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Protected: Flying Upside Down over Wonderland in a Cold-Air Balloon about to Burst: Welcome to Negative Interest in Bond Bubbleland
This month the economic expansion brought to you by your Federal Reserve and by US government largess becomes the longest expansion in the history of the United States! That’s something, right? Something? Let’s take an honest look at what we now call great.Read the remainder of this entry »
The US deficit this year is already over three-quarters of a trillion dollars, putting the first eight months of the fiscal year almost equal with the entire past fiscal year. It is also $200 billion above the previous record for this portion of the year, and this May’s deficit alone was 40% higher than last May’s.
The previous deficit record was set in the middle of the last recession, which means the government is already spending more than it did to try to pull us out of the last financial crisis. In spite of all of this fiscal stimulus, the economy appears to be receding on many fronts.
The government (Donald Trump) is now routinely begging the Fed for assistance and tweeting tantrums when the Fed sits on its hands. The stock market is begging the Fed for assistance, too, and will certainly throw a tantrum of its own if none comes. All eyes are on the Fed this week, but the Fed may no longer be up to the task.
QT is QE on the QT
I’ve laid out in earlier articles how the Fed’s member banks may already be feeling a liquidity squeeze that will force them to stop refinancing the government from their excess reserves, which are in excess no more, until the Fed restarts quantitative easing. (See “Liquidity Stress Fractures Begin to Show in the Federal Reserve System.”) I think that will play out next year, but for now the Fed is continuing to intentionally tighten the system.
The Fed built up those excess reserves in its member banks in order to make the bank’s more “robust” against future problems … like crops failing across the midwest because they never got planted, leaving farmers to default on loans. A graph in the above referenced article shows those excess reserves are rapidly depleting (by 50% so far), meaning banks are becoming less capable of weathering future problems.
The depleting of those member-bank reserves as the Fed continues its QT is a covert form of quantitative easing (QE) because, as the Fed draws down its balance sheet by letting bonds mature so the government has to pay them off, money is flowing out of the reserve accounts of the Fed’s member banks and to the government to buy up new government bonds so the government can refinance that debt and new debt for its current spending. The new-debt money that goes into the government keeps the government buying goods and services and paying employees and so stimulates the economy and becomes a major part of measured GDP, weak as it now is.
It’s FedMed forever
What happens to interest on a massively and rapidly growing government debt when the second tier of lenders of last resort — the Fed’s member banks with their easy money — have spent out all their excess reserves and, so, have to stop? It seems to me you have only two choices — interest on the national debt soars at that point of low liquidity when banks cannot deplete their reserves any further to soak up government debt because their depleted ability forces the government to find other creditors who are not so robust with extra cash, OR the Fed goes right back to QE and has to reverse its whole tightening regime in order to keep monetizing government debt.
The latter, of course, is the scenario I’ve said for years you can bank on. The Fed’s recovery was unsustainable from the onset and requires ever greater amounts of QE, because QE is getting tired … really tired. Because its big numbers create shock and awe no more, the Fed gets less bang for the buck.
By September, QT will be finished, and the Fed will be back to lowering interest rates (probably starting in July). By next year it will become obvious that ending QT and cutting rates is not enough. In fact, it will be hard for the Fed to get its base rate, the Fed funds rate, down any lower than it already is without reverting to more QE; so, the Fed will have to rewind its rewind (rewind its recent attempt at balance-sheet reductions) and go right back to overt QE to keep the government from ever facing skyrocketing interest when its member-bank reserves get too tight to continue the covert QE.
That means it’s rinse and repeat of the last cycle, except this time FedMed won’t work because we’ve all been here before and all know now the Fed has no end game. The Fed can never tighten again, so it is QE4-ever, which will cast a dismal pall over the already waning global economy. (That’s a teaser for next year because I’m not quite ready yet to say where next year is going in any specific way, but it reveals the overall direction I think is most likely.)
Meanwhile, what could scream “recession” more confidently than this:
CME Group’s FedWatch Tool has the odds of a rate cut by end of next month at 79.4%, 95.2% by September 2019, and then a staggering 98.6% by the end of 2019. Talk about confidence that rates are indeed heading lower. JPMorgan was the first to jump the shark, changing their forecast to two rate cuts by the end of 2019, while Barclays quickly followed suit and upped the ante, changing their forecast to a stunning three rate cuts by the end of 2019. These forecast revisions are “seemingly” being confirmed by recent figures being released, most notably the latest US job numbers, which just missed the mark in a significant way.
You don’t start slashing rates like that (or expecting the Fed to slash rates as quickly and as often as that unless your true outlook is that you see the economy rapidly heading into recession. The last time the New York Fed’s yield-curve model (the difference between 10-year bonds and 3-month bills) looked as recessionary as it became this May was near the start of 2007 and we tipped into recession by the end of that same year. By the time it got to this same level in 2001, we were ALREADY IN a recession:
The end of confidence in the con game
President Trump recently denigrated the Fed as “very, very disruptive” because it didn’t listen to him, so it raised rates too much and should not have done quantitative tightening. In a way he’s right because I’ve always said here that the Fed could not possibly do what the tightening it said it could, which it also said would be “as boring as watching paint dry.” (Of course, the real problem is that it ever did QE in the first place.)
What a bunch of stumble-bums these overtrained economic eggheads who run the Fed are according to the president. While I think he is right, I can’t see how his talk does anything but create a lot less economic confidence. And the Fed, without public confidence in its confidence game, is dead. So, the president’s efforts to kill confidence in the Fed are bound to be somewhat suppressive to the Fed’s ability to stimulate the economy.
And the Fed knows it. In a recent Premium Post, title “Teasing out the Fed’s Big Plan for our Future,” I laid out in the Fed’s own candid words how concerned about “declining trust in public institutions.” I showed how its words really add up to its being concerned over its failing reputation because Powell kept talking about the Fed having to work “hard to build and sustain the public’s trust” in order to retain its “monetary policy independence.”
That all means, if you think the good times are going to keep rolling because the Fed is coming to the rescue, think again. We are moving into deeper tariffs, diminished bank reserves, higher government interest on skyrocketing new debt as far as the eye can see at a time when we have a Fed that has been weakened by the failure of its last plan and by the president slashing away at it.
If you think the latest bad news like rising unemployment, fewer new jobs, falling GDP, diminishing corporate earnings are good news because it all means more Fed free money, rethink. The nation is more fed up with the Fed than ever and is overfed on debt. The next round of lower interest and renewed QE are nothing more than proof that FedMed failed.
Now that failure is being underscored by the president of the United States saying the US money managers are all a bunch of loser, dunderheads:
Trump told CNBC’s Joe Kernen on ‘Squawk Box.’ ‘Our Fed is very, very disruptive to us….” The Fed chairman is navigating three discrete challenges: setting a policy to extend what is already a 10-year-old expansion, explaining clearly why the Fed does what it does, and ignoring the loudest public Fed badgering from a president in recent memory.The Washington Post
Trump bemoaned the Fed’s unwillingness to submit to his control and tried to distance himself from the Fed, even though the people he is most upset with were his appointments:
They haven’t listened to me…. We have people on the Fed that really weren’t, you know, they’re not my people, but they certainly didn’t listen to me because they made a big mistake. They raised interest rates far too fast. That’s number one. Number two, they did quantitative tightening.Value Walk
When the president of a nation is shaking a big stick at its central bankers, claiming they are disruptive, don’t take orders and have “made a big mistake,” that can bring the nation to a crisis of confidence in its syndicate of banksters. When the president is right in claiming their tightening failed (we all saw it happen), it makes the tightening look like a big mistake.
The real mistake, however, was all the quantitative easing that was never sustainable in the first place because it created a market that would always be dependent on continued easing, leaving us in a recovery from which we cannot recover. That was obvious from the outset, or I wouldn’t have been saying for years that the present situation was where we were going to wind up.
Whether you view that situation the Donald’s way (as the tightening failed) or mine (as the quantitative easing was a recovery plan from which we could never recover), the cartel of bankers clearly doesn’t merit confidence. The failure is theirs to own either way. Now, when people lose confidence in their monetary system, economic collapse follows, and the president biting at the Fed’s heels to make sure people know where to put the blame is going to help make sure that happens.
Laughable Larry Kudlow, as high priest of the Laffer Curve, has long been servant of “King Dollar,” as Larry has often reverently referred to US currency. The Laffer Curve is the central creed of trickle-down economics. It’s a bell-curve that demonstrates how lowering tax rates actually increases tax revenue to a certain point by stimulating the economy and then, beyond that point, lowering taxes lowers tax revenue. (If the latter were not true, the highest tax revenue would come in at a tax rate of zero, which is ludicrous. So, logically, you know at some point tax-rate reductions start to result in diminishing returns for revenue.)
Where there is room for disagreement is in determining where the high point for the revenue curve lies on that continuum between a 100% income tax and 0%. Larry places it a lot closer to a 0% tax rate than I would or than Larry’s former boss, David Stockman (head of Reagan’s budgeting office) places it. That’s because Larry lusts over tax rates that fill his own pockets, not rates that optimize the balance between government revenue and economic stimulus. (Just part of the voodoo in Voodoo Economics.)
Larry and his sidekick Stephen Moore are now on a journey to cajole the Fed into doing everything Larry has ever said the Fed should not do — dethrone King Dollar. Laffable Larry’s change of heart has come about because it is now unavoidable fact that the tax plan he concocted with Stephen Moore, based on Larry’s beliefs about the Laffer Curve, is not only failing to pay for its own tax breaks as Larry & Moore assured the world it would, but also not doing a whole heck of a lot to stimulate the economy any more.
Larry & Mo’s tax plan boosted the stock market … for awhile … but GDP got only one boost in the second quarter of last year and has been falling ever since.
This quarter, GDP growth is expected to come in well below where it was when Larry & Mo’s plan became law (diving to somewhere around 1%). And that is why Team Trump — the Trickle-down Trio of Larry, Mo, and Surly (the orange one) — is working the Fed to get some monetary salvation for their damned tax plan.
(I’m using the word literally because it is a tax plan from hell that is breaking the government financially, failing to stimulate the economy anywhere near as much as promised, and that ought to be damned because it is making the 1% wealthier at a faster clip than they have ever known while Larry is running at an even faster fast clip to the Federal Reserve for financial salvation in the form of more nearly free money.)
The White House pressure on the Federal Reserve heated up again on Friday after President Trump’s adviser Larry Kudlow said he wanted the U.S. central bank to “immediately” cut its benchmark interest rate by 50 basis points.MarketWatch
“Immediately” doesn’t sound like there is any great need, and Kudlow has often assured us the economy is going to come in like gangbusters.
The Fed, on the other hand, is only interested in holding interest rates right where they are now for the indefinite future, though numerous prognosticators, including those far more bullish than myself, are betting the Fed cannot. All the while, Chairman Powell insists he is paying no attention to the White House.
Krazy Kudlow’s prayerful petition to the Fed
King Dollar is the divine ruler in whom Larry Trusts. That is why the dollar has “In God We Trust” inscribed upon it. It is Larry’s god. It is many people’s god, but Larry is now beseeching the Temple of the Dollar, otherwise known as the Eccles Building (or the Fed’s HQ), to diminish the value of his god by dropping interest rates by the largest change in one drop the Fed has made in a long, long time.
Larry is begging. Never mind that only a few months ago Larry was pontificating about the superior health of the American economy. If you believed him then (in November) and now (when he blames economic decline on the Fed going to far with interest increases), then you are forced to believe a mere quarter-percent raise in the Fed’s target rate (in December) snuffed out a vibrant and potent economic expansion!
Right now Larry claims the economy needs the devotion of the Fed to greater stimulus to the tune of dropping its interest target half a percent. (Consider that, for the past seven years, the Fed hasn’t moved more than a quarter of a percent at a time.)
Axios reports that Kudlow “would love to see” such a downward move, adding that the central bank shouldn’t have ever set overnight interest rates past 2%…. The problem for Kudlow in calling for this immediate rate-cut is this – the last three recessions all saw a Fed rate-cut three months before they started.Zero Hedge
So, the economy that Larry has repeatedly said is doing admirably well under his plan cannot survive a Fed benchmark interest rate above a “highly accommodative” (as the Fed likes to call its relaxed monetary policy) 2%. What is Larry so worried about? Normally, the Fed has never dropped its prime lending rate down to 2% unless the nation is already deep in a recession.
