The Global Bubble, several decades in the making, is in the process of bursting. A new cycle is emerging, replete with extraordinary uncertainties. Acute instability has become a permanent feature, at least through the cycle transition phase…
by Doug Noland on Credit Bubble Bulletin:
These are not statements made to be provocative, but rather to offer an analytical framework that might help us better comprehend such a complex and increasingly alarming world.
CNBC’s Steve Liesman: “You talked about using 50 basis point rate hikes or the possibility of them in coming meetings. Might there be something larger than 50? Is 75 or a percentage point possible? And perhaps you could walk us through your calibration?”
Chair Powell: “So, 75 basis point increase is not something the committee is actively considering… Assuming that economic and financial conditions evolve in ways that are consistent with our expectations, there’s a broad sense on the committee that additional 50 bps increases should be on the table for the next couple of meetings… We’ll be paying close attention to the incoming data and the evolving outlook, as well as to financial conditions… So the test is really just as I laid it out, economic and financial conditions evolving broadly in line with expectations.”
The Financial Times’ Colby Smith: “Given the expectation that inflation will remain well above the Fed’s target at year end, what constitutes a neutral policy setting in terms of the Fed funds rate? And to what extent is it appropriate for policy to move beyond that level at some point this year?”
Powell: “So, neutral. When we talk about the neutral rate, we’re really talking about the rate that neither pushes economic activity higher, nor slows it down. So, it’s a concept really. It’s not something we can identify with any precision. So, we estimate it within broad bands of uncertainty. And the current estimates on the Committee are sort of 2 to 3%. And also, that’s a longer-run estimate. That’s an estimate for an economy that’s at full employment and 2% inflation. So really what we’re doing is we are raising rates expeditiously to the — what we see as the broad range of plausible levels of neutral. But we know that there’s not a bright line drawn on the road that tells us when we get there. We’re going to be looking at financial conditions, right. Our policy affects financial conditions and financial conditions affect the economy. So, we’re going to be looking at the effect of our policy moves on financial conditions. Are they tightening appropriately?”
Powell referred to “financial conditions” 17 times during his relatively short press conference. “Nimble” made it only once, in the Chair’s opening statement. The S&P500 rallied 3.5% during and immediately following Powell’s press conference, with the Nasdaq100 surging 4.5%. Taking 75 bps hikes off the table was the spark, but the general tenor of the press conference was much less hawkish than markets had feared. A Financial Times headline succinctly captured its essence: “Investors Detect Dovish Undertones to Powell’s Campaign Against Inflation.”
Powell’s neutral rate comments (“current estimates on the Committee are sort of 2 to 3%”), while open to interpretation, suggest a more measured tightening cycle than markets anticipate. There was reference to inflation-restraining reductions in fiscal and monetary stimulus, along with continued focus on eventual supply chain normalization.
Mainly, nervous markets were comforted by the focus on “financial conditions.” The Fed’s hawkish tightening cycle is, after all, on a Collision Course with faltering Bubbles, De-risking/Deleveraging Dynamics and serious liquidity issues. Powell faced an extraordinary challenge in conveying to the public and Washington politicians the Fed’s focus on and commitment to reining in inflation, while signaling to the markets that he is appropriately monitoring unfolding market instability. From this perspective, Powell’s preparation and performance were masterful.
Powell: “Before I go into the details of today’s meeting, I’d like to take this opportunity to speak directly to the American people. Inflation is much too high, and we understand the hardship it is causing, and we’re moving expeditiously to bring it back down. We have both the tools we need and the resolve it will take to restore price stability on behalf of American families and businesses.”
With his overt opening display of hawkishness out of the way, he subtly turned his attention to vulnerable markets. “Going to raise rates, and you’re going to be kind of inquiring how that is affecting the economy through financial conditions…” “We need to look around and keep going if we don’t see that financial conditions have tightened adequately…” “We just would be looking at very broad measures of financial conditions—all the different financial conditions indexes, for example—which include equity, but they also include debt and other—many other things; credit spreads, things like that too.” As for balance sheet reduction, Powell noted this tool’s high degree of uncertainty, implying flexibility and, again, a focus on financial conditions.
