Wednesday, 2 March 2022 — Albert Park

[6 min read]

Dear Reader,

News from the Fed always gets a response from markets. But does it actually matter?

Jim Rickards says that maybe it doesn’t. The tapering announced in September 2021 is an example of this. At the time, Jim spoke to an insider who told him just how seriously to take these kinds of announcements.

So make sure you know how to figure out the real story — it will be vital to your investments…

Best wishes,

Callum Newman,
Editor, The Daily Reckoning Australia

Dear Reader,

September’s financial headlines were dominated by reporting on the Federal Reserve Open Market Committee (FOMC) meeting on 21–22 September, and their policy announcement and economic projections unveiled on 22 September. Markets responded approvingly in the following trading days.

At this time, they confirmed expectations that they would begin tapering asset purchases in November. With the tempo they suggested, the taper would be completed by July 2022. At that point, the money printing will be over, and the Fed will be poised to begin raising interest rates, the so-called lift-off.

Investors should understand that all this talk from the Fed was nonsense. The Fed has one of the worst forecasting records of any financial institution. It is consistently wrong in its forecasts by orders of magnitude. The Fed cannot make accurate predictions six months forward. The idea that these two- and three-year projections are accurate is absurd.

This photo might be called ‘Fed in the Time of COVID’. It shows Fed Chair Powell seated alone in the board room in Washington for an FOMC meeting. The FOMC meeting is usually packed with 40 or more participants, many seated along the walls. I was once a guest of the Fed and able to visit the board room. The Chair usually sits in the middle of the long side, back to the windows.

The forecasts described above are from the dot plot where members of the FOMC and other regional reserve bank presidents are allowed to offer their forecasts. The various forecasts are put on a graph as dots. TV talking heads then average the dots and present these as Fed estimates.

I spoke about this to the ultimate Fed insider who has worked for Ben Bernanke, Janet Yellen, and now Jay Powell. He’s the one who composes the Fed’s statements and forward guidance. He told me the dots ‘are a joke’ and that no one inside the Fed takes them seriously. He also told me they ‘wish they had never started’ the dot plot but feel they have to continue it because the public and Wall Street expect it. That’s fine; at least he was being honest with me. Still, the dots are a joke and there’s no need to give them any weight in our analysis. In fact…

The Fed is impotent, and its actions do not affect the real economy

Fed announcements and the dot plot are pure theatre. The real economy is slowing for many reasons that have nothing to do with the Fed, including high savings rates, low velocity (or turnover) of money, slack in the labour market, disinflation, and the slowdown in China.

Nothing the Fed is doing will make any of these things better; in fact, the Fed taper in November will probably make them worse. The Fed will be tightening just as the economy is slowing on its own. This will continue a long tradition of the Fed taking the worst possible actions at the worst possible time.

Taper tantrums are unlikely during this new taper. The reason is that bond markets understand that the Fed doesn’t know what they are doing. The 2013 taper tantrum happened because the taper was believed to signal a return to strong growth and higher interest rates. Leveraged investors quickly unwound carry trades where they had borrowed in yen and invested in emerging markets. When the taper signalled higher growth in the US, capital flows quickly shifted to the US, which caused a disorderly reaction in emerging economy stock and bond markets and currency markets.

This time, investors know that there will be no strong growth, and the Fed’s economic projections are simply wrong. As a result, market participants have not made leveraged bets on strong economic growth, so there’s no need to unwind any carry trades.

It’s a bit of a paradox. On the one hand, the Fed is irrelevant. Their policy actions have no impact on the real economy. They can print as much or as little as they like, but the resulting money supply is completely sterilised in the form of excess reserves held by banks at the Fed. The money doesn’t go anywhere; it is not lent or spent, and it doesn’t show up in the economy. This is evidenced by still-declining velocity and now, emerging disinflation (to replace the false narrative of inflation).

On the other hand, to the extent that markets believe the Fed matters, there may be a short-term impact. If markets believe that Fed tightening indicates a stronger economy, they will bid up stocks. That’s a false narrative, but it is powerful. We’ve seen that in the quick stock market recovery from the mini crash on 20 September 2021. Investors didn’t panic. They saw the drawdown as another chance to ‘buy the dip’. They believe the Fed has their back.

