SEMI-MONTHLY FISCAL/MONETARY UPDATE – THE BEAT GOES ON !! FED CHAIR POWELL’S REMARKS ARE NOT COMFORTING!
As a backdrop, the US deficit in February was announced at $311B, up 32% YTY. Five months into the US government’s fiscal year ending September, the deficit is $1.05 trillion, up 68.3% YTY. Of course, the big spending, to cope with Covid-19, last year started in April, running the deficit in the year ending 9/30/20 to $3.1T. The most recent Congressional Budget Office (CBO) estimate for this year was $2.3 trillion (about 11% of GDP), which is higher than ever except in WWII, but that was before the $1.9 trillion Covid-relief bill was passed. This year’s deficit is therefore going to be well in excess of last year’s $3.1T and the Biden administration says a multi-trillion, multi-year infrastructure effort is coming. All this is only possible with the help of our Federal Reserve, which is funding over half of the deficit with fresh currency created by the click of a computer. It is worth noting that foreign buyers of US debt are steadily reducing the percentage of their participation in the US debt auctions. Their holdings of US Treasuries as a percentage of their foreign exchange reserves is also coming down, so perhaps they know something?
Chairman Powell’s remarks, two days ago, were not comforting and not even logical. He doesn’t see a bubble in the capital markets but he has also said that it is very hard to spot a bubble when it is in progress. He obviously doesn’t consider that almost $200B of “blank checks” that have been written in the SPAC market in the last fifteen months, to be leveraged with relatively low cost debt to over a trillion dollars of buying power, is a bubble. He also isn’t concerned that the market value of Bitcoin is about a trillion dollars, which translates into potential purchasing power of goods and services. Setting aside the speculative activity in Gamestop, he apparently doesn’t view the dozens of tech stocks that are a long way from profitability, each trading for tens of billions of dollars to be a source of concern. He isn’t concerned that investor margin debt has accelerated recently to a new high, which has almost invariably signaled a recession just ahead.
Chairman Powell suggested that the trillions of dollars of newly minted dollars over the last ten years, as well as the interest rates suppressed to levels close to zero, will not spark uncontrolled inflation because “it has not happened so far”. The metaphor we suggest is snow accumulating on a mountain slope. It is unknown which “flake” will trigger the avalanche, but it is best to have an escape plan.
Chairman Powell discussed how inflation is still firmly “anchored” in a sub two percent level and the Fed objective is to stimulate a level above two percent for an indeterminate time frame, producing “symmetrical” two percent over the long term. First, the inflation rate, as measured by the Consumer Price Index, is debatable, to say the least. The CPI has been “adjusted” a number of times, always resulting in less sensitivity to true consumer spending. Powell is not living in the same world as the rest of us if he really thinks that his cost of living is rising less than 2% per year. On this score, the capital markets are signaling a coming increase, bond prices in particular moving sharply upward, and bond market investors have historically predicted economic trends far better than the Fed.
On the subject of interest rates, the Fed has, with their intervention in capital markets, destroyed current interest rates as (1) an economic indicator and (2) a controlling influence on risk and reward. Interest rates have been described by the legendary monetary historian, James Grant, as the economy’s “pituitary gland”. The pituitary is the “master” gland, secreting hormones that regulate blood pressure and reproduction, affecting vision, the brain, skin and other organs. The Fed has therefore become a doctor evaluating the patient after destroying a crucial diagnostic instrument.
Chairman Powell described how the increases in short term interest rates have been “orderly”, so should not be of concern. The implication is that the inflation to come would also be orderly, and the few current indicator upticks would be “transitory”, in any event. The objective is for inflation to be modestly (our word, not his) above 2% for a while anyway, so it’s all “okay”. We wonder: when inflation hits a 3% rate, will that be “transitory”? At what point, and for how long, does a 3%, 4%, 5% become something other than transitory, and require the Fed to move, or allow the market to move, interest rates higher. Would he be concerned, at that point, that, based on today’s $28 trillion of debt, every point of new interest expense would amount to $280 billion.
It seems to us that Powell becomes more dovish every time he speaks. The interest rate rise is “orderly”. The inflation indicators are “transitory” and “well anchored”. He continues to “not even think about thinking about” raising interest rates or reducing Fed bond purchases. There is no “taper tantrum”, cessation of the increase of the Fed balance sheet, in the cards and says he would warn the market when that time comes. He doesn’t see any signs of bubbles in the capital markets, so the Fed is sticking with their plan.
Jerome Powell, to be fair, did not create this mess. It is a result of decades of fiscal and monetary mismanagement. There is just no graceful solution. The “Maestro”, Alan Greenspan kicked it off in response to Y2K, the deflation of the dotcom bubble, and two wars, then escaped the consequences. Bernanke escaped, Yellin escaped, Powell may also escape the “chickens coming home to roost”. These trends take a long time to play out, but the snow keeps accumulating on the mountain. It’s just a question of time.