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Fed Pivots to More Hikes, More Pain
Fresh rate hikes and Quantitive Tightening promise more pain
Until recently, the Fed was confidently hinting — and markets were predicting — that they were done with hikes. That inflation was draining away so they’d pause, look around a bit so it’s not too obvious that they screwed up going too far too fast, then start cutting.
This was eagerly anticipated since it would give some breathing room to banks — well, at least it wouldn’t pour gasoline on the banking fire. And it would be prudent given there’s a well-known lag between rate hikes and impact on the economy — typically about 12-18 months. Given rate hikes didn’t really get restrictive — meaning above the 2019 level — until September, that’s only 8 months ago.
So we don’t even *know* what the hikes they’ve *already done* are going to break.
So, yes, the prudent thing would be to pause. Well, actually, the prudent thing would be for Powell and Yellen to pressure Congress to cut government spending so inflation can come down on its own and they could actually cut rates.
Waller Brings the Pain
Sadly, it’s not to be. Even before the debt ceiling debacle greenlighted fresh trillions in inflationary federal spending, a few weeks ago Fed Governor Waller surprised markets by saying even if they pause, he wants to get right back to hikes.
Waller noted what I’ve been saying, that inflation isn’t going anywhere, despite the most aggressive round of rate hikes in 50 years — he noted 6 out of 7 of the Fed’s inflation measures are flashing red.
Waller also cited house prices, which are holding up, and consumer spending, which is also holding up. These make him think there’s enough life yet in the real economy that it needs a couple more kicks in the head so it stays down, clearing the road for the federal government to spend everything their shriveled little hearts desire.
The problem is both housing and consumers are false signals: house prices are holding up because nobody’s selling — even if the kids go to college, you’d have to trade a 3% mortgage for a 7% mortgage. Better to hold on until rates come down.
Meanwhile, consumer spending usually does rise going in to a recession — in fact, it’s a main reason that we have recessions in the first place as resources shift from subsidized investment — fueled by easy money — to the less subsidized consumer industries people actually want.
In other words, home prices are holding up specifically because people expect the rate cuts that recessions bring, while consumer spending is also predicting a recession as resources shift to consumption.
Lest we hope that’s just Governor Waller hitting the bottle, fresh Fed meeting minutes are now saying the same thing: the Fed is a deer in the headlights, terrified that all their burning and pillaging has failed to kill the real economy. So, going by Fed rate probabilities, we’re looking at even more pain from the Fed with no letup for at least another 7 months.
QT to finish it off
Unfortunately, rates are only half the story. Act 2 hasn’t even begun: Quantitative Tightening.
Quantitative Tightening is when the central bank sells stuff instead of buying stuff: it reduces its balance sheet to try and cancel the inflation it’s already created.
Normally, if a central banks wants to artificially boost the economy for political reasons — which it almost always wants to do — it does this by printing money and using it to buy stuff like government bonds or mortgages. This floods cheap money into the economy, boosting it like a tissue fire — burns bright but burns short.
The problem is printing money makes inflation, so central bankers try to cancel it by doing the opposite: Selling all that stuff they bought and cancelling the proceeds. So Quantitative Tightening is the money printer in reverse.
The problem is that’s all in theory — the two times they actually tried in 2013 and 2019 it failed spectacularly, causing huge spikes in Treasuries and inter-bank loans. So both times they gave up.
In other words, going by actual experience, printing money is like salting dinner — easy to add but hard to take away. Or, as Chris Irons of Quoth the Raven put it, “you can’t taper a Ponzi.”
Thing is this time they *can’t* give up and quit Quantitative Tightening because they’re out of options: The Fed sees the economy headed to recession and knows it can’t hike rates into a crash, yet inflation isn’t going anywhere. Meaning they have to Tighten those Quantities and pray it doesn’t break too much this time.
Nobody knows what breaks first, or how bad. But expect a lot more bankruptcies, layoffs, failed banks and even failed pensions. All with an inflation that isn’t going anywhere.
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