Notes From Underground: Dear Jerome

I have not been a fan of yours since your January 2019 “Powell Pivot,” when you allowed yourself to be fooled by the markets. In an effort to rein in Ben Bernanke and Janet Yellen’s QE programs you went for what Stan Druckenmiller  called the “double shotgun approach” and raised interest rates while reducing the Fed’s balance sheet — what Peter Boockvar called Quantitative Tightening (QT).

In a July 9th hit with Rick Santelli we discussed that the FED OUGHT to embark on one or the other but refrain from both raising rates and QT as it could shock the over-leveraged global financial system. By the end of 2018, Treasury Secretary Mnuchin was worried about a possible solvency issue for over-leveraged money-centered banks, which ultimately motivated you to call off the whole effort as the financial pain was far too much for the Powell FED. More importantly, Yellen had hubristically stated that QT would be similar to watching PAINT DRY. (Well, I’m glad my grandchildren weren’t in the rooms with wet paint.)

And now, since the onset of 8% inflation, the FED — with the BLESSING of the Biden White House — has begun a program of slaying the demon of inflation through the combination of raising overnight rates while preparing to speed up the process of draining liquidity from the financial system. So now you and the world’s central banks are willing to do what needs to be done in an effort to regain the FED‘s credibility.

The FED cannot eliminate supply bottlenecks but it can reduce demand by raising rates and reducing liquidity through WEALTH DESTRUCTION. That means crushing the global stock markets as the Telegraph’s Ambrose Evans-Pritchard wrote in an oped, “The US Federal Reserve actively wishes to crush Stock Markets: Ignore It At Your Own Peril.” Evans-Pritchard delineates what the FED‘s objective is, and Powell and his minions, “are now on a mission to redeem themselves and prove they can conquer inflation after all. Zeal is a dangerous thing. That is why I fear the Jackson Hole of 2022.”

Readers of NOTES FROM UNDERGROUND and all the blog posts from contributors will be familiar with the most of critical points in this piece, but I’m afraid, dear Jerome, the FED will err yet again in an effort to reclaim its diminished CREDIBILITY. While many commentators are pushing for the central bank to go faster in raising rates in an effort to find you inner-Volcker, I have caution against this. I encourage you to read a piece from Ed Yardeni’s comment piece in the Financial Times last week, titled, “Why the Fed Might Be at Neutral Already on Monetary Policy.”

The strength of the DOLLAR and the real impact of QT on the economy is something that needs to be taken in to account. As Yardeni wrote, “I conclude that the peak in the federal funds rate during the current monetary tightening cycle will be lower than otherwise because the combination of QT and the strong dollar are equivalent to at least a 1 percentage point increase in the federal funds rate.” He also advised, “The Fed undoubtedly has some estimates from its in-house models on the equivalent rate rises represented by the strong dollar and QT. If so, they should share that information with the public.”

LIke Mr. Yardeni, I believe the strong dollar is going to unleash some real pain upon the global financial system, which will fall back on the FED. Good thing the swap lines and repo facilities are in place to backstop the entire global financial system. Those who praise the strong DOLLAR are singing from a 1970s hymnal when trade was paramount to finance. But in today’s world of FED policy unleashing massive dollar funding upon the emerging markets, be very careful. KING dollar is not what it once was and this is coming from an Austrian-based sound money analyst.

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17 Responses to “Notes From Underground: Dear Jerome”

  1. Asherz Says:

    I generally agree with Evans-Pritchard but not on this one. He maintains that the Fed wants to destroy the global equity markets in its fight against inflation. I believe that the first mandate of the Fed in the last decade has to support equity markets and in any case prevent a crash. A crash would be the last barrier to prevent the Greatest Depression. The debt fueled rise in the equity markets since 2009 has been there for all to see.
    But they are faced with 8% inflation which cannot continue unchallenged. So raising overnight rates and QT become front and center, loudly proclaimed by Powell and his fellow little dwarfs on a regular basis. Yes some short term action but jawboning is the main tool being used and not turning off the fire hose for good.
    Jerome pictures himself as Samson, but the younger version. The one where he takes the jawbone of an ass to slay inflation and not the final version where he grasps the two pillars of FF and QT to bring the house down on all as per our friend Ambrose.

    • David Richards Says:

      Mr Powell is no Volcker but in fairness to him, the US of today is in a much weaker position than it was in Volcker’s day particularly in terms of debt, gdp, demographics, productivity, industry, and war cycle. In a nutshell, today the country cannot afford to tackle inflation. But we also know that the country cannot afford to not tackle inflation. So to use a technical term, it’s fubar’d either way. And of course, many other countries of lesser stature are in the same boat, oh-oh.

      History shows (see my previous post today) that a Central Bank head in a similar position to Powell will know must rightly be done, but he will also be torn in conflict by his civil service demands to not allow the system (read house-of-cards) to collapse.

      As the CB thrashes about from what is right for the long run to what is politically practical in the present, you get huge market volatility that wipes out people as I described in my previous post, even as the big overall trend is that the currency purchasing power collapses and nominal asset values soar as denominated in the currency.

    • David Richards Says:

      Asherz, I love your metaphor and I completely agree with you about Evans-Pritchard and the Fed. I’d add that as the most important CB by far in the world, the Fed should also be aware of the pain it’s inflicting on its weaker allies in Europe and Japan, as I’m sure their policymakers aren’t shy about telling US authorities so. What is the Fed gonna tell the allies to do, abruptly deleverage themselves or else crash?

