The Fed Isn’t a Magic Money Tree

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There seems to be no end to the Federal Reserve’s arrogance. Fed officials believe that through their wise actions, they can eliminate the business cycle, lower unemployment and make society prosperous.

But it’s actually much more limited in what it can do.

All the Fed can reliably do is stop bank runs and limit liquidity panics. It can also fund (or “monetize”) the U.S. federal deficit, as it has done in recent months.

By buying essentially the same amount of U.S. Treasury securities the government has issued, the Fed has taken pressure to fund mammoth federal deficits off of the private sector.

But such actions are not cost-free.

They store up trouble for the future. These actions swell the Fed’s balance sheet, which will limit the Fed’s flexibility and its willingness to tighten policy during the next inflation spike.

The more the Fed intervenes, the harder it is for it to reverse course without causing damage.

By promising the public that it can do anything more than offer dollar liquidity, the Fed is setting up both investors and workers for disappointment.

Yet it’s going to try anyway. And it’ll only undermine its limited reputational capital in the process.

“Yield Curve Control”

The Wall Street Journal recently reported that the Fed is considering implementing “yield curve control” in the Treasury market. This policy hasn’t been used since WWII and the early postwar period.

It essentially funded the war effort. If unleashed today, it wouldn’t be done to support a civilization-saving war effort but to maintain the debt-saturated economy to which we’ve become accustomed.

Here’s how it would work in practice:

The Fed would set a target range, or cap, on yields for Treasury bonds of a specific maturity — say, 3-, 5- or 7-year Treasuries.

It would defend this target by buying unlimited amounts of Treasuries at that yield — however many it took to bring the yield down to its target rate (remember, bond prices and yields move in opposite directions. Buying bonds lowers their yield).

If adopted, the Fed would switch its QE policy from a fixed dollar amount (currently $120 billion per month) to an unknown amount that will depend on supply and demand in the Treasury market.

Yield curve control has been underway in Japan for the past few years. It has proven to not be effective at stimulating the economy, so there’s little reason to expect it would work here.

Here Comes Helicopter Money

We’ve had our fill of quantitative easing over the years, but it’s mostly inflated assets while doing little for overall economic growth.

The quantitative tightening, or QT, process that occurred from early 2018–mid-2019 slowly reversed that process until the Fed ran into a wall of resistance from the markets. Since then, we’ve obviously had another epic wave of QE.

But here’s what’s different about the current round of QE from the QE programs of the past decade:

A much greater proportion of the money the Fed has created to buy bonds will be injected into the real economy through the federal budget. It won’t just be sequestered on Wall Street, where it pumps up asset prices.

As the brand-new U.S. money supply that is currently sitting in the U.S. Treasury’s General Account at the Fed is injected into citizens’ checking accounts through stimulus checks, unemployment insurance, tax refunds, Social Security checks and more, consumers will have plenty of purchasing power.

The Treasury General Account balance is currently $1.5 trillion, which is easily 10 times higher than the historical average. This will be sent out to recipients of federal dollars in the months ahead.

Will the recipients spend it all at once?

No, they won’t. They’ll likely hold precautionary savings in a weak economy. But make no mistake: The cash is there, it will get into consumers’ hands and it will eventually be spent — even if the economy remains sluggish.

It’s like water that’s built up in front of a dam. All it takes is to open the sluices (in this case have the Treasury spend down its cash balance) to inject an unprecedented amount of cash into the economy.

The U.S. job market (and wages) won’t necessarily have to fully recover for a chronic inflation problem to set in, because the tool for the Fed to inject newly printed cash into the economy (through the federal budget) is well established.

That’s a recipe for stagflation.

Turning Money Into a Hot Potato

It involves a chronically high federal deficit, a Fed balance sheet that is expanding with the deficit and private-sector productivity growth that lags the growth in newly printed money.

Historical evidence shows that when government debt and deficits are high, central bank balance sheets are growing rapidly and private-sector productivity growth lags the growth in newly printed money, inflation will be the result.

When the public starts to recognize that supply of a fiat currency is too plentiful today and expects money supply to grow much faster than production of goods and services, then the public will start treating that currency as a hot potato.

This is the psychological part of inflation that’s so difficult for mainstream economists to grasp. It’s nonlinear and unpredictable. This is why Jim Rickards calls inflation a “psychological phenomenon.”

And that brings me to Modern Monetary Theory, or MMT.

MMT Doesn’t Understand Money

Consider this question: Do you hold cash as a store of value solely for the purpose of paying taxes?

Of course not. Thus, legal tender laws do not give fiat money intrinsic value. Fiat money only has value to the extent that its holders believe it can be exchanged for goods and services both now and in the future.

But Modern Monetary Theory (MMT) is ultimately based on the notion that fiat money derives its value from the fact that citizens need it to pay their taxes.

But MMT advocates might be surprised if they survey the public and discover that the public does not, in fact, save money for the sole purpose of paying federal taxes.

The exchange of fiat money for goods in the future is critical. In Chapter 5 of his book Aftermath, titled “Free Money,” Jim identifies the essential problem with MMT:

“The problem with… MMT is not that the theory is wrong as far as it goes; the problem is that it does not go far enough. MMT fails not because of what it says but because of what it ignores. The issue is not whether there is a legal limit on money creation but whether there is a psychological limit.”

Promoters of MMT consider taxation the solution to inflation. If inflation becomes a problem, their solution is to raise taxes, which would drain money out of the economy. But they don’t understand the psychology of inflation.

They focus on the accounting mechanics of dollar creation and downplay how their policy proposals might affect the use of dollars in the real world. I’ve seen no successful real-world case study showing that MMT works.

It’s an abstract theory that is not supported by historical evidence. That’s why detractors often make fun of MMT by calling it “Magic Money Tree.”

The Fed is not a Magic Money Tree today… and it wouldn’t become one even if MMT were officially adopted in the future.

Owning gold and gold-related assets is the best protection against the damage that the Fed and the federal government are doing today and what they’ll do in the future.

The damage isn’t yet obvious, but it will be more noticeable in time.

Regards,

Dan Amoss
for The Daily Reckoning

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These Statues Must Come Down

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Today we enter into the revolutionary spirit of the times… topple idols… and haul down statues.

We will be declared subversive. We will be denounced as vandalous. The establishment will yell blue murder and demand our immediate arrest.

Yet justice is with us.

For we bring low the authors of destruction, of human inequality, of wickedness itself.

Which icons, which statues come crashing down today?

You will have your answer shortly. First to the site of a famously iconic statue — the statue of a fearsome bull…

Pandemic Fears Grip Wall Street

Faces were taut on Wall Street today… and nerves in tatters.

An uprising of the coronavirus is the evident cause. It presently lays siege to the Sunshine State. Explains CNBC:

The major averages hit their lows of the day after Florida said its confirmed cases jumped by 5,508 on Tuesday, a record, and now total 109,014. The state also said its positivity rate rose to 15.91% from 10.82%.

To Florida we must add fresh insurrections in California, Arizona, Texas and others.

“We’re going to eclipse the totals in April, so we’ll eclipse 37,000 diagnosed infections a day.”

That is the warning of former Food and Drug Administration Commissioner Dr. Scott Gottlieb.

And so the stock market took a severe fright today…

The Dow Jones plunged 710 points by closing whistle.

The S&P shed 81 points today; the Nasdaq 222.

And so the V-shaped recovery goes on ice.

But the stock market is not our central concern today. For a mad passion seizes us… and we are hot for mischief.

Central Bank Theory

Before we shatter icons, before we pull down statues… let us identify the source of our heat…

Central banks run on this primary theory:

Higher interest rates encourage saving and discourage consumer spending.

Low rates, meantime, coax bashful dollars out of wallets… and into consumer goods.

Why save money — after all — if it merely rots down in your wallet?

And consumer spending is the engine of inflation. There must be inflation, we are told.

