Notes From Underground: The Week That Was

This past week has been the most challenging to recap because at least 20 central banks released statements about their monetary forecasts and outlooks. The most significant banks that we were watching — the FED, SNB, BOE, ECB and BOJ — performed as expected as the FED, ECB and BOJ announced the expected outcomes.

The Bank of England raised its overnight lending rate by 15 basis points as they had already ended asset purchases so a minimal rate increase was all they had to give in order to slow the rise in headline inflation. The Powell FED took the most DOVISH route possible in an effort to placate the Biden White House and its effort to stem the narrative of headline inflation and election outcomes. We at NOTES FROM UNDERGROUND had contemplated a complete end to QE but Powell (in his efforts to do something) merely doubled the pace of tapering laying the outcome to a finality in March rather than June. This is only important if the FED maintains its “forward guidance” of no rate hikes until the U.S. central bank’s BOND PURCHASES have concluded.

Peter Boockvar highlighted the anti-inflation battle in his synopsis of the latest University of Michigan consumer confidence report: “When directly asked whether inflation or unemployment was the more serious problem facing the nation, 76% selected inflation while just 21% selected unemployment. The inflation belief was widespread for all income, age, education, region, and political subgroups. Also, the inflationary erosion of living standards are currently reported by one in four households.” As Powell noted in his press conference, headline UNEMPLOYMENT had improved faster than previously forecasted so the FED had the ability/desire to confront rising concerns about inflation since it’s now been declared no longer TRANSITORY.

The more liberal press kept Powell off-balance as they peppered him with questions about what is maximum employment and why the turn before allowing wages to rise and minority employment reached pre-pandemic levels. Many reporters raised the issue of LABOR FORCE PARTICIPATION, which Powell said several times it was a concern but felt confident that it reflected temporary conditions and would be corrected. In response to this participation issue Powell maintained the issues of medical concerns with Covid, childcare and adultcare issues, as well as the idea that participation is LOWER because of ASSET APPRECIATION (house stocks and forced savings) allowing Baby Boomers to finally retire. The participation debate and its impact on wages will be an ongoing concern/rationale for the FED to move its mandate targets yet again. That’s my forward guidance.

Markets performed in line with the Fed’s dovish posture. Yield curves steepened even as tapering pace doubled. The EQUITY markets started the week down as there was some sense that the FED might strike a more hawkish tone but rallied making new all-time highs in the S&Ps during Powell’s press conference. By week’s end the global stocks were down as the onset of OMICRON concerns were spreading fear of additional global restrictions. Over the weekend, it was reported that the DUTCH were shutting down and other nations raised their protocol levels. That should stem travel, especially during the winter holidays. Be patient as this is a liquidity-starved week and the algos will be delivering plenty of volatility.

***The ECB’s policy meeting ended with the consensus based outcome, except for President’s Christine Lagarde’s insistence. During the press conference, she read the critical paragraph four times: Even though PEPP was ending March 31, the ECB would be doubling its asset purchase plan to 40 billion euro for the second quarter, 30 billion euro for the third quarter in order to act with FLEXIBILITY AND OPTIONALITY. This is critical. It is a direct effort to prevent any widening in the spreads between yields on 10-year debt within the European Union.

When Lagarde took the reins of the ECB two years ago, she declared in a press conference that it wasn’t the ECB’s job to maintain spread differentials between European countries’ debt instruments (a major faux pas). As a result, German/Italian spreads exploded and the ECB head was forced to explain she was misunderstood. In response to this idea of flexibility and optionality, the Financial Times published a story online noting that the Greeks were pleading with the central bank to continue PURCHASING ITS DEBT EVEN THOUGH IT WAS NOT INVESTMENT GRADE, which violates the rules established for the ECB under the LISBON/MAASTRICHT ACCORD.

Lagarde spoke about the Greek situation twice in her remarks, which is why she demands the ECB have the flexibility/optionality to be able to operate with discretion in meeting the sanctity of the CAPITAL KEY. European capital markets are now subject to the dictates of the ECB president. The German/Italian spread currently at the highest level in a year and that’s even with President Lagarde’s new discretionary power. The German/Italian spread initially widened upon the END OF PEPP BUYING BUT CONTRACTED a bit following mention of the optionality/flexibility provisions. Very DOVISH.

***Finally, I’ve posted a podcast recorded with Professor Michael Pettis and moderated by Richard Bonugli. This is an attempt to analyze CHINA from a global macro perspective. Please listen and await your responses to this grand effort by the Financial Repression Authority and Bonugli to shed a world perspective on the Chinese economy.

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15 Responses to “Notes From Underground: The Week That Was”

  1. Michael Temple Says:

    Meanwhile, LaGarde may soon need help from a Dutch boy to hold up the duke. Little discussed is the fact that French debt has now overtaken Italian sovereign debt.

    Somebody may wish to inform the algos that they ought to leave Italy alone and start picking on the French.

    Germany’s Target 2 balances now exceed 1 Trillion

    Go Big or Go Home!!

