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. 

GLOBAL LIQUIDITY COLLAPSE

Now that every investor is positioned for higher inflation, it's time for the totally unexpected deflationary financial "accident"...

Zerohedge/GS: "The CPI Doesn't Matter At All"

Sure.

It's clear that whoever writes this crap for Goldman Sachs was recently playing Dungeons & Dragons in their dorm room.  Then Zerohedge charges a premium to read it, which means the reader is paying twice: once for the bullshit, and twice for the failed trade.

The desperation on Wall Street is becoming palpable, as the pandemic pump and dump is turning into a major bust:

Not to say that ZH/GS are alone by any means in late cycle chicanery. It's now becoming clear that today's pundits were only "good" at predicting markets when central banks were guaranteeing a one way trip higher. Now that true price discovery has returned, they can't find their ass with both hands.

On the economy it gets far worse of course because the Fed is now being pushed into making a biblical magnitude policy error. They are using the 1970s demand-side playbook to deal with supply side inflation. 

Today we learned that real wages were FLAT in 2021:

So much for the wage-push inflation theory. Year over year wages flat. And the U.S. Federal deficit has fallen the most in history year over year. And the Fed is tightening the most on both ends in history: They've never simultaneously tightened on the short end and long end by this amount.

As I showed on Twitter recently, the Fed has tightened mortgage rates back to the level of 2008. However, rates rose from a much lower level and at a far greater pace. Whereas in 2007 era, rates rose from 5% to 6.5%. This time they rose from record low 2.5% to 6%. And they did it with home prices at record highs. 

What we are witnessing is extreme RATE SHOCK added on to extreme inflation shock:

Which is why the monthly supply of homes is increasing far faster than the last tightening cycle. Back then, the Fed raised rates by 4% the same amount they plan to raise rates this cycle. However, at the point the Fed stopped raising rates in 2007, the monthly supply of homes was lower than it is today.

And then it kept rising even as rates came DOWN. 

What this all points to is FINANCIAL inflation caused by a combination of asset bubbles and rampant corporate profiteering. Which is why the traditional inflation models are not working.

Therefore policy makers are making a huge mistake deja vu of September 2008 when they were solely focused on inflation. 

This CNBC article sums it up:

“This period of accelerating rate hikes that we’ve seen so far has impacted the real economy because it has squeezed the borrowing costs … for real people, real consumers,” 

“Whereas for Wall Street, money still remains cheap and leverage still remains high in the system, and the Fed’s book still remains just a touch under $9 trillion, which is double what it was going into the pandemic period, and since the financial crisis of 2008.”

Prins argued that by targeting wage inflation when wage rises are failing to keep pace with broader inflation was a mistake"

Yes, it's a huge mistake which is going to lead to deflation. This past week Elon Musk asserted that the Fed policy would be deflationary. Peter Schiff said it would be hyperinflationary. But he also admitted that it will first lead to a massive crash.

Clearly Schiff has never heard of Japan or China, both of which countries are further down the path of deflation than the U.S. Japan is easing at the zero bound and yet they have lower inflation than every other developed nation. Why? Excess capacity and consumer UNWILLINGNESS to borrow. Chinese consumers are just about done on the borrow to buy strategy. And the U.S. is NEXT. 

One could call this central bank induced liquidity collapse a "Black Swan" event, because it's clearly non-linear. However, ALL of the attendant risks are coalescing in broad daylight. So it will be hard to claim that no one saw it coming when Michael Burry has been pounding the table the hardest. Can you imagine these dolts ignoring the exact same guy who became famous calling the last exploding bubble? I can. 

Which gets us to the casino.

The market is no longer oversold. In fact it's as overbought as it was back in June which was the last time the CPI surprised everyone to the upside. As we recall that event took place the week before the FOMC and then the Fed decided over the weekend to upgrade their rate hike from .5% to .75%. A decision that was leaked via the Wall Street Journal. Markets crashed into the meeting. So it is that we find a similar dynamic taking place, with the risk of an accident having increased dramatically. Let's say to September 2008 levels. Fed futures now see a 35% chance of a full 1% rate hike at next week's meeting. 

In summary, the Volcker gambit is going to explode at the zero bound. Which will be highly deflationary when there is no adequate policy response to global meltdown. Bulls will be reliant upon the politics of the day, which are the most divisive in U.S. history. There is no incentive to bailout anyone this time around. 

