MONETARY FAILURE AT THE ZERO BOUND

In the perfect world for stocks, the Fed implodes the middle class, inflation comes down, and the Fed rescues markets before they collapse. This is what Wall Street now universally expects from the Fed, because it's been standard policy for the past 40 years. This time, they are flirting with disaster at the zero bound. Anyone who is now betting policy-makers can pull this off, deserves their certain fate...

The CPI print did indeed come in hot. As expected, the hotter than expected reading INCREASED bets on massive rate hikes.

"Stubbornly hot U.S. inflation is fueling bets that the Federal Reserve will get more aggressive about trying to cool price pressures and even potentially ditch its own forward guidance by delivering a jumbo-sized interest rate hike in coming months.

Yields on the two-year Treasury note, seen as a proxy for the Fed's policy rate, topped 3% for the first time since 2008"

Commodities just round tripped back to the 2008 high and the two year just hit the same retracement level it reached in 2008 when markets went into meltdown. In other words it took 14 years for investors to forget the exact same policy error that took place in 2008. Only this time on a far greater scale:

The belief that the Fed is behind the curve on rate hikes is now extant on Wall Street. The fact that these higher interest rates are already imploding the middle class are of NO concern. Now the Fed is under pressure to go big on rate hikes. Which means they are falling ever further behind the curve on bailing out the collapsing middle class.

Nevertheless, we are to believe that these rate hikes are to help the middle class by bringing down inflation. In other words, the Fed will implode the middle class in order to save them. A 2008 meltdown on steroids. And yet no pundits question this idiotic narrative. 

So be it. This money printing gambit was always doomed to end at the zero bound with an Idiocracy certain of the invincibility of central banks. So here we are.

We have now reached the point at which monetary policy can no longer save the middle class from imploding. But investors are betting THEY will be the ones who are bailed out.

It's not going to work out that way.

We got news late on Friday that consumer sentiment just hit an all time low. Lower than 2008 and 1980 which were the two worst recessions since WWII. And at the same time we see that corporate profits are at an all time high. It's no wonder investors are delusional. 

Consumer sentiment is at a record low and yet the Fed stress index is ALSO at a new record low, clearly indicating the Fed considers middle class implosion to be a sign of low risk. 

Meanwhile, corporate profits are at record high. 

So it is that Wall Street sees new highs on the horizon:

Putting it all together, the middle class will continue imploding and Wall Street will continue making new highs. And if you believe that then there is nothing you won't believe. Except the truth. Which means you are wasting your time here.

What happens next is dictated by basic logic:

A global RISK OFF event leading to financial bailout failure aka. "The Gong Show". It's now logically impossible for this next stock market bailout to work as well as the last one. Considering the fact that the Fed was in FULL bailout mode back in 2020 and they are in FULL tightening mode now.

Financial bailout failure will be followed by a Fed slow to realize the magnitude of their policy error. At that point stocks enter Death Valley. The point of no return wherein future returns are deeply negative for long term bag holders. In addition, political acrimony will rise in a mid-term election year. Politicians will be slow to enact a fiscal bailout. The combination of inadequate monetary and fiscal economic fire power combined with an asset collapse will ensure that the recession is much deeper than anyone currently expects.

Consider consumer sentiment has already hit a record low with home prices at a record high. Back in 2007 consumer sentiment collapsed AFTER home prices collapsed.

 

The Fed's next bailout visualized:

 

DENIALATION. THE PROBLEM THAT FIXES ITSELF.

The overwhelming consensus that inflation is "sticky" and won't easily come down ignores the past 40 years of data, and instead recounts 1979. Sadly, in a circle jerk of like-minded fools there is no strength in numbers...

First off, I am not making a bet on tomorrow's CPI. I wouldn't write an entire blog post around a single data point. Suffice to say that if the CPI continues to run hot it will only make the Fed policy error that much larger. So, for those in the ultra crowded inflation camp, move along this is not for you. Take solace in the fact that you are part of an overwhelming consensus right now that inflation is intractable. My bet is that the  inflation consensus is wrong and the consequences will be cataclysmic. 

