The Pivot Fallacy

Haaaa ha ha ha haaaaa. Hello, dear friends. I'm back with another economic update for you.

Have you ever seen those old videos of Evel Knievel, the legendary stunt performer, taking his motorcycle and jumping over parts of the Grand Canyon? If he misjudged the speed of his motorcycle, the incline of the ramp, the distance of the jump...any slight miscalculation and the fall would certainly kill him. But he was an artist, and the variables he was working with were few. The only real secret ingredient to his success was courage.

Now imagine Federal Reserve Chairman Jay Powell in that motorcycle. Wearing the American cape on his back, there is determination on his face. He revs up the engine, sending the interest rates up many hundreds of basis points. His motorcycle hits the inclined ramp at an incredible speed, crushing residential and commercial real estate, tightening credit, setting off layoffs in the tech industry. And then at the very peak of his flight, he pivots, cutting interest rates back to zero, and landing safely on the other side. The crowd goes wild, investors throw themselves at his feet. He has achieved soft landing.

That's the fairy tale the stock market is feeding itself these days in a state of frenzied ecstasy. Sure ole Jay can do it. He can raise rates at historic rates for more than a year, and then when the economy goes into recession, he can quickly cut rates back to zero, and all will be well. No need to look down to see how deep the canyon is. He can make the jump.

This is a foolhardy assumption. The Federal Reserve board and it's chairman have made it clear multiple times that their priority right now is getting inflation back down to 2 percent, by creating tightness in the labor market. Which is Fed Speak for "we want people to get laid off and stop spending". Unemployment is a lagging indicator, usually the last shoe to drop in a slowing economy. So the Fed is ignoring all the coincident indicators that show that the economy is slowing dramatically, and riding that motorcycle looking in the rearview mirror. Even as all the forward looking indicators are flashing Red, the Fed is STILL raising rates. After the humiliation of getting "transitory inflation" call so wrong, they are determined to over correct on the other side. Jay Powell has made it clear that PAIN will be involved. Which means no PIVOT to cutting rates is coming. Not unless things break so badly that the Fed is forced to abandon it's inflation fight.

It's incredible that this is the thesis the market is resting it's hopes on. That the credit tightens so dramatically, and things break so clearly, the Fed is forced to pivot on it's policy stance. Even if the Fed does cut rates, like it has historically during economic crises, that pivot is usually accompanied by a crashing stock market. And low rates are no immediate panacea either. Just like high rates take anywhere between 12 to 18 months to show up in the economy, it's the same in converse when you're cutting rates. No matter what the Fed does, we WILL go through a severe downturn in the coming quarters. Pivot or not, an earnings recession is on it's way, combined with higher unemployment. The passive flows from retirement accounts into the stock market ETFs and mutual funds will reduce liquidity during a recession, as people get laid off or reduce contributions or reallocate assets. Credit is already tightening due to QT and higher rates. Add to that the regional bank crisis, which will tighten the availability of credit even more. After the failure of Silicon Valley Bank, which was the second largest in the American history, First Republic, another large regional presence, is now on the chopping block. As i give this market update on the 29th of April, it's likely that First Republic goes into receivership with the FDIC come Monday. More credit tightening.

The current fallacy of the Fed Pivot being a cure for a falling stock market will take retail investors by surprise, when they find that the act of cutting rates coincides with devastating financial events, and the Fed like always, will be way behind the curve, trying to dowse a fire they themselves started. To complete the motorcycle analogy, nobody knows how deep that canyon goes. Nobody. You're better off just clapping from the sidelines, as the Fed's motorcycle vanishes into the dark abyss. 

Cheerio!

Fed's Fatal Flaw

Psychologist Gabor Matay describes addiction as a response to trauma, and an attempt to escape suffering, at least temporarily. People partake in addictive substances or behaviors in order to feel momentary relief from the background of trauma and suffering that they have been exposed to. The problem of course is that this behavior does nothing to address the root cause of the suffering, but creates a downward spiral from which it's increasingly difficult to extricate oneself. The brain needs higher doses each time, and the crashes from those highs get increasingly debilitating. The final outcome, quite often, is complete destruction.