Without inflation we risk deflation. And deflation is the great bugaboo of economics.

Under deflation, consumers cling to their cash in anticipation of lower prices tomorrow.

Before long the entire economy is trapped in the vortex of deflation… and the wolf of depression soon snarls at the door.

Central banks therefore pursue low interest rates — and a moderate dose of inflation — with a zeal verging upon mania.

But do their theories hold together?

The Magic 4%

Bank of America recently hauled central bank policy in for interrogation…

It released a report bearing this title: “Stagnation, Stagflation or Elevation.” Here is the question it pursued:

Do low interest rates truly spark consumption — and inflation?

The answer is yes, concedes the report — but only to a point. Below that point rates do not encourage spending. They encourage hoarding instead.

Low interest rates, meantime, do not yield inflation. They rather yield deflation.

What is that point of separation between spending and hoarding, between inflation and deflation?

Four percent.

Interest rates beneath 4% do not bring out more consumption. They store in more savings.

And rates beneath 4% do not yield inflation — but deflation.

The Vicious Cycle

Reports Bank of America:

As low growth and inflation make low-risk-asset income scarce (e.g., from government bonds), households are forced to reduce consumption and increase savings in order to meet retirement goals.

Forced saving further depresses demand in a vicious cycle.

And the lower rates slip beneath 4%, the more people save — and the less they spend.

We might remind you that rates presently stand scarcely above zero.

The iconoclasts of Zero Hedge in summary:

[Bank of America] shows that while lower rates indeed stimulate spending and lead to lower savings, this effect peaks at around 4% and then goes negative. In fact, the lower yields — and rates — drop below 4% — not to mention to 0% or below — the lower the propensity to spend and the higher the savings rate!…

And so the Federal Reserve is the snake devouring its tail, the man who shoots a hole in his foot, the goalkeep who rifles the ball into his own net.

That is, the Federal Reserve is its own saboteur.

It digs and digs in the belief it is digging its way up. Yet in reality it is digging its way down:

It demonstrates without a shadow of doubt that hyper-easy monetary policy is not inflationary but is deflationary. Which is catastrophic for central banks, who publicly state that the only reason they are pursuing ultra easy monetary policy, which includes QE and negative rates, is not to goose the market higher (even though by now we all know that’s the real reason) but to stimulate inflation.

And the cycle it has begun is truly vicious:

This means that the lower (and more negative) central banks push rates, the lower (not higher) the spending, the higher (not lower) the savings rate, the lower the inflation, the higher the disinflation (or outright deflation), which in turn forces central banks to cut rates even more, to add QE, yield curve control, buy junk bonds, buy ETFs or pursue any of a host of other monetary policies that are even more devastating to consumer psychology, forcing even more savings, resulting in even more disinflation, causing even more intervention by central banks in what is without doubt the most diabolical feedback loop of modern monetary policy and economics.

Said otherwise, monetary easing is deflationary. Let that sink in.

We have let it sink in. And it penetrated clear through to the marrows.

Scarlet Sins

And so today we are out to yank down the statues of those who have perpetuated “the most diabolical feedback loop of modern monetary policy and economics.”

Wall Street erected the statues.

The artificially low interest rates the Federal Reserve has chased — after all — inflated the stock market to dimensions grotesque and obscene.

But their economic sins are scarlet… and of the mortal category.

And so we come now to the bronze statue of Alan Greenspan, stately, regal, august…

Down Comes “The Maestro”

“The Maestro” is chiseled into its pedestal.

At once we seize our canister of spray paint… and graffiti “Traitor” over the inscription.

That is because Mr. Greenspan once exalted the gold standard and the golden handcuffs it placed upon central bankers.

Yet when he directed the central bank of the United States, he slipped the cuffs…

He tinkered interest rates downward against his own earlier advice.

He engineered two manias — the technology mania and the housing mania — earning him the applause of Wall Street and title of Maestro.

Both of his creations came tearfully to grief.

And so we string a chain around Mr. Greenspan’s cold metal wrist, hitch the other end to our bumper… and flatten the accelerator.

Down he comes with a mighty and rapturous thud.

Thus Mr. Alan Greenspan’s is the first statue to topple. Central bankers everywhere moan in sorrow, decrying our wanton vandalism.

“Helicopter Ben” Is Next

Next we come to “Helicopter” Ben Bernanke. This fellow’s pedestal bears the dedication: “The Courage to Act.”

We reach once again for our spray can. We improve the inscription with “Coward.”

Come the crash…

Mr. Bernanke could have allowed the profound imbalances within the financial system to correct — as they would have under honest capitalism.

The pain would have proved acute. But the pain would most likely have proven brief.

A newer, healthier economy… erected on surer footings… would have risen upon the wreckage of the old.

Yet Mr. Bernanke lacked the courage to let the free market take its natural course.

He instead pummeled rates to zero, devised quantitative easing… and inflated the greatest stock bubble market in history.

For his crimes against economics, his statue too comes crashing down today.

Even Janet Yellen?

Now, what is this? A rare statue of a female — Ms. Janet Yellen, next in line after Bernanke.

She is honored for being “The First Female Chairperson in the History of the Federal Reserve.”

This we cannot dispute. Yet she perpetuated Mr. Bernanke’s economic vandalism.

She did not believe another financial crisis would befall us “in our lifetimes,” she declared in retirement.

And so today we razz her prophecy, in red spray-paint upon her pedestal:

“We Must All Be Dead.”

Yet we are highly gallant. We are therefore loath to rip down the statue of a woman. Yet we yield to an egalitarian impulse…

We cannot discriminate on the basis of gender. Down Janet Yellen comes in the customary manner. And with the customary clank.

Powell’s Day Will Come

Mr. Jerome Powell is still on duty. His statue has therefore yet to be dedicated. That day will come of course.

He will be depicted upon a galloping horse, in the manner of Napoleon.

He will be credited with saving the United States economy at its darkest moment since the Great Depression.

And so we will be there with our spray paint, our chain… and our pickup truck…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The Fed’s “Big Shift”

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There have been endless announcements by the Fed that they will add this and that to their asset-purchase programs. The media jumped all over these announcements, how the Fed is going to get into the junk bond market and ETFs with hundreds of billions of dollars.

Each time, all kinds of hoopla broke out in the markets with stocks soaring and junk-bond ETFs soaring, and everything soaring — despite the worst economy in memory, despite 30 million people on unemployment insurance, and despite shocking earnings reports heading our way.

The Fed has set up an alphabet soup of programs so far — and it has been buying some of the assets it said it would buy.

In all, the Fed has indirectly monetized about 65% of the government debt it’s taken on since March. But here’s what you might not realize:

The Fed’s monetization of the U.S. debt has slowed to a trickle in recent weeks after the original shock-and-awe spree in March and April, whittling down its purchase programs of Treasuries.

It also has been shedding alphabet-soup assets it had bought in March and April, and cutting back its purchases of mortgage-backed securities (MBS) for the past two months.

And believe it or not, total assets on the Fed’s balance sheet actually shrank by $74 billion last week:

IMG 1

This $74 billion decline in total assets last week was powered by a few factors. First, there was a plunge in “repo” balances. If you weren’t already familiar with the term, you might remember “repo” from late last year when the Fed pumped in trillions in liquidity to liquify the overnight lending markets that were seizing up.

Anyway, a dramatic drop in repo balances partly account for the drop in the Fed’s balance sheet.

Also contributing to the balance sheet decline were foreign central bank liquidity swaps, while some alphabet-soup programs also unwound. And the junk-bond and ETF buying program stalled.

I don’t want to get deep in the weeds on any of these things (it’s all rather technical), but they explain the $74 billion decrease in the Fed’s balance sheet. Now, in basic terms the decrease is little more than a rounding error. It only brought the Fed’s total assets down to a still breath-taking $7.095 trillion.

