Thursday, March 18, 2021

Hyper Asset Inflation Hyper Asset Crash

Monetary policy is no longer helping the economy and the fiscal multiplier has collapsed, so the ever increasing firehose of "stimulus" is having its primary effects on markets...

The greatest risk we face - and one that none of today's pundits are discussing is the fact that ludicrous amounts of stimulus are now needed to move the economy. Stimulus that is having far more impact on markets than the economy. This is a risk that policy-makers have implicitly accepted and of course casino gamblers could not be happier. However what it all means is that the inevitable reversion to the mean will be a devastating crash AND there will be no stimulus safety net. 

Here we see from a chart of cyclicals that long-term bond yields have just now reached the 2009 lows. And yet, all of today's pundits are panicking that bond yields are too high. Why? Because back in 2009 at this level of deflation, cyclicals were down -80% from the highs, whereas now they are up 180% from the lows. Again, all of today's monetary policy is now fixated solely on markets, and because this stimulus is having a dwindling effect on the economy, we now have a case of epic over-valuation and a moribund economy.

Policy-makers are pushing markets inexorably towards an epic crash with no economic safety net. 

The reason why all of today's economic analyses are clueless is because economists are using year over year % gains to measure improvement in the economy. When the baseline is the worst depression in 90 years, year over year comparisons are meaningless. They need to compare to 2019 as their baseline, not 2020. For example, on GDP, the Congressional Budget Office puts calendar year 2021 GDP growth at 6.3%. Goldman Sachs estimates 2021 growth at 8%. However, using 2019 CBO numbers as a baseline, the TWO YEAR growth rate is actually 3.8% which is 1.9% per annum. Somehow, 2% GDP growth and 20% growth in national debt, doesn't sound as good. It implies a fiscal multiplier of 10% - spend $10 of government money to get $1 of GDP. 

We see this type of disingenuous data mining all the time. Here we see that the most recent CPI came in at 1.68%. And yet according to Zerohedge, we are on the verge of becoming Zimbabwe. 

What we have isn't sustained inflation, what we have is asset inflation due to rampant speculation, feeding back into the economy, where it's doing far more harm than good. 

For example, we are told that a lumber shortage has caused lumber prices to skyrocket, which is now tanking the housing market. 

Here we see housing starts (black) with lumber prices (red). Housing starts today are far lower than during the housing bubble, yet lumber prices today are far higher:

Of course monetary policy is now ENTIRELY skewed towards markets. At the 0% bound, there is no room to cut rates to help the over-levered economy. In addition, quantitative easing is solely intended to give risk asset markets the feel good fake wealth effect. The theory is that the economy will eventually catch-up to epic over-valuation. Someday, over the rainbow. 

Unfortunately, there is no such thing as "free money". This is a lesson that today's pundits, the public, and the Fed still haven't figured out. By attempting to monetize the Biden deficit, the Fed is now driving reflation expectations higher. Which means they are in a box - they can keep buying bonds and driving bond yields higher until global risk assets implode, or they can stop buying bonds and watch the over-supplied t-bond market go bidless, imploding risk assets. Either way they have effectively lost control of the bond market. 

This article from Mohammed El-Erian gives the long version of what I just said. And no, the Fed did not just "thread the needle". They bought a one day short-covering reprieve from higher bond yields. 

Here we see the Fed balance sheet and T-bond prices. In the deflationary phase  of 2020 massive bond purchases held up the bond market. Now, in the reflationary phase, the massive doses of liquidity are having the predominant effect of driving up reflation expectations, which is crushing the bond market.

This past year the Fed expanded their balance sheet by $3.5 trillion, mostly buying long-term Treasury bonds. And yet prices have collapsed. What should they do now, buy more?

"Trying to calm the yield concerns by signaling more purchases of securities, thereby risking yet another leg up in inflationary expectations"

Of course we've seen this movie before but never when the impending outcome was this dire. We saw headfake reflation in 2008, 2011, and 2018. The Dow drawdowns were -55%, -20%, and -20% respectively. 

What it comes down to, is that in order to appease financial markets, the economic bar just keeps getting lower and lower and lower, while asset markets keeping going higher.

This is an asinine divergence that can only end one way. When everyone agrees it's an asinine experiment. In the meantime, they need to get conned by asset inflation and the attendant bullshit, one, more, time...