Neutral Rates and Xi's Whatever it Takes
Doug Nolan
September 27 – Bloomberg:
“Chinese equities capped their biggest weekly rally since 2008 with a burst of trading that overwhelmed the Shanghai stock exchange, underscoring a dramatic shift in investor sentiment after Xi Jinping’s government ramped up economic stimulus.
In an echo of the rally that followed China’s massive stimulus during the global financial crisis, the CSI 300 Index of large-cap shares soared 4.5% on Friday — bringing this week’s gain to 16%.
Trading activity was so intense that it led to glitches and delays in processing orders…”
Federal Reserve Bank of Chicago President Austan Goolsbee (September 23, 2024):
“My view has been for some time, we set the rates extremely high – highest in decades.
And the way I think of what the rate is – we set a rate and then subtract off inflation.
That tells you the real fed funds rate – that’s the thing that matters.
That’s the highest in a very long time, as inflation has come down.
Before this cut, we set the rate high and held it there for more than a year as inflation came down.
So, we’re tightening in real fed funds terms every single meeting.
By not cutting and going along with inflation, we’re tightening.
When inflation is coming in at the target and unemployment is where you want it, do you want to be the tightest in decades?
If you’re restrictive for too long, you’re not going to be at that sweet spot on the dual mandate for much longer.
So that’s why I think the cut of 50 bps to start makes sense.
It’s the kind of thing where it is a demarcation that we’re shifting back to a normal dual mandate mode where we’re thinking about unemployment and inflation – and out of what we have been for a year and a half which is singularly and prioritizing the fight against inflation – which we had to.
But make no doubt about it, we’re hundreds of basis points above the neutral rate.
And if you look at the statement of economic projections – which comes out once a quarter – and everybody on the FOMC says what in their personal opinion – what do they think will be appropriate over the next year or two years and three years.
It’s not just one cut.
The important thing… if conditions continue like this, there are a lot of cuts to come over the next 12 months.
There’s virtual unanimity about that.
So, whether the next one is 25 or 50 or zero or whatever, my view is over the next 12 months we have a long way to come down to get the interest rate to something like neutral to try to hold the conditions where they are.”
Following Goolsbee’s line of reasoning, how many years did the Fed run extremely loose rates – loosest in decades?
After all, the Fed held rates at zero (to 25bps) during the period 2010 through December 2015, as y-o-y CPI averaged 1.7%.
Rates didn’t reach 2.0% for almost another three years, averaging 0.9%, while average inflation rose to 1.9%.
When inflation had jumped to 2.9% in July 2018, the fed funds rate was still 1.75% (to 2.0%).
Rates were back to zero during the pandemic and stayed at zero through 2021, despite inflation averaging 4.7% during that year.
Inflation had spiked to 8.5% by March 2022, yet the fed funds rate was still down at 0.25% (to 0.5%).
And even at the June 2022 peak inflation rate of 9.1%, the policy rate had only reached 3.0%.
It's curious that the real fed funds rate – “that’s the thing that matters” - seems to matter a lot more to the Fed these days.
During periods of relative monetary stability, there’s a case that the real funds rate has some use as a policy indicator.
But it has negative value during periods of monetary disorder, the backdrop that has dominated over recent decades.
There are myriad price levels that impact financial and economic stability, with asset prices topping the list for importance.
The Fed’s singular fixation on consumer prices is dangerously misguided.
Importantly, the real fed funds rate failed as a policy indicator during the mortgage finance bubble period, and only somewhat less so during late-nineties financial excess.
Ignore the critical role that low consumer price inflation (and a resulting “high” “real” fed funds rate) plays in Credit, asset Bubbles, and system stability at everyone’s peril.
Goolsbee: “But make no doubt about it, we’re hundreds of basis points above the neutral rate.”
Okay wise guy, Gold has jumped $89, or 3.5%, since the Fed meeting.
Silver has risen 2.8%.
The Bloomberg Commodities Index is up 3.3%.
Gold and Silver enjoy y-t-d gains of 28.9% and 32.7%.