But there is a big shift happening right now that Wall Street doesn’t seem to understand:

The Fed has started lending to entities, including states and banks, under programs that channel funds into spending by states, municipalities, and businesses, rather than into the financial markets.

These programs include the Paycheck Protection Program Liquidity Facility ($57 billion), the Main Street Lending Program ($32 billion), and the Municipal Liquidity Facility ($16 billion).

This is not QE but more like paying businesses and municipalities, and ultimately workers/consumers, to consume. This money is circulating in the economy rather than inflating asset prices.

These types of programs are propping up consumption — not asset prices. That’s a new thing. I don’t think the hyper-inflated markets, which have soared only because the Fed poured $3 trillion into them, are ready for this shift. Again, that’s an important change and a big shift. But it’s not getting any attention.

You can see from the curve that last week’s decline in the balance sheet isn’t an accident, but part of a plan to front-load QE and then back off, rather than let it drag on for years:

IMG 2

Now, the Fed is still offering theoretically huge amounts of repos every day. But it has tweaked the offering terms, so that there is now almost no appetite for them, and what’s left on the balance sheet are older term repos that unwind and are gone.

The repo balances dropped by $88 billion from the prior week to $79 billion, the lowest since September 18:

IMG 3

Meanwhile, the Fed’s “dollar liquidity swap lines” with other central banks had been roughly flat for seven weeks, after the $400 billion surge in early April. But last week some swaps matured and were unwound, and the balance dropped by $92 billion to $352 billion.

Of that drop, $75 billion came from the swap line with the European Central Bank, $9 billion from the Bank of Japan, and $7 billion from the Bank of England (country data via the New York Fed).

With these swaps, the Fed lends newly created dollars to other central banks and takes their domestic currency as collateral. When the swap matures, the Fed gets its dollars back, and the foreign central bank gets its currency back.

This is where much of the media hype has focused on, following the endless announcements by the Fed. The Fed says that these bailout schemes are authorized under Section 13 paragraph 3 of the Federal Reserve Act, as amended by the Dodd-Frank Act. And Powell calls these creatures “thirteen-three facilities.”

Under the program, the Fed creates a Special Purpose Vehicle (SPV) as a limited liability corporation (LLC). The Treasury pads it with taxpayer equity capital. The Fed lends to the SPV with a leverage ratio of 10 to 1. Then it’s off to the races, with the SPV buying up the entire world, or so it would seem, according to the media.

The number of SPVs keeps growing. There are 10 active ones on today’s balance sheet. But in dollar terms, by the Fed standards, they’re small. After an initial burst in early April of $130 billion spread among the first three SPVs, there came a lull, and the overall balance declined. New SPVs were added, but as the balance of the first three SPVs declined, the overall balance also declined until mid-May.

Starting in late May, the new SPVs added enough so that overall balances began rising, and reached $196 billion by June 10. But last week, the overall balance ticked down by $1.6 billion:

There are now three SPVs that route funds into consumption rather than asset purchases: Again, these include the Paycheck Protection Program Liquidity Facility ($57 billion), the Main Street Lending Program ($32 billion), and the Municipal Liquidity Facility ($16 billion).

The Fed added $26 billion of Treasury securities during the week, bringing the total to $4.17 trillion. Over the past four weeks, the balance increased in a range between $9 billion in $26 billion, about the same range before the outbreak of bailout mania:

IMG 4

This progression of the Treasury purchases, from front-loading to tapering, is visible in the flattening curve of total Treasuries on the Fed’s balance sheet:

IMG 5

The Fed has cut its purchases of government-backed mortgage-backed securities (“Agency MBS”) after the initial burst. But its MBS trades take one to three months to settle, and the Fed books them after they settle, which creates an erratic pattern. So what we’re seeing today are settled trades from some time ago.

The balance of MBS rose by $83 billion to $1.92 trillion. This includes Agency Commercial Mortgage Backed Securities that the Fed started buying as part of its bailout program. But the balance of these CMBS has remained flat over the past three weeks at $9.1 billion.

For the stock market, a new phase has started. It now has to figure out how to stand on its own swollen and inflated legs in the worst economy in a lifetime, with the worst corporate earnings reports coming its way, while stock prices are ludicrously inflated.

So good luck to Wall Street.

Regards,

Wolf Richter
for The Daily Reckoning

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Goodbye, Free Market

This post Goodbye, Free Market appeared first on Daily Reckoning.

Fremdschämen.

Fremdschämen is a noun of the German language. It translates this way:

Embarrassment for those incapable of feeling embarrassment.

Today we suffer embarrassment for Mr. Jerome Powell and his fellows of the Federal Reserve…

For no action they take lowers their heads in shame… or blushes their cheeks with embarrassment.

Mr. Powell is simply in the hands of Wall Street… and on his knees to Wall Street.

Well does he know the taste of shoeblack.

Yesterday Mr. Powell got a fresh coat on his tongue. Details to follow.

But first, let us look in on his masters…

A Banner Day on Wall Street

Wall Street was in full roar today.

The Dow Jones jumped an additional 582 points. The S&P gained 58 points; the Nasdaq, 169 points of its own.

CNBC, by way of explanation:

Stocks rose on Tuesday as a record jump in retail sales — coupled with positive trial results from a potential coronavirus treatment and hopes of more stimulus — sent market sentiment soaring.

Government number-torturers reported this morning that May retail sales jumped a record 17.7%.

The chronically erring Dow Jones survey of economists had projected a 7.7% increase.

Yet we are not surprised by the surge. April’s numbers were true abominations. But certain economic restrictions were waived in May.

A trampolining back was therefore expected.

Meantime, a medicine named dexamethasone — a widely available medicine — is evidently effective in the treatment of deathly ill coronavirus patients.

It reportedly axed hospital deaths by perhaps one-third.

Thus the market had its spree today. But it merely added to yesterday afternoon’s joys…

Powell Licks Wall Street’s Shoes

The Dow Jones had been off 762 points in early trading yesterday, quaking with coronavirus-related fear.

But then Mr. Powell sank to his knees… and tongued Wall Street’s wingtips…

For the Federal Reserve announced it intends to purchase individual corporate bonds — not merely ETFs.

By its own admission, it will:

Begin buying a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.

We will not burden you with the plan’s intricacies. You need only know this:

Yesterday’s announcement “pressed the risk-on button,” as money man Bill Blain styles it…

“Central Banks Are Now de facto Guarantors of the Corporate Bond Market”

Fears about the rising number of reopening coronavirus hotspots and economic threats were superseded by unbounded joy as the Fed announced it will buy secondary market corporate bonds direct[ly] rather than through ETFs, without any need for companies to certify their eligibility. That pressed the risk-on button — and markets recovered.

And so the free market sinks deeper into oblivion:

Central banks are now de facto guarantors of the corporate bond market.

What has all this QE Infinity and ZIRP interest rates created?… Where market prices have become meaningless as a result of financial asset inflation? Where junk bonds are priced like AAA securities, allowing private equity funds to thrive?

I am beginning to wonder if there is any point in thinking about markets any more… Just follow the central banks… don’t think. Just buy.

“Don’t think. Just buy.”

We think the proper advice might rather run this way: “Don’t buy. Just think.”

Yet we do not dispense financial advice.

Picking Winners and Losers

Our own Nomi Prins penetrates to the core of yesterday’s message. Nomi rings dead center when she says:

As if the Fed hasn’t done enough to destroy honest markets, now it plans to start buying individual corporate bonds. It’s just another step closer to the Fed deciding the winners and losers in the market.

Thus the Federal Reserve is a referee who has taken a bribe, a butcher who thumbs the scales, a rogue, a traitor to justice.

A central banker with a conscience might lower his head in shame… and a red flush of embarrassment might stain his cheeks.

Yet Mr. Powell holds his head high and puffs his chest, proud as any peacock.

His cheeks, meantime, are pale.

Yet ours are scarlet — scarlet with embarrassment for the man incapable of embarrassment.

