There was an article in Foreign Affairs this week by Graham Allison, the dean of American political scientists, titled, “Putin’s Doomsday Threat: How to Prevent a Repeat of the Cuban Missile Crisis in Ukraine.” The piece raises an important tactical question about escalating the violence in an effort to prevent a greater catastrophe similar to what President Kennedy was threatening in 1962. It’s worth a read as it was Allison’s book, “The Essence of Decision,” that provided the understanding of the bureaucratic mindset during the nuclear age. It provoked me to think that the escalate to de-escalate seems to be the paradigm of the FOMC as complacency over zero interest and transitory inflation has given rise to policy makers’ more hawkish jawboning. Uber-doves Charlie Evans, Mary Daly, Jerome Powell, Lael Brainard have been on a mission to find their INNER VOLCKER (at least rhetorically).
This week there were many comments about the central bank’s NEED to raise rates by 50 basis points at each meeting going into the FALL when the FED will be cautious heading into the November elections.
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Question for data enthusiasts: How many times have the FED raised rates during the labor day/November elections?
On the balance sheet front, the minutes of the latest FED meeting gave markets a sense of just how fast policy makers the balance sheet unwind — or QT — will progress. We at NOTES have been more concerned about the impact of QT on an overleveraged global financial system, especially bonds, equities, commodities and real estate. As Peter Boockvar has pointed out, the maximum $95 billion a month unwind pace will be close to the same rate as when the balance sheet totaled $3.8 trillion back in 2017-19. (Remember, it’s almost $9 trillion now.) The impact from the minutes was that U.S. bonds were sold off with some significant correction in the 2/10 and 5/30 curves.
The FED has a potential problem in how to unload its stockpile of mortgage-backed securities without breaking the robust residential real estate market as rates are speeding toward 5%. When the FED sells $35 billion of MBS a month how much higher will MORTGAGES rise as buyers wait to receive even higher yields. (Or, as Chris Whalen suggests, a potential MBS buyer strike.) My point with the FED and why I come to bury Powell and not praise him is that the central bank kept increasing reserves even as the negative economic effects of the COVID pandemic were proven to be contained. The massive fiscal stimulus from Trump and Biden administrations should have constrained the monetary stimulus that has created enormous losses for BOND BUYERS during those 24 months. As Jerome Powell would says, through NO FAULT OF THEIR OWN.
As the FED searches for its INNER VOLCKER the next six months will be extremely volatile. Louis Gave and I discussed this coming period of heightened uncertainty in an FRA podcast on April 7.
Louis and I cover the world from U.S. dollar and the sanctions impact, global commodities, equities and the recent weakness in the Japanese YEN. (Louis has a very important view on the meaning of YEN weakness.) Also, what is the significance of the Turks dropping the prosecution of the defendants in the Kashoggi trial? Investing will not be easy in the months to come as inflation, war, high food prices and rising interest rates will add more instability. Listen to the podcast for some clarity. Oh, and did I mention the French elections are taking place today in which President Macron is suffering from all the things just listed. If you thought that 2+2=4, you haven’t been reading NOTES FROM UNDERGROUND.