Notes From Underground: Could Paul Volcker Find His Inner Volcker In This Environment?

Since the Zoltan Pozsar challenged Federal Reserve Chair Jerome Powell to find his inner Paul Volcker and raise interest rates high enough to bring the inflation expectations to heel. (He argued draining liquidity and raising rates to a NEUTRAL level OUGHT to be the medicine needed to truly render the current high inflation levels TRANSITORY.) Last week, Pozsar pushed on the theme again with a piece titled, “Ride of the ‘Volkyries'” in which the issue of financial conditions tightening is discussed in reflection to current FED policy of curbing inflation through the crushing of demand.

As Pozsar wrote: “The FED appears to have chosen price stability as the priority: it wants slower growth and higher unemployment; further, tighter financial conditions mean some financial instability by definition — nothing systemic, but turmoil still.”

This is the constant in what the FED is attempting to do: Crush U.S. consumer demand through the TIGHTENING OF FINANCIAL CONDITIONS because it is by Powell’s own admittance that it’s the only tool available as it cannot by waving a wand increase supply of computer chips, autos, energy or any other good. The Bernanke FED was concerned with idea of disinflation and asset liquidation, which is why it created a portfolio balance channel that used massive amounts of liquidity to elevate personal wealth. As I noted in the last blog post, Powell is tasked with the opposite.

The problem for Powell is that in seeking his inner-Volcker against the current economic backdrop would even stymie Volcker. During his tenure at the Federal Reserve from 1979-1987, public and private debt levels were substantially lower, which allowed Volcker to press harder on the monetary breaks without sending the U.S. economy into a depression. (Financing the debt at 20% would’ve tightened financial conditions to a level that crashed the global economy.) The preponderance of debt makes Powell’s task much more difficult, which is why we will continue to hear the cry about tightening financial conditions.

On Thursday, Treasury Secretary Janet Yellen joined the conversation on financial conditions by discussing the concerns caused by a strengthening DOLLAR. While at the G-7 conclave in Bonn, Germany, Yellen said, “From the standpoint of the administration, we’re committed to a market-determined exchange rate.” (NOTE: One of my regular readers said this is laughable because why don’t they believe in market-determined BOND RATES?) Yellen added, “There are many countries with dollar-denominated debt, and a rising dollar makes it more difficult for countries to bear that debt. We know that often emerging markets worry about how they will fare in an environment of higher interest rates and tightening monetary policy.”

THIS IS THE FIRST TIME THE WHITE HOUSE HAS NOTED THE NEGATIVE ASPECT OF TIGHTENING FINANCIAL CONDITIONS. This suggests that there was much concern about the stress from a financial world loaded with dollar-denominated debt. While I criticize Powell for not engaging on this issue I know it is the Treasury’s bailiwick. While headline inflation is a domestic policy concern the systemic stress from a rapidly rising DOLLAR is a systemic financial concern. Would heightened tightening of financial conditions due to massive losses in global bond and equity markets slow the FED or force them to reach for other deals? Listen to all statements coming from the G-7. In dealing with its allies on the Ukraine invasion and sanctioning of Russia, the U.S. is asking a great deal. Will the White House listen to its friend in need of relief form financial stress?

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15 Responses to “Notes From Underground: Could Paul Volcker Find His Inner Volcker In This Environment?”

  1. ShockedToFindGambling Says:

    Fed Funds futures are predicing a “terminal rate” somewhere over 3%. As the recession becomes obvious later this year, equity markets sink, credit spreads go out and the USD strengthens, I doubt the FED gets over 2%.

    That said, I think the Stock market, Short Treasuries, and Euro FX put in short term bottoms last week.

    Plaza Accord Part Deux???….I was one of the morons who didn’t hear about the Part One in advance.

  2. Richard H Papp Says:

    As the Dow Theory Equity Bear continues to maul the World, it should be no mystery why the UST long bond found “a little” support in this level.
    1. If you go back to Oct, 2018, the continuous near term futures contract in Chicago has support @ 137 the current low area of this move.
    2. On a very long term view of said contract the trendline from the June,1984 bottom intersects the current 137 area.
    3. In the Cash Market the 3.75% UST of 2041 recently bottomed in the 104/105 area. Now go back to Oct, 2018, and that area was the low for this issue.

    My last comment: My point and figure count for the downside extent of Bond Bear has either 119 or 80 as the bottom.

    My continuous thanks for Yra and his fine effort!

