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Karl Denniger: Market Has Best Month!

‘Market has Best Month!’ Could that be one of the stupidest headlines you’ll ever read?

posted by Karl Denniger on The Market Ticker.

That headline, which is of course all over from Friday’s close, is one of the most-stupid things I’ve read in years.

The most-amusing part is that you can have both accurate and stupid in the same article, and this is no exception.

The S&P went from 3741 to close at 4130 Friday, a gain of about 10.4% or 389 handles.

But on 3/14 it traded 4166, and on 3/29 4637, which is a 471 point gain or 11.3%, larger on both measures over half the time.

Of course that was a false God; the plunge began afterward, falling one thousand points in an express elevator ride southbound to 3636.

The ramp-job this last week was mostly about people placing bets that, from my point of view, are wildly idiotic.  The basic belief, which has now persisted for about a month (thus the ramp over the last month) is that The Fed will not actually stomp on inflation and, in the next month or two, will reverse course by either not removing liquidity via portfolio roll-off, will lower rates once again or both — irrespective of the impact on inflation.

I remind you that the very same belief was in play in the early part of 2008.  The Fed had declared “subprime is contained” and, despite Bear Stearns blowing up through the summer months we saw a marked recovery in what had been a wild dive southbound in the markets.

Then came September, of course.

Inflation is much worse than a stupidity crisis in banking, however.  Once it gets embedded into the psyche of the people its very hard to break it, because inflation tends to drive behavior.  If you believe everything will be more expensive in the future you shift demand forward to today on things you can shift.  Not everything, of course, can be, and this is one of the reasons The Fed more-or-less ignores food and energy, because those are “must buy all the time” things, and as a result while it sounds crazy to ignore them for the most part its well-grounded in psychology.

The problem comes when those ramps in price turn into inflationary expectations on things you don’t have to buy all the time and have discretionary control over.  Once that happens its extremely hard to extinguish and only sustained and material DROPS in price change the psychology of the public, just as it was the sustained and material increases that did so in the other direction.

It of course does not help one bit when you have various scolds, from the WEF to the current administration openly calling for higher prices in certain things, or even worse — destroying availability entirely.  Witness the WEF’s recent statements that we “should” ban private car ownership, for example, or Biden’s attacks on energy.

The market has acquired a Pavlovian response over the space of a couple of decades and, in combination with Congress which has run up wild deficits and thus public debt, there is a common belief that The Fed can’t raise rates high enough to matter.

This is flat-out wrong for a number of reasons, not the least of which is that all Treasury debt held by The Fed costs the Treasury nothing irrespective of the interest rate on said debt because The Fed remits the interest paid on it back to Treasury!  Yes, they deduct from that their operating expenses but those expenses do not change with the interest rate so for all intents and purposes such changes cost the government zero.

It is true that publicly-held debt does indeed roll over, but do remember that this is exactly the point; it is only on newly issued Treasuries that the rate rises.  If I hold a 10 year Treasury bond that had a 2% coupon that 2% never changes for the entire 10 years.  When the ten years is up then the debt has to be rolled (since we presume they can’t pay it off) and then the higher interest rates do bite.  But not today.

There is another aspect of this which is that only externally-held debt actually exits the US economy in the form of interest expense; the rest gets spent.  The largest external debt holders are, depending on where you cut it off, about 10-15% of the total and thus while that’s real its hardly the end of the world.  In addition Treasury interest is taxable as income and most holders are subject to very high marginal rates (since they’re wealthy on a percentage basis) it is not what it seems.

If I have to pay $1 billion in interest as Treasury but $370 million of it comes back as income tax then the real impact is $630 million, not a billion.  While it certainly is real money the often-repeated claim that “The Fed can’t raise rates because Treasury can’t pay” is garbage.  Congress can go even further by diddling the tax rates on Treasury debt, further effectively reducing the interest coupon!  While there will be plenty of screaming about that if and when they do the fact remains that Congress can in fact machine their way out of what the foolish claim is an impossible scenario, The Fed knows this and in fact has all the flows of funds in their hand because they are producer of the Z1, which is the flow of funds statement, and given the four year maturity cycle there is plenty of time to do it without causing a default.

The political impact of all of this is another matter, but mechanically yes, The Fed can raise rates without bankrupting Treasury.  Math just is, and if you and I have a deal where I give you five $20s and you give me back two of them I may have technically paid you $100 but in fact I really only paid you $60.

There are times betting against the market can be insanely profitable, although timing can be difficult.  Back in 2008 one of the mantras about “subprime being contained” was that the math made it impossible for institutions like Countrywide to collapse.

That was wrong, I pointed out at the time that it was wrong and why — and they did collapse.

Don’t get caught on the wrong side this time; the distortion is much worse now and the fact that indeed The Fed can remedy it without collapsing Treasury are both facts.

Originally posted by Karl Denniger on The Market Ticker

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