middle class.

But nothing new there. The Fed is a banker’s-bank and a Wall Street backstop; it doesn’t give a hoot about the middle class.

What If…

If, however, and only if, the Fed actually and truly did cut liquidity (i.e., no back-end support via repo lines, swaps, and front-end curve/money market issuance to cover a “fake taper”), then just about every asset but the USD and VIX will suffer, including gold and silver.

That, however, is highly unlikely.

As we’ve written before: Addicts are predictable, and the Fed’s (as well market’s) addiction to liquidity won’t stop just because, as Ackman ironically believes, it ought to.

In short, prepare to see the liquidity run, the dollar loose even more of its inherent purchasing power and real stores of value like gold shine.

The Real Economy Isn’t Smiling, It’s Warning Us of a Recession

As for the markets, they may and will receive more “accommodation” from a Fed who cares little for the real economy, but that real economy still matters—and it’s sending dangerous warning signs.

Recently, for example, I noted that the NFIB’s rating for small business conditions in the U.S. had its 3rd lowest levels in 50 years.

Well, that same NFIB has also just reported that the cost of labor for those businesses is hitting a 48-year high.

The Fed ignores problems in the real economy, such as the labor shortage.

The foregoing data (12-handel) is not only a screaming inflation indicator, but a time-tested recession indicator.

At levels of 8 and above, this late cycle barometer has always seen recessions follow within 19 months.

Gosh, facts are stubborn things, no?

In short, and regardless of what the Fed pretends, they can’t print away, hike away or repress away an economic recession, which will likely be the bottom-up straw that ultimately breaks this artificial market’s back.

Just saying… 

The Risks and Rewards of Playing Chicken With China

China has ways to confound speculators betting on Evergrande contagion—thanks to a broader, murkier regulatory toolkit than most foreign investors know

By Nathaniel Taplin

China Evergrande has legions of unbuilt apartment units, including this one pictured outside Nanjing last week./ PHOTO: QILAI SHEN/BLOOMBERG NEWS

Evergrande, the heavily indebted Chinese property developer spooking global markets, appears to be running out of money and customers. 

Nonetheless it surprised creditors by paying off $83.5 million of interest on a dollar bond last Thursday. 

Meanwhile it needs to make another $45 million payment by this Friday, and its dollar bonds are still trading at around 20 cents on the dollar, implying a very high probability of default or deep haircuts.

What are investors to make of all of this? 

If the company is going to default eventually, why make payments now? 

Especially given that Evergrande is also on the hook to deliver so many unbuilt apartments to Chinese families who are presumably Beijing’s priority?

The answer may lie, in part, with some unique features of China’s political economy. 

First, property rights in China are often malleable in practice. 

Companies and individuals that run afoul of Beijing, and sometimes even of local governments, can come under irresistible pressure to “donate” resources or accept large losses, as a more palatable alternative to extralegal detention, exit bans, or other forms of harassment. 

Second, because regulators aren’t effectively checked by the courts or parliamentary oversight, they often intervene in markets in aggressive and unpredictable ways to deter what they see as bad actors—for instance foreign speculators betting against the yuan.

The salience of the first point was highlighted on Tuesday when Bloomberg, citing anonymous sources, reported that Chinese authorities have told Evergrande’s billionaire founder Hui Ka Yan to use his own wealth to help settle the company’s debts. 

Bloomberg estimates that Hui is worth about $7.8 billion. 

That is a drop in the bucket of Evergrande’s liabilities—which added up to over $300 billion in June. 

But it could help settle some particular debts and avoid the perception of a rapidly escalating, uncontrolled meltdown. 

Hui has also agreed to inject some of his personal money into a bond-funded residential project, according to Reuters. 

It is unclear what the ultimate source of the funds for last Thursday’s interest payment was.

From Beijing’s perspective, forcing Hui to pony up personally could be attractive for several reasons. 

First, it metes out direct punishment, which has political appeal. 

Second, helping Evergrande stand behind some high profile debts injects some doubt into the calculus of speculators—both foreign and domestic—betting on a continual drumbeat of bad news and broader financial contagion. 

Evergrande’s long-run prospects look dim, but the fate of many other developers is still much less sure, and will depend substantially on market perceptions.

Chinese regulators have a long history of employing aggressive, unconventional measures to unravel perceptions of one-way bets they don’t like. 

Several times in 2016, while China was still battling significant capital outflows related to a previous debt and property crisis the year before, Chinese state-owned banks intervened heavily in the offshore yuan market based in Hong Kong—forcing the overnight rate for borrowing yuan over 60% and crushing speculators betting against the currency. 

Throughout late 2015 a “national team” of state-backed funds stepped into China’s stock market whenever Beijing felt the market was getting unduly bearish.

Beijing clearly has little desire to truly bail out struggling property developers—unless it has no choice—so such heavy-handed interventions are unlikely. 

