Major Recession Alarm Sounds

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Red, red, in every direction we turn today… red.

The Dow Jones shed 800 scarlet points on the day.

Percentage wise, both S&P and Nasdaq took similar whalings.

The S&P lost 86 points. And the Nasdaq… 242.

And so the market paid back all of yesterday’s trade-induced gains — with heaps of interest.

Worrying economic data drifting out of China and Germany were partly accountable.

Chinese industrial production growth has slackened to 4.8% year over year — its lowest rate since 2002.

And given China’s nearly infinite data-torturing capacities, we are confident the authentic number is lower yet.

Meantime, the economic engine of Europe has slipped into reverse. The latest German data revealed second-quarter GDP contracted 0.1%.

Combine the German and Chinese tales… and you partially explain today’s frights.

But today’s primary bugaboo is not China or Germany — or China and Germany.

Today’s primary bugaboo is rather our old friend the yield curve…

A telltale portion of the yield curve inverted this morning (details below).

An inverted yield curve is a nearly perfect fortune teller of recession.

An inverted yield curve has preceded recession on seven out of seven occasions 50 years running.

Only once did it yell wolf — in the mid-1960s.

An inverted yield curve has also foretold every major stock market calamity of the past 40 years.

Why is the inverted yield curve such a menace?

As we have reckoned prior:

The yield curve is simply the difference between short- and long-term interest rates.

Long-term rates normally run higher than short-term rates. It reflects the structure of time in a healthy market…

Longer-term bond yields should rise in anticipation of higher growth… higher inflation… higher animal spirits.

Inflation eats away at money tied up in bonds… as a moth eats away at a cardigan.

Bond investors therefore demand greater compensation to hold a [longer-term] Treasury over a [short-term] Treasury.

And the further out in the future, the greater the uncertainty. So investors demand to be compensated for taking the long view.

Compensated, that is, for laying off the sparrow at hand… in exchange for the promise of two in the distant bush.

But when short- and long-term yields begin to converge, it is a powerful indication the bond market expects lean times ahead…

When the long-term yield falls beneath the short-term yield, the yield curve is said to invert.

And in this sense time itself inverts.

Time trips all over itself, staggered and bewildered by a delirium of conflicting signals.

In the wild confusion future and past collide… run right past one another… and end up switching places.

Thus an inverted yield curve wrecks the market structure of time. It rewards pursuit of the bird at hand greater than two in the future.

That is, the short-term bondholder is compensated more than the long-term bondholder.

That is, the short-term bondholder is paid more to sacrifice less… and the long-term bondholder paid less to sacrifice more.

That is, something is dreadfully off.

It suggests an economic winter is coming…

We fretted and moaned recently that the 10-year Treasury and the 3-month Treasury inverted.

But many believe the 10-year versus 2-year sector of the yield curve is the one to watch.

Its recession-forecasting talents overmatch all others.

And now…

For the first instance since 2007, the 2-year Treasury note and the 10-year Treasury note have inverted.

That is, yields on the 10-year have dropped beneath yields on the 2-year.

Its significance is not “fake news,” as explains Justin Walters, co-director of research and investments at Bespoke Investment Group:

Given prior inversions of other curves… the fact that the 2-year note and the 10-year note has now inverted isn’t “fake news.” Inversions are not a good sign for the economic outlook, having preceded prior recessions with frightening regularity.

Bank of America Merrill Lynch strategists claim today’s inversion means “the equity market is on borrowed time.”

The question then becomes:

How much borrowed time?

But the question is easier asked than answered.

An inverted yield curve is not necessarily an immediate scourge.

History reveals the grim effects of an inverted yield curve may not manifest for 12–18 months — or longer.

Of course… they may also sting earlier. The hour and minute are truly on the knees of the gods.

But how badly might recession batter the stock market?

The BAML strategists ransacked the numbers.

They reveal the S&P often attains maximum height 7.3 months after a 2-year/10-year inversion — on average.

The S&P may therefore run higher through next March.

But once the inevitable recession comes hammering down…

Data indicate recession claims some 32% of the S&P’s value — again — on average.

Are you prepared for a 32% trouncing?

Would you like to know who is not?

The president.

The gale might blow straight through the 2020 presidential election.

Given how he pins his reelection on a roaring stock market… President Trump had better hope the recessionary forecast is false.

Below, Robert Kiyosaki shows you why it is more important to own gold — “God’s tears” — than ever. Read on.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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EXPOSED: Another Currency Manipulator!

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Currency manipulator!

Today we point an indignant and accusing finger at the latest currency manipulator.

Let all proper authorities take notice.

The accused is not China — incidentally.

But we cannot proceed without first noting another manipulated market…

The stock market presented a distressed scene this morning.

Plunging bond yields are the explanation widely on offer (falling yields reflect a poor economic outlook).

Yields on the 10-year Treasury slipped to 1.595% this morning — lowest since autumn 2016.

The Dow Jones was down 589 points before an invisible hand intervened, stabilized the bond market… and redirected the stock market.

The index nonetheless lost 22 points on the day.

Both S&P and Nasdaq gained on the day.

Meantime, gold spins into delirium — gaining another $25 today — to $1,509.50.

But now that the administration has hung a “currency manipulator” sign from China’s neck… we are duty-bound to expose the latest currency manipulators.

Our spies have marshalled the evidence. It is circumstantial evidence, we freely concede.

It is nonetheless damning — more than sufficient to empanel a grand jury.

Who are these latest currency swindlers?

Here we refer to the dastardly Swiss.

The Swiss are currency manipulators.

Our spies inform us…

That Swiss sight deposits — bank deposits that can be withdrawn immediately without notice — surged 1.6 billion francs in the week ending Aug. 2.