You can see in the following Fed graph that a rate of 2% never happens outside of efforts to recover from recessionary times. In fact, a rate that low rarely happens at all. Moreover, as Zero Hedge noted above, the first drop in interest from any level after an extended period of rate increases almost always happens shortly before a recession. Never has a reversal from a protracted period of raising the Fed Funds rate to dropping that rate happened when the Fed’s rate is already this low:
Larry is imploring the Fed to do something it has never done before! How desperate is that?
Why the desperation?
Sven Henrich of Northman Trader calls out the obvious regarding Larry’s laughable claim that the economy is great but needs major stimulus:
My take here: The budget is blowing up in their face and they know it. The tax cuts did not pay for themselves and deficits are ballooning, federal spending is the highest in 10 years as tax receipts have been slowing. It’s a receipe for budget disaster. Don’t give me this two faced nonsense: “I don’t think the underlying economy is slowing” when everyone with a brain and basic understanding of data knows it is. It’s cheerleading and playing the confidence game, while at the same time demanding a 50bp rate cut by the Fed, an utterly ridiculous suggestion especially in light of the earlier statement.Northman Trader
As Sven goes on to argue, you have to be really “worried about a lot of things” in order to utter such a request out of one side of your mouth while you are praising the strength of the economy under your tax cuts out of the other side. You have to know that is going to look stupid and irreconcilable, so you have to be desperate to hope that somehow you can pull it off.
Trump wants Moore, Moore wants more
The Fed already acquiesced to President Donald Trump’s efforts to humiliate Powell into stopping the Fed’s plan of raising interest rates and downsizing its balance sheet (methods of tightening the monetary system). The Fed learned a harsh lesson that the economy (fake as the recovery has been) cannot survive any more tightening so it abruptly curtailed its plans to continue down that path just as The Donald required.
Desisting from damaging the effete economy, however, was not enough capitulation to the president’s requests. So, now the president is appointing a henchman to infiltrate the Fed and cajole it internally into re-relaxing monetary policy. One might well say that, according to Larry, the nearly flatlining economy already needs a major shot of adrenaline to lift it back into the land of the living.
Stockman warned, as did I, that there was never a snowflake’s chance in a modern university (I mean hell) that the Trump Tax Cuts would ever pay for themselves or that the economy would ever survive a move back to normal monetary policy by the Fed. Yet, the government is even ramping up its deficit spending. It has spent more in the first five months of Fiscal 2019 than it did in any five-month period since 2009 during the Great Recession. (At the same time, federal tax revenue has hit a four-year low.)
Remember that was a time the Washington Post billed as “what may be the biggest government bailout in American history,” after the biggest economic downturn in modern history. That same fiscal year 2009 included the Obama stimulus package, which Obama called “the most sweeping financial legislation enacted in the nation’s history.” For further perspective consider that, at the time, the government believed the net longterm cost of its recovery programs would come to “increase federal budget deficits by … $787 billion over the 2009-2019 period.”
Hah! The federal government is now running at almost that deficit level every year now just to maintain normal annual operations. Its budget is a sea of red ink as far as the eye can see. Yet, the Trump government believes it needs to maintain that spending in order to get re-elected because … well, imagine how much worse the economy would be doing if all that fiscal stimulus ground to halt, stalling the great military-industrial complex and all the jobs created by creating all those weapons of mass uncreation.
So, it is no wonder that the Trickle-down Triumvirate is demanding more stimulus. More, more, Moore! Since Powell claims he is paying no attention to the White House, some infiltration was necessary that would put the Trump tax planners directly at the Fed’s cerebral cortex. Thus, Trump has anointed Stephen Moore to fill one of the empty posts on the Federal Reserve’s Board of Governors. (In the three-headed team’s defense, it is not as if they can make the Fed hydra any more of a monstrosity than it already is.)
To reassure us all that the White House is not staging a Fed coup, Larry said of Powell,
He’s our chairman. We’re not going to displace himMarketWatch
“Our chairman?” As if he’s wholly owned by the White House?
“Not going to displace him?” As if they believe they even can?
Moore has assured us all that his monetary policy is a perfect match to President Trump’s monetary policy. That assurance should not leave us thinking that Trump is trying to implement his own monetary policy for his own political reasons via an inside operator. To assuage our concerns, “Growth Hawk” Moore, as he calls himself, says repeatedly in the embedded video below that he believes in his own independence (though he says nothing about Fed independence, which must, therefore, be less important).
Am I distrustful of human sincerity or contemptuous or distrustful to think Moore is being embedded in the Fed to steer it by his own independent actions toward more economic stimulus throughout this laborious presidential election cycle? What incumbent president would want to do that? According to Trump’s endorsement, Moore is joining the Fed because he is “a very respected economist.” (Not by me. Moore is an economist from the trickle-down Heritage Foundation, and I find him as dizzy as Lunatic Larry.)
Federal Reserve nominee Stephen Moore called the Fed’s December interest-rate hike “a very substantial mistake” while adding that he looks forward to working with Chairman Jerome Powell to help ensure the U.S. economy continues to expand.Bloomberg
Sure he does because the plan he and Larry concocted certainly isn’t doing the trick! So, they need to get into the Fed to “help” make it happen there.
“I really believe we can have 3 to 4 percent growth for next five to six years.”
That’s what he said last time, and the Fed’s plans to keep raising rates and to start reducing its balance sheet were already widely known.
I’m glad, however, to hear all the president’s men declare the Fed’s monetary tightening was a “very substantial mistake.” I’ve said for years that the Fed will come to realize its tightening is a substantial mistake but will realize it too late. (Actually, the mistake was starting down the path to recovery that the Fed chose in the first place, but my point has been there is no exit that doesn’t crash this fake recovery, which is why I call it fake. It is dependent forever upon huge fiscal and monetary stimulus that is not sustainable, and THAT is what we are now seeing.)
With the president scurrying to insert his own tax planner into the Fed and Larry crying in public for the Fed to cut its interest rate target half a percentage point (a 20% reduction of the 2.5% rate), I’d say it sounds like they all believe the Fed learned too late and went too far.
Moore said that Powell and others members of the Fed board “should be thrown out for economic malpractice’’ after raising rates….
The Fed’s attempt to return to normal, not only killed its recovery (which was totally predictable) and cropped the stock market by 20% last fall, but it zapped all of the mojo out of the great Trump Tax Cuts. So, this is damage control by Team Trump — “substantial mistake” recovery time.
“I’m worried more on the deflation side right now than the inflation side,’’ [Moore] said
But, hold it, deflation increases the value of King Dollar, and Larry has always said he loves a strong dollar. So, why are they trying to create inflation with interest-rate reductions when that reduces the value of King Dollar?
These luminaries of irreconcilable interests and beliefs are our brilliant planners!
In my first Premium Post back in January, “2019 Economic Headwinds Look Like Storm of the Century,” I laid out sixteen major headwinds that would be howling against the economy this year. One of those was the government debt, which I said was about to skyrocket:
If you thought the government deficit exploded last year when taxes were cut and spending was increased, wait until you see how bad it looks this year…. Even in 2018, we saw GDP decline after the second quarter, so the idea that the stimulus effect of tax breaks will start to pay for those tax breaks is an idea that went bust after the second quarter. The fourth quarter is actually expected to come in no better than an average OBAMA quarter! “
And, so, the fourth quarter did come in no better than an average Obama quarter, and today we got to see just how bad the deficit did explode as a result. The US Treasury reported a total blow-out in the government deficit. The first four months of the fiscal year lit up the afterburners, adding a 77% boost to last year’s massive deficit.
The budget deficit for the first four months of the fiscal year, widened to $310 billion, a whopping 77% higher than the $175.7 billion reported for the same period last year, largely the result of the revenue hit from Trump’s tax cuts and the increase in government spending…. The jump in the deficit was despite the bump in customs duties, which almost doubled to about $24.5 billion this fiscal year from $12.6 billion a year ago, reflecting the Trump administration’s tariffs on Chinese imports.Zero Hedge
Here is a picture of just the revenue side of that equation:
Unfortunately, since receipts are set to decline even more in the coming months, the overall budget deficit is set to widen further…. Some policy makers and economists are flagging concern about the growing debt burden, saying it risks America’s credit quality among borrowers….
I also predicted in that first Premium Post that all of this expanding debt would create a chain reaction in the government’s interest payments:
That [deficit] … will snowball for the government as the rising interest costs also make each new round of bond issues larger and harder.
To which concern ZH reports
Finally, and perhaps most concerning, is that for the first four months of this fiscal year, interest payments on the U.S. national debt hit $192 billion … 10% more than in the same four-month period last year and the most interest ever paid in the first third of the fiscal year…. interest on U.S. public debt is on track to reach a record $575 billion this fiscal year, more than the entire budget deficit in FY 2014 … or FY 2015 … and equates to 2.7% of estimated GDP…. Expect interest on the debt to keep rising, especially if the Fed reverts to its tightening trajectory, and hit $1 trillion per year in a few years, making it one of the biggest spending categories, and on pace to surpass total US defense spending (roughly $950BN per year) in dollar terms in just a few years.
Or, as I similarly concluded in my January post,
At some point, whether this year or next, it becomes an all-out storm because there is almost certainly no way to diffuse the problem.
That didn’t take long.
[If anyone signs up this week as a supporter at the $5 level or above, I’m giving free access to that original article plus the last two Premium Posts here on the website so that you don’t miss any of what has already come. After that, a different password will be required that won’t work on the past articles.]
We are in the end time of an unprecedented era of financial expansion — the greatest expansion of the world’s money supply ever attempted, expansion of the Federal Reserve’s vast and unchecked powers far beyond what the Fed could do before the financial crisis, and super-sizing expansion of banks that were already way too big to fail.
I am calling this time in which we are now unwinding this monetary expansion the Great Recovery Rewind because I believe this attempt by the Federal Reserve and other central banks of the world to move us away from crisis banking is taking us right back into economic crisis. That is why this was the top peril listed in my Premier Post, “2019 Economic Headwinds Look Like Storm of the Century.” It is more potent in possible perils than all the trade tariffs in the world.
Even the CEO of one of the Fed’s largest member banks says no one knows what devastating effects the Fed’s unwinding of its balance sheet will cause. JP Morgan Chase’s Jamie Dimon warned that the Fed’s unwind is a massive experiment as untried as the quantitative easing that is being unwound.
“QE has never been done on this scale,” he said. “We cannot possibly know all of the effects of its reversal.”Financial Times
Jamie Dimon, the chairman and CEO of JPMorgan Chase, is one of many prominent figures in finance who warn that this reversal of direction could send stock prices plummeting and derail the U.S. economic expansion. “I don’t want to scare the public, but we’ve never had QE [before]. We’ve never had the reversal [before]. Regulations are different. Monetary transmission is different. Governments have borrowed too much debt, and people can panic when things change….”
Earlier this year, noted bond fund manager Bill Gross expressed his own concerns about the effect of this unwinding. Last year former Fed Chairman Alan Greenspan warned of a massive bond market bubble that will be deflated in the process….
Former U.S. Treasury Secretary Lawrence Summers says, “tightening involves real dangers and needs to be carried out with great care.”
According to Peter Bockvar, the chief investment officer (CIO) of … Bleakley Advisory Group, “I believe the market … is headed for a brick wall the deeper quantitative tightening gets.”
Ray Dalio, founder of hedge fund Bridgewater Associates, observes that quantitative tightening is bound to produce effects entirely opposite to those from quantitative easing, namely, “higher interest rates, wider credit spreads and very volatile market conditions.”Investopedia
Sounds like now.
Even the Fed Prez, himself, uses language that casts the Great Recovery Rewind as experimentation:
“We are looking carefully at that [the unwind’s impact on interest rates], and the truth is, we don’t know with any precision,” Fed Chairman Jerome Powell told reporters on Wednesday…. “Really, no one does. You can’t run experiments with one effect and not the other. We’re just going to have to be watching and learning. And, frankly, we don’t have to know today.”Bloomberg
However unprecedented the Great Recovery Rewind is, some outcomes can already be readily extrapolated; and they are playing out as I thought they would.
The withering economic effects of the Great Recovery Rewind
Rising reserve risks. You may recall the Fed pumped up its member bank reserves to make us all more secure in case of runs on banks as we almost saw during the financial crisis of 2007-2009. Now, as you’ll see below, the reserves in the accounts of member banks have been bleeding out faster than red ink in the last days of a failing Ponzi scheme.
