Less Negative is Positive

"A negative times a negative equals a positive."
--Jaime Escalante (Stand and Deliver)

Negative interest rate policies (NIRP) enacted by central banks across the globe in the middle of last decade spawned a mountain of negative interest-bearing debt. It was hard to imagine who was buying it although, in reality, central banks themselves were hoovering much of it up as part of their quantitative easing (QE) programs.

The worm has turned dramatically as inflation has picked up and CBs are now raising rates. After hitting a peak of about $17 trillion in 2020, negative yielding debt has plummeted to less than $2 trillion. Most of that decline has come since the beginning of 2022.

As NIRP debt declines, it seems likely that broken conventional discounting processes get repaired.

Central banks become extra big losers as NIRP reverses. They bought $trillions of negative yielding bonds that have now been pounded as rates rise and bond prices fall. Many CBs are approaching the broke point on paper.

While these institutions can simply print more money out of thin air to rectify their upside down balance sheets, this would create quite the paradox of creating more money in an inflationary environment.

TINA Turning?

All I want is a little reaction
Just enough to tip the scales
--Tina Turner

During the era of interest rate suppression, people turned to stocks, particularly dividend payers, because it seemed there was no alterative (TINA). With yields presently moving higher, the TINA attitude should dissipate as investors switch out of stock in favor of the relative safety of high yielding bonds.

Today the 2 yr Treasury yields touched 4%. This more than 2x the S&P 500 dividend yield.

The higher this spread goes, the more pressure we should see on stocks as investors flock to 'risk-free' cash yields.

CAPE Fear

I'm a walkin' in the rain
Tears are fallin' and I feel the pain
Wishin' you were here by me
To end this misery
--Del Shannon

Although stocks have come in, Robert Shiller's CAPE index suggests much more downside work must be done before 'normal' valuations return.

Could be, although I wonder how massive market stimulus and, now, structural goods/services inflation factor in.

See the Signs

Life is demanding
Without understanding
--Ace of Base

Article lays out five signs of recession currently flashing red:

1) Declining monetary base. As quantitative tightening proceeds, money supply should drop even more.

2) Inverted yield curve. Inverted yield curves are leading indicators of economic problems, and have preceded every recession for decades.

3) Tighter lending standards. Economic slowdowns increase risk aversion. Banks tighten credit standards to avoid losses during recessions. We're approaching tightness associated with past recessions.

4) Falling housing market prices. Mortgage rates have more than doubled over the past year. As prices and borrowing costs go up, demand for houses has gone down. Inventory is now above 10 months of supply--a threshold that has consistently been associated with past recessions.

5) Declining manufacturing and trade sales. Sales are down over one percent YOY. Declines below zero have coincided with every recession since the 1970s.

These indicators suggest that a recession is not imminent. Rather, it is likely already here.

Euro Energy Bailout

Here I am in silence
It's a game I have to play
You and I in silence
With nothing else to say
--Information Society

On the back of yesterday's post, headlines this morning find euro bureaucrats committing to massive bailouts of consumers and producers as they face virtual margin calls as energy prices spiral higher.

These bailouts are forms of stimulus--subsidies that work against efforts to reign in higher prices.

Still wrapping my head around how this spills over to the US. The obvious consequence is an even strong USD vs the euro.

Leveraged Loans

"The mother of all evils is speculation--leveraged debt."
--Gordon Gekko (Wall Street 2: Money Never Sleeps)

Leveraged loans are loans extended to entities that already have high levels of debt and/or poor credit history. Loans are usually arranged by at least one investment or commercial bank, and are often syndicated to other banks or institutions.

This article estimates the current value of leveraged loans outstanding at $1.4 trillion--nearly double the 2015 market size. I have read elsewhere that leveraged loans have become popular among college endowments and other institutional investors as high yielding alternative investments.

With that high yield, of course, comes higher risk. Leveraged loan borrowers are more prone to default. Indeed, the article also suggests that leveraged loans may be a useful 'canary in the coal mine' this time around as credit market stress builds.

We know that tight monetary policy moves are often lagged in their effects. The leveraged loan market may be a good place to look for manifestations of the Fed's previous actions.

Utilities Yielding to Miners

"You know, the worst ain't so bad when it finally happens. Not half as bad as you figure it'll be before it's happened."
--Curtin (The Treasure of the Sierra Madre)

Those seeking dividend income often flock to utilities given the sector's consistently high payouts. However, the income-producing status of utes is currently being challenged by...mining stocks. The dividend yield differential has narrowed to decades+ lows.