    • judd Hirschberg Says:

      Richard good work. 3.30% is 30 Yr qtrly Cloud Yield resistance and the app channel line going back to the Plaza accord. Expand your time frames and charts and make sure you verify with Pit Futures data that gives you an additional 20 years of data.

      3.30 ish Yield has much bigger ramifications since Euro & Yen are doing Plaza accord swings, for this would be the level that the FED and Treasury would likely lose control of the Dollar simply based off interest rate differentials.

      Stocks and Bond Futures have been going in the same direction since 1982. Higher Equities fueled by lower rates. That trend is now in reverse, a reversal that began last year.

      Let us not forget that one of Yra’s favorite tools is Spoo/Bond which is a relative strength indicator and terrific trading tool.

      Trade to make money and trade the market in front of you. There is much opportunity on the horizon.

      A shout out to Shocked. I stood on the top step of the Yen Pit that Friday afternoon and watched a few members buy 1K Yen Futures from dealers after the close.

      I was one of those idiots that did nothing! You are not the Lone Ranger.

  3. Michael Temple Says:

    Lots of cross currents in markets and geopolitics.

    While all eyes are on stocks and inflation, folks seem to be skipping over the extraordinarily rich pricing of TBills, with yields far far below Fed fund expectations.

    Screams collateral shortage and highly correlated, in my view, to the strong dollar.

    Look for some credit event, perhaps overseas.

    Might somebody be way offside?

    Credit markets are not functioning well, which is a MAJOR problem in such an overindebted world as we see.

    As you point out, Powell and his minions gloss over this as they outdo each other in trying to channel their inner Volcker

  4. Keith Bronstein Says:

    Worthy insight and the establishment of a few key markers to monitor for policy effects going forward

  5. Michael Temple Says:

    One huge factoid about current wealth destruction in markets

    Saw a report that $34 Trillion in stocks and bonds has evaporated during this awful start to 2022
    Here is the eye opening comparison
    This represents 14% of global wealth

    At the bottom post Lehman, the destruction was 19%

    QE was the solution then. I suspect Pavlov’s dogs will similarly respond

  6. Yra Says:

    From Yra—a shout out to all the posters tonight.The interchange between Judd and Richard Papp is top notch and shocked quite prescient and important to note—-Biden is in Asia and probably getting an earful on the Dollar because of the huge structural change of the Dollar as a trade issue to the dollar as a debt instrument as the FED kept the throttle wide open which led to more debt being absorbed into the global financial system—important to listen to Austrian Bank Vice President Dr Barbara Kolm for an in depth Austrian economic view—no pun intended

    • ShockedToFindGambling Says:

      Yra, what do you make of the large RRP operations?….records I think.

      • Yra Says:

        Alexandra Harris at Bloomberg has written a few articles on this —maybe somebody can post them for all to read and absorb?—-thanks for all your input

  7. david Says:

    does anybody else find it odd that Davos was delayed until now from earlier this year? Supposedly for fear of omicron but I would venture to say it’s so they can be backstage while equities and financial markets are roiled for the first half the year. Now they come out and say cash trash/equities trash? Sell equities long energy. What good does this do the normal guy? I’d say be better off getting long equities here and short energy?

    • Yra Says:

      David—I am not that cynical but as my readers have know for 13 years the battlecry remains—pepper spray davos

  8. Yra Says:

    Reply to all—-Quick note to ponder—since this NOTE published Sunday the Dollar has weakened against a broad spectrum and seems to providing some support to equities as maybe the market believes that a fall in the DOLLAR will lessen the GLOBAL TIGHTENING FINANCIAL CONDITIONS—-financial conditions are the main concern of wealth destruction leading to demand destruction which will result in a lessening in HEADLINE inflation—-see 2+2=5 is a real outcome

  9. ARTHUR Says:

    Two things,

    1) BRICS members back China’s call for expansion

    2) Foreign Holdings of Federal Debt:

  10. The Bigman Says:

    Today the ruble is 58 to the dollar- stronger than at the beginning of the year and gas is $3.38 per gallon in Russia. Yeah those sanctions surely work. Elvira, Yra’s girlfriend and high priestess of the Central Bank of Russia, is cutting rates while Jerome E- who me worry? Neumann oops I mean Powell and the Fed are tightening into a recession as gas topped $5/gallon today Who exactly is winning this war?

  11. Arthur Says:

    Yen weakness undermines Japan’s growth outlook in 2022 (The Economist)

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