For those banks to drain their reserves, the Fed has to reduce its reserve requirements; so the Fed has to be involved in this great reserve flush. It may be allowing this on the basis that it believes the world is more financially secure now, so it thinks the concern about runs on banks is long gone; but we all know from the last financial crisis that the world can become financially insecure in a small window of time, while the scars from an economic crash can endure a lifetime.
Compounding US government debt. One of the side-effects of the Fed sucking money out of the global monetary system is that the Fed used to roll over its holdings in US treasuries by purchasing more at an incredibly low interest rate for the US government. The government is now forced to sell a lot more treasuries in auctions to its primary dealers (member banks in the Federal Reserve System) without the Fed backstopping that by sucking them all up.
That presses the government to either pay higher interest on its treasuries to attract new buyers or raise less money with each $1,000 bond it issues. (Say, sell a $1,000 bond for $945, instead of $950.) Either results in higher yields on government bonds. (See: “BOND PRIMER: What is the difference between bond yield, bond interest, and bond price?“) That accelerates the government debt vortex.
Interest impact. Here’s another side effect that justifies calling this time the Great Recovery Rewind: Because government bonds are foundational in the credit market, higher yields on government bonds result in higher interest on all kinds of things, including home mortgages and auto loans. On large items, people shop payments, so those items are now less affordable. Therefore …
Housing Collapse 2.0 and Carmageddon. Rising interest is already taking us into another housing crisis and Carmageddon. I’ve been writing about these as the first major industries that will get the impact of the Fed’s Great Recovery Rewind. (My next article will show how deeply into a new housing crisis we have already fallen, and we’ve all heard about the number of automobile factories closing in the US.)
I think there is an insidious way rising mortgage interest is taking down the housing market besides just making houses more expensive. While mortgage applications are down by almost half due to rising interest, an even more interesting development is that the percentage of applications that are getting approved is also down by about half.
With total applications being down, you’d think banks would be inclined toward approving a higher percentage of the apps they get. So, why are they approving a lower percentage from an already much smaller stack of applicants? Losing half of your applicants and then cutting the percentage of those that get accepted in half is a 75% drop in approved loans! (See Business Insider‘s “Americans stopped buying homes in 2018, mortgage lenders are getting crushed, and an economic storm could be brewing.“)
Here is what I think is happening: Banks don’t usually issue loans to carry them until they are paid off. They issue them to resell them to other banks and investors. In terms of the loan resale market, loans are somewhat like bonds. In the same way that the bond you hold falls in resale value (price) when bond interest on other bonds is rising, fixed-interest loans a bank issues today will be worth less when it resells them in a month if interest rates are rising quickly. (Who’ll want to buy that loan when they can buy one that pays higher interest?)
Even if a bank plans to carry the loan itself, it might think it makes more sense to wait another month or two to loan out its money at an eighth-of-a-percent more interest for the next thirty years than to loan it out now if it is certain rates will rise that much in a short time. (Or it might just want to use its money to buy and hold those risk-free government bonds now that interest is getting interesting again!)
A full rewind back into the housing market collapse that began in 2007 could be readily foreseen as an obvious effect of the Fed’s tightening because 1) tightening after a period of sloppy easing triggered the last collapse; and 2) one of the reasons the Fed gave for buying government treasuries was to reduce mortgage interest and other long-term interest specifically to prop the housing market back up and stimulate the economy.
This is why I’ve repeatedly maintained that, when the props are pulled, we’ll fall back into the same recession. It took total denial to believe doing the opposite would not have the opposite effect. We have seen the opposite effect happening with long-term interest ever since the Fed began its balance-sheet unwind. Falling back into the same pit by winding back what we did to get out of the pit is why I call this the Great Recovery Rewind.
Hence, my prediction a couple years ago of a major stock market upset last January (as began in the last week of January) with a much worse one in the fall of 2018 when the Fed would hit full Recovery Rewind speed. (O.K., I also said something big would happen in the summer with stocks, and not much did, except the deFAANGing of the high-tech market that drove the bull market for a decade.) That’s why I was so certain of the timing of these stock market’s major plunges turns and of the summer start of a repeat crisis in housing and automobiles that certainly materialized.
Stock drop. This brings us to another inevitable side effect of the Federal Reserve’s Great Recovery Rewind — loss of stock values. Think about it: Another one of the main reasons the Fed eventually admitted for hoovering up government bonds was to save us from the 50% crash in stock values that happened between 2007 and 2009. It did this by taking interest so low on bonds that it pushed investors into riskier assets in order to make money. In the process, this created money in bank reserve accounts that banks could use to buy those riskier assets. That worked.
Naturally, reversing that flow would raise bond interest and correspondingly suck money back from stocks by providing safer assets that are starting to provide a profitable return again. How could it not? We witnessed that throughout 2018, seeing each major increase in the Fed’s Great Recovery Rewind speed immediately cause greater damage to stocks.
That is why I’ve always maintained the Fed cannot unwind without crashing its fake recovery. (Fake in that it’s not really a recovery if the patient has to stay on artificial life support forever. It’s just prolonged dying. It’s only true recovery when a patient becomes capable of living on his or her own.)
Another effect of all this, of course, has been the flattening of the yield curve, which typically presages a recession (as I wrote about in two recent articles titled, “Does Inverted Yield Curve Indicate Recession?” and “What is an inverted yield curve and what does it mean?“)
How could the Federal Reserve not see its great recovery rewinding?
When the Fed merely suggested it would begin tapering its purchase of bonds (quantitative easing) in 2013, it created what became known as the “Taper Tantrum,” a full-scale financial panic that I remember well because the Fed made this surprise announcement the day after my wife and I decided not to lock in the interest rate on our pending home purchase. Over the weekend, we saw our new interest rate rocket upward; so, we locked in as fast as we could on Monday and have forever paid a little more because of what felt like the fastest rise in mortgage rates even known to humankind.
Stock prices plummeted then, too, as the 10-year treasury note soared a full 100 basis points to 3% yields. The Taper Tantrum cost a lot of people a lot of money, and that was just an announcement many months out that the Fed would slowly begin to buy fewer additional treasuries, not that it would start rolling back the actual number it already held. The Fed was very careful this time to telegraph its unwound intentions more slowly and sedately.
So far, the Fed’s Great Recovery Rewind has certainly not been “as dull as watching paint dry,” as Fed Chair Janet Yellen assured us would be the case. The crisis in stocks grew so severe so quickly last fall when the Fed finally kicked its rewind up to it full projected speed that the Federal Reserve has already voiced possible capitulation to the market’s fear by stating it is taking its balance-sheet unwind off of autopilot after all.
Fed Chair Jerome Powell pivoted and said the Fed will be monitoring the stock market with a more patient approach in the Fed’s deliberate raising of interest targets. He’s even hinted the Fed may slow or pause its balance-sheet unwind. That contradicted his own auto-pilot statement in the fall when the Fed rose to full rewind velocity. Such an abrupt about-face makes it clear the Great Recovery Rewind sure ain’t paint drying.
While flattening of the yield curve happens before recessions, the recessions don’t occur until right after the Fed reverses policy and starts lowering interest rates again due to the problems a flat yield curve creates. With talk already of reducing rewind velocity, a move back to easing may not be far ahead.
I think the Fed actually sees the recession coming but can never say so because its mere change of a pronoun reverberates throughout markets. What would happen if it ever said it sees a recession developing? Why else would the Fed start easing if it didn’t see trouble coming? By the time the Fed returns to easing, a recession is already foaming at the mouth. So, either they see it coming but lie and say they don’t — as Ben Burn-the-banky famously said in the summer of 2008 — or they are blind in the area of their supposed expertise.
My reservations about reserves
If the Fed continues to tell banks they must hold a certain ratio in reserves-to-loans as the most liquid form of protection against runs, then liquidity is going to tighten up if reserves fall and interest rates are going to rise due to shorter supply of loans. That could also explain why banks are not approving as many loans because reserves are falling.
It appears that the Federal Reserve’s member banks are buying up US treasuries with their reserves and holding them, rather than reselling them, because their excess reserves are depleting rapidly. (Remember my comment above about how banks may not be issuing as many loans if treasuries with rising rates are looking attractive because they are seen as completely safe?)
It also appears the Fed is telling banks they have to maintain that ratio:
One reason why people may have underestimated bank demand for cash to meet the new rules is that Fed supervisors have been quietly telling banks they need more of it, according to William Nelson, chief economist at The Clearing House Association, a banking industry group.Bloomberg
The Fed’s Great Recovery Rewind is reducing bank reserves as follows:
By shrinking its balance sheet, the Fed reduces the amount of reserves in the financial system, therefore lowering the amount of money banks have to lend to consumers and businesses.FXCM
In a Premium Post that accompanies this post, I contacted the Federal Reserve and got a direct explanation of how the unwind actually draws down member bank reserves. (I was never satisfied with the answer that they are just evaporating the money, and they are not.) Even without that complex explanation, you can see how the balance sheet unwind is playing out in the following graphs from the Federal Reserve with the top graph showing the Fed’s own holdings and the bottom graph showing the reserves of all its member banks that are held in Federal Reserve banks:
First, the Federal Reserve stopped quantitative easing (flat part of the black and blue lines in the top graph), which meant the Fed stopped buying government treasuries (black line) and mortgage-backed securities (blue line) from its member banks, which it had been doing by creating deposits in the banks’ reserve accounts that they could lend against. Then you can see how, as the Fed began unwinding its balance sheet (were the black and blue lines in the top graph begin to fall), bank reserves (red line) plunged more.
Finally, you can see how bank reserves (red line in the bottom graph) have declined by almost half already during this time. Although Janet Yellen recently reminded us that “correlation is not causation,” I can tell you that my correspondence with a Fed economist in the Premium Post says there is direct correlation to what is happening in bank reserves.
What I cannot prove is motive, but I believe the Fed encouraged banks to start reducing their balance sheets in order to provide liquidity to the stock market and other markets during its tapering from QE and now during its final runoff of bonds. The member banks may even be holding government treasuries to protect the government from rising interest rates just as the Fed did. The consumption of bank reserves looks to me like a massive buffer for the government and the economy as trillions flow out of bank reserve accounts and into sopping up treasuries.
The Fed’s largest member banks are the primary dealers for Fed treasuries, which they buy in auctions. They transfer money from their reserves to the government treasury when they buy those treasuries. Now that the Federal Reserve is no longer buying those treasuries back from banks by creating new money in the bank’s reserves, their reserves are dropping, whether it is because the banks are choosing to hold the treasuries for the interest or because they cannot resell them all or because they are putting the money they make from selling treasuries to other uses. The bottom line is their reserves are plummeting in step with the Federal Reserve’s Great Recovery Rewind.
The Fed has told me it deletes money from the government’s bank account as treasuries mature because the Fed is the government’s banker. So, the Fed loses its treasury asset in the roll off, but it also wipes out an equal liability in the government’s reserve account as its payment from the government. Thus, both sides of the Fed’s balance sheet come down the same amount in order for the sheet to “balance.” (Deposit money is considered a liability by banks because they have to give that money back upon demand.)
That, however, would not deplete the nation’s money supply, except that the government has to replenish its bank account (or build it up in advance of the Fed writing it down), which it does by selling new treasuries to the Fed’s member banks that are the government’s treasury dealers. Those banks transfer money from their reserves to the government’s account at the Fed to pay for their treasuries.
I suspect the member banks’ purchases of the new treasuries the government has to issue to replenish its funds have been the mitigating factor that has kept government bond interest from soaring during the roll-off by providing a market as ready and large as the Fed, itself. However, if they buy and hold the treasuries, it depletes their reserves, which means they have less money to loan against in the general marketplace. That would be how money exits the monetary system.
Alternately, they may buy and resell the treasuries but not put the money from their treasury sales back into their reserve accounts because they now have better investments than the interest the Fed pays them on their excess reserves (“excess reserves” meaning those that are above what their Liquidity Coverage Ratio is requiring of them). Either way, the money from all those treasury sales the government is making is not going back into the the member banks’ reserve accounts.
If the banks don’t soak up those treasuries by holding them as their own assets, they resell them on the open market. That would likely drive the government’s financing costs up in order to find enough buyers. That can happen in the form of higher interest on the open market or a lower bond price (as described above). That would feed back through the system to what the primary dealer banks will expect in government auctions in order to assure a retail profit on the treasuries.
While I don’t have all the facts about what banks are doing internally, it is obvious from the graphs above that the monetary is tightening up in direct correspondence with the termination of QE and its unwinding. We know banks are approving a smaller percentage of a smaller pile of loan applications, and we know their reserves have plummeted, which means they have less money to loan against and could easily explain why they are approving far fewer loans.
