Discounting the Loss of Fed Independence
Doug Nolan
The Federal Reserve is under assault.
Our nation, as we have known, is under assault.
Equities, well, they seemingly couldn’t be chippier.
Bloomberg:
“Wall Street Gets the Rally Signals From Powell It Was Hoping For.”
The Friday rally saw the Nasdaq Bank Index jump 4.5%, the Dow Transports 3.3%, the KBW Bank Index 3.2%, the Semiconductors (SOX) 2.7%, the Bloomberg MAG7 Index 2.5%, the Broker/Dealers Index 2.0%, and the S&P500 1.5%.
The ARK Innovation ETF jumped 4.1%.
The Goldman Sachs Short Index surged 3.4%.
Friday’s “may warrant adjusting” triggered a decent squeeze and unwind of hedges, in a replay of the market’s response to Powell’s “time has come” 2024 Jackson Hole speech.
An explicit signal of looser monetary policy on August 23, 2024, saw the S&P500 gain 1.1%, MAG7 1.8%, the Semiconductors 2.8%, the KBW Bank Index 2.4%, the Broker/Dealers 1.8%, the small cap Russell 2000 3.2%, the Goldman Sachs Short Index 3.7%, and the ARK Innovation ETF 4.5%.
It's worth noting that the S&P500 has returned 17.6% since “time has come”, the Banks 37.3%, Broker/Dealers 59.0%, MAG7 35.2%, Goldman Sachs Short Index 24.4%, and the Nasdaq100 21.5%.
ARK has returned 72.9%.
Notable one-year returns include Nvidia 44%, (Micro)Strategy 168%, Palantir 141%, and Tesla 61%.
Political, economic, and geopolitical backdrops have changed so momentously in a year.
Market dynamics, not so much.
If anything, Bubble markets have turned only more speculative, ensuring a keen fixation on financial conditions.
Markets rallied a year ago on the prospect of the Fed slashing rates despite already loose financial conditions, strong Credit growth and highly speculative markets.
Markets rallied Friday on confidence in more of the same.
At this market juncture, it doesn’t take much to trigger squeezes.
The risk attentive (who hedge and short) have been burned so many times they operate in the markets with weak (singed) hands.
They are easily targeted, especially at key events (i.e., Jackson Hole, CPI, Non-Farm Payrolls) where potential bearish scenarios are avoided.
Shooting fat bear in a barrel.
“May warrant adjusting” was actually less dovish and more “Balanced Powell.”
The rates market Monday was pricing an 85% probability of a 25 bps September rate cut, and ended the week at 81%.
Powell:
“In the near term, risks to inflation are tilted to the upside, and risks to employment to the downside—a challenging situation.
When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate.
Our policy rate is now 100 bps closer to neutral than it was a year ago, and the stability of the unemployment rate and other labor market measures allows us to proceed carefully as we consider changes to our policy stance.
Nonetheless, with policy in restrictive territory, the baseline outlook and the shifting balance of risks may warrant adjusting our policy stance.
Monetary policy is not on a preset course.”
Last year’s “time has come” speech delivered a five bps 10-year Treasury yield decline, to 3.80%.
The Treasury market’s loose “money” enthusiasm was short-lived.
Yields were at 3.90% a week later; 4.29% to close October; and 4.57% to end 2024.
Ten-year Treasury yields declined seven bps Friday, to 4.26%.
It will be interesting to see how long bond market warmth for loosey-goosey lasts.
And how long will the bond market accommodate the administration’s moves to seize control of the Federal Reserve?
As the Chair spoke in Jackson Hole, President Trump threatened to fire one of Powell’s fellow Fed Governors.
August 22 – CNBC (Kevin Breuninger):
“President Donald Trump said Friday he will fire Federal Reserve Governor Lisa Cook if she does not resign from her position.
‘What she did was bad,’ the president told reporters…
‘So I’ll fire her if she doesn’t resign,’ he said…
If Trump were to successfully remove Cook ‘for cause,’ he would get the chance to reshape the central bank’s governing board, potentially for years to come.
Two of the seven current governors, Christopher Waller and Michelle Bowman, are Trump appointees.
Both dissented from the Fed’s most recent decision to hold interest rates steady.
Another seat opened up earlier this summer, when Adriana Kugler announced she would step down.
If Trump is able to remove Cook, he would appoint her successor — potentially ensuring that a majority of the board shares his view on monetary policy.