So what is reality?

Meanwhile, in the Treasury note market, serious players know the real story. Declining yields since March 2020 are a sure sign that bond market investors expect weaker growth. Yields will continue to decline as they have in stages since last March. The bond market has a much better record of accurate forecasts than the stock market. The bond market still presents opportunities for capital gains for those who buy five-year and 10-year Treasury notes today.

Once again, we see signs that tension is building between the false narrative (stronger growth and inflation) and reality (weaker growth and disinflation). Reality always wins in the end, but it can take time.

All the best,

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.

Dear Reader,

It’s Putin’s fault.

Shutdowns were necessary to save lives. Shutdowns caused supply chain disruptions. So COVID — a virus — caused today’s inflation; the feds are blameless.

And last week, the Russians invaded Ukraine.

So now we have another crisis. We have to keep printing money to fight the Russians and the supply chain disruptions.

Inflation? It’s Putin’s fault.

Amy Bell at the Financial Times:

‘Russia’s invasion of Ukraine has shattered hopes of a strong global economic recovery from coronavirus, at least in the short term.’

Another headline at the FT: ‘Ukraine conflict disrupts grain trade and provokes fears of global food shortages’.

And here’s another: ‘Conflict raises possibility of stagflation’.

When we left you yesterday, Russian troops were said to be advancing on Kyiv. The government there, headed by a Mr Zelensky, was handing out guns — AK47s, with instructions to defend the capital.

Surely, the Ukrainians were nervous. But there was nervousness all around. The Russian stock market lost a third of its value on Thursday. Lukoil CEO Vagit Alekperov lost US$13 billion, according to Bloomberg’s handy billionaire index.

Incredible claims

One of the problems with foreign policy is that it is too foreign. No one really knows what is happening at home, let alone abroad, especially not the ‘experts’. Hillary Clinton, for example, was quick to seize the opportunity. The Russian invasion was a ‘state of emergency for democracy’, she said, and a time for ‘rebuilding our credibility’.

Uh oh. ‘Credibility’ is almost always cited just before a major foreign policy blunder. While she was Secretary of State, under Barack Obama, Ms Clinton approved bombing raids on seven different countries, largely because US ‘credibility was at stake’.

The emergency then was ‘terrorism’. Ms Clinton didn’t speak any of the many languages of the countries she bombed. Nor did she know their histories, cultures, religions, economies…or anything else. They are too ‘foreign’. Any real knowledge would have caused her to think twice…to consider the ambiguities, the nuances. But the mob wanted blood. The foreigners made good ‘targets’…and kept Ms Clinton in the public eye — readying her for the election of 2016.

Like the Middle East, the situation in Ukraine may not yield readily to a simple-minded analysis by the patriotic masses or foreign policy ‘experts’. There’s always more to the story. And they don’t want to know it.

But what a marvellous opportunity to strut your stuff. Hillary is back in the news with her opinions. So are the US’s retired generals, drawing on their experiences from the US’s 20-year debacle in Afghanistan, where they repeated the Soviet Union’s mistakes.

Self-harm ahead

The Biden administration, a light to the civilised world, expressed outrage on Thursday. And then it seemed to realise that Russia is the major source of strategic metals — such as titanium — on which much of modern industry relies. For their part, its European allies merely looked at their thermostats and hoped Russian gas would keep making its way into their furnaces and power plants.

Within hours, the emergency — like a snow squall — seemed to pass. The very next day, the oil price — thought to be most sensitive to the Russian menace — dropped…and prices for Russian stocks rose 45%.

There was talk of a negotiated settlement. And on Friday, in the US, the Dow shot up more than 800 points.

Recently, the press reports that the Russian invasion seems to have ‘stalled’. But the sanctions, including blocking Russian banks from the international money exchange system known as SWIFT, have gone ahead. Foreigners are now forbidden from trading in Russian equities. Russian assets are falling again. US stocks are headed down too.

The US will probably not be harmed, in any plausible way, by what is going on in the Ukraine. But the war will give it plenty more opportunities to harm itself.

Regards,

Bill Bonner,
For The Daily Reckoning Australia