Unfortunately, we must first re-visit the definitions for inflation and deflation before we can reach a prediction for what comes next. At the individual level, inflation and deflation can feel similar - a lack of spending power. Cost of living higher than wages. A declining standard of living. 

It's at the macro level where they are nothing alike. Recall that coming out of the pandemic demand greatly exceeded supply due to the demand stimulus colliding with a supply chain shock. Now, I predict those two factors will reverse. Meaning demand will collapse and supply will overshoot. In everything at the same time. Homes, cars, durable goods, crypto currencies, Tech stocks, and commodities. A glut of EVERYTHING at the same time.  

Why will this happen? Because the consumer will collapse. Nothing about this is sustainable. And yet Wall Street is convinced it is. Just this week we see these articles:

CNBC:

Bringing Down Inflation Will Take Time

No it won't. It will take sell orders and limit down markets. Not time. 

Einhorn:

The Fed Can't Bring Down Inflation

Yes they can. They have every time since WWII and they're going to do an even better job this time. 

Suze Orman:

Inflation Is Here To Stay

You get the point. Inflation is a broad based consensus at a very lethal juncture. 

First off, as I showed in my prior post the economy has changed drastically over the past 40 years. This is now an import dependent economy and therefore the relative value of the dollar has a huge impact on U.S. inflation. Here we see the dollar is at a two decade key breakout level. A break above this level will likely collapse Emerging Market currencies. More on that later.

On a long-term basis, macro deflation is a result of outsourced industries and imported poverty leading to a lack of  domestic demand brokered by debt. Debt is deflationary. Now we are seeing the fastest increase in consumer debt in decades. 

The net effect of the pandemic was to create a supply/demand imbalance which boosted the prices of everything. But then, policy-makers took away stimulus. So now not only are prices higher, but LIABILITIES are higher as well. Unfortunately, prices can come down but liabilities are contractual. So the middle class is about to get trapped in a deflationary collapse. One in which asset prices collapse and liabilities remain high.

This year will see the largest stimulus removal since the end of WWII, which by the way was a recession. 

From almost 20% of GDP last year to less than 5% this year. I can't say when the "official" recession will begin however growth is currently hovering at 0% right now, which means that ex-deficit we are ALREADY in a 5% recession.

This story got ignored today ahead of tomorrow's CPI, despite being a harbinger of what's coming:

"Target is canceling orders from suppliers, particularly for home goods and clothing, and it’s slashing prices further to clear out amassed inventory"

The actions, announced Tuesday, come after a pronounced spending shift by Americans, from investments in their homes to money spent on experiences...That’s a change that arrived much faster than major retailers had anticipated"

Today we also got this deflationary factoid:

At the same time as new mortgage applications are going into meltdown, the annualized % price increase just reached an all time record, AND homes under construction just reached an all time record.

Which equates to the mother of all impending housing gluts. 

Worse than last time. 

Not to be outdone, we have EM debt going into late stage meltdown mode. A function of EXTREME monetary policy divergence between the U.S. and Emerging Markets.

And strong dollar:

Amid all of this burgeoning risk it's only fitting that the Fed financial stress index just reached an ALL TIME LOW this week. Why? Investor complacency. 

AKA. DENIAL.

A buffoonish level of over-confidence has given the Fed a green light to double hike the Fed rate next week while reducing the balance sheet at a monthly accelerating rate. 

In summary, Millennials who don't believe any of the risks of the past decades were real will now experience all of the risks at the exact same time with no monetary safety net.

This is what happens when you get bailed out for 14 years straight. 

You eventually take a lethal amount of risk, sans bailout. 

Our so-called leaders are idiots. And they will clearly be the last to know that their reign of idiocy is ending. 

Badly.

BOUNDING INTO THE ABYSS

The sum total of serial failure is coming home to roost in the worst way possible. The final magnitude of this economic disaster is now visible from outer space, and it has now officially become a Category 5 Shit storm...

The so-called "elites" are totally oblivious to the plight of the middle class. Hence they are the LAST ones to see this coming. For the first time in history the economy is collapsing AHEAD of the stock market. That can only happen when the ruling class is locked in a circle jerk of lethal proportions. In my last missive I laid out the bull and bear case for the stock market. In this post I will review the history of how we got here and why our policy-makers are doomed to fail on a biblical scale. 

