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“Don’t Fight The Fed”

"Don’t Fight The Fed"

Authored by Lance Roberts via RealInvestmentAdvice.com,

“Don’t Fight The Fed.” But, unfortunately, that mantra…

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This article was originally published by Zero Hedge

“Don’t Fight The Fed”

Authored by Lance Roberts via RealInvestmentAdvice.com,

“Don’t Fight The Fed.” But, unfortunately, that mantra has remained a “call to arms” of the financial markets and media “bullish tribes” over the last decade.

Armed with zero interest rate policy and the most aggressive monetary campaign in history, investors elevated the financial markets to heights only rarely seen in human history. Yet, despite record valuations, pandemics, warnings, and inflationary pressures, the “animal spirit” fostered by an undeniable “faith in the Federal Reserve” remain alive and well.

Of course, the rise in “animal spirits” is simply the reflection of the rising delusion of investors who frantically cling to data points that somehow support the notion “this time is different.” As David Einhorn once stated:

“The bulls explain that traditional valuation metrics no longer apply to certain stocks. The longs are confident that everyone else who holds these stocks understands the dynamic and won’t sell either. With holders reluctant to sell, the stocks can only go up – seemingly to infinity and beyond. We have seen this before.

There was no catalyst that we know of that burst the dot-com bubble in March 2000, and we don’t have a particular catalyst in mind here. That said, the top will be the top, and it’s hard to predict when it will happen.”

Is this time different? Most likely not. Such was a point James Montier noted recently,

Current arguments as to why this time is different are cloaked in the economics of secular stagnation and standard finance workhorses like the equity risk premium model. Whilst these may lend a veneer of respectability to those dangerous words, taking arguments at face value without considering the evidence seems to me, at least, to be a common link with previous bubbles.

Mental Gymnastics

While the “bulls” are adamant, you shouldn’t “fight the Fed” when monetary policy is loose, they say the same when it reverses. Such got evidenced by Fisher Investmentsarguing rate hikes are NOT bad for stocks.

“Many pundits blaming 2018’s stock market decline on that year’s Fed hikes. While we can’t predict Fed policy from here, we can correct the record on 2018, which we think had very little to do with the Fed.

Fisher does “mental gymnastics” to suggest the sell-off in 2018 was due to forces other than the Fed. However, what reversed the “bullish psychology” was evident.

“The really extremely accommodative low-interest rates that we needed when the economy was quite weak, we don’t need those anymore. They’re not appropriate anymore. Interest rates are still accommodative, but we’re gradually moving to a place where they will be neutral. We may go past neutral, but we’re a long way from neutral at this point, probably.” – Jerome Powell, Oct 3rd, 2018

That sharp sell-off in the chart above started following that statement from Jerome Powell. Why? Because even though the Fed had already started hiking rates previously, the comment suggested much tighter policy to come.

What reversed that “bear market psychology” just two months later? The Fed’s reversal on their “neutral stance.”

“Where we are right now is the lower end of neutral. There are implications for that. Monetary policymaking is a forward-looking exercise, and I’m just going to stick with that. There’s real uncertainty about the pace and the destination of further rate increases, and we’re going to be letting incoming data inform our thinking about the appropriate path.” – Jerome Powell, Dec 18th, 2019

By the summer of 2019, the Fed’s interest rates returned to ZERO.

Why did the market rally?

“Don’t fight the Fed.”

Never Fight The Fed

“Rate hikes aren’t inherently bearish, in our view. Like every monetary policy decision, whether they are a net benefit or detriment depends on market and economic conditions at the time, including how they affect the risk of a deep, prolonged, global yield curve inversion. 2018’s rate hikes flattened the yield curve, but they didn’t invert it.” – Fisher Investments

They are. It is just a function of timing between the first rate hike and when something eventually breaks the “bullish psychology.” Aswe discussed previously:

“In the short term, the economy and the markets (due to the current momentum) can  DEFY the laws of financial gravity as interest rates rise. However, as interest rates increase, they act as a “brake” on economic activity. Such is because higher rates NEGATIVELY impact a highly levered economy:”

Fisher is correct that rates may not impact the financial markets in the short term. However, most of the gains got forfeited in every instance as interest rates slowed economic growth, reduced earnings, or created some crisis.

