Longform’d. Fight the Fed! (parte 3)

Un anno fa, in questo Blog, noi di Recce’d abbiamo scritto “Fight The Fed”. Un anno dopo, si leggono messaggi twitter come quello che leggete qui sopra, scritto da un notissimo gestore di portafoglio, dove si afferma che la Federal Reserve per uscire dalla scomodissima situazione nella quale si trova oggi “ha bisogno di una crisi finanziaria”.

Ma soprattutto, ed è la ragione per la quale ci siamo decisi a scrivere questo Post, adesso nell’ottobre 2021 lo dice … persino la stessa Federal Reserve.

Essendo che una crisi finanziaria a moltissimi dei lettori di questo Post (non ai nostri Clienti) farebbe perdere tanti soldi, il tema merita la massima attenzione da parte dei nostri lettori. Molti tra i quali proprio non hanno capito che oggi la Federal Reserve è il principale nemico del loro benessere finanziario.

Molti tra i nostri lettori non lo hanno ancora capito: ed una parte importante di questi non intende proprio capirlo. Non vuole sentire: si sente di avere “diritto alla felicità” e non vuole vedere, assolutamente, la realtà intorno.

A questi lettori sognatori farà bene leggere l’articolo che segue. Perché … adesso anche la Federal Reserve dice “Fight the Fed"!”.

Nell’articolo si racconta che la stessa Federal Reserve, nelle scorse settimane, ha pubblicato un documento che critica le scelte della Federal Reserve post pandemia, e lascia quindi intravedere non soltanto l’esistenza di un conflitto interno alla Fed (che è cosa nota) ma pure un possibile cambio di strategia nella gestione della politica monetaria USA.

Cambio che, se si realizzasse, prenderebbe il mercato del tutto di sorpresa: come già accadde, ma nella direzione opposta, nel gennaio 2019, e quindi poco più di due anni fa.

Vi lasciamo alla lettura per poi procedere più in basso con uno sguardo verso il futuro.

It seemed last week that the Federal Reserve may have avoided a taper tantrum when it signaled that an announcement on the slowing of the rate of bond purchases may come as soon as November, with the buying stopping altogether by the middle of 2022.

The typical market reaction didn’t happen—the yield curve actually flattened at first. Even when that reversed and yields began to jump, stocks were unaffected. That all changed Tuesday, as the technology-heavy Nasdaq Composite tumbled 2.8% on its worst day since March and the S&P 500 declined 2%.

So is this a delayed taper tantrum? It might seem that way, but there’s plenty more going on. Investors are becoming increasingly worried about inflation, particularly in light of surging energy prices, and the prospect of rising interest rates. The Fed now sees the first rate increase next year, while St. Louis Fed President James Bullard said Tuesday there could be two increases in 2022.

There’s also just a lot of uncertainty. Global concerns over the China Evergrande situation may have eased but the crisis has yet to be resolved. There’s the issue of the U.S. debt ceiling, a potential government shutdown, and the question marks over Fed Chair Jerome Powell’s second term were catapulted back into focus Tuesday as Sen. Elizabeth Warren (D., Mass.) said she would oppose Powell’s renomination, calling him a “dangerous man” for making the banking system less safe.

It could also be a dangerous time for investors. The 10-year yield, in the 2013 tantrum, took about seven months to peak.

—Callum Keown

A day after Federal Reserve Chair Jerome Powell said at a press conference that “inflation expectations are terribly important,” Jeremy Rudd, a senior Fed economist who has served at the central bank since 1999, released a new paper.

The title: “Why Do We Think That Inflation Expectations Matter for Inflation? (And Should We?)” His answer to the parenthetical question was a resounding no.

Fed watchers had varying interpretations of Rudd’s paper. Some saw it as validating the new policy framework around inflation, which aims for observed price growth that modestly overshoots 2% for some time rather than making decisions based on potentially erroneous forecasts. Others viewed it as a warning: Counting on surveys that show stable longer-term inflation expectations runs the risk of missing a real-time regime shift in the economy. 

The summary of the paper creates room for reading between the lines. “Economists and economic policymakers believe that households’ and firms’ expectations of future inflation are a key determinant of actual inflation,” it says. “This belief rests on extremely shaky foundations, and a case is made that adhering to it uncritically could easily lead to serious policy errors.”