But a little arm-twisting here and there could help slow the cycle of speculation and contagion, and buy time for some of Beijing’s own modest property easing measures to take effect. 

China’s economic planning agency met with several unnamed companies on Tuesday about their foreign debt holdings, according to a statement on the regulator’s website.

Many Chinese developers will no doubt continue defaulting—most recently, Modern Land on Tuesday. 

But investors should probably prepare for more confounding last-minute saves as well. 

The Promise of European Power

While some in Europe beat the drum of “strategic autonomy” and set their sights on faraway regions, the specter of renewed nationalism and war still stalks the bloc’s immediate neighborhood. A serious EU security and foreign policy would address these nearby threats before venturing farther afield.

Joschka Fischer

BERLIN – In light of ongoing global political changes, there is much discussion in the European Union about the need for “strategic autonomy.” 

The thinking in EU institutions in Brussels, and among leaders in Paris and some other capitals, is that the global rebalancing of political and economic power away from the North Atlantic requires Europe to develop a more forceful security and defense policy so that it can engage in the geopolitically ascendant Indo-Pacific.

But the Indo-Pacific is far from Europe. 

Even if France still believes that it has strategic interests there by dint of its overseas territories, the same most certainly does not apply to Europe as a whole. 

Moreover, even if France aspires to be a Pacific power, it no longer has the requisite strength. Its foreign-policy ambitions must be recognized as mere echoes from a bygone era.

This is not the eighteenth or nineteenth century. 

If a twenty-first-century Pacific power really had aggressive designs on one of France’s far-flung Pacific territories, France would be unable to muster an effective defense. 

It would be in the same situation as Great Britain vis-à-vis Japan during World War II: totally dependent on the United States.

Because the EU is not, in fact, a global power, it cannot be a stabilizing force in global security. 

Though it faces no shortage of challenges and threats, these emanate primarily from its immediate neighborhood (mostly the European continent and the Mediterranean), and stem largely from its own internal contradictions. 

It remains ultimately reliant on the credibility of the US security guarantee for its own defense.

The new debate about “strategic autonomy” follows from the fact that US policies in recent years have called into question the credibility of that guarantee. 

But if Europeans want to reinforce the principle of mutual defense by increasing their own contribution to transatlantic security (as I believe they should), they ought to look first and foremost to their own neighborhood.

Util now, the EU has had only one truly effective security-policy tool at its disposal: the promise of accession to the bloc. 

But since the EU’s great eastward expansion in 2004, it has had to deal with internal crises caused by nationalist governments in Hungary and Poland, both of which have directly challenged the EU by rejecting the supremacy of EU law.

In any case, the enlargement process has effectively ceased, owing to the frictions introduced by previous expansion and older member states’ inability to implement the necessary internal reforms. 

Yet even though the EU has deprived itself of the means of achieving an independent role in security and foreign-policy matters, it has begun to bang the drum of “strategic autonomy.” 

This should be recognized as a dangerous contradiction.

It is worth remembering that at the June 2003 Thessaloniki Summit after the war in Kosovo, the EU made a binding commitment that has since underpinned the postwar settlement and maintained the prospects for regional peace. 

Here is what it said:

“The EU reiterates its unequivocal support to the European perspective of the Western Balkan countries. 

The future of the Balkans is within the European Union. 

The ongoing enlargement and the signing of the Treaty of Athens in April 2003 inspire and encourage the countries of the Western Balkans to follow the same successful path. 

Preparation for integration into European structures and ultimate membership into the European Union, through adoption of European standards, is now the big challenge ahead. 

The Croatian application for EU membership is currently under examination by the Commission. 

The speed of movement ahead lies in the hands of the countries of the region.”

Ten years later, in 2013, Croatia was admitted to the EU. 

Reneging on this promise for the region’s other countries, or postponing additional accessions to a later date ad kalendas Graecas (meaning never), would have disastrous consequences. 

While one can argue over whether Turkey really counts as part of Europe, there is no doubt whatsoever that the Western Balkans do. 

Nor is there any doubt that instability there poses a danger to the entire continent. 

The long, violent breakup of Yugoslavia in the 1990s ought to have driven that point home.

On top of this geopolitical risk are the dynamics associated with new great-power rivalries. 

Russia and China have already shown that they are all too eager to play the Balkan card against the EU. 

If faith in the EU’s earlier promise to the region were to evaporate, a revival of aggressive nationalism would likely follow, creating the conditions for a return to war.

Viewed from this perspective, the EU simply cannot afford to abandon enlargement, especially not if it is serious about achieving “strategic autonomy.” 

To be sure, recent internal challenges have shown that modifications to EU governance may be necessary. 

But breaking the promise of membership is not an option. 

It is in the Balkans, not the distant Indo-Pacific, that European security and foreign policy must prove itself. 

And it is in the entire West’s interest that Europe acquit itself well there.

Joschka Fischer, Germany’s foreign minister and vice chancellor from 1998 to 2005, was a leader of the German Green Party for almost 20 years.