Most importantly, a much higher degree of reversion occurs when the Fed tightens monetary policy during elevated valuations. For example, beginning in 1960, with valuations over 20x earnings, the Fed started a long-term rate-hiking campaign that resulted in three bear markets, two recessions, and a debt crisis. The following three times when the Fed hiked rates with valuations above 20x, outcomes ranged from bear markets to some credit crisis needing bailouts.

Yes, rate hikes matter, they matter more when there are elevated valuations.

I Fought The Fed, And The Fed Won

The primary bullish argument for owning stocks over the last decade is that low-interest rates support high valuations.

The assumption is the present value of future cash flows from equities rises, and subsequently, so should their valuation. Assuming all else is equal, a falling discount rate does suggest a higher valuation. However, as Cliff Asness noted previously, that argument has little validity.

“Instead of regarding stocks as a fixed-rate bond with known nominal coupons, one must think of stocks as a floating-rate bond whose coupons will float with nominal earnings growth. In this analogy, the stock market’s P/E is like the price of a floating-rate bond. In most cases, despite moves in interest rates, the price of a floating-rate bond changes little, and likewise the rational P/E for the stock market moves little.” – Cliff Asness

The problem for the bulls is simple:

“You can’t have it both ways.”

Either low-interest rates are bullish, or high rates are bullish. Unfortunately, they can’t be both.

As noted, rising interest rates correlate to rising equity prices due to market participants’ “risk-on” psychology. However, that correlation cuts both ways. When rising rates reduce earnings, economic growth, and investor sentiment, the “risk-off” trade (bonds) is where money flows.

With exceptionally high market valuations, the market can remain correlated to rising rates for a while longer. However, at some point, rates will matter.

This time will not be different. Only the catalyst, magnitude, and duration will be.

Investors would do well to remember the words of the then-chairman of the Securities and Exchange Commission Arthur Levitt in a 1998 speech entitled “The Numbers Game:”

“While the temptations are great, and the pressures strong, illusions in numbers are only that—ephemeral, and ultimately self-destructive.”

You can fight the Fed, but eventually, the Fed will win.

Tyler Durden
Fri, 01/14/2022 – 08:46











Author: Tyler Durden

Economics

Whither r*?

(Note: This article was delayed because of technical difficulties. I finally found a work around.)Although hand-wringing about Quantitative Easing and the “transitory-ness” of inflation is catching most people’s attentions, there is an interesting theo…

(Note: This article was delayed because of technical difficulties. I finally found a work around.)

Although hand-wringing about Quantitative Easing and the “transitory-ness” of inflation is catching most people’s attentions, there is an interesting theoretical concern that is about to get quite pressing. That is: what is up with r* (which is the modernised version of the “natural rate of interest,” although the word “natural” was finally dropped from the jargon). Although post-Keynesians generally argue that r* does not exist — so this is a non-issue — neoclassicals cannot easily embrace that position.

From what I have seen, various estimation techniques for the not-directly-measurable variables loved by neoclassical theory blew sky high during the pandemic, and I have not paid any attention to whether the techniques have since been patched. My assumption is that this is a major topic of interest for researchers, but I doubt that there will be a consensus fix this quickly.

I wrote about the problems with the Holsten-Laubach-Williams (HLW) estimation technique in this earlier article. The New York Fed website — which previously published the estimate — suspended updates when the pandemic data hit. The chart below what happened to the r* estimate based on the initial data in 2020. I have not updated the chart to include more recent data. As noted in my earlier text, one of the problems with the pandemic data is that it was so extreme that the previous estimates of r* were also mangled, since the fit was much worse than was the case for data ending in 2019.

Even if we do not know what neoclassicals think r* is supposed to be, we can what the real policy rate. Or at least we sort-of can, given that it is unclear what rate of inflation we are supposed to use to get the real rate.

The figure at the top of this article shows what I label as the “historic” real rate: the spot Fed Funds (I use the midpoint of the band) less core CPI. It started off with the same sort of mildly negative values we saw in the past cycle, then went deeply negative in 2021. Since it is hard to see the dates associated with the last plunge, the real policy rate started 2021 at around -1%, then first went below -4% in June (ending at -5.4% in December).

The problem with using the “historic” real rate (although it is common in analysis) is that we are comparing a forward-looking interest rate versus the past year’s percentage change in the CPI. In neoclassical models, the variables of interest are the policy rate, and the next period expected inflation rate.

Expectations Matter. Maybe.