We are seeing declines in housing prices, declines in the auto industry leading to closing factories, increases in the government debt due to rising interest (in addition to the increases that happened due to declining revenue and the increases that are due to rising spending). The rise in interest that is happening due the Fed’s Great Recovery Rewind will also mean a decrease in stock buybacks just as the extra cash from the Trump-Tax-Cuts repatriation (a one-time occurrence in 2018) is used up so that corporations have to return funding buybacks with credit if they’re going to do them. Stock buybacks have been one of the leading drivers in the stock market’s climb over the past decade. So, all of this is a complex and toxic brew of chemical reactions.
Some have opined that the Federal Reserve’s Great Recovery Rewind will not be as potent as its initial easing because it created new money at the rate of $80 billion a month and is only backing out of that at the rate of $50 billion a month. However, it could actually become more intense. Consider that the Fed was creating $80 billion a year when the economy was shrinking and needed a push. So, it was pushing against the drainage. Now the Fed is subtracting $50 billion a year just as the economy has started shrinking again and still needs a push. So, the unwind pulling things down with the drain.
The Fed is also tightening as global trade is tightening and as tariffs are going up, making things more expensive to consumers. It’s also doing something that makes a lot of people feel unsettled, rather than something that makes them feel happier. No one is likely to enjoy unwinding as much as they enjoyed economic stimulus. The Fed is unwinding in an unforgiving environment that might be more reactive to withdrawal than a stifled economy is to stimulus.
For Premier Post Patrons who want to drill deeper into the Great Recovery Rewind, here is some deeper content that explains how the Great Recovery Rewind works, how it impacts interest rates, and how it may be monetizing the US government debt:
2018 was the year Wall Street was wrong about everything. You can trust your stock broker if you want, but 2018 doesn’t give much confidence in her ability to stop talking her book and start talking straight. However, this overview of global economic headwinds — greater in number and more severe than I can ever recall — should give you a good feel for what the global economy has in store. This is not so much an article of 2019 economic predictions as an article that lays out the many forces that are already in play and that show every likelihood of continuing to grow in severity.
As a subscriber to The Great Recession Blog, you are among the only ones who will get this broad overview. I probably won’t be writing many subscriber-only articles because my goal is to help as many as people as possible and to build resistance against the establishment; but I will try to make subscriber-only articles premium articles that are worth your extra support so you’ll feel you got a big cut of meat while the rest are dining on the daily cereal.
The Fed’s Great Recovery Rewind tightens to breaking point: The ultimate downdraft for the entire global economy is the Fed’s balance-sheet unwind. If you get that, you’re ahead of the Fed because they clearly don’t, and neither do market analysts or most economists. The Great Rewind is far more significant than the Fed’s targeted interest rates, which really have just been playing catch up to what the zapping out of existence of fiat money is doing.
We saw last January that the market plummeted when the Fed doubled down on the rate at which it is rewinding its recovery accomplishments, and then we saw the market immediately fall to pieces in the fall when the Fed finally amped up to full rewind velocity. This retraction of money from the monetary system affects some industries quite severely and not just stock prices or bond prices.
As money disappears from the monetary system, we see those pumped-up bank reserves insidiously collapsing, as shown in the chart below. These reserves were supposed to be our insurance against another banking blowout like the last one. They are down now by a trillion dollars since their high in the fall of 2014.
That decline makes sense to me because the Fed originally pumped up those reserves when it was buying bonds from banks in what it called quantitative easing. This how the money supply was inflated. The Fed is not allowed to buy its bonds directly from the US government, so it asked banks to buy them and then bought them from the banks by creating new money in their reserve accounts. Because banks can create loans out of thin air at a 70:1 ratio (or whatever ratio the Fed sets), the new money is hugely multiplied as new loans are issued. So, I would think now that they are rolling the bonds they bought off their balance sheet, they would have to suck money out of the bank reserves that they pumped up in order to meaningfully take money out of the system and to properly balance their books.
When did stocks take their first plunge? End of January 2018. When did the combined balance sheets of central banks peak and start to decline? End of January. When did stocks go totally crazy? When the Fed’s balance-sheet unwind hit full speed in the fall.
Morgan Stanley’s chief US equity strategist Michael Wilson argued that the inexorable rise in interest rates from September into the beginning of October put US equities in overvalued territory for the first time since January.Zero Hedge
Note the connection: stocks drop in January because of rise in bond interest rates that happened as soon as the Fed started casting off bonds; stocks next big drop comes in October after another big rise in bond interest rates. This is called “equity-risk premium.” The more low-risk bonds offer in yield, the more stocks have to offer as a premium above bonds in order to attract buyers. It is not just this competition for investors that causes money to move from stocks to bonds but concern that rising interest rates will diminish future corporate profit margins by raising the cost of doing business. Lower margins equal lower earnings per share.
If the Fed’s monetary policy is not the central cause of the stock market’s demise, why did everyone from Crazy Cramer to Donald J. Trump start crying for the Fed to take its foot off the brake? Their focus, however, has been on the Fed’s stated interest targets, but the market soared through a whole year of interest-rate target increases. So, it’s not the Fed’s interest target that is the problem. The stock market didn’t fall until the combined balance sheets of the Fed, ECB and BoJ began to decline in January and then again when the Fed reached full Rewind pitch in the fall. I’ve always said, this is where the big action will be; and because everyone is more focused on the Fed’s interest rate policy, the Rewind is likely to go too far.
Taking Stock in the Year of the Bear: The stock markets of this world are only bits and pieces of that vast economic landscape over which these dry, cold winds are starting to howl, but what happens in the markets has a big impact on the overall economy, so the two often are conflated. 2018 closed as the worst year in stocks since the Great Recession with the worst December since the Great Depression. That left 2019 starting with the S&P sitting on the bear barrier and with the Nasdaq and Russel 2000 decidedly in bear country. This has transformed the market’s decadal dynamics from “buy the dip” to “sell the rip.”
While this article is about headwinds that face the economy as a whole, the stock market, itself, is already positioned to be a source of major turmoil to the general economy. Twelve-trillion dollars in global stock value has evaporated, leaving the world to feel twelve-trillion dollars less wealthy. That effects the whole economy. We are at a tipping point where any further erosion in stocks will start to damage banks, which have been hit the hardest so far, and other companies to where dominoes start to fall.
Up-and-down chop is making the market feel woozy, and the chop is being made worse by mysterious algorithms with their occulted self-taught formulae running the trade. (Even the original programmers say they do not know how their own algorithms now look because of the algo’s self-programming ability.) Algos, which include high-frequency traders, run a higher risk of volatility exploding at any unknown minute into flash crashes. Set against rapidly changing reality in the economic landscape, these algo’s become even more unpredictable as to how they will rewrite themselves.
This bear cub, born out of the worst December since 1931, is already a storm rocking the economy. As market analysts struggle to figure out why the stock market is falling when economic statistics, as they view them, have been solid, you know they’re looking in the wrong direction. The answer is bond interest. Bonds have become a great vacuum, sucking money out of stocks. So, let’s move on to bonds:
In stocks and bondage: Right now, capital flight from stocks is saving the bond market by helping to pull yields back down. This creates a seesawing effect between stocks and bonds that I have said will be the new dynamic for 2019. Nevertheless, a shuddering mysterious tremor hit the bond market during the New Year’s Eve festivities. Overnight bond repo yields skyrocketed from 2.5% to 6.125%, the sharpest increase since 2001. Some have suggested this was a foreshock of deep bank liquidity problems that are starting to surface. One securities trader noted that year-end funding pressure should have created a 50-basis-points rise, but this was a 350-basis-points rise. The spike left mouths hanging open. It suggested banks suddenly had to raise cold cash.
On the same day, the yield curve on one-year bonds over two-year bonds suddenly plunged dramatically and inverted, hitting its lowest level since 2008. The yield curve on ones over sevens also inverted. In fact, every yield curve up to 8-year bonds has inverted now. Inversion of the yield curve — especially if it hits the 10-year level — is considered the strongest evidence that a recession lurks on the near to medium event horizon.
The unprecedented bond interest spike is a hint that bond yields could have more surprising upward moves in store. They are, of course, being tamped down right now due to money fleeing stocks. So the big bond bust probably won’t happen until the stock market is depleted of capital. (If you buy and hold bonds until maturity, rising interest rates are a good thing; but if you buy bonds to hold them and then resell them when their price goes up; rising yields means falling prices, which can leave bond funds in trouble as the value of their holdings drop. You don’t own bonds in your 401K. You own membership in a bond fund; so there goes your retirement fund if bond funds go down and they were your safe-haven strategy.)
Collateral collision course: The value of stocks and bonds deteriorated enough in December that we are going to start seeing collateral feedback loops in markets where those assets were pledged as collateral. The drop in collateral value forces all kinds of snowballing cycles, such as margin calls in the stock market. Rushed selling to match leveraged positions with declining collateral pushes prices down more, which creates more margin calls, etc. Bank collateral requirements on their derivatives (those nasty things that were central to our last collapse) are reduced to the extent they buy government bonds. The lowering of government bond prices as yields rise reduces the value of those bank reserve assets, requiring the banks to add to their collateral or to sell their derivatives into a falling market. The need to raise collateral can force banks to cut dividends or sell stock into what is now a falling financial market, pushing the value of stocks down further.
Credit crisis: There are so many ways in which a credit crisis is developing of such magnitude that I will be dedicating a full article soon to that topic. This developing headwind is felt particularly in the bond and collateral problems mentioned above. This change in how robust bank reserves are as their holdings in bonds devalue creates fear between banks, reducing their willingness to lend to each other, which tightens up the credit market for the whole economy because money stops moving as freely. At the same time, leveraged loans (meaning loans extended to companies or individuals who already have taken out a lot of credit or who have a poor credit history) are showing signs of crumbling in mass, creating a high default risk.
This is more in the realm of prediction than current headwind, but this gentle wind looks likely to whip up later in the year. The vital note here is that credit of every kind is tightening as central bank money supply shrinks. We’ve seen sudden spasms in bond rates. Recently, major loan sales have failed that banks usually wouldn’t have had a problem with. When banks cannot sell large loans, they are less inclined to make them, and they have to drop the price at which they are offering those loans. The issuance of new high-yield bonds also ground to a near halt in December. That hasn’t happened since November of 2008. Because the world is built on debt-based monetary systems, a credit seizure is everything; and we can now see dust falling out of the cracks in these columns that support our economy.
US Banks gone bonkers: Twice in two weeks, the government yelled out, “The banks are fine; don’t worry,” which caused everyone to worry about why the government felt the need to make such proclamations. The first unintentional alarm was rung loudly by Secretary of the Treasury Steven Mnuchin, who created a Christmas Eve Market Masacre; and the second alarm was accidentally rung at the start of the new year by the Office of the Comptroller of the Currency, which announced in an unanticipated report that the U.S. banking system has “strong capital and liquidity” and is “well-positioned” to navigate more adverse market conditions.” He added that “OCC expects supervised institutions to understand exposures within their portfolios and take appropriate action to mitigate any risks…. Hubbard also explained that possible risks could include adverse effects on liquidity, pricing, or terms for corporate loans and bonds.” (Zero Hedge) Again, no one was anticipating a report from him, so people wondered why this came pouring out of the blue.
Maybe the severity of the crash in bank stocks during the fourth quarter of 2018 into such a deep pit caused our financial engineers to fear we might all be fearing. Bank stocks fell about 30-40%. It seems the Treasurer and OCC were yelling, “Nothing to see here, folks. Move along!” That always makes me want to stop and look down into the sinkhole to see how deep it is.
Apparently, all of that still wasn’t enough alarm, so the next trading day, the FDIC joined the chorus and spooked stocks even further down by announcing, again unexpectedly, that they had “no concerns” because banks are “superbly capitalized.” (Never mind that steep decline in the Fed’s graph above of member bank reserves.) “Nothing that happened in December gave us concern,” the FDIC continued. It seems we are prepared for whatever is happening, so I wouldn’t worry about it. The same people that had it all under control in 2007 and 2008 have it all under control.
Eurozoning out: This past year of the Fed’s Great Recovery Rewind has been made a little easier by the fact that the European Central Bank was still printing money (still engaged in quantitative easing). That, we have been assured, just ended at the close of 2018. While ECB President Draghi is not reducing his balance sheet like the Fed, the end of new free money takes more lift out of the global economy, stock markets and bond markets in particular. Some of the ECBs new free money was making its way into US markets as a safer refuge than the Eurozone (best horse in the glue factory). Unless Draghi goes back on his word, fewer European bonds being soaked up by the ECB will mean European bond yields tend to rise to find other buyers, which will put additional upward pressure on the bond yields of other nations in order to complete in the global bond market.
