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. 

  

OFFICIALLY, THE WORST CASE SCENARIO

What is taking place right now is officially the worst case scenario for markets and the economy. Sold to the public as a "soft landing"...

The multi-decade collapse in interest rates to the zero bound was driven by mass outsourcing, mass immigration, and of course mass automation which was accelerated by the infinite rate of return implied by "free money". This theory that record low interest rates could abide infinite valuations as the economy collapsed, will soon be viewed as one of the greatest  mass delusions in human history. After 2008, the patented borrow-your-way-out-of-debt crisis gambit worked so long as economic growth remained stagnant. 

Then, along came the pandemic at the end of the cycle which foiled the Fed's attempts to normalize interest rates for the first time in history. The pandemic forced the Fed to record ease into pandemic-exacerbated global supply chain bottlenecks. The worst case scenario for end of cycle normalization. In addition, pandemic fiscal stimulus programs drove up demand for durable goods as services collapsed. And then QE drove up asset prices into the largest asset bubble in world history.

Now, investors are trapped in what I call the Fed punishment zone. 

Why? For ignoring end of cycle risk, which came back with a vengeance as soon as the economy re-opened. 

Now it's all unwinding, however the decelerating rate of economic change has concealed the end of the cycle. Goldman Sachs said just this week that "soft landing" is STILL on the table. When the year started, Fed futures predicted four rate hikes for 2022, now they're predicting 16 rate hikes, but the soft landing is the same:

We are to believe that the longest cycle in U.S. history was corrected by the shortest recession in U.S. history - two months - featuring not only NO de-leveraging, but a massive increase in debt. The pandemic was the first time in history that corporate debt rose during a U.S. recession. 

Over the next two weeks amid incipient global meltdown, the ECB and Fed combined will attempt to raise interest rates by somewhere in the range of 1.5% (.75% each). This is 6x the amount of monetary firepower that exploded global markets in 2018 (Not including the Fed's double QT gambit).

It's a dumbfuck idea, in the tradition of ever-increasingly dumbfuck ideas.

Which means I'm all for it. 

Fortunately, for today's con men, by the time the public realizes this is all a massive con job, it will be far too late. 

Because as the first chart above clearly shows the NBER has an unbroken history of declaring recessions long after most of the stock market damage is already done. And that's just fine by Wall Street, because what else can they say when official confirmation arrives, but  it's too late to sell, you may as well ride this one out. 

Which explains how investors end up BURIED in the "valley of death" wherein returns are negative for years if not decades.

Any questions?

PREPARE FOR SYSTEM TEST

Gamblers are convinced it's different this time.

They're right, it's far worse...

Let's see, newbie gamblers piling into a bear market lured by Reddit-ordered pump and dump schemes. Peak Boomer retirement. Central banks correcting their massive over-easing error by massively over-tightening. Europe's Lehman Moment. China's Lehman Moment. Japan-U.S. largest monetary divergence since 1998. Tech bubble imploding, housing bubble imploding. Record low liquidity.

What's next? System test.

This coming week is all about Europe because Russia finally cut off natural gas supply and stated that it won't be coming back online. The nuclear option. 

Back in June, many pundits warned this would catalyze Europe's Lehman Moment:

June 23rd, 2022.

As we see in the bottom pane, in August German economic confidence was already the lowest since 2008, even before this latest gas cutoff. Now consider this chart in the context of an ECB STILL planning to raise interest rates on Thursday. 

It's totally ludicrous. 

 

This past weekend, in a very rare warning El-Erian told investors to get the hell out of these "distorted" markets.

"Stock and bond markets appear "distorted," meaning it's high time for investors to tweak their portfolios, according to Mohamed El-Erian... El-Erian's embrace of cash is somewhat contrarian, as historically high inflation is eroding the value of currencies"

Contrarian indeed. 

El-Erian's warning is far too little, too late. 

As we see above, the August AAII positioning report indicates that investors are far too over-loaded on stocks going into recession. This is because they believe the inflation hysteria and are convinced "Cash is trash". Which means the impending losses will be exorbitant.

