THE GLOBAL MINSKY MOMENT

This week the British Pound kicked off the global Minsky Moment with a currency crash and attendant bailout. Stock gamblers see their last chance to get in...

Just one day after saying they would not revise monetary policy until their scheduled meeting in November, the BOE panic intervened in the UK Treasury market to restore order. The 10 year UK Bond had catapulted from under 1% to 4.5% in less than a year. 

That's all it took for global gamblers to rush back into risk markets. Bailout Watch is back. Leave aside the fact that it was only a few weeks ago that Fed Powell monkey hammered global markets with the message that pivot was not on the table. The stock market has been straight down since that time and is now camped perilously at the June lows.  

Zerohedge was all over this new central bank "pivot", because it checked their box for imminent hyperinflation, dollar demise, and commodity super cycle. The latter of which has been a failed trade ever since the war in Ukraine began. More than a few pundits took the opportunity to assuage the concerns of trapped gamblers.  

Yet again, in order to believe in this latest central bank fantasy one must believe that the middle class will continue to go under the bus due to inflation and higher interest rates, while financial markets receive another bailout. It's the same theme of the past 14 years, however this time running up against 10% inflation.

What the Bank of England is attempting now, is known as "impossible". They are attempting to monetize a new tax cut, raise interest rates to cool rampant inflation, and stabilize the currency. No one told them these objectives are mutually incompatible, so they will learn the hard way. This new easing policy is highly likely to undermine the currency which has already collapsed.

All of which makes this the Boris Johnson of financial bailouts - it's here for a good time not a long time. The more central banks outside the U.S. capitulate, the more it will drive the dollar rally. 

It's the Fed that must capitulate, but there is not even the slightest sign of that taking place. Don't take my word for it, even perma-bull Jim Cramer understands the Boris Johnson bailout won't last:

"CNBC’s Jim Cramer said that Wednesday’s rally will likely reverse course as soon as a Federal Reserve official reminds Wall Street of its hawkish stance against inflation"
 

The market is short-term oversold so this nascent bounce could last a few more hours or days. Or it could already be over. This is a good article to understand the potential short-term path of this rally and ramifications for trapped gamblers:

The Big Short Squeeze Is Coming Here

The article asserts that "everyone" is bearish. Which is moronic, because the target audience for the article is trapped bulls. However, the real punch line further down in the article after setting the stage that sentiment is negative:

"During bear markets (2008), negative sentiment provided very small opportunities to reduce risk before further declines"

I agree, and I'm not even that bullish. However long it lasts, this could very well be the last bounce before the market accelerates lower. Anyone can see below, there is no sign of real panic the likes of which we saw in 2008 and 2020. This isn't even as extreme as 2011, 2015, and 2018. In all of those times the VIX hit 50.

Consider also that those blue squares represent ACTUAL Fed bailouts. Not imaginary bailouts, like this current one. It's shocking to realize that investors are the MOST complacent at a time when bailout is LEAST likely. Today's financial managers don't understand moral hazard. All they understand is bailouts. 

And 2022 is the year when bailout investing will fail catastrophically.

Below I put together this illustrative chart to show what I believe to be the next sequence of events. My original chart was somewhat optimistic, so I made this revised one to take into account the full scope of impending dislocation. This of course is a best "guess", so take it with a grain of salt. I will adjust accordingly as circumstances evolve.

Once this oversold rally ends and the June support level is broken, it will take serious U.S. dislocation before the Fed turns neutral. In the meantime, all hell can and will break loose. It will be a non-binary event meaning having dislocations that are very hard to predict in advance aside from brick shitting panic. Market liquidity will collapse. Ultimately, the Fed will be forced to turn neutral and attempt to calm the market. I predict that will further spook investors which is what happened in March 2020 - The first rate cuts were met with more selling. Ultimately bulls will capitulate and that will set-up a trading rally. After that, the market will continue lower amid widespread rumours of mass defaults in a new global credit crisis. Once the Fed panic capitulates and goes ALL IN on QE then likely a multi-month headfake rally could begin. 