The problem with “expectations” is deciding whose expectations matter. In neoclassical models, we just have a small number of representative households (often one) who are the only entities that matter, so you just need to survey them, since the uncountable infinity of other agents will just agree with whatever representative agent represents them. The problem in the real world is that we never seem to be able to pin down who exactly is the representative agent, and so we have an inconsistent mish-mash of inflation survey results.

The figure above shows the Fed Funds rate deflated by the inflation expectations component of the University of Michigan Survey. On that measure, the real rate started 2021 at -2.9% in January, and dropped below -4% in May, ending the year around -4.8%.

What is the problem that I see? If we look back at the (admittedly mangled by the outlier) HLW r* estimate, it was getting close to 0% at the end of 2019. The real rate based on the Michigan Survey started 2021 about 300 basis points below that, and ended up about 500 basis points lower at year end.

(The HLW algorithm uses a smoothed version of inflation — adaptive expectations! — so the inflation rates would presumably be lower in 2021, at the cost of being higher if and when inflation rates moderate.)

Lots of Stimulus

If we are to believe neoclassical theory, deviations of the real policy rate from r* ought to have a somewhat symmetrical effect on the economy. Unless r* magically moved a lot lower in 2021, there should have been a stimulative effect equivalent to hiking rates hundreds of points above r*.

And that is not all. We had a large fiscal stimulus — which is of course ignored in the HLW algorithm, because everyone knows fiscal policy does not matter — and there is whatever stimulative effect provided by the Fed’s balance sheet expansion.

If one believes neoclassical macro theory, then one should expect inflation to rip even higher in 2022. (Which does put the Fed’s stance into a curious light.) I cannot guarantee that will not happen, so we will need to wait and see. But if it does not, it does raise the question: does r* even exist?

Why Non-Existence Matters

The whole theoretical core of DSGE models are based on the assumption that households trade off future consumption versus the present, and if they do not consume now, they invest in Treasury bills. The ratio of present to future consumption is given by the real interest rate: the Treasury bills have a nominal return, but the future prices of goods should rise by the expected inflation rate.

If the real interest rate does not matter, then that core mechanism of the model is meaningless. Although it was possible to add epicycles to handle things like the financial system, it is harder to replace core dynamics.

Alternatively, we can ask: what is the value of the mathematisation of economic theory, if we cannot answer a basic question like what level of the policy rate is where it starts to slow inflation and/or growth?

Email subscription: Go to https://bondeconomics.substack.com/ 

(c) Brian Romanchuk 2022
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Author: Brian Romanchuk

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Peter Schiff: This Bubble Economy Is Going To Burst

Peter Schiff: This Bubble Economy Is Going To Burst

Via SchiffGold.com,

Peter Schiff recently appeared on the Rob Schmidt Show on Newsmax to…

Peter Schiff: This Bubble Economy Is Going To Burst

Via SchiffGold.com,

Peter Schiff recently appeared on the Rob Schmidt Show on Newsmax to talk about the trajectory of the US economy. Peter explains how the Federal Reserve and the US government created a massive bubble, why it is going to ultimately pop, and how to protect your savings and investments when it does.

The First question Rob asked was how is the Federal Reserve going to fix the inflation problem?

Simply put, it’s not. The Fed will make it worse.

Peter said in the first place, the Fed is lying about the extent of the problem. The CPI doesn’t measure the rise in prices accurately.

If we just use the same CPI that we used during the 70s and 80s, and applied the numbers today, we would get about 15 percent inflation for 2021. So, last year was worse than any year of the 1970s, and it was worse than 1980 when CPI was up 13.5 percent. So, this is the worst inflation we’ve ever seen.”

Peter said, unfortunately, it’s going to get even worse.

We have just seen the tip of an inflationary iceberg.”

How did we get into this mess to begin with?

The Fed created the problem.

They’ve been printing all this money. They sent the printing presses into overdrive during the pandemic. But we had an even bigger problem. The government forced people to stop working during the pandemic. So, people weren’t on the job. They weren’t producing goods. They weren’t supplying services. They should have spent less money because they weren’t earning money. The government made the mistake of sending everybody stimulus money so they could go out and spend money to buy products that didn’t even exist because they weren’t created. That’s why we have a supply shortage — because everybody is spending money that the Fed printed, not money that they earned producing goods and providing services. So, it’s a double-whammy. Prices are going ballistic. And this year is going to be worse than last.”