As I showed on Twitter, investors are now in a bind between a Fed intentionally forcing recession and a Fed rate that is  currently nowhere near high enough to offset recession. In both 2000 and 2008, the Fed had to cut rates by 5% to forestall depression. However with the CPI far higher today, the Fed has no choice but to keep pushing rates higher. All of which means that the 2000/2008 -50% stock decline is now the best case scenario. It also happens to be the least likely scenario.

The most likely scenario is markets meltdown and a lack of stimulus at the zero bound.

Bailout failure means system failure. First and foremost because it portends extreme volatility and market dislocation. Secondly because it means that people will lose faith in the "system". They have poured their life savings into a dead end Ponzi scheme. As John Hussman constantly points out, at these levels of over-valuation, future returns are deeply negative years into the future. However, that's not how it happens in the real world. What really happens is that losses are "front loaded", after which forward returns become positive again. Once the masses panic out of the casino at the bottom. 

 "Prepare for an epic finale," Grantham said. "If history repeats, the play will once again be a Tragedy."

Zerohedge: In Order To Hit New Lows Markets Would Have to Do Something They've Never Done Before:

"The S&P has never set a lower low in any of the 13 post-World War II bear markets after recovering 50% of its peak-to-trough decline"

Pre-War World II. The most famous crash in history. 

 

Finally, investors will ask themselves the question ALL pundits should be asking right now - Why are WE different than Japan and China, who are already stuck at the zero bound? And the answer is because we're not.

COUNTDOWN TO MELTDOWN

Bulls can thank rampant inflation hysteria for initiating global meltdown...

Again. 

The inflation hypothesis is now extremely well "anchored" in the minds of today's economists. Few if any of them question central bank policy at this juncture. One must ask the obvious question: why is inflation considered structural now versus cyclical as it has been during every recession since 1980? The answer is because there is now an abiding belief among economists that employees have the "upper hand" in job negotiations. Around the U.S., unions are forming at various fast food outlets and service businesses that formerly have never been unionized. All of which is feeding into this manic drive to not only kill inflation but to weaken the job market. 

The main reason the job market remains strong is because real wages are NEGATIVE which means it's highly profitable to keep hiring people. Therefore what none of these pundits is considering is the DEMAND side of the equation.  Negative real wages means that consumers are not keeping up with inflation and therefore they are running down savings and increasing debt. Therefore it's only fitting that having cheered the supply side decimation of the middle class since 1980, these pundits would back the largest monetary policy error in modern history. All because they believe that the middle class has been reconstituted by profit-driven inflation and exploding cost of capital. 

Sure.

Spot the inflation:

And because inflation is now secular instead of cyclical, these pundits are all willfully ignoring cyclical deleveraging risk.

Which will be their fatal denouement. All indications from markets since Jackson Hole is that the countdown to a global Minsky Moment has now started:

"The U.S. dollar strengthened to a 20-year high against a collection of foreign currencies this week, spelling more trouble for heavily indebted smaller nations around the world. The stronger dollar makes payments on loans owed in U.S. currency more expensive"

"If you look at the history of emerging markets debt crises...All of those periods always coincide with periods of interest rate hikes in the U.S."

"The number of emerging market borrowers that have debt trading at distressed levels has doubled over the last six months"

Here we see the EM currency ETF is camped at a similar level as September 2015 when the Yellen Fed pulled back on a quarter point rate hike. Then in December they went through with it and imploded global markets. This month global markets are facing potentially a .75% hike in Europe and the U.S. $95b/month QT in the U.S.

Alternatively, we can compare to December 2018 when the Fed imploded global markets with a quarter point rate hike and $45b/month in QT:

In summary:

Of course I don't agree with the assertion that inflation is no longer cyclical. But, clearly that's irrelevant. What matters is that the majority of pundits now share this same belief. What it means is that having conditioned investors for fourteen years of expansion to expect bailouts, now in recession, no bailout is forthcoming.