      Remember, oil and commodities going to Europe UK and Japan are priced in dollars, so their prices have soared especially for oil & natgas in terms of their own falling currencies. Now their natives are restless. So I think the realpolitik of the situation is that some allies are telling the US to reverse course on the dollar and rates, or else they’ll have no choice but to break US sanctions by buying Russian commodities oil & gas at the 30% discount for Russian “friendly” nations. Like neutral India already is doing without any US punishment, demonstrating how sanctions are sanctimonious, as the US cannot chastize India and have it slip closer toward Russia & China (as India already has this year, along with most of ASEAN and the Middle East ex-Israel).

      What some say was a Yellen policy to drive USD up to 1.10 in order to punish Russia & China like her dollar spike did in 2015-16, has instead had little impact on those intended targets (as they have large gold reserves and trade surpluses of in-demand exports), and instead this time Yellen’s dollar drive has unintendingly more-punished US allies in Europe UK and Japan and even S.Korea, despite all their exclusive dollar swap lines with the Fed. Ofc, a bunch of dollar borrowers in EM with no dollar swap lines are hurting too even more, but we don’t care about them unless they have sufficient geopolitical significance.

      Bottom line, once this unsustainable Fed chest-thumping about fighting inflation diminishes, the dollar by necessity is going down-down for both international and domestic considerations.

      • David Richards Says:

        … and if one correctly anticipates the future direction of the dollar, then one can probably correctly anticipate its affect on markets – back to your original point of supporting equity prices!

  2. David Richards Says:

    From a trading perspective, do you suspect that much of this analysis is understood and already priced into markets?

    I suspect the dollar has either topped or is close to topping but I might be wrong and regardless I’m awaiting a technical confirmation.

    If a course change is ahead for markets, then a pair of my preferred sectors will be the beaten down and out-of-favor gold miners and emerging markets.

    I think it’s worth repeating that the history of markets during the Weimar Republic shows extreme market volatility, in sharp contrast to the 50,000-foot chart view that shows the reichsmark steadily collapsing and gold & stocks soaring in a fairly straightforward manner.

    I’m not saying the US is fully Weimar by any stretch, but I think we’re reliving some characteristics of that era and it’s worth taking note that market volatility is high during periods of price & political instability so you can get whipsawed easily – maybe avoid leverage. To obtain some insight of that era and its Central Bankers in the US, England, Germany, and France, it’s worthwhile to read the Pulitzer-prize winning book “Lords of Finance: The Bankers Who Broke the World”. Nothing happening today in central banking is really new.

  3. yraharris Says:

    Dave Richards—you and Asherz certainly elevate this blog in its effort to educate,elucidate and seek profitable trades and investment.I love your comments on the DOLLAR but the critical one is “I’M awaiting a technical confirmation.”We had a great conversation about awaiting yesterday in the great chat room of Whitewave Trading about if you are early you are wrong in the statement of the most proficient technician I have ever known and I know many of the very best–it is an art not a science—-we are repeating many of the same errors as Weimar as I wrote a few years ago although we are not as yet redoing the political violence but it is early—I also wonder where the voices of Lisa Cook and Phillip Jefferson are in all the FED discussions but that is for the next Blog——again thanks

  4. judd Hirschberg Says:

    Thanks Yra! You’re insights elevate the macro conversation. I appreciate your support during a physically trying time. All my best and many thanks for your friendship thoughout the decades. Judd

  5. kevinwaspi Says:

    I second the motion made by David Richards on rereading the classic Liaquat Ahamed book, “Lords of Finance: The Bankers Who Broke the World”.
    What’s old is new again!

  6. Blacklisted Says:

    Can someone please explain how raising rates reduces inflation when the govt is the biggest borrower. The only thing that will happen is interest expense will go back over 70% of total debt.

  7. David Richards Says:

    J-Powell at J-Hole, 26 Aug 2022: “Without price stability, the economy does not work for anyone.” Not bad, I like it. But action speaks louder than words so let’s watch.

  8. David Richards Says:

    The relatively strong dollar (mostly against the hapless euro pound and yen) is a symptom not of US economic strength or US success in combating inflation. Rather it’s symptomatic of a rapidly worsening sovereign debt crisis globally, the first one in the lifetime of anyone reading this. Some have long forecasted this inevitability, even for this timeframe, and how capital will flood into the reigning core economy – the US and USD. It doesn’t end well, sorry.

  9. Rob Syp Says:

    I’m selling a rental property closing next month it has an adjustable rate mortgage statement arrived today on November 1st interest goes up max it can between years by 2% from 2.875 to 4.875%.

    Hello another belt loop tightens!

  10. Pierre Says:

    Such an informative blog. Still love coming here to read the comments!
    My thoughts are that we are seeing an epic battle between Oil and USD. (Russia and the U.S.) that will change history. Who will break first? Probably anyone’s guess…
    Like any past huge conflicts there will be collateral damage!

    • Yra Says:

      Pierre—thanks and I would suggest you read the last two Zoltan Poszar pieces—-the sitution before us is very complex with many moving parts .The Russia/energy conundrum is certainly a critical piece but many things are in play and the dollar as a financial tool and not trade trade tool is also a critical part of the puzzle

  11. David Richards Says:

    “Believing in central banks’ omnipotence is like second marriages: the triumph of hope over experience.”
    Louis Gave

  12. The Bigman Says:

    What if they held the next Bretton Woods and the US wasn’t invited?

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