We just saw France trying to exceed the budget deficit ceiling required by Europe in order to placate flaming Parisians. Allowing that would mean Italy, Spain, and Greece get the same treatment. Not allowing it could create a rift between the Eurozone superpowers — the French and the always austere Germans. Brexit, Grexit, Spexit and Italeave are always swirling around like autumn winds caught in eddies that can’t make up their mind which way to blow the leaves. No one knows if or how any of those pieces will fall, but the potential negative energy from Europe never stops building as the number of swirling leaves grows, making it a near certainty that the European Community weighs negatively on the global economy this year.
I have always believed the EU is destined to failure because there is far less commonality holding it together than holds the states of the United States together, while there are infinitely more differences wedging those European states apart. Even in the US, that glue is cracking and the wedging is intensifying. Slowing growth in Europe (and China) can also cause significant US dollar appreciation, which further suppresses US exports.
Declining global economies: Synchronized growth skidded to a halt near the start of 2018, and 2019 looks much worse. China’s PMI just dropped below the 50-point neutral level. Europe’s remains below, and the US got one blip of great GDP growth in the 2nd quarter of 2018 with the third quarter down about a point, and fourth quarter looking like it will come in at least a point below that. US manufacturing PMI slipped to a fifteen-month low in December. “Everybody is terrified that this is a sign of a global slowdown,” Art Cashin, director of floor operations at UBS, told CNBC on the first trading day of the new year. Both the Richmond Fed and Dallas Fed business surveys plunged last month. The Richmond Fed’s manufacturing index saw shipments plummet to their lowest since 2009, local business conditions hit their lowest point on record, while new order volume and backorder backlogs both fell and inventory started stacking up, which means pressure into the year. The composite of this survey took its biggest drop in history:
Carmageddon and the Retail Apocalypse: GM and Ford have already announced factory layoffs due to the decline in auto sales that was long forecasted here. It seems like every quarter Sears announces more store closures. Problems in these two economic sectors, which along with housing, led the way into the present crash, are not abating. In fact, tariffs are making pressure in both auto sales and retail worse. While the jobs report in December was a burst of good news that might seem to belie the idea of looming layoffs, the unreported part of that news was that most of December’s apparent increase came due to downward revision that happened in previous monthly statistics! The rest was likely due to “seasonal adjustments,” which I’ve dug into in the past to show how jobs are adjusted way up for December “due to extreme cold” and then go way up again the next December “due to unseasonable warmth.” Apparently there is only one perfect temperature for December, which is never the temperature of December Present!
Trump Trade: The Trump Tariffs can swing either way in terms of what they will do to markets and the economy in 2019, depending on how they are resolved. For now they are a lid on the stock market and on the expansion of global sales markets. Because they have struck a lot of fear into the stock market and into corporate business strategies, their resolution would likely cause the stock market to briefly boil over … until all the other problems discussed in this article regained control over the market’s mind. It looks like resolution could take awhile, though, and will most likely end, as did Trump’s European trade war, with paltry promises of minor concessions that have yet to materialize (and may never materialize as the major players find ways to stall through Trump’s next two years). U.S. Trade Representative Robert Lighthizer says he wants to prevent President Donald Trump from accepting “empty promises” from China, and he has warned Trump that more tariffs may be needed to get to meaningful negotiations. In the end, this tariff turmoil will probably have yielded us little balm for our bruises; but I would anticipate resolution of this strong headwind sometime this year to cause some temporary lift.
Delayed tariff impact via GDP: Irrespective of what happens in the future with tariffs, I noted last summer that the main reason US GDP rose in the second quarter was that industries all over the US saw sales jump in order to close before tariffs hit. Everyone did as much buying and warehousing as they could to stock up ahead of tariffs. That brought future economic activity forward. I projected GDP would decline in the third quarter but still remain fairly high due to one pre-tariff month coming in that quarter. And that’s what it did, dropping from the 4s to the 3s. With all pre-tariff sales completed before the 4th quarter, I project that quarter will come in down in the 2s. From there, we will now pay in the first quarter of 2019 when it is reported later in the year with even more shrinkage in GDP growth down into the 1s, due to a temporary decline in purchases as we burn through the overstock created last year as well as due to all the headwinds above taking their toll. GDP is a number a lot of people watch more than they should because is highly rigged, but there is limit to how much they can rig it and be believable, and because it is the most lagging of all economic indicators, telling us only where we were months ago. Nevertheless, it is watched by many, so the number all by itself can create its own feedback loop into stock markets and the general economy. People change how they plan if it looks like we’re going into recession (where GDP growth turns negative; i.e. GDP recedes).
Housing over the hump: We all know the American economy has long been designed for housing growth to be its major driver. Nearly two years ago, I said the Fed’s balance-sheet unwind, which primarily impacts long-term interest rates, would drive down the housing market. I’ll have a full article on housing soon, but suffice it to say in this headwinds overview that we saw a housing decline begin in 2018, and it will grow worse in 2019 as mortgage rates rise even further. New housing feeds real-estate agents, mortgage brokers, bankers, developers, road crews, carpenters, landscapers, drywall installers, painters, plumbers, electricians, furniture salesman, cabinetmakers, glazers, appliance manufacturers, furnace manufacturers, lumber mills and loggers, the grocery stores, restaurants and gas stations that supply them all. You get the point, and that is why we build our economy around it. It’s why so many people want immigrants (partly for cheap labor and partly because they will need more housing). That is a minuscule part of the total list of people who make money off of new housing and off of remodeling old housing. So, with housing now clearly going down, the economic impact comes down to simple math: higher interest equals higher payments in a land of flat wages, which means fewer buyers and/or lower prices to get the payments back down. Housing sales and prices are falling now in Australia and Canada, too.
China Syndrome: (Bear in mind that the following is just about current headwinds that are building from China and not risks on the event horizon, such as military conflict in the South China Sea or over Taiwan.) The People’s Bank of China has warned the Chinese people not to buy housing because there is no longer any money to be made due to extravagant prices and high vacancy rates. (There are only 50,000,000 (yes, million) vacant Chinese apartments right now. That’s 22% of China’s urban housing that is unoccupied, double the US, which is second-highest in the world. However, 75% of Chinese wealth is held in housing, as opposed to 28% in the US. So, when you have millions of Chinese underwater on their condos and fifty-million vacant homes, it does dent the world’s second-largest economy. Remember, the Chinese economy helped save the rest of the declining world through the Great Recession. That doesn’t look likely this time.
For the first time since 2011, other Chinese economic data, such as manufacturing surveys, retail sales indicators, factory output, investment, hiring, and consumption are way down — both year on year and quarter on quarter. China’s individual, corporate and government debt are also all much higher than they’ve ever been, and China no longer runs a surplus budget, leaving China less room for new stimulus. Moreover, the Law of Diminishing returns has insidiously crept up on China to where it now takes twice as much capital investment to create a given amount of GDP increase than it did 2007.
If you’re not sure how much China matters, just remember the times the US market and other world markets plunged because Chinese markets plunged. And then think of how Apple’s stock tanked 10% ($100,000,000,000) when it announced iPhone sales in China would be down in 2019. The world is still connected, so China is a hard-blowing threat already to the rest of the global economy. Check the graph out below to see where we were the last two times China’s GDP growth was this low (not proving cause, but certainly correlation with major downturns):
Oiled up or oiled down: I’m not going to venture a prediction on where oil prices are headed, but will just note that they currently have entered a troubling level and show little sign of rising. Low oil prices are customarily thought to be good for the economy because cheap oil greases the economic skids by making energy and transportation and product ingredients less expensive for business while increasing available consumer income because consumers are paying less for auto fuel and heating fuel and, in some areas, electricity. However, we saw in 2016 that prices below $50 a barrel cause companies in the oil industry to collapse and jobs to be lost in those regions and stocks in all those companies to plummet and their bankers to shudder. We’ve just entered that danger zone where low oil can cause the economic engine to seize up. One has to also consider the cause of falling oil prices. This time around it is not due to OPEC over-production in an attempt to shut out US shale drillers, as it was last time, but due to declining demand; so the prices are indicative of what is already happening to the general economy, which will begin to show up in GDP numbers.
A taxing problem: The repatriation of years of foreign corporate profits at lower tax rates was a one-year program that helped prop up the stock market after its January plunge in 2018 because some of the big tax advantages were front loaded into the Trump Tax Cuts with the express purpose of getting as much economic acceleration from the tax cuts into the first year as possible. That accelerant is over! Instead of being used to build stronger companies, the repatriated cash was largely used to fuel record stock buybacks after a long period of prior record stock buybacks and to inflate dividends.
Yet, those record buybacks, impactful as buybacks are to corporate earnings per share, were not able to lift the market last year. They were not even able to keep the market from falling. So, how much worse will stocks do this year as the fuel for buybacks (low interest and repatriated cash) all comes to an end? There is probably still enough repatriated cash in the coffers from last year for some buybacks, but you can certainly expect fewer than we saw in 2018.
Moreover, with stock prices falling badly, CEOs now have to return to their board rooms to explain why they used up vast sums of corporate cash just to make shareholders poorer because now they have nothing to show for it. Whereas, if they had spent the cash on R&D or capital improvements or market expansion, the investors would have something extra in value for all the money spent; but the money vaporized as quickly as stock values fell. Pretty sure that is going to make it hard to convince boards to do more of same.
We saw the same thing happen leading into and then during the last financial crisis. Corporations raised their stock values exponentially with buybacks right before the big crash only to watch it all evaporate and then wound up selling stocks into a plunging market. Maybe it turns out the CEOs are the dumb money unless they, at least, got all their own money out during the buyback period by using company cash to buy their own stocks (which I reported about a year ago many were doing). Pretty sure all of that is ending.
Government debt bomb: If you thought the government deficit exploded last year when taxes were cut and spending was increased, wait until you see how bad it looks this year. Foreign-profit repatriation dumped huge stockpiles of cash into corporate tax payments last year. While it got taxed at a lowered rate, it still got taxed. Some of that will remain to be paid in the first quarter of this year, but then that is over! Even in 2018, we saw GDP decline after the second quarter, so the idea that the stimulus effect of tax breaks will start to pay for those tax breaks is an idea that went bust after the second quarter. The fourth quarter is actually expected to come in no better than an average OBAMA quarter!
The now-skyrocketing government deficit from tax cuts and spending increases forces more government bond issues at a time as the Fed’s Great Recovery Rewind forces the government to refinance more of its old maturing bonds. That becomes double pressure on bond interest rates this year, which will snowball for the government as the rising interest costs also make each new round of bond issues larger and harder. The generally rising rates on government bonds (allowing for the seesaw effect mentioned earlier) mean financing costs for corporations will rise this year because their bonds have to compete against safer government bonds.
This time bomb is exploding in slow motion. We are now on a course of trillion-dollar annual deficits as far as the eye can see in an environment pressuring interest up. Europe’s sovereign debt bombs and Japan’s and China’s are all worse. Some of this is just risk and not actual headwinds yet, but the breeze is already stirring your hair. At some point, whether this year or next, it becomes an all-out storm because there is almost certainly no way to diffuse the problem.
Social disruption and government stalemate: Why is there no way to diffuse the government debt-bomb problem … at least, in the US? The animosity over the 1% versus all the rest of us has pressured the US into intensely polarized social discord between Left and Right. With congress now divided again, and half of congress hating Donald Trump viscerally, this discord makes government less able to do anything about anything. Gridlock is guaranteed.
The battle between fake news and false presidential statements is also likely to get worse — and more polarizing to audiences — as Trump comes under increasing fire now that Democrats have resumed a little control. Now that Trump has committed the unpardonable mistake of being at war with the military brass, expect more heat. Those guys fight back, and they’ve got the ammunition to do it. Again, this article isn’t about predictions but actual headwinds; so suffice it to say this current headwind of constant disruptions shows only signs of intensifying. Markets don’t like disruptions.