Which means the July "pivot" rally was a bull trap:

"The S&P 500 has slumped 7% since its mid-summer rally in a sign markets are starting to realize inflation isn't cyclical, and investors won't be able to pressure the Federal Reserve into a making a dovish pivot"

 

GLOBAL COORDINATED COLLAPSE

Global central banks agreed at Jackson Hole to tighten as quickly and brutally as possible. The exact inverse of the pandemic. What we are watching in real-time is a global coordinated collapse...

The major policy mistake being made globally is believing that inflation is driven by wages and is hence "sticky" and intractable. Today's inflation is driven primarily by asset prices and therefore it will collapse far faster than anyone predicts. Central bankers are already tightening far past the point of "neutral" and thereby collapsing the global debt bubble that has grown inexorably since 2008. You have to be a dunce not to see this coming, hence it's largely unforeseen.

Another widely ignored "feature" of the pandemic and resulting inflation was mass hoarding across every consumer and industrial sector. Buyers responded rationally to the supply side shortages by increasing their inventories. Now we are facing a glut of everything at the same time. What started with toilet paper is now reaching semiconductors, housing inventories, mainline retailers, durable goods, and smartphones. Next it will be automobiles. 

The hoarding artificially inflated profits which sucked in maximal capital. Now, as central banks unwind liquidity, they will force asset values lower which will reverse the wealth effect. This in turn will implode the economy and bring profit margins back down to the historical baseline. The pandemic in effect created an end of cycle bull trap for global capital. 

EM currency crisis is the locus of maximum risk. China is allowing their currency to weaken dramatically. The British Pound is near record lows relative to the dollar. The European central bank is planning to potentially increase rates by .75% on September 8th. Their second shock rate hike in consecutive meetings. Central banks are now competing to see who can raise rates the fastest in order to avoid currency-driven inflation. So far, the Fed and U.S. dollar are winning by a long shot. However, all it would take is for Japan to join this hunt and the Yen carry trade would explode global risk markets spontaneously. There is already talk of currency market intervention to support the Yen. 

The other enormous policy error is not understanding that Quantitative Easing will be inert at the zero bound. All it will do is ensure that asset prices are totally disconnected from the underlying fundamentals. Central banks have no means to bail out the middle class which will lead to extreme societal acrimony. Financial institutions are in no way equipped to deal with the impending level of insolvency. They have not been "stress tested" to withstand a global margin call on a scale larger than 2008. 

As I've said many times, Wall Street analysts have been intentionally slow to re-rate their 2022 earnings estimates. Now this Powell hawkish pivot puts them even further behind the curve. Analysts who had been pounding the table for a Fed pivot, finally got crushed on Friday. It took a Powell sledgehammer to finally get the message across. An indication of the level of denial that has been weaponized against the public. The level of fraud and criminality that is about to be exposed will make 2008 seem like a boy scout jamboree by comparison. 

The likelihood of an economic hard landing just increased dramatically. However most economists still believe that recession can be "avoided", which is to assume it's not ALREADY happening. It would indeed be a miracle if somehow two negative quarters of GDP could be reversed after the fact. Only China's government can pull that off.    

“We’ll definitely have a recession as the lagged impacts of this major monetary tightening start to kick in...They haven’t kicked in at all right now”

“Go back to the type of pain Paul Volcker had to impose on the U.S. economy to wring out inflation. He had to take the unemployment rate above 10%”

We learned recently that half of U.S. companies are already planning to cut jobs and the other half are freezing hiring.

August 18th, 2022:

"Half of respondents said they’re reducing headcount or plan to, and 52% have implemented hiring freezes"

In summary, what investors face is either a markets crash which very quickly brings down inflation and forces global central banks to quickly pivot. Or, central banks will continue tightening monetary policy until an economic depression is a foregone conclusion. Regardless, in either case asset prices will decline to a nadir far below this current level. At which point depression becomes inevitable. Amid all of the sturm and drang surrounding the stock market on Friday, it's shocking that no one mentioned the impact this will have on the already imploding housing market. We face a GLOBAL housing collapse of biblical magnitude. Which will bring far greater economic dislocation than the stock market which is skewed towards wealthy households. 