The late 1990s capped off a two decade bull run that was only briefly interrupted by the 1987 crash and the 1990 Gulf War recession. Both were mild events by historical comparison. The late '90s featured a Tech-driven melt-up that stumbled during the Asian/Russian /LTCM Financial crisis of 1998. Up until then the Fed had been normalizing monetary policy by raising rates. The LTCM bailout and attendant rate cut set the stage for a melt-up rally into the Y2K Millennial date change. The Fed was reluctant to raise rates in 1999 because they wanted markets to be well liquefied going into the seminal date change. Which set off the final stage blow-off top Dotcom bubble. By May 2000 the Fed was playing catch-up and hiking rates at .5% per meeting. By the end of the year the Tech bubble had collapsed -60%. 

Sound familiar?

The Dotcom recession began in early 2001 and got worse with 9/11. Stocks finally hit bottom in 2002 with the Iraq war. The Fed rate was at 1.5%, down from 6.5% at the Y2K top. It took a FULL 5% decline in rates to put a floor under stocks and the economy. Low rates continued just long enough to inflate the housing bubble, which had started years earlier and continued growing through the Dotcom bubble. The Fed then slammed on the brakes with 17 consecutive rate hikes and burst their own monetary-driven housing bubble. Their next trick was the 2008 bailout and ZERO % interest rate policy. Japanification had arrived: The zombification of markets and the euthanization of investors with "free" money.  

What followed was a boring but metronomic rise in the stock market amid tepid economic growth. Stocks rose in lockstep with the Fed balance sheet. Every attempt to stop QE and/or raise interest rates led to a market crash. This monetary dependency continued until 2016 and the Trump election. When Trump was elected, the futures went limit down. But by the time the U.S. market opened green, the promise of a tax cut was making the rounds on Wall Street. The FISCAL melt-up began, which allowed the Fed to raise rates and pare the balance sheet for the first time since 2007.

It was all going well until late 2018 when the glue fumes from the tax cut had worn off and the Fed reached for one more rate hike in December 2018. Global markets imploded. Trump demanded Powell reverse policy which he did. It was off to the races again. However, the Fed cut rates three times in 2019 as "insurance" and they began expanding their balance sheet to deal with the "repo" crisis.

And then the pandemic hit, which is where this all gets interesting. 

The pandemic had two long-term deleterious impacts on the economy which we are now confronting. First off as we all know it clusterfucked the supply chain. Inventories of everything became depleted. Double ordering ensued. Consumers hoarded merchandise. And THEN the tsunami of combined fiscal and monetary stimulus hit the economy. So not only did the supply curve shift in, but the demand curve shifted out. From an economic standpoint, that meant MORE demand and LESS supply and therefore higher prices of EVERYTHING at the same time. What happened during the pandemic is the WORST thing that could happen late in a cycle, because it has NEUTRALIZED monetary policy. 

Fast forward to 2022, and now all of that stimulus is receding. There's only one problem. The price of EVERYTHING remains at record highs. So just as consumers are seeing less income, they are being asked to pay more for everything. 

Where today's pundits are ALL wrong is in assuming this is 1979 deja vu when the middle class was at its apex. Today, union membership is at an all time low. Which means workers have very little bargaining power. Sure, they've benefited from a tight labor market, but that doesn't mean they've recovered from 40 years of wage deflation.

Contrary to popular belief the economy did not float back from China which is why U.S. capacity utilization remains at record late cycle lows. 

Which means that the middle class is under economic duress from all sides - record gas prices, record food prices, record home prices, record car prices, record durable good prices, rising interest rates. All at the same time. It's no wonder that consumer confidence has collapsed down to the lowest levels in decades. And YET, our elitist financial pundits constantly inform us that the consumer is strong. Invincible.

How the hell would THEY know? They have no first hand experience AND they are now totally ignoring consumer sentiment polls. For some reason. 

All of which is why this Fed is making a COLOSSAL error late in the cycle with no monetary safety net, with all of today's idiotic pundits along for the ride. The Wizards of Fed will be the last to know that their magical money powers have been rendered inert. 

