What Now, Fed?

 When looking at inflation, the Fed doesn’t much like the mainstream CPI statistics; instead, it prefers the Personal Consumption Expenditures index (PCE).  April’s numbers just came out yesterday, see below. It’s the highest monthly reading in ten years.

PCE Inflation Running Super Hot

The Fed keeps on claiming that this is temporary and will go away soon.  Further, it says it’s all due to “supply chain disruptions” due to COVID.  Really??? How the heck are soybeans impacted, or lumber, or iron ore (China is importing the stuff heavily once again, even at record prices). There is no supply disruption, obviously.  It’s just that those many, many more dollars it created are chasing a finite supply of “stuff”. It’s as simple as that...

Iron Ore Prices At All Time Highs

The cost of shipping all this very expensive iron ore to China is also going through the roof - Capesize charter rates have doubled.

Do the math: the cost of iron ore landed in a Chinese port today is almost three times what it was in early 2020. Prices for all basic commodities show the exact same pattern - or worse.  As these higher costs make their way through the production process consumer prices will certainly start rising faster in months to come.

What will the Fed do then?

Bubbly Junk - And A Bit Of History

 If there is one chart that shows how bubbly the market bubble really is... it is this, from Yardeni Research:

Junk Bond Yields At Record Lows

Junk bond yield spreads are at record lows, meaning that the hunt for incremental returns over safe Treasury bonds has reached the point of desperation, where all caution is thrown to the wind. Why? Because the belief that the Fed and all other central banks will stop anything bad from happening has now achieved religious acolyte fervor.   (Notably - and IMHO very, very importantly from a geopolitical viewpoint - the Chinese central bank is not following along in the monetary madness.)

Notice how spreads historically widen sharply after reaching such lows.  Sense, and a fear of risk, are eventually always restored.  In fact, the Risk-O-Meter always swings from greed to fear.  In fact, it is NEVER “different this time”.

Just as a historical reminder... remember “financial engineering” in the years before the Great Debt Crisis of 2008-09? When such “engineers” (God forbid) had discovered how to transmute junk into AAA CMOS, CDOs, etc? They claimed they had a “formula” that would let them apportion risk into various tranches in precise amounts and - voila! - dung became gold.  

Only problem was ... the formula’s parameters were completely and entirely wrong, so when even slight problems arose the entire tranche structure became unstable and tranches went from AAA into Default in just one step! 

And why were parameters wrong? Because if they weren’t deliberately chosen at the initially erroneous values to begin with, junk would have stayed junk, making the entire tranching operation impossible. Was there malice aforethought? With billions in fees at stake? What do you think?

Find today’s parallel and you can fathom how this is going to play out..

Is The Fed “Stealth Tapering”?

The Fed is between a rock and a hard place.  They know that the torrent of cash they have unleashed will necessarily lead to inflation, most likely much more than their target 2-2,5%, but they are also very weary of overtly easing off their massive QE because a) it will burst the asset bubble and b) drive interest rates up, increasing debt service costs for the Treasury.  Are they doing anything about it? 

Maybe.

The question on everyone’s mind is when will the Fed reverse its radical QE strategy? But, the proper question  may be has the Fed already started tapering, albeit under the radar?

In my previous post I wrote about the Fed’s overnight reverse repo operations that is removing some $400 billion from the system. As of yesterday the amount reached $433 billion, up from $175 billion two weeks ago and nearly zero last month. That’s serious money.  If you’re not familiar with reverse repo, the Fed is borrowing money from banks for one to three days (overnight includes weekends on Fridays) against Treasury collateral. The Fed is accepting all amounts tendered and pays no interest at all (0.00%). And therein may hide the stealthy taper tale..

You see, the Fed isn’t obliged to accept (borrow) any specific amount - or even any at all. It is doing so solely at its discretion - so why is it accepting so much money? Again, it’s entirely voluntary, the Fed is not forcing banks to deposit the money, so no one can accuse the Fed of “active” tapering. Yet...

With markets so overextended and precarious, any overt tapering and/or increase in interest rates would likely lead to a crash as the asset bubble bursts.  The Fed certainly does not want to be blamed for that.  And even more importantly, it does not want to raise rates and put the Treasury in a tight spot with sharply rising debt servicing costs.