  2. Hopgrower Says:

    “The participation debate and its impact on wages will be an ongoing concern/rationale for the FED to move its mandate targets yet again. That’s my forward guidance.

    Sad But True. Thanks Yra

  3. Michael McCord Says:

    A stimulative presentation, enjoyed it all. Mike McCord

  4. nathanaelwills Says:

    This is a very well-written article, IMO. Well worth the read and I would love to get the board’s input and thoughts.

    • The Bigman Says:

      Hi I can speak from personal experience on the farmland asset bubble of the 1970s. In 1962 my father, an electrical engineer by training, bought a 120 acre farm in McHenry County Illinois for $52,000 ($430). By 1978 that land was valued at $2436/acre.
      Using the BLS inflation calculator, corrected for inflation the equivalent value in today’s dollar would be $10,300/acre. We are currently settling my mother’s estate which contains the remaining 40 acres of the original farm. We anticipate to receive ~$7300/acre
      So over 40 years later the real value is still 30% less than in 1978.
      As far as allocative effect of lower for longer, many family farms were bought by wealthy individuals as in those days one could write passive losses from the farming off against other forms of income. Family farmers were priced out of the farmland market and this accelerated the trend to large corporate farming- what some would call creative destruction but what I call greed.
      So if Mr Hoenig is correct, and I believe he is, we are in for a world of hurt and just not economic but societal as well.

  5. TraderB Says:

    So the Fed is getting political pressure to tighten, but we all know that financial markets are too fragile to handle higher interest rates. So what gives? Happy New Year to all.

    • The Bigman Says:

      Great discussion from John Taylor et al on how far the Fed is behind the curve and how we got here:

      Bottom line according to Taylor rule Fed needs to raise funds rate to at least 5% to harness inflation. Just think about that for a while. Especially when Fed policy according to the discussion has become totally divorced from the economic data and reality

  6. TraderB Says:

    Bigman- Great post. Let’s assume service/wage inflation persists at 4-5% in 2022 along with inflation of goods starting to normalize later in the year (all as stated in the video as base case). So the market needs to imply a discount rate of 4-5% to curb inflationary behavior…

    Doesn’t our experience over the past decade tell us that they might tighten only slightly with more hawkish rhetoric. Or do the need to actually take action this time? I.e. reduction of balance sheet to $4T. And a 3-5% short rate?

    • Yra Says:

      Bigman,TraderB and others this is a very important conversation especially as we enter the period of FOMC nominations.The WH wishes us to believe in their fight against headline inflation but when you see the LEAKED or trial balloons flaoted for the three very dovish nominations as Governors it makes me leery of the authenticity of their fight.-Philip Jefferson,Lisa Cook and of course the previous seated Governor Sarah Raskin all have serious dovish credentials—even Jason Furman is quoted in a weekend Bloomberg piece by Rich Miller over the weekend–“are considerably more dovish than anyone’s who’s been on the FED for a long time.”This coming from someone not known as a hawk–BUT I will add this in a hat tip to Robert from Wichita Kansas who noted that GOLD rose even as the FED raised rates 17 times in 2004-06 and then nine times in 2017-18 gold rallied until the onset of Quantitative Tightening did GOLD and other assets begin to decline—all assets are floating on a sea of central bank liquidity which has grown geometrically

  7. The Bigman Says:

    Here is more food for thought. In this long interview with Lacy Hunt at 1:13.45 he decries the adding of full employment as the second Fed mandate in 1978. He states that Powell’s inclusive employment mandate (read Yra’s social mandate) has blown up on the fed:

    In support of Hunt’s position, in the December jobs report unemployment among African-Americans increased from 6.5% to 7.1% All other ethnic groups were essentially unchanged. We can all guess what Hunt must think of the Fed’s climate and market mandates.

  8. Yra Says:

    as i see it—-inflation is financial pornography as i know it when I see it—–more importantly it gives some a monetary erection while others find it repugnant and generates the rape of those not able to avoid its brutality and are easily overpoweredin the mad thrust for monetary pleasure

  9. Arthur Says:

    Yra, waiting impatiently your thoughts on Europe, Ukraine, Germany, Nato, Russia…

    Jan 17 Expanding NATO would be the most fateful error of American policy in the entire post-cold-war era. George Kennan in 1997

  10. Pierre Says:

    I thought this was an interesting video on the what’s happening in the Ukraine.

  11. Mark W Says:

    Yra, as previously discussed late last year I proposed the logical question on why the Fed wouldn’t move an initial 50bps (or more)? We discussed at length why they should move 50bps in Mar, given also the Fed is well aware of having to manage “expectations”. This possibly will carry more weight as we lift off. Can we assume businesses will be reluctant (as they were in the late 70’s) to help by starting to lower prices regardless of any supply chain and Covid alleviations? Forget the looming corporate tax and regulatory environment for a minute. I am now starting to see media and others across multiple platforms now have attached to “shock and awe” describing why the Fed should move an initial 50bps. Controlling the narrative would also be easier if commodities e.g. oil & gas weren’t so broadly underinvested and loathed by this administration, as it now the most attractive performing sector. C’est la vie.

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