“From Lender of Last Resort to Stockjobber”

The Federal Reserve was originally fashioned to be the “lender of last resort.” Yet that designation is presently a cruel and mocking jest.

It has passed from lender of last resort to stockjobber.

Economist Thomas M. Humphrey is the author of Lender of Last Resort: What It Is, Whence It Came, and Why the Fed Isn’t It.

From which:

While there exists such an entity as the classical lender of last resort (LLR) — the traditional, standard LLR model, to be exact — the Fed has rarely adhered to it… The Fed has deviated from the classical model in so many ways as to make a mockery of the notion that it is an LLR. In short, the Fed may be many things, crisis manager included. But it is not an LLR in the traditional sense of that term.

What is the proper function of the central bank, by Humphrey’s lights?

Six Mandates of Sound Central Banking

As summarized by Wikipedia, a central bank exists to:

(1) protect the money stock instead of saving individual institutions; (2) rescue solvent institutions only; (3) let insolvent institutions default; (4) charge penalty rates; (5) require good collateral; and (6) announce the conditions before a crisis so that the market knows exactly what to expect.

A word of explanation, perhaps, on “penalty rates.”

The central bank should charge interest rates above the market rate.

Otherwise the central bank would be a lender of resort — not the lender of last resort.

A high rate further encourages debtors to retire their debts rapidly… to shake loose the heavy burden as soon as circumstances allowed.

Yet what does the Federal Reserve’s actual record reveal?

(1) “Emphasis on credit (loans) as opposed to money,” (2) “taking junk collateral,” (3) “charging subsidy rates,” (4) “rescuing insolvent firms too big and interconnected to fail,” (5) “extension of loan repayment deadlines,” (6) “no pre-announced commitment.

Professional Incompetence

That is, the Federal Reserve takes sound central banking and knocks it 180 degrees out of phase.

It wars against all six mandates and massively against Nos. 1, 2, 3, 4 and 5.

Imagine a plumber who does not patch leaks but creates leaks… a doctor who does not mend bones but cracks bones… a head shrinker who does not shrink heads but expands heads.

Now you have the flavor of it.

Yet the Federal Reserve’s professional pride is unruffled. It displays no embarrassment, no shame at a job done wrong.

In fact, it believes it is a job done right…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The Fed’s Forever War Against Savers

This post The Fed’s Forever War Against Savers appeared first on Daily Reckoning.

The war on savers rages into its second decade.

And yesterday Field Marshal Powell vowed indefinite bombing, shelling, machine-gunning and bayoneting… until the white flag rises over enemy lines.

It is war to the knife… and from the knife to the hilt.

The only peace terms he will accept are these:

Complete, undiluted and unconditional surrender.

These hoarding hellcats must be vanquished. And their cities must be sowed with salt… as triumphant Rome vanquished Carthage… and sowed it with salt.

Here is yesterday’s dispatch from headquarters:

We are going to be deploying our tools — all of our tools — to the fullest extent for as long as it takes… We are not thinking about raising rates; we are not even thinking about thinking of raising rates.

Zero Rates Through at Least 2022

Powell and staff indicated they will clamp rates to zero, or near zero… through 2022.

We wager rates will remain clamped to zero longer yet.

Deflation hangs over the battlefield like a thick cloud of chlorine gas. And the Federal Reserve’s 2% inflation target appears more wishful than ever.

We do not expect any rate hikes until it lifts. And we hazard little will lift until 2022 has passed.

Meantime, Marshal Powell reminded us yesterday that the pre-pandemic 3.5% unemployment rate yielded little inflation.

He suggested, that is, that unemployment could sink below 3.5% before inflation menaced.

But it could be a long, long while before unemployment drops to pre-pandemic levels.

As we recently noted:

After the last financial crisis, over six years lapsed before employment fully recovered — 76 months.

If we assume a parallel recovery… pre-pandemic unemployment would return in 2026.

Of course comes our disclaimer: Pre-pandemic unemployment would return before 2026.

We simply do not know. Nor does anyone.

But who can say if pre-pandemic levels of unemployment will ever return?

The Fed Doesn’t Expect a “V-Shaped” Recovery

Even Powell himself is nagged by doubts:

Unemployment remains historically high. My assumption is there will be a significant chunk … well into the millions of people, who don’t get to go back to their old job… and there may not be a job in that industry for them for some time.

The Federal Reserve therefore fears an arduous and protracted recovery. This is the argument of one Joseph Brusuelas, chief economist at RSM:

It is clear that the Fed does not anticipate a V-shaped economic recovery and is positioned to move forcefully to support the economy…

Adds Charlie Ripley, senior investment strategist at Allianz:

The Fed understands we are just in the beginning phases of the economic recovery and making rash changes to policy or forward guidance is premature at this time.

The Federal Reserve’s fears may well prove true…

We have cited evidence recently that each recession is fiercer than the previous. And that additional debt is required to put down each successive menace.

Comparing the 1990, 2001 and 2008 Recessions

Once again, Michael Lebowitz and Jack Scott of Real Inves‌tment Advice:

  • The [2008–09] recession was broader based and affected more industries, citizens and nations than the prior recessions of 1990 and 2001…
  • The 2008–09 recession and recovery also required significantly more fiscal and monetary policy to boost economic activity…
  • The amount of federal, corporate and individual debt was significantly lower in 1990 and 2001 than 2008–09…
  • The natural economic growth rate for 1990 and 2001 was higher than the rate going into the 2008–09 recession.

“The economic growth rate going forward may be half of the already weak pace heading into the current recession,” these gentlemen conclude.

We in turn conclude that zero interest rates will be with us for years… as will the warfare against savers.

The Fed Will Keep Buying Ammunition

But the enemy of the saver is the ally of the speculator.

The Federal Reserve intends to purchase roughly $120 billion of Treasury notes and mortgage-backed securities each month of the year.

Its balance sheet may swell to 40% of the United States economy by year’s end.

What percentage of the United States economy did it represent in 2007?

A mere 6%… if you can believe it.

These assets represents ammunition in support of Wall Street.

And as long as the Federal Reserve rains down ammunition upon savers… Wall Street can advance under the covering fire.

Powell insists he’s battling for the economy’s life.. If my policies prosper Wall Street, be it so, says he (with a wink and a nod):

We’re not focused on moving asset prices in a particular direction at all — it’s just we want markets to be working, and partly as a result of what we’ve done, they are working.

Just so. But the stock market has evidently advanced too far. And the stock market has evidently advanced too fast.

The Market’s Worst Day Since March

Today the market took to its heels… and fell into panicked and headlong retreat.

The Dow Jones pulled back 1,861 points on the day. Both the S&P and the Nasdaq took similar trouncings.

The S&P did, however, manage to hold the 3,000 line.

The combined rout nonetheless represents the market’s greatest daily plunge since mid-March… at the height of the havoc.

The reasons on offer in the mainstream press reduce to two:

A) Yesterday Powell’s dour comments emptied ice water upon the heads of sunny-siders expecting the “V-shaped recovery.”

B) A resurgence of coronavirus cases following reopenings may delay additional economic progress.

Texas, Arizona, Florida, North Carolina and California among others report what the journalists like to call “alarming” increases.

“This Thing’s Going to Linger Longer Than Probably the Market Had Thought Of”

And so, says Mr. Dan Deming, managing director at KKM Financial, reports CNBC:

“You’re seeing the psychology in the market get retested today” as traders weigh the recent uptick in coronavirus hospitalizations and a grim outlook from the U.S. central bank… “The sense is maybe the market got ahead of itself, which makes sense given the fact that we’ve come so far so fast.

“The reality is this thing’s going to linger longer than probably the market had thought of.”

But the stock market should take heart:

The full arsenal of the Federal Reserve is in back of it.

Savers, meantime, must only despair:

The full arsenal of the Federal Reserve is against them…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The Fed Is Stealing Our Future

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The pestilence presented the Federal Reserve two options.