In summary, of course the Fed is going to pivot eventually.

The question isn't "if", it's "when". And the answer could mean the difference between being financially intact and financially buried. 

THE POINT OF NO RETURN

The widespread belief that this is the 1970s deja vu has ensured this will be the hardest landing since the 1930s. Sadly investors are now trapped in Jackass Utopia...

Mass confusion reigns supreme. Case in point, this week Wharton Professor of Finance, Jeremy Siegel, pounded his fist that the Fed is over-tightening:

"It makes absolutely no sense to me whatsoever, way too tight,"

Back in late May of this year Siegel was still asserting the Fed was way behind the curve and inflation would remain high until 2024:

May 2022:

“We’re going to have high inflation throughout this year and into next year, and I don’t really see a slowdown until 2024,” Siegel said. In fact, the official inflation figures are understated"

In other words, Siegel and the majority of other pundits who have been pounding the table on hyperinflation all year are the reason why investors are now TRAPPED in their imploding Jackass Utopia. 

Of course, Siegel's most recent opinion is correct - the Fed is way overtightening.

The housing market is essentially shut down now as mortgage rates are almost at 7% this week vs. 3% a year ago. 

Who refinanced a year ago and now wants to pay $20k additional interest per year on a $500k mortgage? No one. 

"Some of the biggest players in the real estate industry, including RE/MAX, Redfin and Wells Fargo, have announced layoffs in recent months totaling thousands of jobs. Industry analysts are projecting the cuts could eventually be on par with what was seen during the housing crash of 2008"

The latest fantasy is that there is no subprime this time around and no supply glut. Any blind man can see that in-process supply (lower pane) is higher now than in 2008. As far as subprime goes, it's all been hidden behind the veil of the shadow banking system which emerged from the ashes of 2008. Instead of banks making subprime loans, specialty mortgage companies make subprime loans using money borrowed from banks. This way banks can pretend they are lending to solvent entities.

Then there is the Fed-induced Emerging Market currency "Doom loop", now that the entire world is being forced to over-tighten in lockstep with the Fed. 

Nevertheless, Fed bailout remains a predominant fantasy. Unfortunately, the Volcker gambit ensures that Powell will not be deterred by an EM meltdown. 

At this point in 2008 the Fed was ALREADY easing:

None of this risk is priced in yet, especially when it pertains to the soaring dollar and soaring bond yields:

"Fourth-quarter S&P 500 earnings will face an approximate 10% headwind from the stronger dollar, in addition to other issues like soaring input costs"

The equity risk premium which measures the stock market yield vs. Treasury bond yields has collapsed down to 2008 levels. Signaling "More Bear Market to Come":

“There is no alternative” (TINA), has completely evaporated with the rise in interest rates"

"The Equity Risk Premium has contracted since the market peaked back on Jan. 3. Using history as a guide, this is highly unusual, since it typically needs to widen by +425 basis points, on average, before bear markets come to an end"

The S&P 500 is now testing the 200 week moving average, which historically has been a critical bear market level. Below that level, the last two bear markets accelerated both in % decline and duration. And then investors were informed far too late that the economy was officially in recession. Which is similar to now when economists are pretending the economy is not already in recession. 

Below we see that from the Y2K top it took until 2013 to break out to new all time highs. Well over a decade of lost returns.

To now believe that Powell's Quixotic Volcker gambit will succeed at the zero bound is a fool's errand of the highest order. 

The market is on the cusp of worst three quarter return for the Nasdaq since 2008.

The market is technically oversold, therefore violent brief rallies are to be expected. However, the largest part of the March 2020 decline took place AFTER the market was oversold. In addition, investors should beware that the market was limit down in March 2020 when the Fed restarted QE. File that under careful what you wish for. 

As we see below, GDP and interest rate predictions have completely reversed since the beginning of the year. MASS complacency is borne of mass confusion.

In summary, the Volcker gambit is a disaster. The ubiquitous belief that this is the 1970s deja vu will ensure this is the hardest landing since the 1930s. 