Two things are going on. One is that utility stocks have been bid up recently, causing their yields to fall. The other is that mining stocks, despite their strong balance sheets and cash flows, have been crushed recently, causing their yields to rise.

While they have surely been disappointed that the sector has not yet responded to the present environment as expected, gold bulls are at least being paid well to wait.

position in gold

Jackson's Hole

"You're the disease, and I'm the cure."
--Marion Cobretti (Cobra)

The much-awaited Jackson Hole speech from Fed chair Powell is now in the books. Personally, I always chuckle when Fed heads wax about economic problems that always seem to be exogenous, and the Fed's heroic role in taming them.

The topic this time around is, of course, inflation. Powell suggests that the Fed must draw upon 3 lessons learned. One is that the Fed must take on responsibility for delivering low and stable inflation. The obvious question is why should the Fed be responsible for delivering any rate of inflation at all? Moreover, if the Fed is responsible for delivering low inflation, then how did we get to this state of high inflation in the first place?

The second lesson learned related to 'inflation expectations.' Powell asserts that "if the public expects that inflation will remain low and stable over time, then, absent major shocks, it likely will. I found that statement particularly rich. It suggests that a major goal of 'fighting inflation' is persuasion--persuading the public that inflation is low. 

Never mind the decades of easy money compliments of the Fed.

The third lesson is that the Fed must keep at it until the job is done. That is, keep monetary policy restrictive until "inflation is down to the low and stable levels that were the norm until the spring of last year. But monetary policy was extraordinarily 'unrestrictive' for more than a decade before the spring of last year. 

If that prolonged period of easy money didn't unduly elevate the public's inflation expectations, then how will the Fed 'keeping at it' with restrictive monetary policy do the opposite?

Powell once again markets the Fed as the cure rather than the disease it is.

When the Going Gets Tough

I got something to tell you
I got something to say
--Billy Ocean

The two key charts, updated again. Fed funds rate, recessions/crises, and SPX.

QE, SPX, and related events.

When the going gets tough, what does the Fed do?

Inflation Reduction Act

I bought a novel, some perfume
A fortune all for you
But it's not my conscience
That hates to be untrue
I asked of my reflection,
"Tell me what is there to do?"
--Squeeze

As we've discussed, leftists are rarely honest with their rhetoric. They label things largely contrary of their actual effects.

Cast in point: the proposed Inflation Reduction Act. 

As Ron Paul discusses, the bill does the opposite. It increases government spending by hundreds of billions of dollars. It takes resources out of the hands of private citizens and puts them into the hands of bureaucrats.

Not only does this increase the risk of capital misallocation, but it must be funded. To the extent that citizens are taxed, it reduces economic resources available to people during an era of high price inflation and slowing economic activity.

It is a universal truth that slow economic activity motivates easier central bank monetary policy (read: inflation).

To the extent that taxes won't cover the spending, then those funds must either be a) borrowed, which taxes future incomes, or b) printed (the reason why inflation is called the 'invisible tax').

There is little doubt that the Inflation Reduction Act will ultimately result in more inflation, not less.

Redline Fed Lines

You'll never say hello to you
Until you get it on the redline overload
You'll never know what you can do
Until you get it up as high as you can go
--Kenny Loggins

Yesterday the FOMC raised the Fed funds rate 75 bips as telegraphed. The overnight rate target now stands at 2.25-2.50%.

As is common anymore, the FOMC statement was 'redlined' for wording changes from the previous statement.

The only substantial change was the first sentence, which went from discussing economic strength to signs of economic weakness.

Couple that with the subsequent statement that the Fed is prepared to adjust its policy stance if risks emerge that threaten the attainment of the committee's goals, and you get early signs of a dovish pivot.

Reaching? Perhaps, but markets are partying on the prospects thus far.

Undercover Hero?

My beacon's been moved
Under moon and star
Where am I to go
Now that I've gone too far?
--Golden Earring

I enjoy reading Tom Luongo's work. Thought provoking--even when his general premise is wrongheaded. 

In this recent piece, for example, Luongo gives the Fed entirely too much credit, arguing that the central bank is essentially the 'good guy'--battling inflation wrought by irresponsible fiscal policies that sent money to people in boxes during CV19. 

He fails to mention the Fed's long history of bailing out markets (and policymakers) when markets break, or of the central bank's $9 trillion of balance sheet assets purchased with money created at the click of a mouse. Because, as Friedman observed, inflation is always a creature of monetary policy, arguing that the Fed is somehow not the Dr Frankenstein that created our present monster seems a bit naive.

