Doug Noland is out with his latest Credit Bubble Bulletin, following a week in which some of the things he’s been warning about began to happen.
Definitely read the whole thing (especially the exchange between Representative Warren Davidson and Fed Chair Jerome Powell). But in the meantime here’s a brief excerpt:
Global bond markets have an inflation problem. The international central bank community has an inflation problem. Perhaps Treasuries and the Fed face the biggest challenge in managing around mounting inflationary risks.
The U.S., after all, is running unprecedented peacetime deficits, with a new $1.9 TN stimulus package scooting through Congress. This legislation will be followed by what is sure to be a major infrastructure program. There are literally colossal deficits and Treasury issuance as far as the eye can see.
Inflationary pressures are mounting and broadening – food, energy, housing and beyond. There are worsening inflationary bottlenecks (i.e. semiconductors, global shipping, trucking, steel, myriad supply chains and so on). And we’re in uncharted territory with respect to massive fiscal deficits, with another year of a $3.0 TN plus shortfall in the offing. Meanwhile, the Fed is trapped with rates at zero and its $120 billion monthly QE operation.
Fed Chair Powell and fellow Fed officials have gone out of their way to offer markets strong assurances they will stick with ultra-loose policies – economic recovery or mounting inflation risk notwithstanding. A few notable headlines: “Powell Says Inflation Goal is Still Years Away;” “Fed Officials Shrug Off Rise in Longer-Term Yields;” “Bostic Says Economy Can Run ‘Pretty Hot’ Without Inflation Spike;” “Fed’s Bullard Says Rise in Yields ‘Probably a Good Sign;’” “Clarida: Robust Demand Won’t Generate Sustained Price Pressures;’ and “Brainard Says Fed Won’t React to Transitory Inflation Pressures.”
Traditionally, such cavalier attitudes toward inflation risks would provoke a stern bond market rebuke. But since QE’s introduction, bond market fixation shifted to prospects for additional QE. With consumer price inflation essentially a non-issue, market yields responded positively to any development that could possibly usher in additional central bank bond purchases (i.e. market Bubble Dynamics, heightened money market liquidity risk, economic vulnerability, global instability, pandemic risks, etc.). The Fed well-recognized the risk of rising market yields and an associated tightening of financial conditions ahead of waning QE support (“taper tantrums”).
Powell and Fed officials this week adhered closely to their seasoned playbook. But Treasuries and global bond markets puked on the same old dovish gruel. Perhaps it’s a little premature to declare the long-awaited Reincarnation of the Bond Market Vigilantes. Yet I would caution against dismissing this week’s upheaval in the face of commentary that would have previously stoked market exuberance. The times, they are a changin.
How enormous would Fed Treasury purchases need to be at this point to place a ceiling on yields – especially with additional Trillions of supply in the pipeline? Furthermore, would such huge additional liquidity injections prove counter-productive in a backdrop of heightened inflation concerns?
Powell: “Inflation dynamics do change over time, but they don’t change on a dime. And so, we don’t really see how a burst of fiscal support or spending that doesn’t last for many years would actually change those inflation dynamics.”
Hope is not a strategy. We’re in a period of unmatched synchronized global monetary inflation. Short-term rates are near – or even below – zero internationally. Global “money” and Credit growth is unprecedented. Governments around the globe are locked in massive deficit spending. It is difficult to imagine global financial conditions being any looser.
In an environment of such extremes, it is imperative that central banks remain especially vigilant. But they aren’t because they can’t. Global central bankers are beholden to precarious market Bubbles. Policy tightening measures would incite a de-risking/deleveraging episode that would surely be quite challenging controlling. After expanding its balance sheet by $3.4 TN over the past year – and stoking an epic mania and other Bubble excess in the process – how much additional QE would now be necessary to counter another major deleveraging episode?
Markets have just begun the process of coming to grips with a harsh reality: There are myriad historic speculative and Credit Bubbles, and central bankers are definitely not in control of the process. They have retained a semblance of control only through monstrous monetary inflation. And yet this week demonstrated it’s no longer so easy to manipulate market behavior with the usual pedestrian dovish comments. Markets now scoff at the notion of the Fed anchoring inflation expectations at a particular level. Moreover, even after Trillions of liquidity injections, central bankers are clearly not in command of marketplace liquidity. It is as if Fed credibility is evaporating right along with bond prices.
Read the full article here.