WSJ: Buying The Dip Has Worst Performance Since 1930s

Indeed.

EVERYTHING'S GOING TO BREAK

Central banks are hyper tightening into an incipient global depression. Bulls STILL can't figure out what could go wrong...

The central bank meetings this week were ALL dollar positive. First the Fed announced on Wednesday an even more hawkish stance on interest rates. They want the Fed rate at 4.4% by the end of 2022 which is almost double where it was going into this week. 

The Fed is now primarily concerned about "inflation" in the housing market. Which is ironic, because they continue to be the sole source of housing inflation. During the pandemic, their QE programs caused housing prices to soar, now during the tightening phase, their interest rate hikes are causing carrying costs to soar. This is what Powell said at the FOMC debrief:

“I think that shelter inflation is going to remain high for some time. We’re looking for it to come down, but it’s not exactly clear when that will happen. It may take some time. Hope for the best, plan for the worst”

In other words, the Fed is using their own rate hikes as a justification for further rate hikes. Which means the only thing that will bring "inflation" down is a collapse in housing prices. Which is coming, but not coming fast enough to prevent disaster.

Falling home sales are a precursor to falling home prices.

Next, the BOJ met and kept interest rates unchanged which means there is now a ludicrous 3.7% spread between U.S. short-term rates and Japanese long-term rates. Shortly after the meeting, the Japanese Treasury intervened in the $USDJPY market, but as FX traders predicted, without monetary change, intervention alone had little effect. Which means that the Yen carry trade will continue to hang over this market until such time as there is a final global RISK OFF event. 

Similar to March 2020.

And then the Bank of England met and raised rates .5% while declaring that the economy is likely ALREADY in recession.

In other words, what we are witnessing is central bank hyper tightening into a global depression.

Now, "someone" must blink and capitulate and it won't be the Fed. The dollar wrecking ball is out of control, as the Fed is the tightest central bank on the planet. 

The AAII bears sentiment survey is the highest since 2008, but there is no follow through in markets. The VIX is somnolent because everyone believes that everyone else is capitulating.

They are trapped in moronic deadlock.

The Global Dow is well through the June low and beneath the 200 week moving average for the first time since March 2020.

Bulls who were expecting a Fed pivot in September are now trapped. 

The market won't bottom UNTIL the VIX spikes due to capitulation. 

And when it finally arrives, capitulation will explode markets and expose rampant fraud like a Pinata spilling out candy.

Believe it. Or not.

SLEEPWALKING INTO EXPLOSION

Risks have reached a point at which a bull market would be an outlier event...

The Fed is now the furthest away from a bailout bias as they've been in forty years.

This week features a central bank gauntlet coming at a time when the largest central banks are the least coordinated in history. I am of course referring to the U.S. and Europe both on the tightening warpath vs. China and Japan easing. 

Yesterday the WSJ had an excellent article explaining the background behind Powell's Quixotic Volcker gambit:

"Mr. Powell cited the example of former Fed chairman Paul Volcker, who drove the economy into a deep hole in the early 1980s with punishing rate increases to break the back of double-digit price gains"

“Until inflation comes down a lot, the Fed is really a single mandate central bank” 

Mr. Powell has stopped talking about a so-called soft landing"

It's clear that the Fed is not only willing to risk a recession, they are willing to risk a market crash. Perhaps even welcoming one as a means for accelerating the decline in inflation.

The article goes on to discuss the accumulated moral hazard from the standpoint that this new approach is the binary opposite of the approach they've had since 2008. One which has conditioned investors to expect monetary bailouts:

"Markets have been slow to come around to the Fed’s new posture, largely because it is at odds with how the Fed has acted for years" 

But then comes the punchline regarding the stock market vis-a-vis this summer rally that Powell imploded at Jackson Hole:

"The rally was making the Fed's job harder"

In other words, the Fed used to have a put (option) below the market, now they have a call option above the market. They don't want another bull market and they are intent on ensuring it doesn't happen. 