However, Luongo does make an interesting point toward the end of his article. He notes (correctly) that the Davos/World Economic Forum crowd would like to put an end to commercial banking, and put all monetary power in the hands of central banks--perhaps even in a one world central bank with digital currency-producing capacity.

He then suggests that, in the United States (and perhaps elsewhere), the Fed represents the interests of those commercial banks. As such, the Fed is motivated to break the EU-centric Davos/WEF threat to US commercial banks by raising rates, pounding the euro, and perhaps even driving the EU toward dissolution.

There's lots of holes in that argument--including the Fed's 'institutional obligations' both domestic and abroad--but interesting to ponder the 'undercover hero' thesis nonetheless.

Cruel Summer

Strange voice are saying
What did they say?
Thinks I can't understand
It's too close for comfort
This heat has got right out of hand
--Bananarama

Regional Fed data increasingly suggest that economic activity is quickly contracting. While this may be alleviating near term price pressure per policymaker goals, it also portends nasty political consequences.

As one respondent from the Texas survey commented, "November can't get here fast enough."

Don't Bet On It

They show you photographs of how your life should be
But they're just someone else's fantasy
--Styx

Policymakers seem to be betting that people would rather see inflation than recession. Current policies seek to curtail demand, lower wages, and raise unemployment--with the hope that these things will result in falling prices. 

And people are supposed to be happy with that outcome?

Don't bet on it.

I also wouldn't bet on the either/or proposition. What if it turns out that we get inflation and recession?

Zero Coherence

Maybe someday
Saved by zero
I'll be more together
--The Fixx

Earlier today the European Central Bank (ECB) raised its deposit rate 50 basis point to...zero. The ECB's deposit rate had been in negative territory since 2014, meaning that depositors essentially paid to keep their money in the central bank's vault.

This is also the first interest rate increase by the ECB since 2011.

Needless to say, monetary policy in Europe has been off the rails for quite some time.

To demonstrate that it hasn't suddenly been transformed into an institution with coherence, the ECB unleashed a blizzard of acronym-heavy programs, such as Transmissions Protection Mechanisms (TPI), designed to selectively buy bonds of struggling EU countries (e.g., Italy) to keep sovereign debt from imploding.

Thus, we have a central bank raising interest rates while continuing easy money policy using a quantitative easing (QE) transmission mechanism.

The ECB truly makes the Fed look smart.

On the QT

It happened one summer
It happened one time
It happened forever
For a short time
--Motels

Bank of America (BAC) analyst and former Fed staffer who has a good track record of predicting Fed policy shifts forecasts that the central bank's current quantitative tightening (QT) will be ended much sooner than expected. He thinks QT will cease in early 2023 with about $1 trillion in asset rolled off the Fed's balance sheet.

While consistent with what these pages have been suggesting, I'll pick the under on both. Sooner than early 2023 and less than $ trillion unwound.

position in BAC

9%+

Hundred dollar car note
Two hundred rent
I get a check on Friday
But it's already spent
--Huey Lewis & the News

Another 40 yr high CPI print. Measured consumer goods and services inflation came in at a higher than expected 9.1%.

Interestingly, commodities and their associated stocks are green on the news. Also, interest rate futures are now pricing in 'policy reversal' rate cuts by early 2023.

How long before those rate cut bets start tricking into late 2022?

Commitment to Stupidity

"He chose...poorly."
--Grail Knight (Indiana Jones and the Last Crusade)

The larger question for big government types is this: Have not the past couple of years demonstrated the sheer ineptitude of central planning?

Public health. War and sanctions. Economic and monetary policy. Et al.

Hayek called it the fatal conceit--the belief that bureaucrats in a room can choose better than billions of individuals.

Ongoing belief in central planning constitutes a genuine commitment to stupidity.

That Ain't Workin'

We got to install microwave ovens
Custom kitchen deliveries
We got to move these refrigerators
We got to move these color TVs
--Dire Straits

One factor that influences price pressures is the number of people in the workforce. Less workers mean less supply. Less supply at constant demand means higher prices.

The labor force participation rate has been in secular decline. The 'Great Resignation' resulting from CV19 policies added fuel to the fire as able-bodied people hit the silk.

How are markets likely to compensate for the labor shortfall? Offer higher wage rates--which also, by itself, is inflationary.

As one policy distortion begets others...

Oil's Embeddedness

Then one day, he was shootin' at some food
And up through the ground came a bubblin' crude
Oil, that is
Black gold...Texas tea
--Flatt & Scruggs

Couple of interesting oil charts. First, crude vs events:

Second, that same series alongside the CPI:

Many people don't seem to realize just how embedded oil is in our everyday lives.