This anomaly follows a 1.7 billion increase one week prior.

Add one to the other and the conclusion is clear: The Swiss National Bank (SNB) has been monkeying in the currency markets.

It has been printing francs to purchase euros. Why?

To cheapen the franc… to advantage their exports… and to lift their tourism industry.

Evidence suggests Swiss manufacturing has already sunk into recession.

And the European Central Bank (ECB) is preparing to reopen the monetary faucets in September. The ensuing flow would depress the euro.

In comparison, the Swiss franc would tower high as the Matterhorn.

It is already at its highest peak since June 2017.

And so the Swiss authorities are purchasing euros — on the quiet — to cushion the blow.

That is the case we argue today.

Here we introduce our first witness, Credit Suisse economist Maxime Botteron:

I think the SNB was intervening in the market last week — this was the biggest weekly increase in sight deposits since May 2017. This is a clear sign the SNB was active in the market.

Witness No. 2 presently enters the witness stand, a certain Thomas Stucki.

Let the record indicate Mr. Stucki is former manager of the SNB’s foreign currency reserves:

When the ECB statement was published at 1.45 p.m. last Thursday the euro lost value against the dollar, but not against the franc… Any move by the SNB to buy euros with newly created francs would bolster the single currency [euro]. It is possible that the SNB is behind this development.

It is likewise possible that night will follow day… that a dropped apple will plunge groundward… that a senator of the United States will disgrace his office.

In conclusion we summon the testimony of Mr. Karsten Junius, chief economist at J. Safra Sarasin:

“The SNB are definitely in the market.”

The prosecution rests. The Swiss are currency manipulators.

And we consider the case jolly well closed.

When will the roars of protest come issuing from Brussels?

But let us now switch lawyerly roles… and leap to the defense of a currency manipulator wrongly accused:

China.

The recent charges against China are not only false. They are precisely, exactly, 180 degrees false.

That is, China has been labelled a currency manipulator not because it has manipulated its currency.

China has been labelled a currency manipulator… because it temporarily ceased manipulating its currency.

Here is the dynamic in operation…

China pegs its yuan softly to the dollar. But the dollar packs vastly more muscle than the yuan.

In order to maintain its peg, China manipulates the yuan higher — not lower.

That is, the People’s Bank of China buys yuan… and sells dollars.

And since last April alone, the yuan has appreciated 10% against the dollar.

A 7:1 exchange ratio is widely considered the “line in the sand.”

But this past Monday China temporarily let go of the yuan… and let it slip to 6.97 (the yuan presently trades at 7.06 per dollar).

The United States subsequently labelled China a currency manipulator — for failing to manipulate its currency.

Ponder the loveliness, the blinding brilliance… the staggering beauty of the charge.

Could Mr. George Orwell have improved upon it?

We can identify another term for currency manipulation.

It is a euphemism… designed to take much of the curse off “currency manipulation.”

That term is monetary policy.

The Federal Reserve runs its own.

And it has destroyed 96% of the dollar’s value since 1913…

Regards,

Brian Maher
Managing Editor, The Daily Reckoning

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RIP: Fiscal Responsibility

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Republicans and Democrats have stowed their axes, sunk their differences… and agreed to raise the debt ceiling.

The government will remain in funds for the next two years — beyond the 2020 election, not coincidentally.

The Wall Street Journal reads the truce terms:

Congressional and White House negotiators reached a deal to increase federal spending and raise the government’s borrowing limit, securing a bipartisan compromise to avoid a looming fiscal crisis and pushing the next budget debate past the 2020 election.

The deal for more than $2.7 trillion in spending over two years… would suspend the debt ceiling until the end of July 2021. It also raises spending by nearly $50 billion next fiscal year above current levels.

Failing a deal, the Capitol lights would have winked out Oct. 1. And the federal government would have slammed its door on the noses of the American people.

Chaos and Old Night would have descended upon these shores…

A Rain of Horrors

The ranger at Glacier National Park would have been thrown into idleness…

The Federal Theatre Project would have been thrown into darkness…

And the bright-eyed sixth-grader from Duluth would have been thrown from the Smithsonian.

The last government shutdown (December 2018–January 2019), stretched 35 impossible days.

How we endured those black, unlit times… we cannot recall.

Yet our representatives at Washington have spared the grateful nation a sequel.

Absent a deal…

They would have been required to hatchet spending $120 billion flat, all around.

The arrangement instead raises spending caps some $50 billion this year… and another $54 billion the next.

Both Sides Claim Victory

The president declared the deal “a real compromise in order to give another big victory to our Great Military and Vets!”

With straight faces Nancy Pelosi and Chuck Schumer announced:

With this agreement, we strive to avoid another government shutdown, which is so harmful to meeting the needs of the American people and honoring the work of our public employees.

Democratic Sen. Patrick Leahy gushed the agreement will “stave off economic catastrophe.”

It will furthermore reverse “unsustainable cuts in nondefense discretionary spending.”

Just so.

The Real Meaning of Bipartisanship

The late Joe Sobran labeled Democrats “the evil party.” Republicans were “the stupid party.”

Thus he concluded that “bipartisanship” yields outcomes both evil and stupid.

Perhaps Sobran hooked into something…

Under the deal Republicans get their guns. Democrats get their butter.

And the taxpayer gets the bill.

He pays now through higher taxes — or later through higher interest payments on the debt.

But pay he will.

And so fiscal responsibility lies dead beyond all hope of recall.

“No!”

We expect Democrats to spent grandly and gorgeously.

Since FDR it has read the identical electoral blueprint.

But Republicans traditionally existed for two purposes: to lower taxes — and to square the books.