This week, Fed futures are expecting the third .75% rate hike in a row. However, that's only half the story because bond markets have been front-running the Fed higher all year. Taking into account the record rise in home prices caused by Fed QE during the pandemic, and compounding that by the record rise in mortgage rates this year, indicates the most brutal tightening of housing financial conditions in U.S. history going back to at least 1975. Likely all time periods:

A 100% increase in carrying costs for newly purchased homes (New and used):

Of course the Wall Street Journal fails to mention the greatest risk which is that Paul Volcker had a 19% Fed rate vs. Powell who has a 3% Fed rate. Volcker had ample downside cushion in case the economy imploded. Powell has ZERO downside cushion.

This entire society is assuming that Quantitative Easing can bail them out of every type of financial/economic collapse. Which is the ultimate lethal fantasy. 

The Fed is only part of the story this week. 

The BOJ releases their decision Wednesday evening after the FOMC. Thursday in Japan. The BOJ has already signaled what is called a "rate check" which is a precursor to currency intervention. However, currency speculators are FAT AND HAPPY gorging on the Yen carry trade, so they don't think it will actually happen:

"Last week, the Bank of Japan reportedly conducted a foreign exchange “check,” according to Japanese newspaper Nikkei – a move largely seen as preparing for formal intervention."

“Our economists expect the BOJ to firmly maintain its commitment to YCC zero interest rate policy at this week’s meeting against a backdrop of five other G10 central banks that are all likely to deliver large rate hikes,”

When you read the article you realize that Wall Street is unanimous in believing that the BOJ won't reverse their monetary easing stance. Even though the Yen is now at the same level as it was in 1998 which was the last time they monkey hammered global markets. And considering that Japan's inflation rate is the highest in 31 years. If you can't access the article, it says that inflation is at a 31 year high, but economists all agree the BOJ won't change policy.

What could go wrong?

Whether they actually reverse monetary policy or not, they've already signaled that a currency intervention is coming. So investors are assuming they can ride out a potential MASSIVE short squeeze. 

Why is this important to global markets? Because since the pandemic, Japan has been the largest exporter of hot money globally. And if they succeed in reversing the Yen, then that would catalyze an LTCM explosion x 100. Which is what happened the last time they successfully forced Yen RISK OFF. 

Recall that U.S. markets have been the primary beneficiary of global inflows for all of 2022. And that could reverse overnight.

It gets worse, because the PBOC has now officially lost control over the Yuan. They have been attempting to strengthen the currency for the past month, but every effort has failed. Worse yet, they are accelerating their easing policy making currency control that much less likely. 

Which sets up this week to be an Emerging Markets currency event on steroids. Orders of magnitude worse than what happened in 2015 when China Yuan devaluation forced global risk off. There are many EM currencies waiting to implode right now.

September 4th, 2022:

Last but not least, the Bank of England has their policy meeting also on Thursday. 

"While the Bank of England is expected to raise rates by at least 50 basis points (bps) this week, the prospect of further tightening has failed to shore up the pound"

Given the backdrop of risks above, it's highly possible the British Pound could fall below $1 during the impending melee.

Buckle up.

EVERYONE LEARNS THE HARD WAY

This will do it...

"There is no political solution to our troubled evolution”

The central lesson of Nassim Taleb's Black Swan introductory, Fooled By Randomness, is that those who learn humility early on in markets go on to continued success. Those who have early success in markets, go on to ever larger bets leading to inevitable failure. It’s human nature to conflate all success as skill and all failure as personal inadequacy. Add in over a decade of central bank market bailouts and Taleb's theory is now getting tested on a biblical scale. 

So it is that this central bank experiment in moral hazard has trapped an entire society in an end of cycle super bubble. One in which liabilities remain at all time highs while assets are collapsing. For those of us who learned their lesson in prior asset bubbles this has been an exercise in humility, patience, and frugality. Which is now being rewarded in spades. The only solace in a time like this comes from knowing that bills will get paid independent of market vicissitudes.