It took 20 years for inflation to become fully entrenched by the 1970s. Throughout that time the U.S. middle class was ascendant with respect to quality of jobs and benefits. This era is NOTHING like that one. What investors are positioned for right now is the worst "inflation" since 1979. What they are about to receive is the worst deflation since 1929.

Hugh Hendry predicted investors would become addicted to monetary bailouts to the point at which they would create their own fictional market narratives, which he called "Imagined Realities". 

ENTER LEHMAN WEEK

Prior to Bernie Madoff's Ponzi scheme imploding in the Fall of 2008, a financial analyst named Harry Markopolos warned it was a Ponzi scheme. But, none of the investors would listen. Because they were fat and happy. Until it exploded...

Likewise, those of us who questioned the borrow-your-way-out-of-debt strategy were proven wrong by global central banks after 2008. Now however, global central banks are proving us right. It turns out that in a global Ponzi bubble, you only have to be right once. 

Before it explodes and makes everyone look like an idiot. 

When this year started, it looked like China would be the locus of risk for 2022. Their signature COVID ZERO policy was achieving its goal of collapsing growth down to ZERO percent. Meanwhile, China Evergrande - the world's most leveraged property developer was heading for bankruptcy. Subsequently, the entire Chinese real estate market has imploded, and Hong Kong stocks are trading at the lowest level since 2015. 

That risk was soon eclipsed by the Russian war in Ukraine which sent commodity prices sky-rocketing. Europe threatened to cutoff all energy imports from Russia, but they had no way of following through without causing self-imposed depression. All of that sanction posturing led Russia to pre-emptively cut off natural gas to Europe, THIS week. In the meantime, the ECB  has embarked on the most brutal tightening campaign in Euro history, culminating in a super sized .75% rate hike also THIS week. 

Not to be outdone by competitive idiocy, the U.S. entered 2022 as the tallest midget in the circus, but then the CPI skyrocketed and the Fed was forced to abruptly taper QE and begin rate hiking. In June they began Quantitative Tightening and the most aggressive rate hiking regimen since Volcker 1980. Subsequently, stocks entered bear market, GDP crashed, the housing market rolled over, and consumer sentiment hit an all time low.

Ironically, Japan has been the outlier country in 2022. As of this week they have the strongest MAJOR economy in the entire world, in Q2 registering a by comparison blistering 3.5% REAL growth rate. In addition, Japan's inflation rate is also the LOWEST of the major economies. Which is why it makes no sense that the Japanese Yen is trading at the lowest level since 1998. Except in the context of interest rate policy divergence from the U.S. Which is what global hot money traders are betting will continue forever.

We are one global overnight RISK OFF event away from hot money explosion circa 1998 LTCM.  

All of which gets us to this coming week - the anniversary of Lehman collapse in 2008. Then as now, policy-makers are totally concerned with inflation. Also, then as now there is RAMPANT recession denial. However, this time around the falling dominoes that are being ignored are not U.S. banks, they are entire countries.

Right on time, Michael Burry of 2008 Big Short fame was out this week with another warning of bubble collapse. He ticked off SPACs, Cryptos, Meme stocks and Ark ETFs as evidence of collapsing bubbles. However, those risks are CHUMP change compared to the real risks listed above. When this gong show explodes, no one is going to be talking about Gamestop. Which is why most U.S. investors don't see this coming - because even the bears are totally focused on U.S. markets. Whereas the greatest risks are taking place overseas.

Lehman week is bracketed by the two big central bank meetings - ECB and the Fed. This week, the ECB raised rates by .75% which means that AT MINIMUM this month will see 5x the monetary firepower that imploded markets in 2015 and 2018. Not including all of the other smaller central banks. AND not including U.S. QT ramping up to $95 billion this month.

There is one bullish argument that still holds water - which is that the market is relatively oversold. Which I agree, it IS oversold for a BULL market. But by bear market standards, it's not oversold at all. And by bull market standards, positioning is bearish. But by bear market standards, today's positioning is actually very bullish. If you don't believe me, just look at the Fed's own proprietary Financial Stress index which includes 18 different stock and bond market indicators of financial tightening:

https://files.stlouisfed.org/files/htdocs/publications/net/NETJan2010Appendix.pdf

In summary, entering Lehman week we are watching all of the risks of all of the past several economic meltdowns coalescing into one massive super clusterfuck. Bought with both hands by zombies on auto-pilot.