You wished to spend money you did not have? And throw open the Treasury to the public?

“No!” was the answer you could expect.

Like a sour old schoolmarm with steel in her eye and a rattan in her hand… they might not have been popular.

But you knew where they were. And you could trust them with the checkbook.

But these Republicans are no more.

They have gone the route of fedoras, monocles and spats.

What Happened to the Old-time Religion?

They turned away from their old-time fiscal religion, made their peace with Big Government… and got elected.

They labelled the old religion “root canal economics.”

Republicans instead sat at the feet of Mr. Arthur Laffer, with his famous curve.

They could spend like Democrats without touching the taxpayer.

Deficits do not matter in the new catechism.

Only a few Republican holdouts remain… to keep the tablets.

Reports the Journal:

Fiscal hawks panned reports of the proposed deal Monday before many of the details had been released, warning it could add trillions of dollars more to projected government debt levels over the next decade. 

But they sob in vain…

Drowning in Debt

United States public debt excels $22.4 trillion… and swells by the day, by the month, by the year.

Federal debt presently rises three times the rate of revenue coming in.

To simply maintain current debt levels, CBO estimates Congress would have to increase revenues 11% each year… while simultaneously hatcheting the budget 10%.

Will Congress spend 10% less each year?

We have just received our answer.

For the long-term consequences we turn to the Brookings Institute:

Sustained federal deficits and rising federal debt, used to finance consumption or transfer payments, will crowd out future investment; reduce prospects for economic growth; make it more difficult to conduct routine policy, address major new priorities, or deal with the next recession or emergencies; and impose substantial burdens on future generations.

Deficits to the Horizon

Meantime, the present economic expansion is officially the longest on record.

Can the economy peg along another decade without a recession? Or even half so long?

We already detect smoke rising from the engine, and oil leaking out below.

Trillion-dollar deficits are already in sight.

In the certain event of recession, authorities will flood the economy with money borrowed from the future — deficit spending.

Deficits could double… or possibly triple.

What a Surprise

The only surprise about this debt ceiling deal?

That anyone could be surprised by this debt ceiling deal.

Republicans and Democrats might stage a splendid combat for the crowd. They batten upon each other with savage and vicious blows.

Mr. Trump’s gladiatorial presence makes the show grand beyond comparison.

But watch closer…

The combatants do not strike at the vitals. And the blood is fake.

When it comes to borrowing and spending… Republicans and Democrats are as united as any lovers could hope to be.

Threaten to cut them off.

Then watch the warfare immediately halt… and the hands of peace come extending from both sides.

This we have just witnessed. The debt ceiling is raised.

And so today we drop a mournful tear on the ashes of fiscal responsibility.

As we have noted before, Republicans once defended the approaches to the United States Treasury.

But they have since sold the pass.

And both parties have sold us all down a river…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Into the “Tractor Beam” of Zero Rates

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“We’re probably never going to go away from zero rates.”

So concludes hedge fund grandee Kyle Bass.

Mr. Bass believes the economy will plunge into recession next year. And the Federal Reserve will hound interest rates back down to zero.

There they will remain forever and ever… world without end.

The economy will fall within the inescapable “tractor beam” of zero rates:

As we have all learned, once an economy falls into the tractor beam of zero rates, it’s almost impossible to escape them… Growth numbers are going to come down and real growth might go to zero. We’re probably never going to go away from zero rates.

We fear Bass is correct.

Like a man hooked to a respirator, the economy cannot breathe on its own.

The financial crisis collapsed its lungs.

The Federal Reserve rushed over, plugged in the oxygen… and never took it out.

The economy’s natural breathing apparatus has atrophied from disuse.

Yank the oxygen now… and you will have a situation on your hands.

Dr. Powell attempted to wean the patient off support. But it gurgled, sputtered and flailed.

He will not try again. He is in fact preparing to pump in more oxygen.

But the economy might breathe freely today… if they had only let it recapture its own wind post-crisis.

The initial gasping might have been frightful.

But it would have coughed out the excesses of the previous boom… and gradually filled its lungs with the invigorating air of honest capitalism.

It would have come around on its own.

In went the breathing tube instead…

United States debt — public and private — has moonshot some $21 trillion this past decade.

It presently totals an impossible $73 trillion.

Meantime, GDP equals $20 trillion.

That is, each dollar of GDP holds up nearly $3.65 of debt.

The economy pants and sweats mightily under the burden.

And rising interest rates would increase the cost of that debt.

Any meaningful interest rate increase would pile on too much weight… and the economy would buckle under the strain.

Compare today’s debt-to-GDP with 1970’s — when the Federal Reserve was still jailed in by the gold standard:

Read more here.

No, the economy cannot withstand higher interest rates — or even historically normal interest rates.

The Federal Reserve is trapped.

But here is the problem:

The Federal Reserve cannot raise interest rates, as we have attempted to establish.

But like trying to breathe life into a corpse… or Hillary Clinton… lowering rates will not work the trick.

Today’s debt load is simply too behemoth.

Explains our former colleague David Stockman:

[We are at] a condition best described as Peak Debt, which reflects the fact that a large share of domestic household and business balance sheets are tapped out.

Accordingly, cutting interest rates has increasingly less potency on Main Street due to the crushing absolute level of debt. As of Q1 2019, in fact, total public and private debt weighed in at $73 trillion and is up by $21 trillion from the pre-crisis peak in Q4 2007…

There are now two turns of extra debt on the national income (3.47x versus 1.48x) compared to the long-standing leverage ratio which prevailed during the century between 1870 and 1970. In quantitative terms, those extra turns amount to $40 trillion of extra debt being lugged around by the U.S. economy.