Meanwhile, clueless gamblers instead of de-risking, are doubling down into the abyss on the belief that everyone else is going under the bus. 

Soon to find out they ARE everyone else. 

2022: YEAR OF LIVING DANGEROUSLY

Over the past 14 years of continuous monetary bailouts, "Don’t fight the Fed" has been changed to "Don’t fear the Fed". Now, bad news is good news. So it is that gamblers are doubling down on depression…

In this post I was planning on assessing the bull case vs. the bear case. However, there is no real bull case to consider on a long-term basis. Since the lows of 2008, we've been told that "extreme valuations don't matter" because interest rates were at generational lows. That argument is no longer true. Over the course of this summer, investors will face the most extreme Fed tightening in history. Which means that now, record valuations DO matter. In addition of course, most of today's pundits happily ignore the ongoing Tech implosion and RECORD housing bubble. The only two bearish pundits who capture the magnitude of today's risks are Michael Burry and Jeremy Grantham. Burry made his claim to fame not only predicting the 2008 subprime meltdown, but successfully betting against it. Of course there was a book and a movie, "The Big Short" about the entire debacle. And yet, today's investors seem intent on ignoring his latest stark warnings: 

"Burry's view seems to be that consumers are raiding their savings accounts to weather inflation in food, energy and housing costs, and a recession is likely once those cash reserves are exhausted"

last summer, Burry warned buyers of meme stocks and cryptocurrencies that they were facing the "mother of all crashes."

Here is the personal savings rate with U. Michigan consumer sentiment:

In the past year the Fed has crashed Emerging Markets, Ark ETFs, Cloud internets, IPOs, SPACs, Crypto currencies, and the global bond market. And yet, investors have ZERO fear of the Fed right now. Complacency is rampant. Today's pundits only tell investors what they want to hear. They never mention the EPIC downside risk if this experiment fails. They never tell people that this time there is NO Fed safety net.

Investors have been conditioned over the past decade to believe that bad news is good news. They are now FULLY addicted to Fed bailouts. As risks increase, they are trained to increase risk allocations. Ironically, the Fed sees this mass complacency as a signal to continue tightening. Therefore, they have now commenced tightening their balance sheet for the first time since before the pandemic. In addition to double rate hikes the Fed is  now reducing their balance sheet at $45b/month, which will increase in $15b increments to $90b by September. Back in 2017, the Fed STARTED tightening at $15b/month. So they are starting QT at 3x the level of last time. Adding together rate hikes AND QT, the progression of tightening will look like this, below: 3x this month, 4x in July, and 6x by September (2 rate hikes and $90b in QT). As I said on Twitter, there have been no times since 2008 when the market rallied from this level of breadth disintegration WITHOUT Fed bailout.  

The only bull case right now is for a tactical oversold bounce. The bullish belief is that institutions have become too bearish and therefore a bounce is inevitable. Perhaps. However, it's not true that the market is heavily oversold. And therefore, there will be very little fuel behind any tactical rally. Which means the downside is far greater than the upside at this juncture. Let's take a look at the "bull case", so I can demolish it. 

We hear a lot about a "breadth thrust" meaning a high degree of participation in stocks, which took place last week.

Here we see the S&P 500 with the S&P oscillator (middle pane) the highest since March 2020 AND January 2019. Both were the beginning of large rallies. However, what we also notice is that those times, the oscillator FIRST became heavily oversold attended by a large spike in the put/call ratio. NOT this time. We also see that the last time the oscillator became this overbought was THIS YEAR in April and that was the END of the bounce, not the beginning.

MINOR details that can end up costing A LOT of money. 

The Dow, same idea. Three times the Dow has been this overbought this year and each time the market rolled over. 

Why? No capitulation compared to last times:

The S&P volume oscillator confirms what breadth is saying - this market is NOT oversold. 

I will become bullish when this indicator becomes oversold indicating capitulation AND when the Fed has capitulated and stops raising rates.

That combined scenario is limit down away.

The next bullish argument: "Institutions are bearish". Yes, major institutions have been selling all through 2022 which is what they do at every stock market top. Is that a warning sign or opportunity?