Getting Trumpled underfoot: It all goes without saying, but Trump’s troubles will be a headwind for the economy, especially the stock market, which hates surprises; so I have to say it: Trump loves surprises. Trump loves headlines. Trump loves reality T.V., and Trump loves toying with the press. Trump loves attention, and he’s going to get plenty of it because Trump is in trouble … everywhere. His daughter, son and son-in-law may all be indicted on minor charges by Mueller, whether deserved or not. While I doubt Mueller has anything on Trump regarding Russian collaboration against the Democrats, he has been on a two-year fishing trip that has probably turned up some notable tax problems for the Old Man, too. Trump will fight back like the elder lion against his rival. So, lots of political turmoil is going to be swirling around this year.
The Democrats can finally impeach Trump, even if they cannot successfully bring him to trial, and they probably will if only to please their base, but also just to disable Trump as much as they can. Subpoenas will be flying like paper airplanes between the Capitol building and the White House. As James Howard Kunstler calls it, this will be the year of Investi-Gate.
So, get ready to get Trumped at every turn. In addition to Mueller finally unloading whatever he has on Trump, the 2020 presidential race locks and loads this year. The loose cannon in the White House is going to be unmuzzled and bouncing off the White House walls in a red-hot frenzy every day. I can’t see how that makes for a risk-taking climate in stocks or in business.
I don’t think the Trump Troubles are priced into the market yet because no one has any idea how they are all going to play out, except as some sort of generalized political mess. They will get priced in as each one crystalizes into view. The mayhem surrounding Trump as he fights back also means few in government will be paying attention to steering the ship until the tearing of icebergs against the hull gets everyone back to paying attention. We’ve long seen that party politics trumps patriotism on both sides.
In conclusion: Some of those headwinds that are already roaring could die down, as can happen in any year; but they do not appear likely to, and there are so many already blowing from all directions that this year promises turmoil at every turn. Brace yourself.
If you found this article helpful, please consider leaving a few positive references to it in comments elsewhere on the site when appropriate that will encourage others to sign up at this level. My premium articles will likely be the more comprehensive ones like this, while others on the site will be shorter takes on one specific topic. These take more time digest, so they give you some meat to chew on for awhile; but they also hopefully give you a much more comprehensive picture than the sound-byte size that is common today. Whether they come quarterly or monthly will depend on how often broader or deeper articles seem necessary.
I bet my blog on a stock market crash in the early summer and on global economic cracks large enough by summer that no one could reasonably deny the economy is in a serious downturn. I have both lost and won that bet as I will lay out here. Read the remainder of this entry »
While glowing presidential proclamations about US GDP growth last week did nothing to prevent the stock market from rushing headlong over the cusps of a FAANG stock ledge, the market is taking a breather today. So, let’s take a breather and go back and look at why that GDP report had no bite. Read the remainder of this entry »
Is the US economy collapsing into the Epocalypse that I predicted would start to show up as large cracks in the economy last summer? The initial damage that I forecast for last summer was in auto sales, housing sales, and the ruin of retail stores and shopping malls along with their satellite restaurants. These initial breakups, I said, would likely also include a stock market crash a little later … likely by January, 2018, or, in the very least, by this summer.
Those things that I set out for last summer did begin to materialize on schedule, but autos and homes got a big temporary lift from the hurricanes and wild fires that destroyed hundreds of thousands of each. I also predicted that reprieve as soon as those events took place. I didn’t wait until after the fact as a justification of the change but stated it before any statistics showed the reprieve was happening and before other economists came out saying such a reprieve would happen (though many economists now concur). You can find all of that in last year’s articles. I also indicated then how long that temporary reprieve would last — to the start of this year for autos and probably until late summer for housing. (I’ll come back to those in my next article.)
Fed up with the Fed
In this article, I want to lay out the tidal change in stocks and bonds that is happening exactly on the slower schedule for decline that I gave for those markets. That, by the way, was a prediction that should have been easy for any economist. It is to the utter shame of nearly all economists and stock and bond gurus that the shift that is now appearing everywhere was not in their forecasts. It is even more to their shame that so many still cannot see what is happening even as it now takes place right under them; but we’ve seen that specialized ineptitude in the past.
In fact, I started writing this blog because economists seem uniquely to be the solitary class of experts who understand the basics of their own field far less than anyone in any other field. To their monumental discredit, almost none of them saw the Great Recession coming. The worst of them all, however, was one who was highly regarded for his analysis of how the Great Recession’s predecessor, the Great Depression, came into being. This is the same man who, as the worst possible answer to the Great Recession, gave us the Great Repression of interest rates all over the globe, believing he could engineer our way out of a debt-caused problem by enticing everyone to a lot more debt.
It was just as easy during those recent years when all economists must have been on hallucinogens as it is now to recognize that a global crash of enormous magnitude was imminent. Nevertheless, two heads of our nation’s central bankers (one who was CEO of the central bank at that time and one who was about to be) stood knee-deep in the Great Recession and pronounced there was no recession anywhere in sight! That was one of the most bombastic claims ever made — given that it turned out to be one of the greatest recessions in US history — one that plagues us still. The same highly praised, overpaid economists who missed that one while standing in it are missing the present one, even as they create it.
Because of his astute understanding of the formation of great economic abysses, the younger one of the two (Ben Burn-the-banky) was handed the reins of our economic system by the other (Alan Greenspent). Why national government would readily approve handing the reins over to a blind man after the hindsight of his total blindness was a clear fact is something that would be utterly beyond me to comprehend, except that I readily affirm that is how government and crony systems routinely operate.
So, do not be surprised that none of our nation’s central banksters see what the fallout of their present actions, and do not take their misguided statements about the strength of the economy with any more seriousness than their august opinions deserved in 2008. You have to look to those with no economic training, such as myself (or just look to your own gut-level understanding) to find people who can see the obvious in the face of a multitude of professionals who deny the obvious and odious facts that already engulf us.
To that end, I am going to start this short series about the death throes of the Fed’s recovery by looking at the sea-change in stocks and bonds simply because this was the most self-evident pair of events I predicted, which many still argue with even as they are now standing ankle-deep in the problem’s formation. Most of all, I present it first because it is the area of economic destruction that is directly related to the Fed’s earlier interference in the economy and its new unwind from said interference.
Stocks in bondage
First, let’s look at the stock market. Here is where the stock market was going when I made my prediction last spring as well as where it went as soon as January, 2018, came and where it is headed still:
Pretty clear to see a complete change here in the market’s dynamics and its direction. which exactly matches what I predicted on this blog … even to what I gave as the mostly likely date for the change’s beginning. The stock market rally broke its long-term trend at the end of January. This timed out precisely with the Federal Reserve’s increase in quantitative tightening, which is what I said would break the market when January came in the first place. (The Fed did its January tightening in the final week of the month where the trend reverses almost symmetrically to the hyped enthusiasm of the year before.)
I had said that the US stock market could crash in the fall of 2017 when the Fed’s tightening was scheduled to begin, but that I expected the break to come in January because the Fed’s initial tightening in the fall would be fairly insignificant. That amount would double in January and start to become a significant factor working against the stock market.
I expected, then, that that end of the market’s glory days would not be recognized (or, at least, admitted) by many until this coming summer by which time the Fed’s unwind will begin happening at a furious pace, so that market troubles will be worse than they are now and the trend long enough that no one will be left to deny the change. So, I’ve said all along to anticipate a major drop in January with worse to come by summer. (That doesn’t mean the new down-trend will be a clean line. I have said to expect some reprieve — even in the trend — as that is how major crashes have played out in the past. Remember, for example, that April is typically a good month for stocks, whereas late May through October … not so much.)
The stock-market plunge that ran from the end of January into February included two of the largest point falls in the Dow’s long history, no insignificant event. In fact, it was one of the most rapid corrections from a record high in Dow history. More to its significance — now that we have a little time frame for assessing the damage — is that the market clearly has not recovered — evidence that this was a major market shift point; and there is certainly more of that to come because the amount of tightening is set to increase by another 50% at the end of this month, which I expect will increase the market’s volatility once again, exerting even more downward pressure.
The precise correspondence so far between the Fed’s unwind and the market’s troubles is similar to the market crash that I predicted would happen in 2014 when the Fed said it would stop quantitative easing. I said then that the market would break in October when QE stopped, and here is what happened:
While the market plunge that fall was great, it didn’t quite add up to what many would call a “crash,”as I had said would happen. That’s because the Fed continued a small amount of QE even after it said it would stop by reinvesting its profits in more government bonds and continuing to roll over all the bonds it held. What was extremely significant, however, was that the market clearly broke in a way that it did not recover from for an entire two years. I declared the bull market dead because I don’t think trading sideways and getting NOWHERE for two years can justly be called a “bull market.”
Even though technical definitions say a bull trend hasn’t died unless it is replaced by a bear trend; but I call sideways for two years more bearish than bullish. If you got out of the stock market entirely in the fall of 2014, you could have re-entered the market exactly where you jumped out two years later and missed nothing but a roller-coaster ride in between. That’s a dead bull. (Of course, some investors are great at trading the volatile ups and down and would do well in that secular bear market, but clearly it was a completely different market from the years of almost constant, guaranteed, and serenely smooth rises that preceded that period.)
The death of the bull began exactly with the official termination of QE and continued all the way to the Trump Rally, which finally changed the game again … but only in a final burst of irrational exuberance over a fantasy about the salvation tax cuts will bring. That was a completely new rally because it no longer had anything to do with the Fed, which was driving he Obama bull. It was built on the hopes, which I said were false at the time, that Trump’s tax cuts would deliver great gains for the market. Clearly those hopes have failed so far to materialize now that the tax cuts are the new reality and have had nearly a third of a year to show themselves true. While some short-term reprieve may yet come, those cuts are ultimately as self-defeating as the Fed’s own efforts to restore the nation by expanding debt (for that is exactly what the tax cuts are attempting to do, too — only this time by expanding government debt).
The Trump bull shows no signs of getting a second wind because the trend has now been down, down, down (for as many months as I just gave “downs”); and many new concerns like trade wars and military wars are stacking up against it. (All darts to the bull’s spine that I’ve said were certain to start accumulating.) Most of all, the Trump Tax Plan’s own expansion of our debt balloon guarantees self-anhilation because it will raise interest rates on our unsustainable national debt through natural market responses at the same time that the Fed is raising interest rates by decree and raising them by its unwind wherein it is getting OUT of government debt. It’s the perfect debt storm, which will build to a furious state of affairs by the end of this year.
Why it’s all so predictable (and therefore was avoidable from the start)
The importance of pointing out these predictions again is to demonstrate that the impact any major Fed change of course will have on the market is highly predictable. (End of QE, end of zero interest policy, beginning of QE unwind — I’ve said what would happen with exact timing for those events, and it has happened in substantial ways.)
Thus, when the Fed said it would start raising interest rates in 2015, and we went all the way to November without a raise, I said with complete confidence the Fed would raise rates at its December meeting because, if it didn’t, it would lose face and appear unable to do as its forward guidance had promised. That would make the Fed’s much vaunted “forward guidance” dubious to where people would start ignoring the guidance, making it useless to the Fed’s intention of steering markets. The Fed couldn’t risk that because its credibility is the only thing that stands behind its money and its influence.
Further, I said the market would respond by getting euphoric right after the first rate increase and leaping up the next couple of days. It would do that because the long-anticipated and highly feared date came and nothing bad would happen. Everyone would be ecstatic that the sky didn’t fall. That is exactly what happened.
I also said that following that brief updraft, reality would set in, and people would start to wonder what it means that the seemingly endless days of zero interest were gone — perhaps for good — as an underlying support to the market. The market would start to fall off in the remaining days of the year and then would go over a cliff as reality set in. And that’s exactly what the market did.
To be fair, I initially proclaimed the Epocalypse would begin then. Though the downturn did not turn out as bad as I thought it would, the timing was precise to the day for each gyration in the market, and the January jolt did turn out to be the largest January point-decline in Dow history, so it was no little thing.
Moreover (and of great interest) the recovery from that plunge coincided mysteriously with two emergency closed-door meetings of the Federal Reserve’s board of governors followed immediately by a rare closed-door session between the Fed head and the president and vice president of the United States. We still don’t know what any of that was about; but clearly something significant was in the process of breaking because the Fed almost never has closed emergency meetings of its own board called on short notice and then with the president and vice president. President Obama’s only public response about that emergency meeting with Janet Yellen was a vague, “We compared notes.”
Of course, they compared notes, but what the heck were the notes about? I think something much bigger broke economically (now tucked forever away in those black holes that are carved out by law as dark spaces in every Fed audit) exactly as I thought it would, requiring immediate Fed reaction and immediate presidential reaction. You don’t have two emergency board meetings and presidential summit over anything sub-catastrophic.