Of course investors always want to know the precise timing of the event, so they can front-run other investors in and out of the market. What I call the "FIFO" method of investing, as demonstrated on Reddit via Gamestop and AMC. However, this event is binary and it's highly unlikely anyone will "time" it with any sort of satisfactory precision. Suffice to say the velocity of this next decline will make the first half decline - already a record - look gentle by comparison. 

We're all gamblers now and when the music stops what we will face is an epic everything glut at the same time. Spilling out onto the streets alongside rioters.

There it is - the most likely outcome and therefore least predicted.

THE BAILOUT TANTRUM

The full cost of sugar coated bullshit is about to be revealed...

Allow me to be the first and last person to inform today's bulls that their final season of Bailout Watch is over.

 

“Restoring price stability will likely require maintaining a restrictive policy stance for some time. The historical record cautions strongly against prematurely loosening policy.”

That last line is a nod to the 1970s when the Fed eased too quickly following a tightening regime only to watch inflation surge back even stronger. As I've shown many times, this period is nothing like the 1970s with respect to unionization, employee job security, capacity utilization or bond yields. Oil prices are lower than they were in 2014 and 2008. Therefore this idea that the Fed can keep tightening with impunity until the CPI returns to 2% is lethally delusional with an economy already in recession. 

The risks of a global market crash have now risen to record levels. Far from being a "Black Swan" event, a global Minksy Moment is now the most likely scenario. It's what I call a Brown Swan event - what happens when bulls have an "accident" because they don't get bailed out for the first time since 2008. The Fed has never been this far from an easing bias. Featuring double tightening at both ends of the yield curve at the same time.

It's abundantly clear that most people have never heard of or don't understand the concept of moral hazard. Which is why the most widely telegraphed hawkish pivot in history came as a shock to markets. A warning to bullish investors that the market is no longer discounting any form of reality. The only thing that was priced into markets up until Friday is bailout fantasy.  

The conference kicked off on Thursday and the conference host Esther George gave an interview to Bloomberg prior to Powell's speech. She indicated she had already previewed Powell's speech but she couldn't comment on it. But she believed that rates would have to be raised north of 4% and remain there for an extended period of time. Only a hyper fool would believe she would contradict her boss in the 12 hours prior to his seminal speech. Right up until Powell's speech, Wall Street had been assuring investors that Powell would not be overly hawkish.

Zerohedge:

Goldman's Biggest Bear Expects Powell To Be Dovish

Goldman Sachs doesn't have any bears. That's not how the model works. Giving investors false hope is the Wall Street business model. The stock market is now badly lagging the economy. Over on Marketwatch, Mark Hulbert asserts that the fundamentals of the market have improved since the beginning of the year. Which is a load of crap. What he means is that the price / earnings multiple has improved IF we assume that today's earnings projections can be relied upon. Unfortunately, at the end of the cycle, Wall Street earnings extrapolations have the veracity of a Magic 8 ball. What most people call "fundamentals" is merely a guess at where things will stand a year from now based upon where they are today. That type of "prediction" doesn't make the turn. The game Hulbert and company are playing works great through most of the cycle and then fails catastrophically when it causes the most pain to investors. 

Taking 4% as a likely end target for the Fed Funds rate, means that the Fed is about halfway done tightening. Hence, bulls made a very bad miscalculation when they bid the market following BOTH the June and July rate hikes. 

What I call premature misallocation.

What comes next I call "System test". It's what happens when a generation of new gamblers discovers the sell order for the first time. 

Those who tell themselves that the "smart money" this time around are the ones who trusted Wall Street, will soon realize they are the dumb money.

In summary, what was widely viewed over the summer as the last chance to buy, was very likely the last chance to sell. The exact opposite. So far, the Nasdaq has declined -30% in 2022. So about half way to a bullish Fed "pivot".