The S&P500 sports a 2024 return of 21.6%, with the Semiconductors returning 25.8%, the Philadelphia Utilities Index 31.0%, and the Nasdaq Composite 21.4%.
S&P CoreLogic had July y-o-y home price inflation at 5.0%.
Q2 GDP was confirmed at 3.0% this week, as the Atlanta Fed GDPNow forecast has Q3 increasing to 3.1%.
Following the Fed’s big cut, Money Market Fund Assets surged $121 billion this week to a record $6.424 TN – surely corresponding to boosts in “repo” borrowings and “basis trade” levered speculation.
Central bankers shoulder tremendous responsibility.
Their role demands caution and conservatism.
As we’ve witnessed, experimentation comes with monumental risks.
One would think a series of historic blunders, including the mortgage finance Bubble boom and bust, the more recent inflationary spike, and now omnipresent speculative excess, would have ingrained humility into the contemporary central banker psyche.
Do they somehow fail to recognize the role prolonged monetary disorder has played in our fraught times – with deeply divided societies and perilous geopolitical animus?
Austan Goolsbee has no idea where the so-called “neutral rate” is.
Nobody does.
It’s a flawed concept in a world where Credit, liquidity, and perceived wealth are dominated by highly speculative financial markets.
Anyone today positing that there’s an equilibrium policy rate doesn’t appreciate the precedence held by Bubble Dynamics, and current Credit and market backdrops.
From the global government finance Bubble perspective, the past nine days have been pivotal.
First, the Fed aggressively slashes interest rates despite loose conditions, ongoing strong Credit growth, intensely speculative markets, and uninterrupted economic expansion.
And this week, the U.S.’s chief geopolitical adversary hit the panic button.
September 24 – Bloomberg:
“China’s central bank unveiled a broad package of monetary stimulus measures to revive the world’s second-largest economy, underscoring mounting alarm within Xi Jinping’s government over slowing growth and depressed investor confidence.
People’s Bank of China governor Pan Gongsheng cut a key short-term interest rate and announced plans to reduce the amount of money banks must hold in reserve to the lowest level since at least 2018…
Those moves were followed by a slew of other announcements that fueled gains in China’s beleaguered equity market.
The central bank chief also unveiled a package to shore up the nation’s troubled property sector, including lowering borrowing costs on as much as $5.3 trillion in mortgages and easing rules for second-home purchases.”
September 25 – Bloomberg:
“China’s pledge of up to $340 billion to boost its ailing equities is invoking parallels with past efforts at home and in Japan that largely faltered in lifting the economy after an initial burst of enthusiasm.
The massive support is part of a broader stimulus package unveiled by People’s Bank of China Governor Pan Gongsheng and other top officials Tuesday.
The goal is to reverse a drain on household wealth and prime an economy suffering a years-long housing crisis and mired in deflation and weak demand.
Going by the experience in Japan… that will be a tall order.
‘China’s easing steps may have some short-term impact, but they’ll only help buy time,’ said Shigeto Nagai, head of Japan research at Oxford Economics and former chief of the Bank of Japan’s international department.”
September 26 – Bloomberg:
“Promoters of the theory that China faces a ‘Japanification’ of its economy look set to enjoy a symbolic milestone in the bond market.
The yield on China’s 30-year government bonds is on track to fall below its Japanese equivalent for the first time in about two decades.”
There have been parallels between China’s Bubble and Japan’s eighties Bubble inflation.
Recognizing the damage being inflicted on their country’s social fabric, Japanese policymakers deflated the Bubble.
Chinese officials, in contrast, appear determined to thwart Bubble deflation.
Cementing global superpower status (countering the U.S. and its allies) takes precedence.
Borrowing a page from the Western policy playbook, this week was “shock and awe” and “whatever it takes.”
Xi Jinping must monitor booming U.S. and Western financial markets with a mix of envy and jealousy.
The communists were aggressively out this week with policies specifically to jumpstart Chinese stocks, including a lending facility for institutions to lever equities positions and another to finance corporate stock buybacks.