The first was to wash out the sins of the past decade. The second was to sin on a vastly mightier scale.

Lance Roberts of Real Investment Advice:

    1. Allow capitalism to take root by allowing corporations to fail and restructure after spending a decade leveraging themselves to [the] hilt, buying back shares and massively increasing the wealth of their executives while compressing the wages of workers. Or…
    2. Bail out the “bad actors” once again to forestall the “clearing process” that would rebalance the economy and allow for higher levels of future organic economic growth.

The Federal Reserve selected option two. That is, it chose sin on a vastly mightier scale.

All the imbalances, all the fraud, all the dishonesty of the past decade it is multiplying — by two, by three, by four, by five.

And so it is condemning the United States economy to a lost decade of stagnation and anemia.

Cutting off the Future

The Federal Reserve is dynamiting the bridges leading from present to future. To future recovery. And future growth.

That is because massive debt drains the future… and leaves it emptied.

Plunging into debt introduces a sort of hand-to-mouth living. It diverts cash flow to the service of existing debt — often unproductive debt.

And so investment in the future goes channeling backward. It is a titanic larceny of the future.

And artificially low interest rates are the stickup gun.

The Chains of Debt

Explains Roberts:

Low to zero interest rates incentivize nonproductive debt. The massive increases in debt, and particularly corporate leverage, actually harm future growth by diverting spending to debt service…

The rise in corporate debt, which in the last decade was used primarily for nonproductive purposes such as stock buybacks and issuing dividends, has contributed to the retardation of economic growth…

The massive debt levels being added to the backs of taxpayers will only ensure lower long-term rates of economic growth.

A debt-based financial system heaves every principle of sound economics out upon its ear.

It is an economics of the hamster wheel — frantic — but stationary.

In back of it all is a vicious hostility to savings…

The Fed’s War on Savings

The Federal Reserve would heat your savings into a potato so hot you cannot hold them for an instant.

You must throw them into profitable investments… which will coax the economic engine to life.

Or you must spend them on goods and services. That will yield the same healthful effect.

This is the royal route to growth — as the theory runs.

Thus the saver is a public menace, a criminal of sorts, a rascal.

Saving is a passable evil in normal times, most economists allow.

But in dark times — as these — saving locks needed capital out of the productive economy.

The central bank must therefore suppress savings to increase spending. And investment.

But there can be no investment without savings, say the old economists… as there can be no flowers without seeds.

Saving Equals Investment

Explained the late economist Murray Rothbard:

Savings and investment are indissolubly linked. It is impossible to encourage one and discourage the other. Aside from bank credit, investments can come from no other source than savings… In order to invest resources in the future, he must first restrict his consumption and save funds. This restricting is his savings, and so saving and investment are always equivalent. The two terms may be used almost interchangeably.

The more accumulated savings in the economy… the more potential investment.

An economy built atop a sturdy foundation of savings is a rugged economy, a durable economy.

It can withstand a blow.

In the past we have cited the example of a frugal farmer to demonstrate the virtue of savings. Today we cite it again…

The Prudent Farmer

This fellow has deferred present gratification. He has conserved a portion of prior harvests… and stored in a full silo of grain.

There this grain sits, seemingly idle. But this silo contains a vast reservoir of capital…

This farmer can sell part of his surplus. With the proceeds he purchases more efficient farm equipment. And so he can increase his yield.

Meantime, his purchase gives employment to producers of farm equipment and those further along the production chain.

Or he can invest in additional land to expand his empire. The added land yields further grain production.

This in turn extends Earth’s bounty in wider and wider circles — and at lower cost.

That is, his capital stock expands and the world benefits. Only his original surplus allows it.

He also retains a prudent portion of his grain against the uncertain future.

There is next year’s crop to consider. If it fails, if the next year is lean, it does not clean him out.

He has plenty laid by. And so his prior willingness to defer immediate gratification may pay a handsome dividend.

He can then proceed to rebuild his capital from a somewhat diminished base. Without that savings base of grain… he is a man undone.

We will call this man Farmer X. Contrast him, once again, with Farmer Y…

The Wastrel Farmer

This man enjoys rather extravagant tastes for a farmer. He squanders his surplus on costly vacations, restaurants, autos, etc.

He likes to parade his wealth before his fellows.

It is true, his luxurious appetites keep local business flush. But his grain silo perpetually runs low.

That is, his capital stock runs perpetually low. That is, he has little savings. That is, he has little to invest.

He deprives the future so that he may gratify the present… and rips food from future mouths.

And should next year’s crop fail, this Farmer Y is in a dreadful way.

Assume next year’s crop does fail.

The surplus grain that could have sustained him he has dissipated. He has no reserves to see him through.

He is hurled into bankruptcy. He must sell his farm at a fire sale.

If only this wastrel had saved.

The Lesson

Multiply this example by millions and it becomes clear:

A healthy economy requires a full silo of grain — of savings, that is.

An empty silo means no investment in the future. And society has nothing stored against future crises… like an imprudent squirrel that has failed to stock acorns against winter.

Henry Hazlitt, from Economics in One Lesson:

The artificial reduction of interest rates discourages normal thrift, saving and investment. It reduces the accumulation of capital. It slows down that increase in productivity, that “economic growth” that “progressives” profess to be so eager to promote.

The Enemies of Savings

The critic of savings will concede that saving may make individual sense.

But if everybody saved, he argues, consumption would wind to a halt.

Government must therefore race in to supply the demand that individual savers will not.

It must be “the spender of last resort.”

But that which applies to the individual applies to society at large, the old economists insist.

Saving Is Actually Spending

When society saves in lean times, it is not eliminating consumption. It is merely delaying it.

The demand that is supposedly lost is not lost at all. It is simply shifted toward the future.

Thus today’s savings are therefore tomorrow’s spending, tomorrow’s consumption.

Or to return to Hazlitt:

“‘Saving,’ in short, in the modern world, is only another form of spending.”

Artificially low interest rates drain the pool of savings… and leaves society poorer.

But the Federal Reserve has made its choice. It will drown us all in debt. And all for a mess of pottage.

Thus we face a future of limited growth… slender prospects… and frustrated ambitions.

But at least Wall Street will prosper…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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No Words for This

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6.6 million fresh unemployment claims this week. 3.3 million last week.

Combined you have a cataclysm of 9.99 million claims within two weeks.

“No words for this,” writes Pantheon Macroeconomics chief economist Ian Shepherdson — speechless, gobsmacked, floored, broken beyond endurance.

“What we are going through now dwarfs anything we’ve ever seen,” laments Heidi Shierholz, the Economic Policy Institute’s senior economist — “including the worst weeks of the Great Recession.”

Alas, the lady is correct.

This week’s unemployment figure rises 10 times higher than any week between 2007 and 2009.

In all, the United States economy shed 15 million jobs in that 18-month span. But at the present gallop… the economy will give up 15 million jobs in weeks.

Inconceivable — but there you are.

“The great financial crisis happened over a number of years,” says Wharton finance professor Susan Wachter. “This is happening in a matter of months — a matter of weeks,” she adds.

The New York Times estimates the unemployment rate is presently 13% and “rising at a speed unmatched in American history.”

You may wish to consider the reliability of the source. The true rate may be lower. But this you also must consider:

It may be higher.

And the Congressional Budget Office presently projects second-quarter GDP to plummet to an annualized -28%. That is correct.

One small example:

National box office sales ran to $204 million one year ago this week. And one year later?

$5,179 — essentially a $204 million collapse of the cinema industry.

The travel, retail and restaurant and ale house industries confront similar hells.

An economy such ours is like a long stretch of dominoes. Knock one down and the others go over…

The suddenly unemployed may lack the wherewithal to make rent. The landlord who depends on it may be unable to meet his own obligations. So with the person above him… and the next above him… all the way up the ladder.

