The Fed Never Had Control

ZH: An Apocalyptic Paul Tudor Jones Warns The Fed Is About To Lose Control
Joining such luminaries as Bill Gross and Ray Dalio, who have both claimed the bull market in bonds is over, PTJ joins the choir and warns that "markets disciplined Greece for its budget transgressions; it’s just a matter of time before they discipline us" and as a result he sees the 10-year yields rising to 3.75 percent by year-end as a “conservative” target amid the now traditional and widely discussed bogeymen: supply outweighing demand, economic momentum outpacing the monetary policy response, and "glaring" bond valuations.
I don't take this as a given because the Federal Reserve quantitative easing policies increased long-term interest rates and kept short-term rates from going negative (in the immediate stages during the financial crisis). Each time quantitative easing ended, bond yields fell.
PTJ also pours cold water on the repeated suggestion that higher yields will lead to more buying from pension funds: "Bond pension buying, for example, is very pro-cyclical. When stock prices rise, pensions reallocate their capital gains from stocks into bonds. As we’ve seen, this depresses the term premium and fuels more gains in the stock market. If and when the Fed raises rates enough to stop and reverse the stock market rise, that virtuous circle predicated on increasing capital gains will reverse, and bonds and stocks will decline together like they did in the 1970s."
This is the self-fulfilling scenario. This scenario would also include a weakening U.S. dollar, that would drive exchange rate and commodity inflation, unleashing stagflation on the U.S. economy. The U.S. economy would grow at largely the same 2 percent rate, but instead of nominal growth of 4 percent, nominal GDP would rise 6 percent or more, stock prices would fall for years on end, such that the U.S. slowly cleans up its balance sheet and the wealth gap is closed by collapsing asset values.
Let me describe to you where I think Jerome Powell is right now as he takes the reins at the Fed. I would liken Powell to General George Custer before the Battle of the Little Bighorn, looking down at an array of menacing warriors. On the left side of the battlefield are the Stocks—the S&P 500s, the Russells, and the NASDAQs—which have grown, relative to the economy, to their largest point not just in US history, but in world history. They have generally been held at bay and well-behaved, but they are just spoiling to show their true color: two-way volatility. They gave you a taste of that in early February. Look to the middle and there waits the army of Corporate Credit, which is also larger than ever relative to the economy, as ultra-low rates have encouraged it to gain in size, stature, and strength. This army is a little more docile right now, but we know its history, and it can be deadly when stressed. And then on the right are the Foreign Currency Fighters, along with the Crypto Tribe, an alternative store of value that only exists because of the games central banks are playing; the opportunity cost of Crypto is so low, why not own some? The Foreign Currency Fighters have strengthened by 10% over the past year. Compounding the problem, they have a powerful, ascending leader, the renminbi, to challenge the US dollar’s hegemony as the reserve currency. All of these forces have been drawn to the battlefield because of our policy experiment with sustained negative real rates.

So Powell looks behind him to retreat. But standing there is none other than Inflation Nation, led by the fiercest warmongers of them all: the Commodities. He might take comfort that he is not alone on the battlefield. But then he looks over at the Washington, DC, fiscal battalion and realizes they are drunk on 5% deficit beer. That’s what Powell is facing, whether he recognizes it or not. And how he navigates this is going to be fascinating to watch.
The Fed was never in control of events. It benefited from a confluence of memories of market panic, demographics, capital investment in energy, growth suppressing economic policy in Washington, help from the ECB, BOJ and China, plus the cyclical nature of currency markets.

There's no painless exit for the Fed, or the ECB, or BOJ, or PBOC. All central banks are at the mercy of the global financial system, a credit-based monetary system that ceases to grow when people stop borrowing. Leaving aside a "white swan" of accelerating real GDP growth (perhaps because of a technology breakthrough), debt must be brought into line with asset prices. This is done through collapsing the debt level (deflation) or increasing nominal prices (inflation). The central banks think they won because asset inflation was contained, but there was no "wealth effect" of rising GDP. Instead, high debt levels constrained borrowing. The global monetary system is in a perpetual state of disinflation punctuated by periods of deflation.

There's still no sign of private credit growth. USG could change the picture with rising budget deficits, but that remains to be seen. If there's no credit growth, the central bankers exit will restart the unfinished business of the 2008 financial crisis. Only this time, it'll happen with immigration restrictions and protectionist trade policy. (Imagine 2008/9 as the depression of 1920/1, we're now in 1929.) If credit growth picks up, debt levels could rise as they did in the 2000s, setting up an even larger crisis than 2008 in about 6 to 8 years.

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