Here we see Active Manager positioning is bearish, but it's not as bearish as 2008. ALSO, prior bounces from this level of bearishness ALL had Fed participation. So make the popular 2015/2016 comparison at your own risk. 

In summary, bulls are playing based upon the rules for a BULL market. Which means they see a market becoming moderately oversold and they buy the dip. In a bear market we can expect sentiment surveys to become more and more bearish but less and less useful IF they are not attended by commensurate positioning. Investors are sliding down the slope of hope and  today's pundits are merely greasing the slide for them.

There is a wall of put options below this market and SO FAR that is keeping the market bid. However, below the bear market level there is NO safety net for this market. Grantham predicts the market has 40% downside below this level. I predict that this Disneyfied market will cease to function normally below this level. And that is when ALL of today's bulls will realize that 14 years of continuous monetary bailouts are ending BADLY. As anyone with an IQ of 5 could predict. 

GAMBLE AT YOUR OWN RISK.

FOMC: FEAR OF MISSING CRASH

An unprecedented hurricane of risks. Plus collapsed liquidity. The fastest Fed tightening cycle on record. And calls to buy risky assets. All from the same Wall Street bank. What's not to like?

JP Morgan CEO Jamie Dimon warned yesterday about a looming "Hurricane of economic risks". Last week he was sanguine, this week he's raising the alarm. He specifically is concerned about Quantitative Tightening - the reduction of the Fed balance sheet at double the pace of 2018, which ended badly. He is also concerned about the commodity shocks emanating from the war in Ukraine. 

“We’ve never had QT like this, so you’re looking at something you could be writing history books on for 50 years”

Last week, Dimon referred to his economic concerns as “storm clouds” that could dissipate...But his concerns seem to have deepened since then."

What changed in the past week? What does he know that we don't know?

What Dimon doesn't mention is that both of the key risks he mentioned are highly correlated. The ever-escalating sanctions are creating a commodity supply shock which is forcing global central banks to tighten monetary policy at the fastest pace in decades:

"Policymakers around the world have announced more than 60 increases in current key interest rates in the past three months, according to an FT analysis of central banking data — the largest number since at least the start of 2000"

Here we see copper rolling over into a death cross as global growth implodes. Many pundits forget that it was China that pulled the global economy out of recession after 2008. However, the PBOC is one of the few central banks actively cutting rates. 

For now, oil and commodities are in a push/pull between supply disruptions and the resulting demand destruction which is leading to recession. In the end, demand destruction ALWAYS wins out.

Repeated calls for $185/bbl oil by JP Morgan in 2022 have yet to come to pass. Russia has so far been able to bypass the sanctions by selling their oil to China and India. 

"India bought 27 million barrels of Russian oil in April and 21 million in May,  compared to 12 million barrels it bought from Russia in all of 2021"

In addition, as I write we just got word that OPEC will increase output faster than expected:

“Whilst it’s not an outright promise, Saudi Arabia [has] seemingly thrown the West a bone” 

The pre-FOMC silent period begins COB this Friday. However, the Fed once again is entering this meeting on an extremely hawkish tone. Bullard reiterated he wants a 3.5% Fed Funds rate in 2022 which means .5% rate hikes at EVERY remaining meeting in 2022. 

“This 50 basis point per meeting increase is twice the normal pace that the committee has used in recent years"

So there you have it. DOUBLE quantitative tightening and DOUBLE rate hikes going into the lowest liquidity period of the year:

May 17th, 2020:

"Liquidity, or the ease of trading, in S&P 500 futures is worrisome even by the standards of the Covid-spurred meltdown more than two years ago, according to JPMorgan"

“This implies that the ability of markets to absorb relatively large orders without significantly impacting the price is very low at the moment.”

One side effect of the Fed’s absence as a backstop buyer is that there is greater risk of market fragility when shocks do arise"

To top it all off, JP Morgan's head stock market analyst advises everyone to buy risk assets:

He mentions corporate buybacks as a reason to buy stocks, however corporate buybacks always peak at the end of the cycle. It's the only way to artificially boost share price when earnings growth is slowing. 

Which gets us to the casino set-up going into the strictest Fed tightening on record. 