The Fed has said it plans to raise rates, possibly to 2 percent by 2022. Rob said that doesn’t seem substantial. Peter likened it to spitting in the ocean.

Inflation is already 7 percent, even if you accept the government’s numbers, which are a lie. How do you fight 7 percent inflation with 2 percent interest rates? Remember, the Fed had interest rates at 2.5 percent in 2018 when they had no inflation to fight. CPI was only up 1.9 percent in 2018. Yet, the Fed is not going to raise interest rates now to a level they were back then. So, the whole thing is a lie. The truth is if the Fed actually raised interest rates high enough to fight inflation, it would crush the economy. We’d have a worse financial crisis than 2008. The stock market would crash –bond market, real estate market. Government would have to slash spending because interest rates would skyrocket. And so to prevent that from happening, the Fed is going to not fight inflation and that’s why it’s going to get so much worse.”

But the economy seems healthy. That is until you look beneath the surface. We have record trade deficits. The government is running massive budget deficits.

We’re living in a gigantic bubble, and now we’re beginning to see that because prices are really starting to rise and there’s no way to stop them from going up. And this is when everything comes collapsing down. Because eventually, this stagflationary environment that we’re in, which will be much worse than the 1970s – more inflation and a weaker economy – is going to prick that bubble. So, even if the Fed won’t prick it, the markets are going to prick it for them.”

With inflation so pervasive, Peter said anybody who is retired or who wants to retire needs to get out of dollars.

Inflation is going to wipe you out. It is a gigantic tax and it’s going to impoverish an entire generation unless they act quickly to get into real assets. … You have to own real things that can’t be printed because if you just own paper, you’re going to get wiped out.”

Tyler Durden
Wed, 01/19/2022 – 06:30







Author: Tyler Durden

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Temporary reprieve

Equity markets are recovering some of yesterday’s losses but anxiety and uncertainty continue to dominate after a disappointing start to earnings season….

Equity markets are recovering some of yesterday’s losses but anxiety and uncertainty continue to dominate after a disappointing start to earnings season.

Inflation and interest rate concerns are going nowhere soon and with traders now increasingly considering the possibility of hikes larger than 25 basis points, the possibility of more pain in stock markets is very real.

The idea that we could go from rock bottom rates and enormous bond-buying to rapid tapering, 50 basis point hikes, and earlier balance sheet reduction is quite alarming. We’re talking about markets that have become very accustomed to extensive support from central banks and very gentle unwinding when appropriate. This is quite a shock to the system.

And so far earnings season is not providing investors the comfort they were hoping for. Significant compensation increases and lower trading revenues hurt JP Morgan and Goldman Sachs, and higher wage demands are likely to be a common theme throughout the next few weeks which will put a dampener on the bottom line and not alleviate concerns about persistent and widespread price pressures.

UK inflation jumps again ahead of Bailey appearance

The CPI data from the UK this morning compounded inflation concerns, hitting a 30-year high and once again surpassing expectations in the process. And it’s highly unlikely we’re seeing the peak, with that potentially coming around April when the cap on energy tariffs is lifted considerably to reflect higher wholesale prices. Other aspects will also contribute to higher levels of inflation at the start of the second quarter, at which point we may have a better idea of how fast it will then decline.

Of course, the Bank of England can’t just turn a blind eye until then. The MPC may be willing to overlook transitory inflationary pressures but the rise in CPI has proven to be neither temporary nor tolerable. Instead, it’s become more widespread and the central bank is being forced to act and may do so again next month after raising interest rates for the first time since the pandemic in December. A few more hikes after that are also priced in for this year but if pressures continue to mount, traders may begin to speculate about the possibility of larger hikes, as we’ve seen starting in the US.

All of this should make Andrew Bailey’s appearance before the Treasury Select Committee later today all the more interesting. The central bank has warned of higher inflation and possible interest rate hikes for months but delayed doing so after initial hints ahead of the November meeting. Given what’s happened since, the decision looks all the more strange. Of course, it’s easy to say that with 20/20 hindsight.

Consolidation continues

Bitcoin appears to have gotten lost in the noise of the last few weeks. It’s not falling too hard despite risk assets getting pummelled but it’s not recovering to any great extent either. Instead, it’s floating between support at USD 40,000 and resistance around USD 45,000 and showing no signs of breaking either at this point.

For a look at all of today’s economic events, check out our economic calendar: www.marketpulse.com/economic-events/

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Author: Craig Erlam

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