No one can control history. Neither Democrats nor Republicans. All they can control is who gets hurt the most and the least. That is what passes for political ideology - the distribution of inevitable impacts of failed policy. Those in the heads down working class are easy prey for today’s con men. However among the educated, there is no excuse. We may not have control at the societal level, but we all have control at the individual level. Economic failure has been obvious since Springsteen first started writing about it 40 years ago. However this society has extreme survivor bias. This time around the list of survivors will be taken down to low single digits. A new low water mark that will be obvious to even the most truth challenged observer.

As I've pointed out several times, this housing bubble makes every other housing bubble i.e. 2008, 1980 seem minor by comparison. What saved many U.S. homeowners during the last housing bubble was the fact that only a relatively small subset of owners were using adjustable rate mortgages. In many countries there is no such thing as a 30 year fixed rate mortgage. ALL mortgages reset interest rates every few years. That type of system puts interest rate risk on the borrower. Whereas the U.S. system with long amortization periods puts interest rate risk on the lender. 

"Millions of people who borrowed cheaply to purchase homes during the pandemic boom face higher payments as loans reset"

"How exposed borrowers are to rising rates varies notably by country. In the US, for instance, most buyers rely on fixed-rate home loans for as long as 30 years. Adjustable-rate mortgages represented, on average, about 7% of conventional loans in the past five years. By contrast, other nations commonly have loans fixed for as little as a year"

The middle class is getting crushed at both ends now - higher inflation AND higher interest rates.

"The global economy may face a recession next year caused by an aggressive wave of policy tightening that could yet prove inadequate to temper inflation, the World Bank said in a new report"

Policy makers around the world are rolling back monetary and fiscal support at a degree of synchronization not seen in half a century

Investors expect central banks to raise global monetary policy rates to almost 4 per cent next year, double the average in 2021, just to keep core inflation at the 5 per cent level. Rates could go as high as 6 per cent if central banks look to wrangle inflation within their target bands"

There you have it, the World Bank is saying the best case scenario for investors is 4% interest rates AND 5% inflation. 

https://data.oecd.org/price/housing-prices.htm

September 12th, 2022:

"We maintain a pro-risk stance"

September 18th, 2022

"FedEx CEO Raj Subramaniam did not spare investors from the doom and gloom. Asked on CNBC if a “worldwide recession” was ahead, he answered, “I think so; these numbers don’t portend very well. We are seeing volume decline in every segment around the world. So we just assume at this point that economic conditions are not going to be good.”

His company’s poor results are “a reflection of everybody else’s businesses,” he added on a particularly ominous note"

Who to believe?

EXIT LEHMAN WEEK

It seems to have escaped majority attention that this was the week that Lehman Brothers imploded in 2008. Below is a summary of the key charts heading into FOMC next week...

First off, the Global Dow which includes the U.S.:

Emerging Markets got monkey hammered to new 2022 lows this week. The locus of risk heading into FOMC.

In the U.S., Dow Transports got monkey hammered this week both due to the narrowly missed railroad strike, and due to the Fedex warning.

The chart of the week is the Nasdaq which is heading for its first weekly double test of the 200 week moving average since 2009:

Nowhere near capitulation. Complacency reigns supreme:

Lehman week is over. 

CPI cemented policy error for next week with 100% probability.

EXPLODING HUBRIS

Lethal doses of bull shit are reaching the point of hot air explosion...

The eagerly anticipated pivot to depression will seal the fate of this buffoonish Idiocracy. Their best case scenario is now the worst thing that could happen to markets and the economy. 

Last week Mohamed El-Erian warned investors to get out of these "distorted" markets and hide in cash and short-term t-bills. I highly concur. What makes El-Erian credible is that over the past year he warned the Fed was moving far too slow on inflation and that they ran the risk of slamming on the brakes down the road. And he was right, because that is exactly what they are doing now. They are compounding their earlier mistake of easing for too long by making a larger mistake of tightening too quickly. At the beginning of this year, Goldman Sachs predicted four rate hikes for all of 2022. Now many people are calling for four (1/4 pt) rate hikes NEXT WEEK.

Not the least of which is Harvard dunce Larry Summers:

"Just a couple of days ago we were debating whether 50 or 75 would be sufficient,” he said. “100 bp would be perceived as a panic move.” 