The S&P is two years overbought and the two prior overbought readings this year led to rollover AHEAD of the FOMC. In addition, there has been ZERO capitulation by traders:

The rest of the world ex-U.S. just made its fifth lower weekly high:

In summary, the exact same major bank sees unprecedented risks, record low liquidity, and yet still advises buying risky assets. Investors have NO CHANCE to survive in this ridiculously confused environment. There is far too much conflict of interest masquerading as market expertise. 

The sheeple are lambs to the slaughter. 

And what's new?

"GOOD NEWS. WE HAVE ACHIEVED TERMINAL IDIOCRACY"

The only thing more dangerous than gamblers who believe bear markets no longer exist, are economists who think recessions no longer exist. One thing they all have in common is the belief that printed money is the secret to effortless wealth. The only question they ALL have is, why did no one try it sooner?

For months last year pundits pounded the table that inflation is NOT transitory. Last December the Fed finally agreed, and they slammed on the brakes. Six months later pundits are now saying inflation IS transitory. Stagflation in the 1970s lasted almost six years from 1974 to 1980. This time around it lasted six months. Which begs the obvious question, what is the definition of transitory?

The answer is it no longer matters, because per tradition the Fed is  heading in the wrong direction and this clown car doesn't go in reverse. We don't know if the economy is in recession right now, we only know it's on a slowing trajectory. Which means we are headed for recession and the Fed is accelerating towards the cliff. There is a consensus belief among pundits that the Fed can raise rates to the "neutral" level this year ~2.5% and then start cutting rates next year, all while avoiding recession in the meantime. In other words, the Fed will create monetary buffer by demolishing economic buffer. When they fail, the consequences will be cataclysmic. First the financial bailout will fail. And then the economic bailout will fail. Monetary policy is now a spent farce. 

This recent Fortune article basically sums up the standard view:

Fortune May 2022:

There Are Two Kinds of Recessions. The Good Kind and The Bad Kind. We Deserve The Good Kind:

“It typically takes about 10 months from the low in unemployment to recover to pre-recession employment levels in a typical recession,” Miran said. “For the dot-com [bubble] and the global financial crisis, it took about three times that amount, about 32 months, to recover to pre-recession unemployment levels.”

There are many things wrong with this article. It starts off by assuming there is NO asset bubble this time around. Which is obviously an asinine assumption. We learned today that home prices surged 20% in March. Which is a Black Swan event with a 1 in 420 probability based on known data alone. 

"March’s reading was the highest year-over-year price change in more than 35 years of data"

We have a parabolic housing bubble AND a collapsing Tech bubble, this time with no safety net beneath the economy. Yet both gamblers AND economists are convinced this bear market and this recession will be the easiest of the three. You have to be brain dead to believe this bullshit, which is why it's largely unquestioned. 

The article makes an even more fundamentally flawed and asinine omission when they claim that typical recessions don't last very long and are not as bad as 2008. Because what they fail to mention is that the Fed lowered rates between 5 and 10% in every recession of the past 50 years. Currently the Fed has less than 1% dry powder. So how is it possible to have a "garden variety" recession when the Fed has nowhere to go on rates?

What you notice from this chart is that every recession required the Fed to dramatically cut rates. EXCEPT the pandemic, because they only had 2.5% to go on rates. 

What saved the economy in 2020 was the largest fiscal expansion since World War II MONETIZED by the largest Fed balance sheet expansion on record.

The bet now is that will happen again during a mid-term election:

In summary, we are heading for a very hard landing. 

Whether stocks lead or follow is NOW totally irrelevant. The economic damage is done and the Fed no longer has any rate cut powder. This consensus view that they can head off catastrophe by tightening faster, is a LETHAL assumption. 

Which means we are now facing simultaneous deleveraging in tech stocks, housing, consumption, corporations, state and local governments, emerging markets, all at the same time. 

When the financial bailout fails and markets implode there will be no appetite to bailout out the wealthy. In addition, fiscal stimulus will be insufficient in a mid-term election year heading for political gridlock. 

The belief that printed money is the secret to effortless wealth has reached Terminal Idiocracy. Today's pundits claiming there will be a "soft landing" are borderline criminal. And the complacent masses wouldn't have it any other way.