It’s not until Page 16 that Rudd lays out the practical and policy implications of his argument. Once he does, it’s hard not to read it as expressing doubt about the Fed’s new policy framework and advocating for vigilance and humility about understanding what might be in store for the U.S. economy. The analysis comes at a critical time for the central bank: On Monday, both Boston Fed President Eric Rosengren and Dallas Fed President Robert Kaplan said they would retire within the next two weeks.

This is what Rudd suggests on monitoring for evidence of an inflation regime shift:  

“One development to watch for would be any evidence that a renewed concern with price inflation was starting to affect wage determination — either in statistical form ... or in the form of anecdotes. To the extent possible, we might also try to determine whether quit rates were starting to rise in a manner that was less tied to the state of the labor market and more correlated with consumer price developments, or whether wage increases for new hires were starting to rise appreciably relative to wage increases for workers in continuing employment relationships (the argument being that wages for new hires are more flexible and hence more responsive to economic conditions).”

Yes, the shocks from the Covid-19 pandemic have made parsing economic data trickier than ever. But the Labor Department’s Job Openings and Labor Turnover Survey, or JOLTS, shows that the quits rate remains near a record high at 2.7%. The number of job openings in the U.S. exceeded hires by 4.3 million in July, the most in data going back to 2000. Employees clearly hold the cards — anecdotes abound about businesses scrambling to offer higher wages and one-time bonuses, laying the foundation for the disparity between new employees and existing workers that Rudd highlighted. For now, this is a welcome change, given the power dynamics have favored employers over the past few decades.

Should the quits rate stay elevated for many more months, however, it might raise concern that cost-of-living increases are starting to become front and center in the minds of workers. As my Bloomberg Opinion colleague Noah Smith wrote earlier this month, even though U.S. wages have been rising strongly as of late, on an inflation-adjusted basis, they’re lower than they were in May 2020.

Powell, for his part, said last week that “inflation expectations had drifted down, and it was good to see them get back up a bit.” That was in response to a question about a New York Fed survey, which showed Americans’ median expected inflation rate over the next three years is 4%, the highest ever in data going back to 2013. According to Rudd’s analysis, central bankers’ attempts to influence these kinds of forecasts are a waste of time at best — and dangerous at worst:

It is far more useful to ensure that inflation remains off of people’s radar screens than it would be to attempt to “reanchor” expected inflation at some level that policymakers viewed as being more consistent with their stated inflation goal. In particular, a policy of engineering a rate of price inflation that is high relative to recent experience in order to effect an increase in trend inflation would seem to run the risk of being both dangerous and counterproductive inasmuch as it might increase the probability that people would start to pay more attention to inflation and—if successful—would lead to a period where trend inflation once again began to respond to changes in economic conditions.

Rudd also adds that by assuming inflation expectations are what ultimately drives price growth, “the illusion of control is arguably more likely to cause problems than an actual lack of control.” He warns that “given the huge boon to stabilization policy that results from a stable long-run inflation trend, actions that might jeopardize that stability would appear to face an unusually high cost-benefit hurdle.”

To be clear, the Fed wants to talk a big game on inflation and push expectations higher because policy makers believe that will keep price growth above their 2% target. Rudd argues that:

1. Inflation expectations are relatively meaningless.

2. Policy makers should strive to keep inflation off people’s radar.

3. Engineering above-target inflation risks being dangerous and counterproductive.

“I view Rudd’s policy implications as an indictment of the Fed’s new policy framework,” Tim Duy, a former Bloomberg Opinion contributor who’s now chief U.S. economist at SGH Macro Advisors, wrote in a report. “There is clearly some internal conflict.”

I wrote last week after the Federal Open Market Committee decision that Powell tried to walk back the central bank’s inflation fear, which was evident in the hawkish shift in the “dot plot.” The sort of questions raised by Rudd’s paper only increase the likelihood that policy makers will be leery of inflation that persistently exceeds 2% and that for all the talk about a “substantially more stringent test” to raise interest rates and the steadfast belief that price growth will be transitory, they’ll react similarly to the way they have in the past. 

Bond traders are grappling with what this all means, judging by recent market moves. Eurodollar futures are now pricing in 34 basis points of rate increases in 2022, up from about 25 basis points a week ago. The Treasury yield curve from five to 30 years experienced a rare bout of bear flattening on Monday — it’s just the third time since mid-June that yields on both tenors increased and the curve flattened. That could be seen as investors betting the Fed will raise interest rates in the coming years to avoid inflation that’s too hot.