A fellow going by the name of Mark Zandi is Moody’s Analytics chief economist. His researches indicate perhaps 30% of Americans with home loans — some 15 million of them — could fall into arrears if the economy remains shuttered through summer.

Meantime, the freshly unemployed send additional dominoes toppling…

The unemployed store manager can no longer afford the auto he planned to purchase. And so the automobile salesman goes without. His planned vacation he must cancel. He further abandons plans to renovate the kitchen or add the extension to his home.

The airline and hotel people then must suffer. As must the carpenter who would have worked the job. And the lumber men who would have sold the wood. As must the gasoline vendor who would have fueled its transportation.

And so on and so on, one domino knocking down the next in line, all the way through.

Multiply the business by 10 million, 15 million — 20 million — and you face a situation.

“No words for this.”

The Federal Reserve estimates the unemployment number may scale an unspeakable 47 million.

We find limited solace knowing the Federal Reserve nearly always botches the numbers. It is nonetheless a bleak arithmetic we confront.

The United States government is attempting to choke off the hemorrhaging with payments to businesses and the unemployed. But it will prove dreadfully unequal to its task.

What is more, multiple sources report some checks may not mail for 20 weeks — five months.

How will the unemployed with no savings rub along for five months?

Tens of thousands were driven to suicide during the Great Depression. Over 10,000 took the identical route out of the Great Recession.

Another suicidal wave — a large one — will wash on over should present conditions extend too long.

But you may be relieved to learn that the Federal Reserve is on the job…

It has expanded its balance sheet $1.6 trillion since mid-March alone. It required 15 months to attain that same figure during QE3.

And the balance sheet presently bulges to $6 trillion — a 60% increase in a mere six months.

One staff member of the Federal Reserve, meantime, believes it will swell to $9 trillion by year’s end.

We place high odds that it will expand further yet.

Well and truly… this is a time of superlatives.

But how much can the balance sheet expand… before bursting at the seams?

No one truly knows. But do we wish to find out?

Besides, its previous manias of balance sheet inflating did little for the real economy, the economy of things.

There is little reason — none, that is — to expect a different outcome now.

Here is another superlative:

The Dow Jones has endured its deepest first-quarter plunge in its entire 124 years. And heavier losses await, depend on it.

And so here we are, trapped… the devil to one side… the deep blue sea to the other.

“No words for this.”

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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R.I.P.: Requiem for a Bull

This post R.I.P.: Requiem for a Bull appeared first on Daily Reckoning.

For the longest bull market in history… it is a time to die.

For the Dow Jones, aged 11 years and two days, the soul quit the body yesterday afternoon.

Immediate cause of death: coronavirus disease (COVID-19).

Underlying cause of death: irrational exuberance.

The sickness was brief, acutely brief — a mere 19 days.

Only in November 1931… in the teeth of the Great Depression… did the index plunge from record heights to bear market depths in so short a space. Such was the violence of the death spasm.

Both S&P and Nasdaq joined it in the morgue this afternoon.

And so the flags over Wall Street flap at half mast today… and the black crepe is up.

Yet as we have argued previously:

The stock market is an ingenious device constructed to inflict the greatest suffering upon the most people… within the least amount of time.

In Memoriam…

The eulogies have already come issuiwwng…

Linda Zhang is chief executive officer of Purview Investments. Says she, a pearl of sorrow coursing down her cheek:

This bull market will go down in history as the one that nobody believed would last this long… What destroyed us in 2008 was overleverage. What brought us to where we are in 2020 is too much hope, sky-high valuations.

Doug Ramsey is chief investment officer of Leuthold Group. This fellow labels the late lamented decade the “steroid era” of the stock market — and identifies the supplier:

It was the most hated bull market — people said that early on. I think in the middle of the decade people [got] on board. Certainly in the last year they became believers. I’d also call the whole decade the steroids era because of all the help out of the Federal Reserve. I think it certainly did get a lot of help from the Federal Reserve. This was the steroids era of the stock market — the Fed propped it up.

Will the Federal Reserve attempt to blow life into the deceased? And how long can you expect the bear’s market to run?

Possible answers below.

But the exuberant, marauding bears desecrated the corpse this morning — before the Dow’s body was cold…

Another 15-minute Trading Halt

Within minutes of the opening whistle… the poor Dow Jones plunged another 1,700 points into eternity.

The S&P plummeted 7%, overloading the circuits and tripping the breakers — for the second instance this week.

For another 15 minutes the markets suspended breath.

Why this morning’s fresh stampede out?

The President Fails to Inspire Confidence

Apparently the president’s fireside chat last evening inspired little confidence. It failed to indicate a government response equal to the crying need.

Fifteen minutes after this morning’s halt, markets reopened for business. They should have remained closed…

The rout promptly resumed.

The market — meantime — places 83.4% odds the Federal Reserve will hatchet rates to between 0% and 0.25% next week.

That is, to financial crisis levels.

But dare we ask… is the worst over?

“You Likely Have not Seen Anything Yet”

“You likely have not seen anything yet,” wails Eric Parnell of Global Macro Research:

A potentially great fall lies ahead. Unfortunately for investors, conditions for the stock market have the potential to get worse, much worse, in the intermediate term. And all of the king’s policy horses and all of the king’s policy men may not be able to put this market back together again when it’s all said and done…

In short, you likely have not seen anything yet when it comes to today’s stock market.

After years of policy stimulus, stocks are trading at record-high valuations and bond yields are at historic lows. It is only a matter of time before reality returns to global capital markets.

But the coronavirus may merely be the tip of the berg that has gashed this Titanic down deep…

Think Lehman Bros.!

Phoenix Capital’s Graham Summers, introduced here this week, argues the bulk of the berg is invisible:

Now, let’s talk about the REAL crisis that is hitting the financial system…

[Global] debt-to-GDP is north of 200%. Leverage is higher today than it was in 2007. And the world is absolutely saturated in debt on a sovereign, state, municipal, corporate and personal level.

However, everything was running smoothly as long as nothing began to blow up in the debt markets [or] credit markets.

And despite a few hiccups here and there, the debt markets have been relatively quiet for the last few years…

Not anymore.

Someone or something is blowing up in a horrific way “behind the scenes.”

The Fed was FORCED to start providing over $100 BILLION in free money overnight back in September 2019. And even that massive amount is proving inadequate…

[Two nights ago], the Fed was forced to pump another $216 BILLION into the system.

You don’t get those kinds of demands for liquidity unless something is truly, horrifically wrong.

Think: LEHMAN BROS.

But we suppose that is why the Federal Reserve answered the klaxons this afternoon, dripping icy sweat…and rounded into action…

QE4 Is Here

Shortly after 1 p.m., it announced it is hosing in a staggering $1.5 trillion of liquidity today and tomorrow.

Between September and December it expanded its balance sheet at a rate unseen even during the financial crisis.

But the flow was but a trickle compared to the torrent on tap:

IMG 1

What is more, the Federal Reserve will conduct purchases across a “range of maturities.”

A full range of maturities includes longer-dated Treasuries. Thus it can no longer deny it has resumed quantitative easing…

Its purchases since September centered exclusively upon shorter-term Treasuries. Since QE targeted long-term Treasuries, it could throw out a smokescreen of deniability.

But no longer. Thus today we declare the onset of “QE4.”

The Rescue Doesn’t Hold

The drowning stock market seized upon the life ring thrown its way. And it rapidly made good half its losses on the day.

But it began to lose its purchase on the ring, on life… and resumed its slide into depths.

The Dow Jones finally settled at 21,200 by closing whistle — a 10% loss on the day — its worst since Black Monday, 1987.

Perhaps history will label this date “Gray Thursday.”

The S&P hemorrhaged an additional 9.51% on the day; the Nasdaq 9.43%.

The Leaders up Are Leading the Way Down

Are ruptures within the credit markets why stocks continue plunging, Mr. Summers?