On the other hand, the Fed is certainly worried about inflation, no matter what they say (all the time) about “not being worried”.  I mean, c’mon, just the fact that they have to keep on repeating “we’re not worried” means that they ARE worried. So, they have to do something..  something stealthy, so obscure and under the radar that most people won’t notice or be capable of interpreting.

Thus, the reverse repo... it is voluntary, reversible within just one day and at 0% below even Fed funds rates.. The Fed can easily wash its hands of all responsibility and walk away, if need be, But it does the job!  Because when it is all said and done, the system is now drained of $433 billion.  It’s really a matter of watch what I do quietly and stealthily, not what I say loudly and openly.

Reverse Repo At The Fed: Glut Or Risk Aversion?

The Fed allows banks to make deposits with it in an operation known as reverse repo, usually overnight.  The Fed provides Treasury collateral and pays a very small interest rate - after all, it’s not a deposit taking institution and only provides this service as a sort of last minute choice to tide over banks’ books in their day to day money market operations. Normally, banks have much better places to put their cash to use, and certainly at better than 0%.

In the last two weeks, however, Fed reverse repo amounts have ballooned to $394 billion as the chart from the FT shows. The Fed is paying 0.00% interest.  Think about it... banks choose to get nothing, zero, nada for their excess cash - they can’t find a willing and creditworthy overnight (O/N) borrower in the institutional money market to pay even a tiny bit more - emphasis on creditworthy.  The heaviest users of overnight depo are margin borrowers against all sorts of “suitable” collateral: stocks, bonds, commodities... even cryptos. Keep this in mind..

Yes, as the chart title says, you may interpret the situation as a “cash glut”.  However, there is also another possibility: banks are becoming weary and cautious of lending to “the Street”, aka they are pulling in their risk horns.  Maybe the Archegos snafu has rang a warning bell.  Also, it could be that savvier speculators are cutting back on their leverage and paying down margin loans.

Either way, what is going on is not so much a cash glut  as an increase in risk aversion. Last week’s cryptocrash is only going to heighten caution, for sure. 

Yet another way to look at this is from the Fed’s perspective: it is  currently pumping  out some $95 billion in new dollars per month net (ie after maturities etc), so the $400 billion it has to “accep back” via reverse repo represents over 4 months of “printing”.  Clearly, this is money the economy is not capable of absorbing, it just doesn’t need it.  To make a simile, it’s like throwing so much water to a thirsty horse that you may end up drowning it.

Tulips, Silver and Cryptos

 The rise and crash of cryptomania draws obvious comparisons with the infamous tulip mania in 17th Century Netherlands.  The comparison chart below is eye popping because... it’s from 2017!! Bitcoin was going for $20.000 back then, so bitcoin’s recent spike to $65.000 easily outdistances the tulip madness, putting the top at around 110 on the left scale.  In other words, the CruptoBubble is (was?) easily twice as manic as the TulipMania.

This Chart Is From 2017

Aahhh, but cryptos are not tulips, one may object.  They are the future answer to fiat money (as if the faith in cryptos is somehow different, but, anyway...).  So, my memory went back to silver.  In the early 1980s silver prices spiked almost 30-fold due to a combination of inflation, mass hysteria about a “worthless dollar” and, best of all, manipulative cornering by the Hunt brothers.

Hmmm... does that remind anyone of today? Including manipulation of a guileless and now gutted public?

Slow Train To China? Hardly...

 This article from CNN about China’s incredible high speed train network. is a rude awakening for anyone who still thinks China is not on its way to becoming the world’s preeminent global power, and in VERY fast order, too. 

Where are America’s trains?  They might as well still be burning coal... yup, China has already eaten America’s lunch and it’s going after its dinner, too.

The Radical Fed Buys Votes

 One would not normally call the Fed “radical”, yet that’s exactly what Druckenmiller called them in a recent interview. I couldn’t agree more. He joins a growing chorus of top financiers who are despairing at the Fed’s folly (Dalio, Grantham, Summers...).

Why is the Fed so radical? In a word, politics - populist politics, to be exact.  Just because Trump lost the presidency doesn’t mean that populism has gone away from the American political scene.  If anything, it has only grown stronger as politicians of both parties are vying for the hearts and minds of a deeply divided nation.  They are in a cash bidding war for the votes of Americans who are deeply disenchanted with their political status quo.