Board members serve 14-year terms.”
Washington is so rife with corruption (i.e., insider trading; gifts accepted by Supreme Court justices to lawmakers to the top of the Executive Branch; families accumulating incredible wealth because of Washington policies and connections).
Spare us the histrionics over allegations of mortgages designated for a primary residence that might not have served as the borrower’s primary residence for the required period (typically one year).
This “bad” “mortgage fraud” has resulted in the borrower paying somewhat smaller monthly mortgage payments.
It seems resources would be better spent prosecuting scores of deadbeat borrowers who fraudulently default on loans and mortgages.
August 20 – Axios (Avery Lotz):
“Federal Reserve governor Lisa Cook is the latest target of one of the Trump administration’s new pathways to pursue its perceived enemies: alleged mortgage fraud.
Trump has waged a revenge tour from his seat in the White House, with prominent members of his grudge list now facing probes from a MAGA-aligned DOJ.
If the accusation against Cook evoked a sense of déjà vu, that’s because the Trump administration is also investigating Sen. Adam Schiff (D-Calif.) and New York Attorney General Letitia James (D) on similar grounds.
Driving the news: Federal Housing Finance Agency Director Bill Pulte, a Trump ally, referred Cook to the DOJ over allegations she ‘falsified bank documents and property records to acquire more favorable loan terms, potentially committing mortgage fraud under the criminal statutes.’”
It's despicable to attack a Fed Governor as if she’s on the President’s enemy list.
As a nation, are we okay with normalizing such behavior?
Bloomberg:
“Pulte Regains MAGA Hero Status by Aiding Trump’s Anti-Fed Fight.”
August 20 – Wall Street Journal (Editorial Board):
“Federal Housing Finance Agency (FHFA) director William Pulte… accused Federal Reserve Governor Lisa Cook, a Biden appointee, of mortgage fraud.
President Trump then demanded her resignation.
Where this goes is hard to know, but it’s an ominous turn in political lawfare…
Citing Mr. Pulte’s allegations, Mr. Trump demanded on Truth Social that she ‘resign now!!!’
Mr. Pulte then tweeted that ‘the President has great cause to fire Lisa Cook’ and mused that Federal Reserve Chair Jerome Powell might ‘be complicit with Cook’s alleged fraud.’
He reiterated his insinuations that Mr. Powell is covering up Ms. Cook’s alleged fraud in a CNBC interview.
This is nasty business.
Mr. Powell doesn’t have the authority to remove Ms. Cook, and why would he know anything about her mortgages?
The context for Mr. Pulte’s accusations is relevant.
Mr. Trump is angry that the Fed hasn’t cut interest rates.
Ms. Cook voted with Mr. Powell to stand pat at last month’s meeting of the Federal Open Market Committee.”
August 20 – Bloomberg (Christopher Condon and Katy O'Donnell):
“Federal Reserve Governor Lisa Cook signaled her intention to remain at the central bank, defying calls for her resignation by President Donald Trump over allegations of mortgage fraud.
‘I have no intention of being bullied to step down from my position because of some questions raised in a tweet,’ Cook said…
‘I do intend to take any questions about my financial history seriously as a member of the Federal Reserve and so I am gathering the accurate information to answer any legitimate questions and provide the facts.’”
Dr. Cook is a distinguished economist and the first African American woman (first woman of color) to serve on the Federal Reserve Board of Governors.
To so attack her and for the President to threaten to fire her (apparently without due process) over allegations of erroneous residence mortgage declarations confirm my fears for the direction things are heading.
Put to rest any doubts that the Trump administration is obsessed with taking control of the Federal Reserve.
President Trump:
“We called him too late for a reason.
He should have cut them a year ago.
He’s too late.”
Well, the Fed cut rates 50 bps more than 11 months ago – 100 bps over the past year.
The Dollar Index dropped 1% Friday to a four-week low of 97.716, ominously reversing a recent rally attempt.
While the stock market remains enamored by loose “money” and so far unbothered by Washington’s shenanigans, international investors appear less tolerant of both.
Ten-year Treasury yields ended the week down six bps to 4.25%.
Don’t assume the “all’s clear” has sounded.
Treasury yields traded to 4.35% in Thursday afternoon trading.
After Monday’s pullback, European bond yields were back on the march by Tuesday.
German 30-year yields rose to 3.36% in Wednesday trading, a new high back to 2011.