Needless to say, it is becoming ever harder for the Fed to stimulate more borrowing and spending relative to the nation’s $21 trillion of nominal income. It’s simply a matter of diminishing returns to small reductions in what are already rock bottom rates coupled with the exhaustion of balance sheet capacity.

And so the Federal Reserve wields far less wallop than commonly supposed.

As we have argued before…

The Federal Reserve is a helpless giant, a man behind a curtain, a tissue-paper tiger.

That is why we expect it to flunk the inevitable recession.

And also why we expect a fiscal rescue attempt next time — not monetary.

Read on to see why central banks do not much matter these days. As you will see, there is no actual money in monetary policy.

But if central banks are largely irrelevant, then who… or what… is pulling the monetary strings?

Answer below…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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A “License to Buy Everything”

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Bloomberg captures the mood on Wall Street:

“Traders Take Fed Message as License to Buy Everything.”

Jerome Powell had his telegraph out yesterday… and wired a message of approaching rate cuts.

Federal funds futures give the odds of a July rate cut at 100%.

They further indicate three are likely by January.

And like sugar-mad 8-year olds amok in a candy store… traders are out for everything in sight.

Yesterday they drove the S&P past 3,000 for the first time. And today, freshly inspired, they sent the Dow Jones running to virgin heights.

The index crossed 27,000 this morning — timidly and briefly at first.

Comments by the president sent it temporarily slipping.

China is “letting us down,” Mr. Trump informed us.

Evidently China has not purchased satisfactory amounts of American agriculture — as it had agreed to at last month’s G20 summit.

And so the trade war menaces once again.

But the Dow Jones recalled Mr. Powell’s communique, rediscovered its gusto… and lit out for 27,000 once again.

It ended the day at 27,088.

Is Dow 30,000 Next?

We next await rabid and delirious shouts for Dow 28,000… 29,000… 30,000!

And who can say they will be wrong?

Dow 27,000 sounded plenty handsome not far back.

Yet here on July 11, Anno Domini 2019…  Dow 27,000 it is.

Don’t fight the Fed, runs an old market saw. It has proven capital advice…

The Fed does not box fairly.

It strikes beneath the belt. It bites in the clinches. It punches after the bell has rung.

Those unfortunates battling the Fed lo these many years have absorbed vast and hellful pummelings.

Justice may have been with them. But the judges were not.

“The Bears Have Been Damnably, Comedically, Infamously… Wrong”

With the displeasure of quoting ourself…

The frustrating thing about bears is that they make so much sense.

They heave forth every reason why stocks must collapse — all sound as a nut, all solid as oak.

Chapter, verse, letter, they’ll explain how the stock market is a classic bubble…

And how it has been inflated to preposterous dimensions by cheap credit.

P/E ratios haven’t been so high since the eve of the Crash of ’29, they’ll insist.

Market volatility has returned — and history shows trouble is ahead, they’ll warn.

Or that today’s sub-4% unemployment is a level historically attained only at peaks of business cycles.

And that recession invariably follows.

Et cetera, et cetera. Et cetera, et cetera.

But despite their watertight logic and all the angels and saints…

The bears have been damnably, comedically, infamously… wrong.

Since 2009, the Dow Jones has continually thumbed a mocking nose at them.

First at 10,000, then 15,000, at 20,000… then 25,000. 

Each point supposedly marked high tide — and each time the water rose.

It now rises to 27,000.

But is there some hidden pipe that could suddenly rupture, some unappreciated vulnerability that could send the Dow Jones careening?

Perhaps there is. But what?

The Dow’s Problem Child

Put aside the general hazards of trade war for now.

And turn your attention to Boeing…

Boeing has made the news in recent months — as you possibly have heard.

But its battering may continue yet. Explains famous money man Bill Blain:

Boeing has just announced its H1 [first half] deliveries in 2019 are down 54%. It has only delivered 90 new aircraft this year. Yet it is producing 42 new B-737 MAX’s each month and is having to store them on airport parking lots! It isn’t getting paid for these aircraft, but it still has supply chain commitments to meet. Boeing is hemorrhaging cash to build an aircraft no one can fly…

Boeing is trying to rush deliveries of other aircraft types to buyers to make up for the B-737 MAX cash slack. But there have been problems with B-787 Dreamliners built at its state-of-the-art Charleston factory “shoddy production and weak oversight” said The New York Times. At least one airline is said to be refusing to accept aircraft built outside Seattle. The U.S. Air Force stopped deliveries of new KC-46 tankers for a while when they found engineers had left hammers and other tools in wing and control spaces — a clear indication of “safety standards gotten too lax” said Defense News… This has massive implications for Boeing.

It may have massive implications for the stock market as well.

The Dow Jones is a price-weighted index.

Its components are weighted according to their stock price — not market capitalization or other factors.

And Boeing is the largest individual component on the Dow Jones. It presently enjoys an 11.6% weighting.

When Boeing goes up, the index often goes with it. When Boeing goes down, the index often goes with it also.

“The Likely Trigger for a Market Shock Will Be a ‘No-see-em’”

The bullet that fetches you is the bullet you don’t detect… as legend puts it.

And according to Blain,“The likely trigger for a market shock will be a ‘no-see-em.’”

He believes Boeing could be the “no-see-em” that knocks market flat:

I am concerned the market is underestimating just how bad things could go for Boeing, and when it does, the whole equity market will knee-jerk aggressively, triggering pain across all stocks… The crunch might be coming.

But perhaps Mr. Blain is chasing a phantom menace, a false bugaboo.

Scarcely a day passes that a fresh crisis-in-waiting does not invade our awareness.

Yet they all blow on by… “harmless as the murmur of brook and wind.”

We cannot argue Boeing will be different.