Recall that the Fed panicked in June after the CPI report. They had been telegraphing a .5% move but after the shock CPI they did a .75% increase which sparked the beginning of the summer rally. No doubt many bulls are assuming the same thing could happen now.  

However, this time the set-up is substantially different. 

Peter Boockvar explains:

Sept. 13th, 2022:

"The next rate hike is going to be only the second time in 40 years that the Fed funds rate is going to exceed the prior peak in a rate hiking cycle"

“This 75 bps rate hike might even be a mistake. We know there’s a lag.”

One day later, Jeff Gundlach goes much further saying that these serial mega rate hikes are turning deflationary:

Sept. 14th, 2022:

"The action of the credit market is consistent with economic weakness and stock market trouble"

Gundlach now sees deflation — a fall in the overall level of prices — as the key threat to the economy and markets"

"Buy long-term Treasurys, because in spite of the fact that the narrative today is exactly the opposite the deflation risk is much higher today that it's been for the past two years"

Gundlach goes on to say he's not talking about next month, he's talking about next year.

I'm talking about NEXT WEEK because this is becoming a binary equation similar to 2015 and 2018. However, on 10x scale.

The world's richest man, Elon Musk is also now FIRMLY in the deflation camp as well. He has made it clear that business is slowing. 

"Impending deflation is neither subtle nor secret"

Of course this whole problem stems from the fact that the Fed uses lagging indicators to set interest rate policy. So just as last year the lagging indicators ignored soaring commodities and strong consumer, now this year the lagging indicators e.g. CPI, are ignoring crashing commodities and buckling consumer. 

Regardless, I only showed the above opinions to prove that the deflation theory is now going mainstream.

It doesn't matter what these pundits think the Fed should or will do next week because the damage is ALREADY done. Whether the Fed pivots sooner or later, they have ensured a depression at the zero bound. When they made the mistake of delaying rate hikes far too long, their only real option was to hike rates as quickly as possible before the economy and markets crashed. However, now they are trapped halfway in between the zero bound and normalization, in no bailout land. 

As we see in the chart below. 

Clearly, the Fed's other big mistake was totally ignoring the yield curve and the signals the bond market is sending. The inverted yield curve is saying that yes there is high inflation today, but the Fed has already tightened enough to bring it down in the future. Meanwhile, there were no recoveries in the past 50 years with less than a 5% Fed rate, EXCEPT the pandemic which included the largest fiscal expansion in U.S. history fully monetized by the largest QE in history. Neither of which is going to happen this time around. 

On an Emerging Markets basis this current set-up makes BOTH the 2015 and 2018 pivot scenarios look like a picnic. Which means that the binary "pivot" trigger of global market crash is closer than ever.

This is the definition of optimism:

In summary, the amount of hubris taking place right now is ludicrous. Investors have been conditioned by central banks to ignore all risk. And in turn investor complacency is now feeding back into central bank rate policy error. It's a hubristic death spiral.

An entire generation of NEW investors has known nothing but continuous monetary bailouts. They believe that recessions and bear markets are a relic of the past. So it's highly ironic that at the end of the cycle the Fed is removing all chance of a timely bailout.

I call it a "paradigm shaft"

 

Jim Cramer claims it's too late to sell. He believes the worst is already over. Many bearish pundits such as Jeff Gundlach are calling for a further 20% decline. However, even that is likely highly optimistic. Today's investors believe that a one month bear market corrected the longest bull market in U.S. history. If you measure the ratio of each bear market in months to the duration of the preceding bull market, this is the ratio you would see for the 2020 one month bear market relative to the 2009-2020 bull market:

It's clear now in hindsight with all of the late cycle indicators flashing red, that the pandemic was not a true bear market. It was merely the pullback prior to the final melt-up of the post-Lehman rally. A massive sugar rally fueled by unprecedented stimulus. 

Stimulus of such a magnitude that the Fed literally has no way out, other than to collapse markets and the economy.

And they lived happily ever after.