French yields traded to 4.34% in early Friday trading, also a high since 2011.
Japan’s 30-year yield traded to a record high 3.21% in Friday trading, while 10-year JGB yields rose five bps this week to 1.63% - a new high back to 2008.
Future readers often occupy the back of my mind.
At least there won’t be a TDS diagnosis associated with my analysis.
I can relate to them (to you).
A decade from now – or decades and even a century ahead – future historians and students of history might stumble across my weekly posts.
They will undoubtedly be curious, intrigued and likely befuddled – as I have been reading contemporaneous accounts of the “Roaring Twenties.”
How could everyone have believed it all?
How could they have disregarded so much – remaining oblivious to the Bubble right to the end?
This felt like a notable week – the believing, the disregarding, the power of Bubble excess to so distort perceptions of reality.
It will appear obvious in post-Bubble hindsight.
“Is the A.I. Sell-Off the Start of Something Bigger?”
“Is the Artificial-Intelligence Winter Finally Upon Us?”
“Meta Freezes AI Hiring After Blockbuster Spending Spree.”
“AI Slurs Are Just the Start of the Backlash.”
“Private Credit-Powered AI Boom at Risk of Overheating, UBS Says.”
“Default Warnings Start to Pile Up in the Private Credit Market.”
“Leveraged Loan Default Rate Ticked Up to 5.2% in July: Fitch.”
“The Nationalization of Intel?”
“Trump’s Attacks on Fed Overshadow a Critical Moment for the Central Bank.”
“Trump’s Crackdown in DC Leaves Residents on Edge as Federal Agents Set Up Checkpoints.”
“National Guard Troops From Six Red States Head to DC to Help Tackle Crime.”
“Trump Eyes National Guard Expansion Into New York, Chicago.”
“MAGA Celebrates John Bolton’s Home Being Raided: ‘How Does It Feel?’”
“Putin’s Ukraine Summitry Was a Big Con.”
August 25 – Bloomberg (Myles Miller, Miranda Davis and Georgia Hall):
“President Donald Trump said Friday he’s preparing to expand federal deployments of the National Guard beyond Washington, DC, with Chicago and New York among the cities under review.
The president has already moved the DC’s Police Department under federal control and ordered about 2,000 troops to patrol the nation’s capital.
In the Oval Office on Friday, he said his next steps could involve other large, Democratic-led cities he has repeatedly criticized for crime and mismanagement.”
August 25 – CNBC (Dan Mangan):
“The law enforcement investigation of former Trump national security advisor John Bolton is ‘in the very early stages,’ Vice President JD Vance said on the heels of the FBI’s raid of Bolton’s Maryland home on Friday morning.
Vance, in a new interview with NBC News’ Kristen Welker, said that classified documents are ‘certainly part of’ that probe, but that ‘there’s a broad concern about Ambassador Bolton.’
Bolton is not being targeted because of his criticism of President Donald Trump, Vance told Welker…”
John Bolton has been a distinguished public servant back to the Reagan administration.
An outspoken and controversial hard-line conservative, claims he is not being targeted for his criticism of the President are dubious.
Fed independence under overt attack.
Checkpoints in our nation’s capital, with red state governors sending reinforcements.
Will red state forces be redeployed to Chicago, New York, and San Francisco?
This is going beyond simple disregard.
Markets are complicit.
The President was out Friday touting the Dow’s 1,000 advance.
Indicative of a hasty reversal of hedges, high yield CDS dropped 15 Friday to 313 bps, the largest one-day decline since May 27th (strong gain in consumer confidence data and easing US-EU trade tensions).
Meanwhile, notable curve steepening continues.
More specifically, the five and 30-year Treasury yield differential widened five Friday to 112 bps – the largest term premium since October 5, 2021.
Not surprisingly, but curiously, market inflation expectations (five-year “breakeven rate”) jumped four bps Friday to a one-month high 2.51% - and to within three bps of the high back to April 3rd (day following “liberation day”).
Gold jumped $33 Friday to $3,372, boosting one-year gains to 36%.
Silver surged 2% (up 34% y-o-y) and Platinum added 0.4% (up 43%).
Meager risk premiums indicate extreme complacency.
The weak dollar, steepening yield curve, higher market inflation expectations, vulnerable bond markets, and inflating precious metals prices suggest festering Monetary Disorder concerns.
Exuberant markets may dismiss near-term risks, but discounting the loss of Fed independence has commenced.
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