When Powell revealed the Fed’s shift in strategy in August 2020, his argument went like this: “Inflation that runs below its desired level can lead to an unwelcome fall in long-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations. This dynamic is a problem because expected inflation feeds directly into the general level of interest rates.”

Rudd’s paper calls this whole premise into doubt. The main question investors should be asking: Is inflation high enough to affect Americans’ employment and purchasing decisions? As long as price pressures remain front and center for consumers, the risk remains that Fed officials will be late to notice a structural shift happening right in front of them.

La maggior parte degli investitori nel 2020 ha commesso il medesimo errore. che è quello di pensare che “le cose andranno avanti così per sempre” ed operare sui propri portafogli titoli di conseguenza. Il cambiamento di scenario che è intervenuto fra agosto e settembre 2021 li ha tutti colti di sorpresa, e fino ad oggi molti non si sono mossi solo perché terrorizzati.

Altri cambiamenti stanno arrivando, come spiega benissimo qui sotto William Buiter in un articolo per il Financial Times, e questi ulteriori cambiamenti costringeranno tutti a muoversi, a reagire, a proteggersi e quindi a modificare il proprio portafoglio titoli, come dice proprio in chiusura William Buiter..

The combination of extremely low and relatively stable US government bond yields has confounded many market watchers for quite a while now, also challenging traditional economic analyses. This has made the move up in yields over the past couple of weeks particularly notable, raising interesting questions for markets, policies and therefore the global economy. It is usual to characterise US benchmark government bond yields as the most important market indicator in the world.

Traditionally, they have signalled expectations about growth and inflation in the world’s most powerful economy. They have been the basis for pricing in many other markets around the world. Breaking with a long history, these benchmark measures decoupled in recent years from economic developments and prospects. Their longstanding correlations with other financial assets, including stocks, broke down. And their information content became distorted and less valuable.

Coming out of the 2008 global financial crisis, this was attributed to excess global savings that exerted consistent downward pressures on yields. With time, however, it became clear that the main driver was the ample and predictable purchasing of government bonds by the world’s most powerful central banks under quantitative easing programmes, particularly the US Federal Reserve and the European Central Bank. One should never underestimate the power of central banks intervening in market pricing. The trillions of dollars of bonds purchased by the Fed and ECB have distorted the usual two-sided markets and encouraged many to buy a whole range of assets well beyond what they would normally do on the basis of fundamentals. After all, what is more assuring than a central bank with a fully-functioning printing press willing and able to buy assets at non-commercial levels.

Such purchases legitimatise previous private sector investments and provide assurance that there will be ready buyers of assets for those needing to sell to reposition portfolios. It is a set-up that encourages private sector “front-running” of purchases by central banks at prices that would have traditionally been deemed unattractive.

No wonder that even those convinced of a fundamental mispricing have been hesitant to be on the other side of a bond market dominated by central banks. While these factors remain in play, yields have slowly but consistently been migrating up in the past two weeks from 1.30 per cent for the 10-year bond to 1.50 per cent. With global growth prospects damping somewhat due to the Delta variant of Covid-19, the drivers have been a mix of mounting inflationary pressures and multiplying signs that central banks will struggle to maintain the era of “QE infinity” — that is, endlessly ultra loose financial conditions.

The signs in recent days have included statements from the Bank of England and higher rates in Norway adding to moves in some developing countries. The more rate volatility increases, the greater the risk of yields suddenly “gapping” upwards given that we are starting with a combination of very low yields and extremely one-sided market positioning. The greater the gapping, the bigger the threat to market functioning and financial stability, and the higher risk of stagflation — the combination of rising inflation and low economic growth.

Like a ball deeply submerged in water, a combination of market accident and policy mistake could result in a move up in yields that would be hard for many to handle. Importantly, this does not mean that central banks, and the Fed in particular, should delay what should have already started — that is, embarking on the tapering of what, curiously, is the same level of monthly asset purchases ($120bn) as at the height of the Covid-19 emergency 18 months ago.

On the contrary, the longer the Fed waits, the more markets will question its understanding of ongoing inflationary pressures, and the higher the risk of disorderly market adjustments undermining a recovery that needs to be strong, inclusive and sustainable. For their part, investors should recognise that the enormous beneficial impact on asset prices of prolonged central bank yield repression comes with a consequential possibility of collateral damage and unintended consequences. Indeed, they need only look at how hard it has become to find the type of reliable diversifiers that help underpin the old portfolio mix of return potential and risk mitigation.