The timing between the Fed’s major course changes and major market responses has always been exact in correspondence. While one financial writer, Mike Shedlock, ripped me apart for stating these turns could be predicted, there is a simple reason each market transformation came with exactly the timing I predicted, regardless of Shedlock’s argument against me. (I’ve erred a little in estimating the depth of each impact, but never in the timing or the fact that there would be a significant major negative impact.)
Why is are these sea changes in the market predictable? For one simple reason that has nothing to do with market cycles or charts or even economic fundamentals: As the Fed itself acknowledged, the Fed has been “front-running the market” (their term) with their “forward guidance” that promised huge hits of new money “in order to create a wealth effect.” (That, too, is something I stated about the Fed’s intention long before they admitted it and while many denied the Fed had any such intent; but their intentions were obvious by the timing of their announcements and moves.)
The Fed’s foundational support is as infinite as the Fed wants it to be and is the only reason we have experienced the illusion of recovery from the Great Recession. Any paradigm shift in its actions is going to have a major impact. So, each time the Fed pulls one more major support out from under its fake recovery, the recovery takes another jog down. Now the Fed is slowly pulling out all remaining support (in fact, reversing all of it), so the market is going to go down, down, DOWN.
The restoration of the housing market is fake because it was built on the Fed’s abnormally low long-term interest rates. As mortgage rates are now rising in response to the Fed’s unwind, the housing market will unwind, too — meaning it will collapse again as it did in 2008. So will auto sales as auto loans become more expensive. In part, the collapse of the auto market is also happening because the industry pulled forward sales with all kinds of gimmicks that manufacturers cannot keep repeating. (The retail apocalypse, on the other hand, is its own set of problems, but will be exacerbated by now rising credit-card interest as the retail recovery wasbuilt only on cheap debt due to Fed policies, too.)
That has been the central theme of this blog from day one — that we are still in the Great Recession, that our recovery has been an illusion created by Fed magic that is ultimately unsustainable. Therefore, the crash back into that recession will happen when the Fed’s magic runs out and will be worse than the original crash of 2008.
Economic reality here is that we are still in the Great Recession and simply don’t know it because the belly of the Great Recession was propped up artificially by the Fed. As the last of the props are being removed, we’ll go back into the recession we created, and discover a depth far worse than our first plunge. That will require a huge new global response; but more on that when the time nears.
We have done nothing to correct the deep flaws in our debt-driven economy, and the time to pay the piper for all of our cheap and easy living is NOW as interest rates climb. Our debt collapse may be a slow-moving event, but the stock market will not handle it well (because rising interest pulls money out of stocks and because stock buybacks, which helped drive the market up, were funded on debt that can no longer be supported when interest rises). Its an event the auto market (already flailing) cannot handle either, and certainly an event the housing market (completely dependent on the replay we had of super-low interest and relaxed terms in the early 2000’s) cannot handle. Ultimately (and most importantly), it is an event the US government (now desperately addicted to massive debt financing) cannot handle.
A lot of really big stuff is going to come down as interest rises from the triple forces of Fed rate hikes, Fed quantitative tightening, and rapidly expanding demand by the government for new creditors.
Stock market annihilation
The stock market’s inability to handle the present moves by the Fed and the expansion of government debt spending can particularly be seen in the ineffectiveness now of stock buybacks. I predicted last year that the repatriated money under the Trump Tax Plan would flood into buybacks far more than into capital investments. In complete proof of that, buybacks have now soared to levels even greater than seen in all the rest of the recovery period. If they stay on track with the record level of announcements year-to-date, stock buybacks will hit an insane trillion dollars by the end of the year.
Since the GOP tax bill passed … corporations have announced more than $225 billion in stock buybacks, overwhelmingly benefiting corporate executives and wealthy shareholders, and leaving the middle class behind. Corporate boards—often at the urging of activist investors—now spend an inordinate amount of their profits buying back their own stock and issuing dividends, leaving minimal resources for long-term investments in workers, training and innovation….
Across the country, there is a growing trend of big corporations using massive, permanent tax breaks for stock buybacks – choosing to reward wealthy CEOs instead of the workers who create profit and grow the company. In 2017, Wisconsin workers helped create $3.3 billion in operating profit at Kimberly-Clark. The company spent $911 million on stock buybacks last year and in December, Congress passed and President Trump signed a permanent, corporate tax cut for companies like Kimberly-Clark. Now, Kimberly-Clark announced that it will spend even more on stock buybacks this year. At the same time, the company announced that it would close two Wisconsin manufacturing facilities in the Fox Valley that employ 610 workers….
Stock buybacks are a “boondoggle” for the American economy and a practice that for much of the nation’s history was, in fact, prohibited. (Common Dreams)
And it still should be prohibited (one of the numerous needed corrections for real recovery that never happened as CEOs use the practice to enrich themselves at the expense of the company’s long-term success and at the expense of workers who suffer because the company goes downhill, as did Kimberly-Clark, as did Walmart after announcing buybacks and them closing Sam’s Club and laying off workers).
How can anyone think the Trump Tax Plan will create a platform for longterm economic growth when very little of the money is being spent on capital improvements, worker training/development, or research and development?
I’ve stated repeatedly on this blog that, if the Republicans were genuinely interested in seeing tax savings from repatriated profits employed to better the condition of the middle class via research and development, investing new capital in American factories, improved wages, etc. … they would have put such provisions in the new tax code. (More on the proofs of that failure in a future article.) They wouldn’t have to tell companies what to do, but would have mandated that companies deriving these new tax benefits not spend any money this year or next on once-prohibited stock buybacks. Better yet, as part of passage, they would have outlawed buybacks altogether, as they once were.
The buybacks were completely predictable because we have years of Great Recession history to know where the money is flowing. What I wish to point out here with this note about buybacks is that even with more than a quarter-trillion dollars in buybacks already announced for 2018 — a much higher buyback rate than in previous years — the stock market is still falling. Even with all the other new corporate tax advantages front loaded into 2018, the stock market is still falling. So great is the downdraft from the Fed’s unwind, which is still in its infancy stage.
In fact, at the end of March…
market technicians [warned] that major indexes are on the verge of a full-fledged, technical breakdown. “The extent of the deterioration in equities is very much a concern given the combination of near-term technical damage, along with the decline in longer-term momentum after having reached record overbought conditions into late January,” wrote Mark Newton, technical analyst at Newton Advisors. (MarketWatch)
U.S. equity benchmarks finished lower for a second straight session on Wednesday as a withering decline among last year’s most-prominent stock performers helped to unsettle Wall Street sentiment. (MarketWatch)
It’s been referred to as the “Tech Wreck” in which the FAANG stocks that carried the market up in past years during periods when other stocks were mostly falling are now falling the worst.
Fund managers have begun to ditch so-called FANG stocks that powered the U.S. stock market to record highs in January and are slowly rotating into commodity-related shares and other value stocks which typically outperform in late-cycle recoveries…. On Tuesday, an index which tracks the FANG stocks along with six other mega-cap technology stocks tumbled 6.3 percent, the biggest decline since September 2014…. Each FANG company rose more than 33 percent last year, helping power the S&P 500 to a nearly 20-percent gain. Yet … “Rising volatility and changing market leadership are now pointing towards the possible conclusion that the stock market peaked in late January 2018,” said Douglas Kass, president of Seabreeze Capital Management. (Newsmax)
Even the FAANGs are falling out of the market … and Facebook has been unfriended. While there are many internal reasons they are faltering, buybacks and the Fed put kept them rocketing onward and ever upward during all prior times of internal troubles in the recovery period. Now buybacks aren’t working, and the Fed isn’t there to save them. Nothing was able to pull them all down in unison until … the Fed began unwinding its QE. Thus, even market analyst’s are changing to “late-cycle” thinking, meaning they see the end of the boom is near. In fact, it’s actually here.
Recently, almost every security in the U.S. stock market has seen big moves, and increasingly, they’re all moving in the same direction. Wall Street’s spikes in volatility have coincided with a return of high stock-to-stock correlation, which could mean a far more difficult environment for stock pickers, as security selection is seen as harder when all issues are moving in tandem, fluctuating on macroeconomic issues rather than being driven by company-specific factors. (MarketWatch)
We have just seen the most rapid shift back to high correlation between stock moves at any time other than in 1987 (the year of Black Monday), Stocks are now moving in greater correlation than they have since 1980, and their trend is downward. (Correlation had hit an all-time low in January and is already back to all-time highs … and all in a downward direction. That’s a landslide.)
Even Bank of America’s Chief Investment Strategist, Michael Hartnett, now says, “Cracks in the bull case are starting to emerge, with fund managers citing concerns over trade, stagflation and leverage.”
You’ve heard a lot about the long Trump Rally being nothing but a euphoric melt-up in the market here — the exact kind of irrationality that precedes a major crash. Michael Wilson, chief U.S. equity strategist at Morgan Stanley Institutional Securities, now agrees: “We think January was the top for sentiment, if not prices, for the year…. When we look at our internal data combined with industry flows and sentiment, we think there is a strong case that January was the melt-up, or at least the culmination of it.” According to these banks, it’s downhill from there.
All of that and more is why this time is going to be an economic apocalypse (the “Epocalypse”) and not just another recession. Even the massive new corporate tax revisions are not saving the stock market because the Fed has always been the biggest game in town, and its leaving town. We are now entering (in phases) a time of great revelation about the abject failures of Fed policy for bringing a sustainable recovery and about the folly of our debt-based economic foundations and the corruption of our financial system — all of which we left fully in place and in power. We did NOTHING to resolve the real problems that created the Great Recession. That’s why I say we are really still in it. It’s the same grave financial flaws that are creating the problems we are now starting to feel again as the last of artificial life support is pulled.
An ugly reality will reappear behind our matrix of self-deception exactly as the Fed magic finally dissolves. It is, in fact, reappearing now in the seismic shifts we are seeing the stock and bond markets.
Bonds in the stockade
I’ve also predicted all along that — simultaneous with this change in the stock market — a significant rise in long-term bond interest would come as soon as the Fed started unwinding its bond holdings. In fact, it would be a race to see which crashed first — the bond market or the stock market. I believed the rise in long-term bond interest would be fairly small in the fall and would build quickly as the Fed increased its rate of quantitative tightening. This should have been obvious to everyone, but there are still many who cannot see it even as it is happening (because they don’t want to, which is how denial works).
It is just basic logic and math: the Fed started down the path of quantitative easing by buying long-term government bonds specifically in hopes of lowering long-term interest. Clearly that plan worked, given that long-term interest never went as low as it did during the long period of QE that was intended to lower long-term interest. It should be obvious as the shine on Bernanke’s head then (and its hard to understand why it isn’t to some) that, if you reverse from quantitative easing to quantitative tightening, you are going to experience the reverse effect. (It amazes me how many investment gurus cannot see this even as it is happening.)
You can see in the chart above that long-term bond interest began to rise subtly as soon as the Fed made a clear decision in September to follow through with its promise of quantitative tightening in October. The initial change in long-term bond interest was minimal during the fall months, but those interest rates rose drastically as soon as we moved into the month where the Fed’s unwind of QE was scheduled to double. Eventually, bonds achieved a new equilibrium with the stock market and interest settled on a new plateau, as could be expected. Here is how that math works:
The rise in interest rates was certain to happen because the number of bonds supplied to existing investors increased as soon the Fed began backing away from sopping up most of the government bond market. When the Fed doubled the speed at which it was backing out of the government bond market in January, the rate of rise in interest actually more than doubled.
However, when bond interest rises, it attracts investors away from stocks and into bonds. This is the normal inverse relationship between bonds and stocks that has been long-dormant under the Fed’s QE program; but now we are moving back toward reality. As a result, the demand for bonds rises to meet supply, so interest no longer has to rise to attract more buyers. Thus, by late February, bond interest had become high enough to attract enough buyers (out of the stock market) for the increased supply of available government bonds. So, interest settled at a new higher level — market equilibrium.
Obviously, now that the long-dormant dynamics of supply-and-demand are moving back into play, the Fed’s next roll-back in the amount of government bonds that it buys will increase available supply again. That will require, yet again, the enticement of more investors, which will force the government to offer higher interest to attract a larger pool of investors.
Many of those new bond investors will move money out of stocks in the normal historic pattern. Interest will hit a new level that sufficiently attracts a number of investors that matches the number of available government bonds. Then stocks and bonds as competing investments will find a new equilibrium again until the next interest increase.