Powell spurred a big equities market reversal. Bonds mustered a gain, though the unenthusiastic four bps decline (to 2.94%) in 10-year Treasury yields was portentous. Yields were up 16 bps to 3.10% by mid-day Thursday. It was Bloomberg with the day’s apt headline: “Stocks Stumble as Traders Fret About Fed’s Quagmire.” After rallying 3.0% Wednesday, the S&P500 fell 3.6% in Thursday’s rout. With big tech in the crosshairs, the Nasdaq100 sank 5.0% Thursday, more than reversing Wednesday’s 3.4% recovery. It was the type of volatility one might expect prior to an accident.
Importantly, De-risking/Deleveraging Dynamics attained critical momentum. Investment-grade CDS rose five bps (largest one-day gain since June 2020) Thursday to 83 bps to the high since May 2020. High-yields CDS surged 30 to 460 bps, the largest one-day increase in almost two years and the high since July 2020. Bank CDS jumped to highest levels since April 2020 pandemic instability. JPMorgan CDS gained three to 90 bps, BofA five to 93 bps, Citigroup four to 109 bps, and Goldman Sachs four to 108 bps.
Thursday’s instability was a global phenomenon. European Bank (subordinate debt) CDS traded above 200 bps for the first time since May 2020. European high-yield (“crossover”) CDS surged 19, the first session trading above 450 bps, also back to May 2020….
For decades, the U.S. financial system expanded Credit without constraint or worry. Massive trade and Current Account Deficits would flood the world with dollar balances that would simply be recycled back into Treasuries and U.S. securities. For the most part, the greatest inflationary manifestations remained comfortably within the confines of securities and asset markets. Finance would run absolutely wild, while the Fed monkeyed with conventional central bank doctrine. Somehow, the Federal Reserve became fixated on inflating CPI up to its 2% target, even as central bank balance sheets and Monetary Disorder ran completely out of control – leveraged speculation, manias and shenanigans aplenty.
Arguably, no sector lavished in monetary excess with such flagrance as the indomitable tech sector. More evidence this week of serious leakage from a historic Bubble. Get ready for one brutal and protracted bear market. Losses will be unprecedented….
The short half-life of Powell’s Wednesday rally speaks volumes. Equities players (especially those loaded with tech stocks) were only temporarily relieved by Powell’s subtle lean dovish. Meanwhile, bonds want nothing to do with it – not with inflation dynamics now deeply entrenched. And there have already been Fed officials (current and former) pushing back against Wednesday’s Powell Show (i.e. “Fed’s Barkin Declines to Take 75 bps off the Table”). A divided Fed will only exacerbate uncertainties.
Our system faces a serious inflation problem. At the same time, Market Structure and systemic fragilities simply cannot tolerate a significant tightening cycle. It is a Quagmire. The writing’s on the wall: faltering markets will spur a major tightening of financial conditions, while consumer inflation remains elevated.
Back to the faltering global Bubble. It is in reality myriad interrelated Bubbles, conjoined through global networks of financial institutions, leveraged speculation, market structures and derivatives. China, U.S. securities and assets, European periphery bonds, global tech, and EM, to highlight the most obvious. Basically, it all ripened into One Big Crowded Trade. And as the Crowd heads for the exits, there’s no one with sufficient liquidity outside of global central bank balance sheets.
There are today similarities to previous serious “risk off” episodes – that almost brought down the global financial system. There are key differences: Global Bubbles are today much grander and interconnected; the world’s financial and economic structures are splintering; inflation has become a serious global issue; and Fed and global central bank community liquidity backstops are problematic like never before….
(This is an excerpt of a far longer article, which can be read at Credit Bubble Bulletin. This excerpt focuses in on those parts of the article that are related to this week’s Fed actions.)
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