This is why the markets are failing to rally. It is why every major central bank is out talking about launching new aggressive monetary policies. And it is why the Fed is privately freaking out.

Below is a chart showing [a proxy for] the credit markets (black line) relative to the stock market (red line).

As you can see, the credit market led stocks to the upside during the bull market. And it is now leading stocks to the downside. Credit is already telling us that stocks should be trading at 2,600 or even lower.

IMG 1

This is a real crisis. And from what I can see, the Fed can’t stop it anytime soon.

The Fed’s One Option

But if the prospect of rate cuts and additional QE cannot hold the line… does the Federal Reserve wield any options at all?

So what could stop this?

A globally mandated intervention in which the Fed and other central banks start buying corporate debt.

However, in the U.S., the Fed CANNOT buy corporate debt…

It would need authorization from Congress to do so. And from what I can tell, no one is even suggesting this.

I don’t mean to be a fear-monger, but this is a very dangerous situation.

We would have to agree. It appears a very dangerous situation.

But how long can you expect the bear’s market to endure? The answer in one moment.

But first… will the Federal Reserve actually attempt to reanimate the corpse?

Perhaps not.

The Fed Wants to End the Market’s Dependency

As our own Charles Hugh Smith claimed in a recent reckoning, it has grown fearful of the monstrous bubble it inflated.

But it did not wish to shoulder blame for draining the air out.

Thus the coronavirus has done it a great service by seizing the sharpened pin.

And it may not wish to risk blowing another bubble. Do we speculate?

No. Here former Dallas Federal Reserve President Richard Fisher speaks for himself:

The Fed has created this dependency…

The question is do you want to feed that hunger? Keep applying that opioid of cheap and abundant money? The market is dependent on Fed largesse… and we made it that way…

But we have to consider… that we must wean the market off its dependency on a Fed put.

The question is worth considering. But how long can you expect this bear to run amok?

Here is the answer, says history:

Roughly seven months for the S&P… and perhaps nine months for the Dow Jones.

Of course it could end sooner. But it could also end later.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post R.I.P.: Requiem for a Bull appeared first on Daily Reckoning.

“The Most Critical Time Since the Financial Crisis”

This post “The Most Critical Time Since the Financial Crisis” appeared first on Daily Reckoning.

“We’re faced with the most critical time since the financial crisis.”

This we have on the grim authority of money man Sven Henrich.

Last evening prepared us for this morning’s hells…

In overnight trading, S&P futures plunged 5% in four hours. The selling frenzy tripped the “circuit breakers.”

These fail-safes were installed after 1987’s “Black Monday” to prevent encores.

Thus S&P futures trading screeched to a halt, suspended… lest the fever deepen.

But the opening whistle blew this morning. And the delirium resumed precisely where it had ended…

A Trading Halt

The S&P went instantly careening. It shortly sank 7%.

Once again the violence tripped the circuits (the threshold for regular-session trading is higher than after-hours trading).

The referee called a halt at 9:34 — the first ever under existing rules — and administered a 15-minute standing count.

For 15 minutes the market fought to recapture its legs… and its wits.

At 9:49 the ban came off. Though woozied, the market “stabilized.”

But the battened and bludgeoned market could scarcely maintain the vertical.

The Worst Day Since “Black Monday”

Both S&P and Dow Jones went along, 5% down through noon. The remainder of the afternoon worked little improvement.

The Dow Jones tumbled 8% at one point this afternoon — the most since another Monday, long distant — “Black Monday” in 1987.

It closed the day down 7.79% to 23,851, a 2,014-point waylaying.

The S&P gave back 226 points on the day, for a 7.60% loss.

The Nasdaq similarly absorbed a 625-point trouncing, losing 7.29% on the day.

Thus the three major averages presently camp upon the doorstep of a bear market. One more slip… and they go in.

A bear market is a 20% plunging from recent peaks.

European stocks officially crossed over today — down over 22%. Not three weeks ago they traded at record heights.

Meantime, 10-year Treasury yields plunged to a starvation-level 0.318% this morning.

Words fail us.

“The Path of Least Resistance is Still Down”

Is the worst over?

“The path of least resistance is still down,” shouts Liz Ann Sonders, chief investment strategist at Charles Schwab.

Once again we must point our accusing finger at “passive investing.” The computers caught a fever, unloading positions at electronic speeds.

But there are few buyers on the other end to take them in.

That is why — we theorize — “corrections” have attained great ferocity in recent years.

That is also why markets have gone from record heights to bear market’s doorstep within three weeks.

But what happened this morning? Why did the bottom drop away?

Oil Collapses

Oil is the explanation most widely on offer. Investors Business Daily:

Oil prices began to collapse on Saturday as negotiations between Saudi Arabia, the de facto leader of the Organization of the Petroleum Exporting Countries, and Russia over production quotas failed. The breakdown in talks led the Saudis to sharply slash prices in the onset of another price war. The Saudis also said they would abandon OPEC’s current production curb, a move that opens the same door to other OPEC members, threatening to flood the already-oversupplied oil market with possibly more than 3 million barrels per day in additional production.

Oil prices had already sold off for three straight weeks, losing more than 37% as global markets grappled with the potential impact upon demand of the coronavirus outbreak begun late last year in China.

Crude oil hemorrhaged 25% today — its heaviest rout since 1991. It has come all the way down to $30.93. And oil stocks took a savaging today.

Two “Black Swans” Converge

Thus two “Black Swans” pooled their mischiefs… and came swooping in this morning.

These nightmare birds are the coronavirus and oil. Combined they account for this sudden terror.

So argues Seabreeze Partners Management president Doug Kass:

Over the weekend one old Black Swan (coronavirus) and a new Black Swan (substantially lower energy prices) joined forces in the pond as the collapse in yields and energy prices is serving to crater global equity markets this morning. In scope and rapidity, the accumulated declines in bond yields and stock prices are unprecedented…

There will be enormous fallout where large bets have gone wrong — ranging from bond, equity, commodity and VIX positioning.

Adds one Chris Rupkey, chief financial economist at MUFG Union Bank:

[Stock market investors] want out. Big-time. The sky is falling. Get out, get out while you can. Wall Street’s woes have to eventually hit Main Street’s economy hard.

A Minefield of Debt

The energy sector is soaked through with debt. A fair portion is “high yield.” That is because it is, as the professionals say… risky.

Many of the big banks hang on the other end of it. Bank stocks absorbed some of the heaviest slatings today — not coincidentally, we hazard.

What if losses pile up in the energy sector? Defaults could go barreling through the credit markets.

And woe to ye of earth and sea once they do…

Nordea’s global chief foreign exchange strategist Martin Enlund:

If “unforeseen losses” show up in the high-yield sector (very energy-heavy), it might damage the credit cycle… and if the credit cycle cracks, forget about buybacks, mergers and acquisitions and the S&P’s current valuation.

Buybacks are the chief gimmick behind the market’s gorgeous multiyear spree.

Who will buy if the corporations do not? Who will pick up the standard… and carry forward?

The questions nearly answer themselves.

Next we come to a central actor in the drama unfolding before us — the central bank.

Heading Back to Zero

What can you expect from the Federal Reserve in the days and weeks ahead?

Its recent “emergency” 50-basis point rate cut came thudding down… like a zeppelin of lead.

But of this you can be certain: More is ahead.

Goldman Sachs chief economist Jan Hatzius is convinced the Federal Reserve will hatchet another 50 basis points at this month’s FOMC meeting.

It will proceed to another cut in April, says he:

We now expect a 50bp cut, in part because the bond market is already priced for a large move and the FOMC will likely be reluctant to risk further tightening in financial conditions by refusing to deliver. We are also penciling in a final 50bp cut at the April 28-29 meeting.

At which point rates would hover between 0–0.25% — all the way back to post-crisis lows.

Remember “Normalization?”

