‘The Mistake’ – Things Are Coming To A Head In Markets

‘The Mistake’ – Things Are Coming To A Head In Markets

Authored by Sven Henrich via NorthmanTrader.com,

Things are coming to a head. Things are changing rapidly if you pay close attention. As you know I’ve been hammering on the Fed for overdoing it on the liquidity front causing a historic asset bubble while exacerbating wealth inequality and now having fueled inflation which is hurting the bottom 50% the most. None of this is healthy in my view but the constant stock market new high machine is masquerading it as healthy and positive.

One key change: I’m no longer a lone voice in this assessment, increasingly the Fed and Powell are getting called out for committing a policy mistake and voices across the spectrum (including some on the Fed itself) are increasingly urging the Fed to stop QE. Why? Because broader consensus is emerging that the concerns I’ve been raising are indeed coming to fruition.

Let me tie some pieces together here.

Here’s Mohammed El-Erian calling out the Fed’s policy mistake:

“We’re not going to find out whether we’re in a major policy mistake until the end of the year” says @elerianm on the latest actions by the Fed. “I think we are.” pic.twitter.com/fP93JckzNc

— Squawk Box (@SquawkCNBC) August 23, 2021

The underlying issues: For one the Fed is staying too loose too long throwing in way too much liquidity and then missing a window of opportunity to taper when they could, otherwise financial conditions become too hot, an assert bubble forms and then when things slow they can’t taper or raise rates which I assert is the phase we are already in.

This sentiment very much echoed today from Rick Rieder of BlackRock:

“The Fed could have started tapering months ago,” says @BlackRock‘s Rick Rieder. “We’re talking about $10B-$15B a month of treasuries. It’s just time to go. The liquidity is too big.” pic.twitter.com/ag6YF48w20

— Squawk Box (@SquawkCNBC) August 26, 2021

The other issue being inflation. The Fed has totally underestimated inflation. This is not my assertion this is coming from the Fed itself:

“We have a lot of inflation in the U.S., more than we expected,” says @stlouisfed‘s James Bullard. “A lot depends on whether inflation is going to moderate in 2022 or not. I am a little skeptical … I think we want to get going on taper, get the taper finished by the end of Q1.” pic.twitter.com/DuuTcyegKs

— Squawk Box (@SquawkCNBC) August 26, 2021

Which is an admission of a mistake without making an admission. High inflation hurts the poor the most, even Bullard has acknowledged this.

With inflation continuing to be hotter than expected and more persistent than expected on the supply side then continuing to print (and even tapering is still printing) the Fed continues to throw fuel on the fire which is also the point Jim Grant has been making:

So my contention:

The Fed is not about to make a policy mistake.
It has already made a policy mistake.
And now they’re faced with the largest asset bubble in history and are desperate to engineer a soft landing.

— Sven Henrich (@NorthmanTrader) August 26, 2021

And yes it is the largest asset bubble in history:

Market cap to GDP 205.5%.

Other than that things are perfectly normal & healthy. pic.twitter.com/W55vYTHyXd

— Sven Henrich (@NorthmanTrader) August 26, 2021

This is what happens when you have a market run tit for tat with the Fed’s balance sheet and on autopilot. This is where we are and I highlighted the unique machinations of the market yesterday in my appearance on CNBC where I also raised the next key point: Wealth inequality:

Wealth inequality is a big problem, not just a theorem, and increasingly one has to wonder if easy money policies and persistent money printing are actually damaging the economy in the long term:

Maybe the reason money velocity continues to crater & doesn’t make its way into the real economy is because all the wealth gets sucked up by the few who hold it in the very assets continually goosed up by the Fed.
Which could mean the Fed is actually wrecking the economy. pic.twitter.com/BjgWl48LFg

— Sven Henrich (@NorthmanTrader) August 26, 2021

After all, this all started going haywire once the Fed went on its cheap money spree in the 2000’s following the tech crash, then doubled down following the housing crash it helped ferment, and now has quadrupled down, all producing the same result, except worse each time.

Again, I’m not just blowing smoke here, what was shoved under the rug is getting more and more attention here via Bloomberg:

Which fits with the Harvard Study conclusion: “the U.S. and lower-income families are becoming more indebted, rich people have more money tied up in debt funds, and less money goes toward fostering innovation and prosperity.”https://t.co/SbtRqAzIQY

— Sven Henrich (@NorthmanTrader) August 26, 2021


“wealthier families are more likely to invest in bonds than spend their money, and the disproportionate growth in these households’ assets has been a big driver of demand to buy debt. But there’s another way to look at this same story: The more money the wealthiest individuals have, the less likely they are to recirculate it and help fuel the velocity of money that’s critical to growth”.

The bottomline: It gets harder and harder for Powell to refuse to taper as the voices keep multiplying.

Even the Bloomberg’s editorial board called it past time to end QE:

“The primary goal of QE is to press down long-term interest rates and support aggregate demand. The Fed’s promise to keep buying bonds for an extended period made this push more forceful — which was appropriate after confidence slumped at the start of the pandemic. At the moment, lack of demand isn’t the problem. Supply-side disruptions including shortages of workers and essential parts mean that an excess of demand is pushing up prices rather than boosting output and jobs. This is especially clear in the markets for housing and cars, but the pattern goes wider than that.

The Fed’s preferred measure of inflation stands at 3.5%, well above its 2% target. The unemployment rate is low, at 5.4%, and many employers are finding it hard to fill vacancies. Asset prices have surged and the risk of bubbles and financial instability is growing. All this suggests it’s past time to start dialing back the Fed’s commitment to maximum stimulus.

Now, inflation is indeed a risk, so the central bank must untie its hands and recover its ability to tighten or loosen policy as the situation demands. The QE program inhibits its freedom because the Fed has led investors to believe that it will wind down its bond-buying gradually before it turns, if necessary, to raising interest rates.

Things have changed. The Fed now has to grapple with two risks: that demand will fall short causing the recovery to falter, or that too much demand will force inflation above target and keep it there. Nobody says this is easy. But the costs of extending the commitment to maximum stimulus have come to outweigh the benefits. That’s the message that Powell ought to convey this week: For now, QE has had its day.

Yes, things have changed. Except the Fed has failed to heed all the voices of reason and now they’re stuck with a massive asset bubble that can’t afford to break its trend for failure is not an option and Powell needs to maintain confidence in an environment where consumer confidence has already begun to drop, inflation continues to exceed expectations and supply chain constraints are proving to be much more persistent while margin debt having just rolled over, a historic precursor to market roll overs to come:

These type of roll overs can have minor or major implications.

To be determined but in this age of excess it should come as no surprise that the margin debt debt equation has also taken on historic proportions leaving room for the possibility for a larger unwind to eventually to come than any of us could imagine at the moment:

In this context of note perhaps that while $NDX and $SPX have continued to chug on to new highs the broader $NYSE has not:

In case you’re wondering where & why the broader $NYSE has stalled over the past few months.

And yes, this is a log chart. pic.twitter.com/oI79MLp2qm

— Sven Henrich (@NorthmanTrader) August 26, 2021

Tomorrow then will be another key day for Jay Powell to “save the market” from a break in trend.

The Fed better succeed for the volatility structures we’ve been tracking continue to build cleanly and precisely and continue to suggest a much larger volatility event to come:

I suggest there is little room for error in this era of excess and complacency and any trigger, be it a known or unknown one, could reveal the Fed’s policy mistake for all to see.

From my perch it’s becoming ever more apparent that Powell’s Fed has already made a mistake. Let’s just hope we don’t all end up paying for it in one form or another.

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Tyler Durden
Thu, 08/26/2021 – 15:17

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