In the “best week since 2008,” the Shanghai Composite surged 12.8%, with the CSI300 up 15.7%, and the growth oriented ChiNext Index spiking 22.7%.
I wonder how closely Austan Goolsbee followed Chinese developments.
Despite myriad stimulus measures, China has been losing the battle against Bubble deflation.
Bazookas now a-blazing.
There was money aplenty for the stock market, bank recapitalization, housing, and for the poor.
Rates were lowered across the spectrum.
September 26 – AFP:
“China’s leadership, including President Xi Jinping, admitted Thursday that the country’s economy was facing new ‘problems’, according to state media.
‘Some new situations and problems have emerged in the current running of the economy,’ Xinhua reported after a meeting of the Politburo of the ruling Chinese Communist Party.”
From the FT:
“A hastily convened, joint press conference with several Chinese economic officials on Tuesday unveiled a raft of stimulus measures designed to inject confidence back into China’s deflating economy.”
There were reports of staff working through the night.
While a formidable list of stimulus measures was announced, I was most intrigued by a Reuters (Ellen Zhang and Marius Zaharia) report: “Chinese leaders pledged on Thursday to deploy ‘necessary fiscal spending’ to meet this year's economic growth target…”
China’s metric of system Credit (Aggregate Financing) expanded about $5.0 TN last year.
While government bonds have increased $750 billion, or 18%, over the past year, Beijing has hesitated to open the fiscal floodgates.
It has instead leaned heavily on its banking system to lend freely to resuscitate China’s economic boom.
But with apartment Bubble deflation accelerating, Beijing’s gambit to spur a self-reinforcing recovery was flopping.
Chinese officials were compelled to make an important change in tack this week.
We can assume Xi dictated “whatever it takes” – and I’ll presume there’s now no turning back.
Too much at stake, both domestically and with China’s grandiose global ambitions.
If this analysis is on the right track, Beijing’s fiscal stimulus – to meet this year’s growth target and targets going forward – will necessitate massive deficit spending.
Too many years of aggressive growth mandates promoted a Bubble economy without precedent, where massive unending Credit expansion is now required to hold collapse at bay.
China’s deflating Bubble has been a key dynamic supporting the forces of disinflation globally.
Beijing’s “whatever it takes” could shake things up.
Iron Ore prices surged 12% this week.
Copper jumped 5.9%, Aluminum 6.5%, Nickel 3.0%, Zinc 7.5%, and Platinum 2.5%.
Gold and Silver added another 1.4% and 1.3%.
The Bloomberg Commodities Index gained 2.1% to an 11-week high.
Commodities markets corroborate heightened inflation risk.
But this is three-dimensional chess.
Global bond markets took China news in stride, with most yields flat to lower on the week.
Treasuries just don’t seem concerned with loose conditions, economic resilience, or heightened inflation risk.
That Treasury yields didn’t respond to Beijing’s “whatever it takes” moment is additional evidence that bonds are focused on storm clouds on the horizon.
Friday trading saw the return of yen strength (up 1.8%) and tech weakness correlations.
Bonds could certainly be anticipating faltering yen “carry trade” and “A.I./tech” Bubbles – or a market accident more generally.
Or perhaps bonds are not as oblivious as stocks to the dire geopolitical backdrop.
There was more Putin nuclear saber-rattling this week, while Russia’s “no limits partner” fired an ICBM in the Pacific.
And it’s not lunatic fringe these days to worry that the WWIII fuse might be lit in the Middle East.
As I wrap up this week’s CBB, there’s no evidence Hassan Nasrallah survived Israel’s bunker busting bombing attack.
“Israel’s Attempt to Kill Nasrallah is a Huge Challenge to Iran.”
“Iran’s Supreme Leader Holds Emergency Meeting After Israel Attacks Lebanon.”
“It’s Mayhem: Can All-Out War in Lebanon be Prevented?”
More ominous talk of “red lines” crossed.
This week’s escalation could easily spiral out of control.
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