Hell to Pay

Perhaps we should raise a cheer today for Dow 27,000.

Yet the Lord above did not bless us with a believing or trusting nature.

Instead, we take our leaf from Mencken:

When we smell flowers… we look around for a coffin.

And as we have argued previously:

All things good must end, including bull markets — especially bull markets.

One day, however distant, there will be hell to pay.

And it won’t be the bears doing the paying…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Jerome Powell Caves

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Jerome Powell chummed the seawater this morning. And the voracious sharks rose to the bait… 

In written testimony to Congress, Mr. Powell informed us that:

Crosscurrents have reemerged. Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since [the Fed meeting in June], based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook… Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy.

What is more… he re-babbled his oath that the Federal Reserve would “act as appropriate to sustain the expansion.” 

Translated into good hard English: Expect a rate cut later this month.

Affirms Bloomberg Federal Reserve-ologist Steve Matthews: 

“Powell didn’t say so explicitly, but it’s hard to read this other than he thinks a cut in July would be appropriate.”

Powell’s dispatch, adds Peter Boockvar of Bleakley Advisory Group…

“…fully endorsed the July rate cut and did absolutely nothing to pull the markets back from that expectation.” 

The stock market was up and away on the news…

The S&P Tops 3,000 For The First Time In History 

For the first occasion in its 62 years… the S&P poked its head above the 3,000 mark this morning.

The Nasdaq registered a fresh record of its own. And the Dow Jones bounded nearly 200 points.

But the opening frenzy squandered much of the day’s energy… and the averages gradually lost their steam.

The Dow Jones ended the day up 75 points, at 26,859. 

After catching its first glimpse of 3,000, the S&P dipped back down to 2,992. The Nasdaq, meantime, closed the day with a 61- point gain. 

And so it goes…

100% Chance Of A July Rate Cut

Federal funds futures — incidentally — now give 100% odds of a rate cut later this month.

But what about the rest of the year… and next year? To what inky depths will the Federal Reserve lower rates?

Perhaps even lower than markets expect — if you take history as your teacher.

Markets presently expect Mr. Powell and his goons to cut rates 75 basis points by January.

Seventy-five basis points imply three rate cuts (a typical rate cut — or hike — is 25 basis points).

Three rate cuts by year’s end are plenty heady.

But according to Michael Lebowitz of Real Investment Advice, history argues even stronger drink is in prospect…

Markets Underestimate How Far Rates Could Sink

If the Federal Reserve undertakes a hike cycle, he maintains, it often elevates rates higher than markets project.

And when the Federal Reserve begins cutting rates… it hatchets them even lower than markets expect.

Lebowitz:

Looking at the 2004–06 rate hike cycle… the market consistently underestimated the pace of fed funds rate increases…

During the 2007–09 rate cut cycle, the market consistently thought fed funds rates would be higher than what truly prevailed…

The market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully.

Lebowitz says markets have underestimated rate cut intensity for the previous three cycles.

And Mr. Powell currently has his hatchet out.

In conclusion:

If the Fed initiates rate cuts and if the data… prove prescient, then current estimates for a fed funds rate of 1.50 –1.75% in the spring of 2020 may be well above what we ultimately see. 

And here Lebowitz seizes us by the shoulders… and gives us a good hard shaking:

Taking it a step further, it is not far-fetched to think that that fed funds rate could be back at the zero-bound or even negative at some point sooner than anyone can fathom today.

Who could? Fathom it, that is.

Just last year the monetary authorities gloated about “globally synchronized growth” and their march back to “normalcy.” 

Now they are preparing to about-face… and go scurrying back to zero? 

Who can take these gentlemen and ladies seriously?

The Fed Can Never Normalize Interest Rates

Here is our guess: Once they turn around, they will never come back. 

The Federal Reserve cannot return to normal. 

Returning to normal would knock the economy flat. And the stock market would come down in a thundering heap.

Only low interest rates keep it all vertical.

But as we have noted repeatedly… watch out for the next rate cut.

The past three recessions each commenced within three months of the first rate cut that ended a hiking cycle.

We find no reason to believe “this time will be different.”

The next rate cut — likely this month — starts the clock ticking.

We could be wrong of course. 

The inscrutable gods keep their own schedule. Who knows how long the show might run?

Out of Ammunition

But come the inevitable recession…

The Federal Reserve will have very little ammunition to hurl against it.

And the closer it gets to zero, the less ammunition it will hold.

History says it requires interest rates of at least 4% to wage a successful battle.

Rates are presently between 2.25% and 2.50%.

They are about to sink lower. Perhaps drastically lower. 

That is, the Federal Reserve is badly outgunned as it presently stands.

If the economy somehow pegs along until rates are zero — or near zero — the Federal Reserve would be on its knees… defenseless.

It will have another desperate go at quantitative easing. But multiple rounds did little (nothing) to raise the economy last time.

Why would it work next time?

The Next Crackpot Cure

That is why we expect the next anti-recession cure — disaster, that is — will not be monetary.

It will be fiscal.

The cries will go out…

“QE for Wall Street did nothing for the economy. The time for QE for Main Street has come.” 

The authorities will take to their helicopters, hover over Main… and begin shoveling money out the side.

The throngs below will haul it all in. They will proceed to go spreeing through the stores. The resulting delirium will give the economy a wild jolt.

That is the theory… as far as it runs.

It in part explains the loudening shouts for Modern Monetary Theory (MMT).  

Its drummers claim it can invigorate the wilting American economy.

They further claim it can fund ambitious social programs — all without raids upon the taxpayer.

And if interest rates are shackled down, without blasting the deficit.

The printing press will supply the money.

But as we have argued prior, MMT is the eternal quest for the free lunch… water into wine… something for nothing.