And so Mr. Powell’s previous designs to “normalize” rates now appear a cruel, cruel jest.

We never believed he would succeed. The market is so entirely dependent on abnormal interest rates… it would collapse without the backstop.

He attempted to pull it out gradually after he came on duty. But he put it back after December 2018, when the market wobbled badly.

Now it is riveted into place and reinforced with cement.

But recession menaces — greater than at any point in years.

And like a blunderbuss artillery man who squanders his ammunition ahead of the main action… the Federal Reserve is blasting its remaining “dry powder” ahead of time.

As we razzed last week:

The Federal Reserve will be reduced to scraping powder off the floor. If recession swept in tomorrow… it could scarcely fire off a cannon.

Monetary policy is a spent cartridge, an empty shell casing.

Central banks will be forced ultimately to surrender command to the fiscal authorities.

Prepare for Fiscal Policy

“Helicopter money,” Modern Monetary Theory, some variant of the two, these we will see.

Depend on it.

We opened today’s reckoning with a lament from analyst Sven Henrich:

“We’re faced with the most critical time since the financial crisis.”

And so we conclude with Mr. Henrich:

The constant subsidy of markets and the economy has led us to the largest credit and asset bubble in our lifetimes and the architects of the monstrosity have left themselves weak and depleted. They are now begging for fiscal stimulus from governments that are traditionally slow to react. The big bazookas will come, the question is whether it will be too late.

That is our question as well.

More tomorrow…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post “The Most Critical Time Since the Financial Crisis” appeared first on Daily Reckoning.

Did the Fed Bail out the Market Today?

This post Did the Fed Bail out the Market Today? appeared first on Daily Reckoning.

The good news first:

We learn by the United States Labor Department this morning that the economy took on 273,000 jobs last month.

Consensus estimates came it at 175,000.

Unemployment slipped from 3.6% to 3.5%… equaling a 50-year low.

Meantime, December and January estimates were upgraded by no less than 85,000 jobs.

Thus there is more joy in heaven.

Now the bad news:

The stock market picked up the news… and heaved it into the paper basket.

“Black Swan-dive”

The Dow Jones hemorrhaged another 800 points by 10 a.m. The other major indexes also gave generously — again.

VIX — Wall Street’s “fear gauge,” exceeded 48 this morning. It had guttered along under 15 until late February.

In all, global equities have surrendered $9 trillion in nine days — $1 trillion each day.

Never before have global equities retreated so swiftly and violently.

Meantime, the 10-year Treasury note achieved something of the miraculous this morning…

Yields collapsed to an eye-popping 0.664%.

Many were flabbergasted when yields sank to a record 1.27% low in July 2016. Yet this morning, they were nearly half.

Well and truly… these are interesting times.

Michael Every of Rabobank shrieks we are witnessing a “Black Swan-dive, as yields and stocks tumble in unison…”

A New Contrarian Indicator

But at least the crackerjacks at Goldman Sachs gave us advance notice of this thundering stampede into Treasuries…

A Bloomberg headline, dated Feb. 10:

“JPMorgan Says Bonds to Slump, Fueling a Return to Cyclicals.”

And this, bearing date of Feb. 23:

“JPMorgan Says Rally in Treasuries May Be Nearing Turning Point.”

May we suggest a new contrarian indicator?

The “JPMorgan Indicator.”

The reference is to the famed 1979 BusinessWeek cover declaring “The Death of Equities.”

Of course equities embarked upon the grandest bull market in history shortly thereafter.

Perhaps JPMorgan can provide a similar service.

As Zero Hedge reminds us, most hedge funds are clients of JPMorgan. Those who took aboard its advice are presently paying. And royally.

They “shorted” longer-term bonds — betting they would fall.

If You Don’t at First Succeed…

We imagine Mr. Jerome Powell is scratching his overlabored head today. His “emergency” rate cut Tuesday failed to fluster the fish.

But that does not mean more bait is not going on his hook…

Markets presently give 50% odds the Federal Reserve will lower rates to between 0.25% and 0.50% by April.

The central bank is already woefully unprepared to tackle the next recession. Yet it appears ready to squander what little ammunition that remains.

And Bank of America is already assuming a global recession is underway:

“[Our] working assumption is that as of March 2020 we are in a global recession.”

A global recession can wash upon these American shores.

What is the Federal Reserve to do in event it does?

Dwindling Options

It has little space to cut interest rates, as established. And purchasing Treasuries has lost its punch. Recall longer-term Treasury yields presently dip below 1%.

Additional purchases could drag yields to zero… and below.

Eric Rosengren presides over the Federal Reserve Bank of Boston.

He moans these conditions “would raise challenges policy makers did not face even during the Great Recession.”

Again, what could they do?

In a situation where both short-term interest rates and 10-year Treasury rates approach the zero lower bound, allowing the Federal Reserve to purchase a broader range of assets could be important.

… We should allow the central bank to purchase a broader range of securities or assets.

Full English translation:

The Federal Reserve should be authorized to purchase stocks.

But Is It Already?

This Tuesday we vented the theory that the Federal Reserve has been sneakily — and illegally — purchasing stocks.

Citing Graham Summers, senior market strategist at Phoenix Capital Research:

For years now, I’ve noted that anytime stocks began to break down, “someone” has suddenly intervened to stop the market from cratering…

[And] a year ago, I noticed that the market was behaving in very strange ways.

The markets would open sharply DOWN. Seeing this, I would begin buying puts (options trades that profit when something falls) on various securities, particularly those that had been experiencing pronounced weakness the day before.

Then, suddenly and without any warning, ALL of those securities would suddenly ERUPT higher.

Mr. Summers theorized that the Federal Reserve was purchasing Microsoft, Apple, Alphabet (Google) and Amazon stock.

Because these behemoths wield such vast heft, they can haul the overall market higher.

Did the Federal Reserve possibly resort to the same skullduggery today?

The Smoking Gun?

At 3:08 we noticed the Dow Jones flashing 25,268 — another whaling to conclude the week.

We next looked in shortly after 4 to tally the final damage.

Yet we were astonished to discover the index had surged to 25,938 in that hour.

For emphasis: That is a 670-point spree in the span of one hour.

It settled down to 25, 864 by closing whistle. But the index closed the day only 256 points in red — a victory of sorts.

What happened?

A quick look at Apple revealed it began rising around 3 o’clock… as if by an invisible hand.

Microsoft displayed a nearly identical pattern. And Amazon. And Google.

All mysteriously jumped at 3 p.m.

We leave you to your own conclusions.

A Record of Mischief

It’s long been argued that the Fed shouldn’t and doesn’t buy stocks.

However, the fact is that the Fed does a lot of things it’s not supposed to do. According to the Fed’s own mandates, it should never monetize the debt by printing money to buy debt securities.

The Fed’s already done that to the tune of over $3.5 TRILLION.

Moreover, we know from Fed minutes that as far back as 2012, the Fed was shorting the Volatility Index (VIX) via futures, or options. Here again, this runs completely contrary to the Fed’s official mandate. And if you think this is conspiracy theory, consider that it was current Fed Chair Jerome Powell who admitted the Fed was doing this!

Simply put, the Fed has been skirting its mandate for years in the name of “maintaining financial stability.” In fact, what usually happens is the Fed does things it shouldn’t, denies it for years and then finally admits the truth years later, by which point no one is outraged.

I believe the Fed is currently engaging in precisely such a practice when it comes to the outright rigging of the stock market today.

The Laws Fall Silent

The Federal Reserve Act does not authorize the central bank to purchase equities.

But financial emergency is akin to wartime emergency.

And as noted, the Federal Reserve took… extreme liberties with the law during the last crisis.

It may be taking additional liberties at present. And it will again if necessary.

“Inter arma enim silent lēgēs,” said Cicero — “In times of war, the law falls silent.”

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Did the Fed Bail out the Market Today? appeared first on Daily Reckoning.