It is simply the reverse of what the Fed was doing with quantitative easing in the first place. So, this is not hard to predict, and I don’t know why writers like Mish Shedlock miss it, except that they seem to see only how bond interest goes up when inflation goes up, and they don’t believe inflation will rise.
Many like Shedlock focus on inflation as the factor that determines bond interest. While bonds do have to track with inflation, because it erodes the long-term gains that long-term bond holders expect, bond prices (and as a result bond yields) are governed as much by supply and demand as by inflation. Greek government bonds, for example, have in the past gone up much more due to a growing supply in the face of demand that was rapidly retreating due to fear. To maintain demand, the Greek government had to hugely increase the yield on its bonds (reduce the acquisition price to investors).
Step by step, the restored market dynamic you see now between stocks and bonds is mathematically guaranteed to jack the government up into a situation of peril because the government astronomically increased its debt at a time when interest rates were pinned to the floor by the Fed. As a result, the US government has taken on way more debt than it can actually afford when interest rates normalize.
It is for all these reasons a given that the Fed’s unwind unwinds the whole “recovery.” I have maintained for years that will happen as soon as the Fed’s artificial life-support ends for a patient that actually died during the Great Recession. (It is astounding to me that the Fed is blind enough not to see that the same financial math they applied one way accomplishes a complete reversal of effect when applied the other way.)
Bond interest will rise in stages as the Fed forces the government to find additional buyers for its bonds in stages. Even interest on the government’s short-term debt rose by February to the highest level seen in nine years, which takes us back to the official period of the Great Recession.
This debt problem can easily be played and exacerbated by entities like China, which is the largest foreign buyer of US debt ($1.17 trillion in January), if it, too, decides to back away from buying government bonds — a possibility that China’s ambassador would not rule out when faced with Trump’s first tariffs. When asked about that exact possible retaliation, he replied only, “we are looking at all options.” With extreme deficits rising rapidly in the US as tax cuts fail to pay for themselves and as Republicans ramp up spending, the US can ill afford to have China, which holds about a fifth of the total US debt, back away from buying US debt.
China has two reasons to do stop buying US bonds. One is quite basic: reduced trade under the new tariffs will mean it needs to keep a lower balance of trade dollars and has fewer sales in US dollars to try to bank in US bonds. The other depends on how badly China wants to retaliate and pressure the US. They can back away just to bring economic harm to the US government, but there they will also economic harm to themselves if they go beyond what their lower trade balances mandate.
Regardless of what China does, the Fed’s unwind is sufficient to destroy its fake recovery. We are entering the day of reckoning that I have said throughout the writing of this blog would appear as soon as the Fed removes its artificial life support. Because the removal of the Fed’s resuscitation is happening in phases, the patient will grow increasingly pale in matching phases, but it is as inevitable as death by lack of oxygen.
The Epocalypse is arriving right on schedule
What remains a mystery is how far the Fed will go down this path before it realizes it is unable to unwind its QE without completely destroying its own recovery. Currently, the Fed’s targeted inflation has already risen above its goal of 2% annually. (CPI, the Fed’s yardstick, which understates real inflation, is now clocking in at 2.4% while other measures of inflation are over 3%.) With fuel prices poised to rise this summer, inflation on everything will go up even more because fuel factors into the price of everything.
That will make it extremely difficult for the Fed to retreat from its presently aggressive policy back to lower interest targets or to increase money supply (via low interest and more QE) because increased money supply will tend to push inflation up even more and because the Fed has always maintained that its financial policy is data dependendent (with inflation data and employment data being the primary data streams that concern it by congressional mandate).
It’s longtime claim is proven a lie if the Fed starts ignoring the data. How can the Fed justify easing financial policy again so long its own inflation data and job data show both are strong? It is pressed by its own duel government mandate (keeping inflation down and employment up) to, at least, wait until the job market is clearly deteriorating or until deflationary pressures have returned due to a clearly collapsing economy. By then, the downtrend will have a lot of momentum.
Failure of the recovery will make it clear the Fed’s recovery was always dependent on endless life-support. That means, when and if the Fed does return to zero-interest policy and QE, everyone will know it is now QE4-ever, creating serious credibility problems for anything the Fed attempts. And credibility is everything if the Fed is to retain belief in its money. That’s a whole new world of financial fear and uncertainty, and the markets don’t like either.
The alternative is that Trump gives the Fed governors a great war to blame their failure on or that their political allies get impeachment proceedings into motion as something to blame or that Trump’s trade war gives them something to blame. There are plenty of things coming that they will try to blame before they ever accept blame themselves.
I’ve said all along that Trump presents an easy scapegoat for their failure. He is a president who loves surprise and erratic moves, who feints left and leaps right, who seems inclined toward wider warfare (or toward risking it) and who admits his style of leadership thrives on conflict. All of that creates a shipload more of that uncertainty that markets don’t like. Plenty there for the Fed to throw blame on.
Regardless, it’s Epocalypse now, no matter who takes the blame, because the illusion of recovery is fading, soon to reveal the perilous chasm of debt over which our entire global economy is built.
When everyone starts scapegoating someone else … just keep in mind that all of this was completely foreseeable from the moment the steps of “recovery” began. Our politicians all failed to respond correctly as did all of our bankers, all of our regulators and most of our market advisors and certainly most economists. Instead of attacking corruption and greed, our politicians and head bankers bailed the greediest of them all out — even made them richer and all the more too-big-to fail. They solved none of those problems and have failed to regulate their greed by barring the worst activities of bank involvement in markets that created the Great Recession in the first place.
All of these failures have been laid out here at every turn, and the ways in which it will fall apart have been predicted here many times so that when it all falls apart, you can turn here and say, “No, look this could be seen coming by anyone that wasn’t in denial or blinded by some school of thought (be it Keynesian or Republican trickle-down economics).”
We are watching this economic collapse unfold with stocks and bonds right on schedule. The next set of troubles in the stock and bond markets should hit at the end of this month when the rate of unwind jumps up by 50%. Then things will get real serious in the summer when the rate jumps by another third. Then comes October with its usual Halloweenish spell on the stock market when. Their may be a great October surprise for some when we see what happens as the Fed’s unwind reaches terminal velocity in October.
If you think we’re going through all of that with no greater troubles than what we’ve seen, you’re not really thinking at all. That’s almost impossible.
In my next article, I’ll show how housing and auto sales are starting to widen again as cracks in the economy … exactly on schedule, too — how they started falling apart last year, why they got a predicted respite from that failure, and how they are now falling back on schedule. (All completely predictable because the housing market is entirely dependent on low interest.)
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It wasn’t just the rise in the deficit that I had said was certain with the passage of the Trump tax plan and the spending bill, it was another one of those bad turns where you have to reach all the way back to the official part of the Great Recession to find a matching mile marker. At nearly a quarter of a trillion dollars for just one one month, February’s deficit takes you all the way back to 2012 to find another February as deep in the red.
Of course, the deficits back then were exceptional attempts to bail the US out of the worst financial crisis since the Great Depression. This, however, is supposed to be a time when the recovery is all in and we are seeing America made great again.
The listed causes
Some will argue due to their own political bias that this month’s huge deficit is only because it’s going to take awhile for the dreamliner tax plan to bring the prosperity that will make America great again. However, even I, who totally dislike ThRump’s huge giveaway to the establishment, thought the first few months of the year would show a surplus for the simple reason that the biggest revenue producer of the entire Republican tax plan — the repatriation of billions of offshore dollars — is has already begun. I would expect government revenue to be rising rapidly as companies start making that one-time move of foreign profits to the US.
Moreover, this huge increase in the deficit is before the congressional spending bill that was passed in February even kicks in! With government spending set to get quickly worse, I don’t think the gradual increase in revenue from growing commerce is going to offset that.
According to today’s reportage, disaster relief and Pentagon spending drove the February budget like a pile driver. Those, of course, were forces that I promised would be creating larger deficits this year. The biggest driver of all (on the expense side of the budget), however, was … drum roll … interest on the national debt! Can anyone say, “I told you so!” The interest rate increases I’ve said will eat us alive due to Trunp’s rising government deficits and the Fed’s Great Unwind have barely begun, yet interest on the debt for February has already leaped upward by 8%.
Maybe you still believe we’re not going to have trouble with the national debt due to those two huge forces. Well, get over it. It’s not just the debt that is going to become an impossible burden, but everyone that requires business financing will actually start slowing down their business growth, as rising interest offsets lower taxes.
While some businesses may grow due to having more of their money left to play with, others will shrink due to the rising cost of financing. (Hint: corporations were never going to grow anyway because they were going to spend all that money on stock buybacks, as predicted here, and already shown to be a fact.)
It’s not just the businesses that will find financing for expansion harder, but their customers. That means fewer new homes built, fewer existing homes sold, fewer cars bought and made. Those who promised tax savings would expand business do not appear to have thought about the negative impact of rising interest on everyone when the government has to finance the larger deficits.
On the income side of the budget problem, the government is now experiencing lower revenue from withholdings and is reportedly already paying back higher tax refunds. That is in spite of the fact that wages are up. Most reports today are stating these things are the cause of the big deficit increase.
How bad was it?
Government revenue fell 9% in February, and overall spending rose 2%, bringing the deficit for February alone to $215 billion. If that rate were annualized, we would leap in one bound all the way past the $1 trillion annual deficits I was predicting here, straight into $2 trillion annual deficits.
Let’s hope February, even though it was a short month, turns out to be the longest month on deficits. Don’t know why it would, but March will tell. Maybe the tax refunds will prove to happen mostly during February and will slow down some. Maybe there is a payment timing issue that will balance back out in March.
For the overall fiscal year, which began in October, the deficit is only up by $50 billion, but that is because most of those months were pre-tax-plan and pre-spending-plans and because the Fed’s unwind was so small back then as to be unnoticeable. Everything changed in January with the doubling of the Fed’s unwind and the kicking in of the new tax plan.
Bond vigilantes on the march again
If you think the government debt isn’t going to be a problem this year as the Fed’s unwind gets up to full speed, take a look at history and at the perspective of one of the nation’s infamous bond vigilantes:
E. Craig Coats Jr. never set out to be a bond vigilante. As the former head of Salomon Brothers’ Treasuries desk, the last thing on his mind running the world’s biggest debt trader in the 1970s and 80s was fighting Washington’s fiscal largesse…. It’s been a generation since traders like Coats last imposed their will on Washington and Wall Street alike. Yet the original vigilante says he’s seeing signs that the once feared punishers of profligate spending are lurking again, lured back by an expansionary fiscal policy and signs of resurgent inflation — just as the world’s central banks dial back years of unprecedented bond buying that’s largely shielded politicians from market pressures. “Some of the stirrings from what we used to know about the old days of inflation are really starting to rear their head,” Coats, now retired, said from Florida. Back then “people paid a lot more attention to the deficits and the cost from the standpoint of what it was to the Treasury. Not so much now, but I think those days are going to be coming back.” (Newsmax)
With monthly interest on the debt already up by a whopping 8%, get ready for some rough action because the Fed’s unwind and the government’s spending spree have barely begun!
“This is a big problem, not just short term deficits but the debt,” said Liz Ann Sonders, chief investment strategist for Charles Schwab & Co. “We are playing with a lot of large numbers now. It changes the supply-demand dynamic in the Treasury market.” To keep pace with this rising shortfall, net Treasury issuance to the public will average $1.27 trillion per year over the next five years, according to strategists at BMO Capital Markets. That compares to an average of $658 billion over the past five years.
Two-year yields rose sharply today, going back to their 2008 milestone, and the 10-year yield keeps toying with 3% … a level of resistance it has yet to break beyond, but the pressure behind such a break is rising quickly:
Analysts, in turn, are reexamining their 2018 yield forecasts. JPMorgan Chase & Co. last month lifted its year-end calls for the 2- and 10-year notes to 2.95 percent and 3.15 percent, respectively, from 2.7 percent and 2.85 percent.
All of this moves toward fitting in precise detail with the scenario I laid out in my own economic predictions for this year — not just the particular events that I’ve said would collapse the economy but the rate at which they are picking up.
“Stimulative but unpaid for tax cuts in the late stages of the business cycle have pushed up bond yields to the point where it has already started to cause stress,” said Jeff Caughron, chief operating officer at Oklahoma City-based Baker Group, which advises community banks with over $45 billion in investments.
Yes, the stress is just beginning. Wait until the Fed’s unwind hits full RPM late in the year and repatriation of foreign funds has climaxed and is diminishing. From that point on, the downward forces prevail.
We are now prisoners of our national debt.