Given this context, one must wonder about the nature of pain and suffering that haunts the American economic landscape, and requires ever increasing amounts of drugs in the system. For no analogy fits better what the Federal Reserve has been doing to the American economy over the last two decades. As the ultimate drug peddler, the Fed has been forced to increase it's dosage....sorry, stimulus....with every new crisis. Interest rates, the beating heart of capitalism, for that's how capital risk is assessed, keeps getting pushed down to stimulate economic activity for longer and longer periods of time. Higher rates are now blips on the time series. Money printing, or what's popularly called debt monetization, has now become a permanent part of monetary policy. The economy at large is now addicted to artificially low rates and waves of easy liquidity sloshing around the system.

So what happens when these economic drugs are taken away, even briefly? What do the withdrawal symptoms look like? Well, given how deep the addiction now is, the face of economic withdrawal is quite ugly. Corporations that were until recently flushed with easy money and didn't have to show profit for years, are suddenly finding it hard to refinance their debt at higher interest rates. Layoffs have ensued, and will continue to pick up pace for the foreseeable future. Regional banks are suddenly realizing that their 'safe' bond assets have actually gone down significantly in real terms. I'm guessing many state pension plans have a similar issue. Residential real estate sales have fallen off a cliff. The devastating combination of high rates and high home prices have created an affordability crisis in the housing market. Commercial real estate is facing even worse headwinds. Office vacancies have skyrocketed due to the post-pandemic work preferences. And debt restructuring at higher rates has become much harder, especially with the current crisis in regional banking which constitutes most of the lending. Used car sales have also plunged, and prices have now begun to follow. The M1 money supply has seen it's sharpest rate of change contraction in many decades, which will show up in economic activity sooner than later. Speaking of long and variable lags, we have just begun to see the effects of last year's rate hikes manifest in the economy. At this point, no matter which way the Federal Reserve pivots, an economic recession is baked in.

Why not just cut rates and go back to the printing presses, you may ask? Well....one word.....the Fed's Achilles heel.....the Fatal Flaw in it's central planning agenda.......INFLATION! For over a decade, pundits have lambasted anyone that criticized Fed's loose monetary policy. "What's the problem"....they would ask...."money printing was supposed to create inflation......but it hasn't.....so why not keep doing it?" An entirely new economic philosophy called Modern Monetary Theory or MMT came into being around this premise. They completely ignored that money printing in fact DID create inflation. It was just in financial assets. The trillions of dollars that the Fed manufactured out of thin year never made it out of the canyons of Wall Street. Stocks and housing boomed, yet consumer inflation at large remained under control. There was no incentive for Wall Street to lend money out......their arrangement with the Fed gave them the profits they needed. ....Until Covid happened......, and the Fed, perhaps for the first time, was forced to share a piece of the pie with the public. Suddenly it wasn't just Wall Street getting bailed out, but Main Street as well. The drugs were now available at the local pharmacy, no prescription required. And general inflation raised it's ugly head across the American economy.......as had always been predicted. And now we're all on the same page.....after the initial high of seeing money magically appear in your bank account..... everyone  now understands the pain inflation can wrought, especially on those who can least afford it. It's the bitter invisible tax that nobody wants to admit.....a monster hiding in your finances, chewing away at your ability to proper and leave a legacy for your children.

That's the Fed's Fatal Flaw. It presumed that it could cover up the general suffering of the American way of life by drugging them up with extremely loose monetary policy. With no ill side effects. And now the chickens have come home to roost. The drugs are being withdrawn, and the patient is beginning to convulse, begging for more as time goes by. But the Fed's hands are tied, because it cannot risk the Inflation monster, created by it's own misshapen policies, to run loose. We are about to find out just how much trauma and suffering was being covered up by the Fed. The real rot in the system is soon going to reveal itself. ............... It will be on us to not shy away from it, and maybe in a very long time.......look our trauma right in the eyes.