And that world has no existence.

MMT would likely yield a gorgeous inflation. But the economic growth it promises… would be a promise broken.

It will join the broken promise of monetary policy…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Jerome Powell Caves appeared first on Daily Reckoning.

“You Are a Traitor!”

This post “You Are a Traitor!” appeared first on Daily Reckoning.

“You are a traitor, go back to Great Britain!”

This weekend’s reckoning, “Was the American Revolution a Mistake?” argued that the American colonies in 1775 were perhaps the freest society on Earth.

The subsequent revolution raised the curtain on a ruinous inflation, the article continued. And that the American tax burden tripled after 1783.

Never again did the American people regain their prerevolutionary economic freedoms.

The issue drew a heavy mail — and an impassioned mail.

We opened with the comments of reader Charles H… who fingers us for treason.

He further banishes us to the crowned and sceptered isle, in the footsteps of Benedict Arnold.

Reader Emrich S. even offers us a royal title:

How about I sell you the title Duke of BS. You and Rupert Murdoch think it was a bad idea and he and you have been undermining our ideals ever since. Why?

For no other reason — perhaps — that we are traitorous, seditious, malicious, villainous… and treacherous.

Of course, we cannot address the motivations of Mr. Murdoch.

And above the name Lenny M. we are dealt with as follows:

Revisionist-history socialism and rules for radicals… You make Saul Alinsky proud.

Just so. But the article banged a drum for those dreamy days when Americans paid out perhaps 1–2.5% in taxes.

Would a socialist sob over higher taxes?

Sample excerpt:

What would libertarians — even conservatives — give today in order to return to an era in which the central government extracted 1% of the nation’s wealth? Where there was no income tax?

Meantime, reader Stephen K. suggests we are merely working an angle… to catch a penny:

The colonists left England and the continent to obtain freedom that they did not have before. Don’t whitewash history to sell your books.

But not all readers would pack us off to the gallows…

Joining us in treason, for example, is reader Ken H.:

Brilliant and accurate analysis… Thank you! I discovered the same in my advanced-placement American history class quite some time ago!

Randy M. adds: “This is an interesting angle on U.S. history I’ve never heard.”

Finally, reader Eric P. says: “Thank you very much for this piece of history.”

Was the American Revolution a mistake?

Upon deep and sober reflection this weekend, we have come around to the belief it was not.

That is because we are heart and soul for freedom.

Imagine that America remained an English colony to this day.

Further imagine the tyrannical crown spent us into oblivion… and buried these colonies under a crushing $22.4 trillion debt.

Can you conceive of such a despotism?

But as independent Americans…

We can be proud that we accomplished it all by ourselves… freely.

Regards,

Brian Maher
for The Daily Reckoning

The post “You Are a Traitor!” appeared first on Daily Reckoning.

GDP: The New “Slow” Normal

This post GDP: The New “Slow” Normal appeared first on Daily Reckoning.

“Is Slow Still the New Normal for GDP Growth?”

The Federal Reserve Bank of San Francisco raises the question… and proceeds to answer it:

Estimates suggest the new normal pace for U.S. GDP growth remains between 1.5% and 1.75%, noticeably slower than the typical pace since World War II…

A larger challenge is productivity. Achieving GDP growth consistently above 1.75% will require much faster productivity growth than the United States has typically experienced since the 1970s.

Productivity — as we have argued prior — is the spring of enduring prosperity.

Productivity growth transformed these United States from a bucktoothed backwater into a global behemoth… a modern Colossus bestride the world.

Productivity growth averaged 4–6% for the 30 years post-WWII. But after 1980?

Average productivity has languished between 0–2%.

Meantime, labor productivity averaged 3.2% annual growth from World War II to the end of the 20th century.

But since 2011… a mere 0.7%.

What might account for America’s declining productivity growth?

We have previously implicated Richard Nixon and his 1971 murdering of the gold standard.

The gold standard, though a sad caricature in its dying days, nonetheless enforced an honesty.

A wastrel nation that consumed more than it produced would eventually run through its gold stocks.

The fiat dollar, the unbacked dollar, lifted the penalty.

A liberated Federal Reserve finally broke loose from its golden shackles… spread its nets… and ensnared the nation in debt.

Michael Lebowitz of Real Investment Advice:

The stagnation of productivity growth started in the early 1970s. To be precise it was the result, in part, of the removal of the gold standard and the resulting freedom the Fed was granted to foster more debt… Over the last 30 years the economy has relied more upon debt growth and less on productivity to generate economic activity.

“Unfortunately, productivity requires work, time and sacrifice,” he adds.

But the emerging American economy left behind the grimy toil of the factory floor and the workbench…. and headed for Wall Street.

It went chasing after the fast buck — the easy buck.

The financialization of the American economy was underway.

Ten percent of GDP in 1970, the finance industry grew to 20% of GDP by 2010… like weeds in an abandoned factory.

And like spreading weeds, finance choked the path of labor…

The bottom 90% of American earners advanced steadily from the early 1940s through the early 1970s.

But they’ve been sliding back ever since — or held even at best.

In contrast we find the top 1% of earners…

From 1920 to the early 1970s they lost ground to the bottom 90%.

But beginning around 1980 they went leaping ahead… and began showing society their dust:

Read more here.

But perhaps we can declare the race a wash.

Labor’s loss is simply capital’s gain. And the economy as a whole comes out even. Perhaps the transaction even benefits it.

But has it? Has the United States economy benefited from financialization?

The facts may run precisely the other way…

Economists Gerald Epstein and Juan Antonio Montecino slaved over the numbers.