So, when in doubt, buy them out. No matter which party governs, it’s no longer an ideological contest but a cash-slinging mud fight.  Good luck with that... I have seen many a country try that and it ALWAYS ends up the same way: bankruptcy and misery.  Argentina and Greece come immediately to mind, but history is full of similar examples.

You Don’t Have To Be An Economist.. Or A Cockroach

 The battle between the Fed/Treasury and monetary sanity is red hot.  We “sane” people were recently called “monetary cockroaches” by Nobel laureate Paul Krugman, because we believe inflation is about to run much higher than expected due to the gusher of new dollars created by the Fed/Treasury.

But, you know what? You don’t need a Nobel Prize in Economics, not even a PhD, to see things as they are: as Warren Buffett said a couple of weeks ago, the US economy is “red hot”. And you certainly aren’t a money roach when you look at retail sales reaching all time highs at breakneck speed, precisely because of the new money being thrown hither and yonder.

.Look At Them Retail Sales... Bang, Zoom, To The Moon, Alice!!

Still, if I have to choose between HeliMoney4Ever and roachdom.. well, bring out the Roach Motel ‘cause I’m checking in 😜😜

... and just for perspective, here are some price increases in the last 12 months (futures prices).  They are merely indicative, just about every product you can think of shows similar price gains. I have chosen the ones that are most important in the global economy.

Gasoline +115%

Iron ore +75%

Copper +95%

Aluminum +65%

Lumber +340% (no, it’s not a typo)

Soybeans 95%

Corn +110%

Lean Hogs +81%

Sea Transport, Dry Cargo +580% (also not a typo)

Finally, EU CO2 emission permits (carbon rights) +100%  

— this last one is very interesting, look at the chart below.  In a year when EU CO2 emissions fell by a record 13.3%, and economic activity is still below 2019 highs, why have permit prices doubled to all time highs?? There is certainly less demand from industry (they don’t need them), so the only explanation is.. speculative trades driven by torrents of new cash from the ECB and Fed.

But... what do I know, right? I’m just a monetary cockroach...

Bring Back The Gipper

 April CPI data came in and, just as for payrolls, they were waaaaay beyond expectations, with core inflation (ex food and energy) rising at the fastest pace since Ronald Reagan’s first presidency. But unlike Ronnie’s Fed which had the good fortune to have a giant (literally) as Chairman (Paul Volcker), today we are stuck with a wishful thinking non-professional (Jerome Powell).

Good luck to us all, but mostly say a prayer for the US dollar as global reserve currency.  Because with Jerome and Janet calling the shots, it hasn’t got a prayer...

Core CPI Rising At Fastest Pace Since The Gipper Was Prez

Inflation? Nah... Head In Sand, All Is Fine

 Milton Friedman has famously said that inflation is always and everywhere a monetary phenomenon. Despite the self-evident nature of this the Fed and Treasury continue to ignore it because... populism sells.

Here’s the result.. commodity prices are soaring to record highs, in step with the gush of dollars created by the most irresponsible monetary policy in the entire history of the US. 

Even the labor market is screaming warnings.  Friday’s payroll numbers came in as a complete and utter surprise, disastrously lower than expected (266.000 vs 1.000.000). Why? Because despite lots and lots of  job openings people just don’t want jobs.  And why should they?  The government is sending out free money to everyone, including an EXTRA $300/week in unemployment benefits.  Predictably, wage pressures are rising, particularly in the leisure and hospitality sector where labor costs jumped a huge 3.6% in just one month.

Job Openings Back To Near Record High 

Hospitality And Leisure Wages At Record High

Dunno, methinks inflation is already happening.... But hey, ostriches with heads in the sand know best, right?

Development Instead Of Expansion

 The current economic model focuses on “growth”, ie the constant expansion of GDP, a condition I have termed Permagrowth.  Since 1960 global GDP has expanded from $1.37 trillion to almost $90 trillion today.

The cost to our habitat is catastrophic, with CO2 emissions exploding.

The only solution is to quickly transition to a radically different economic model that will focus on Development instead.

Knock On Wood

 If you thought cryptos are hot and bubbly, look at this:

Lumber Prices Up Fivefold

Wood, the most prosaic ho-hum of materials, is rip roaring ahead.  Why? Yes, home building in the US is really going gangbusters, but... seriously, now?

Anyway, yet another nail for the “low inflation” coffin, along with grains and metals.  But, hey, let’s keep printing and see what happens - maybe it will all go away...