Since 1990, they conclude…

The financial sector has drained as much as $22 trillion from the United States economy:

What has this flawed financial system cost the U.S. economy?… We estimate these costs by analyzing three components: (1) rents, or excess profits; (2) misallocation costs, or the price of diverting resources away from nonfinancial activities and (3) crisis costs, meaning the cost of the 2008 financial crisis. Adding these together, we estimate that the financial system will impose an excess cost of as much as $22.7 trillion between 1990 and 2023, making finance in its current form a net drag on the American economy.

Meantime, we sag and groan under majestic mountains of debt.

A financialized economy demands perpetually increasing credit — debt, that is — to keep the show going.

Servicing that debt absorbs increasing amounts of society’s income. That in turn leaves less to save… and to invest in productive assets.

It is a dreadful cycle.

Eventually it leaves the cupboards bare… and the future empty.

Average real annual economic growth since 2009 runs to 2.23%.

Compare the past decade’s 2.23% with the larger 3.22% trend since 1980.

One percentage point may seem a trifle. And one year to the next it is.

But Jim Rickards calculates the United States would be $4 trillion richer — had the 3.22% trend held this decade.

Run it 30, 50, 60 years… Jim concludes the nation would be twice as rich over a lifetime.

Here is Lebowitz with the sting in the tail:

“Given the finite ability to service debt outstanding… future economic growth, if we are to have it, will need to be based largely on gains in productivity.”

But from where?

Below, George Gilder shows you how real money could “work miracles of growth.” Read on.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post GDP: The New “Slow” Normal appeared first on Daily Reckoning.

The War of Stocks and Bonds

This post The War of Stocks and Bonds appeared first on Daily Reckoning.

Jerome Powell dangled the morsel yesterday — rate cuts are on the way.

And like Pavlov’s famously conditioned dogs, Wall Street heard the opening bell this morning… and began drooling.

The major indexes were instantly up and away.

They lost momentum after the president intimated he may take a swing at Iran for downing a U.S. drone.

“You’ll soon find out” was his response when asked if the U.S. would retaliate.

The bulls nonetheless won the day…

The Dow Jones was up 249 points at closing whistle. The S&P gained 28; the Nasdaq, 64 points.

Gold, meantime, went skyshooting $44.50 today — $44.50!

Combine the prospects of vastcentral bank easing with possible fireworks in the Persian Gulf… and you have your answer.

What about the bond market?

Stocks vs. Bonds

The bellwether 10-year Treasury slipped to 1.98% this morning… its lowest point since the 2016 election.

And so the infinitely expanding gulf between stock market and bond market widens further yet.

One vision is bright, cheery, trusting. The other is dark, dour… and morose.

One of these markets will be proven right. One will be proven wrong.

Our money is on the bond market.

We have furnished ample evidence that recession is likely on tap within three months of the next rate cut.

Here analyst Sven Henrich reinforces our deep faith in the calendar of misfortune:

Every single time the Fed cut rates when unemployment was below 4%, a recession immediately ensued & unemployment shot to 67%. Again: Every. single. time.

We remind you:

The United States unemployment rate presently stands at 3.6% — the lowest in 50 years.

“A Gorgeously Wrapped Gift Box Containing a Time Bomb”

An unemployment rate below 4% is a false prize, a sugar-coated poison… a gorgeously wrapped gift box containing a time bomb.

Unemployment previously slipped beneath 4% in April 2000 — at the peak of the dot-com delirium.

The economy was in recession by March 2001.

Prior to 2000, unemployment had previously fallen below 4% in December 1969.

The economy was sunk in recession shortly thereafter.

The pattern stretches to the 1950s.

The proof, clear as gin… and equally as stiff:

Chart

And unemployment often bottoms nine months before recession’s onset… according to the National Bureau of Economic Research.

Meantime, it is 10 years into the present economic “expansion.” Next month will establish a record.

A Very Strange Expansion

An expanding economy is generally a time of surplus.

It is a time to store in reserves, to squirrel away acorns, to save against the rainy day — the inevitable rainy day.

These savings will see you through.

But during this economic expansion, during this season of bounty… the United States has only sunk deeper into debt.

The cupboards are empty.

Trillion-dollar annual deficits are presently in sight.

The national debt rises to $22.3 trillion — some 105% of GDP.

And interest payments on the debt alone will likely eclipse defense spending by 2025.

Come the inevitable recession, Uncle Samuel will plunge even deeper into debt.

That is, he will reach even further into the future… to rob it for our benefit today.

Deficits may double — or more.

How is the business at all sustainable?

But it’s not only a doddering old uncle going under the water…

The Corporate Debt Bomb

Corporations have loaded themselves to the gunwales with cheap debt — cheap debt coming by way of the Federal Reserve.

First-quarter nonfinancial corporate debt increased to $9.93 trillion. That is a record.

And this we learn from the Treasury Department:

Today’s nonfinancial corporate debt-to-GDP ratio is the highest since 1947… when records began.

And here we spot a straw swaying menacingly in the wind…

Fitch informs us nearly $10 billion of high-yield corporate bonds have already defaulted in the second quarter — double the amount of first-quarter defaults.

Warns Troy Gayeski, co-chief investment officer at SkyBridge Capital:

“Whatever the cause [of the next recession] may be, the acute point of pain will be in corporate credit.”

Depends on it.

Finally we come to the fabulously and grotesquely indebted American consumer…

Consumers Drowning in Debt

Total U.S. consumer debt notched $14 trillion in the first quarter — exceeding the roughly $13 trillion before the financial crisis.

Twenty-three percent of Americans claim that life’s essentials — food, rent, utilities — constitute the bulk of their credit card purchases.

And 60% of Americans hold less than $1,000 in savings.

How will they keep up come the next recession? How will they meet their debts?

They already groan under the load — and the economy is still expanding.

Meantime, the cost of a middle-class lifestyle has surged 30% over the past two decades.

But Pew Research reports the average American worker wields no more purchasing power today… than he did 40 years ago.

That is, he has jogged in place 40 years.

Utter and Complete Failure

The past 10 years of central bank intervention on a grand and heroic scale have worked little benefit.

The coming recession will bring yet more intervention— on an even grander and more heroic scale.

But why should we expect it to yield any difference whatsoever?

For the overall view, we turn to Mr. Sven Henrich:

The grand central bank experiment of the last 10 years has ended in utter and complete failure. The games of cheap money and constant intervention that have brought you record global debt to the tune of $250 trillion and record wealth inequality are about to embark on a new round… The new global rate-cutting cycle begins anew before the last one ever ended. Brace yourselves, as no one, absolutely no one, can know how this will turn out…

We are witnessing a historic unraveling here. Everything every central banker has uttered last year was completely wrong. Every projection they made over the last 10 years has been wrong… Why place confidence in people who are staring at the ruins of the policies they unleashed on the world and are about to unleash again?…

All the distortions of 10 years of cheap money, debt, wealth inequality, zombie companies, negative debt… will all be further exacerbated by hapless and scared central bankers whose only solution to failure is to embark on the same cheap money train again. All under the banner to “extend the business cycle” at all costs. Never asking whether they should nor considering the consequences. But since they are not elected by the people and face zero consequences for failure, they don’t have to consider the collateral damage they inflict.

Unfortunately, the rest of us do…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post The War of Stocks and Bonds appeared first on Daily Reckoning.

Capitalism Is Broken

This post Capitalism Is Broken appeared first on Daily Reckoning.

The announcement came rolling from the Eccles Building at 2 p.m. Eastern…

No rate hike today.

Jerome Powell has decided to sit on his hands — for now.

In his very words:

It’s important that monetary policy not overreact to any one data point… The FOMC will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion.

That is precisely why the next move will be a rate cut.

We have reckoned lots lately about the inverted yield curve… and the recessionary menace it represents.

The 10-year versus 3-month yield curve recently inverted to its lowest level since April 2007.

Meantime, 10-year Treasury yields hover at two-year lows — 2.04%. One Bloomberg opinion piece instructs us to prepare for 1% yields.

As the old-timers know… the bond market gives a truer economic forecast than the chronically dizzied stock market.

Meantime, the New York Fed’s recession model reveals a 30% probability of recession within the next year.

It last gave those same odds in July 2007 — merely five months before the Great Recession was underway.

JP Morgan places the odds of recession in the second half of this year at 40%.

And Morgan Stanley gives a 60% likelihood of recession within the next year — the highest since the financial crisis.

Yes, the Federal Reserve will soon be cutting rates.

One clue?

Conspicuously absent from today’s statement was the word “patient.” Thus Mr. Powell telegraphs that he is ready to move.

Federal funds futures presently give nearly 90% odds of a July rate cut.

The market further expects as many as three rate cuts by this time next year — perhaps four.

We are compelled to restate the blindingly obvious:

The Federal Reserve has lost its race with Old Man Time.

The opening whistle blew in December 2015… when Janet Yellen came off the blocks with a 0.25% rate hike.

If the Federal Reserve could cross the 4% finishing line in time, it could tackle the next recession with a full barrel of steam.

Alas… it never made it past 2.50%.

The Federal Reserve cannot return to “normal.”

The stock market will yell blue murder and take to violent rebellion if it tried — as happened last December.

No, Wall Street has Mr. Powell in its hip pocket — as it had Janet Yellen, as it had Ben Bernanke, as it had Alan Greenspan before him.

But it is not only the Federal Reserve…

Last year the world’s major central banks were pledging to “normalize.”

But now they are in panicked retreat…

All have taken to their heels, hoofing 180 degrees the other way.

For example:

Both the Bank of Japan and European Central Bank are now gabbling openly about rate cuts and/or additional quantitative easing.

“It’s all in the open now. Front and center. The new global easing cycle has begun before the last one ended.”

This is the considered judgment of Sven Henrich, he of NorthmanTrader.

We must agree.

Yet the central banks have only themselves to blame…

They grabbed hold of the poisoned apple during the financial crisis.

They gulped… and took the first fateful nibble. It proved nectar to the stock market.

Encouraged by the results, they soon munched the full dose… and later went plowing through the entire tainted orchard:

Zero interest rates, QE 1, 2 and 3 — Operation Twist — the lot of it.

Even with trade war raging and recession hovering, stocks are within 1% of record heights.

And so the banks are too far gone in sin to turn back now.

Their greatest casualty?

Capitalism itself.

Henrich on the wages of central bank sin:

Let’s call a spade a spade: Equity markets and capitalism are broken. Neither can function on any sort of growth trajectory without the helping hand of monetary stimulus. Global growth figures, expectations and projections are collapsing all around us and markets are held up with promises of more easy money, in fact are jumping from central bank speech to central bank speech while bond markets scream slowdown.

We fear Mr. Henrich is correct.

We further fear capitalism will get another good round pummeling in the years to come…

The Federal Reserve’s false fireworks will land as duds against the next recession.

Cries will then go out for the artificial savior of government spending — Modern Monetary Theory (MMT).

Free college tuition… universal Medicare… jobs for all… a $15 minimum wage…a possible Green New Deal…

These and more will be in prospect.

Politicians will go running through the Treasury as a bull runs through a china shop… and leave the nation’s finances a shambles.

Only then — too late — will they discover that debt and deficits matter after all…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Capitalism Is Broken appeared first on Daily Reckoning.