Will QE Be the Needle That Bursts the Bond Bubble in 2018?

If you wanted more evidence that Central Banks will stop at nothing to induce inflation, consider that yesterday Bank of Japan stated that it will continue with its QE program and with negative rates for as long as it takes to achieve 2% inflation.

Mind you, Japan’s economy has just posted its SEVENTH straight quarter of growth, having exited its last recession at the beginning of 2016.

Put another way, the Bank of Japan is running CRISIS-type monetary policies (NIRP and ~$750 billion in QE per year) at a time when the economy has been growing for nearly TWO YEARS.

Throw in the ECB which will continue €30 billion in QE per month in 2018 and you’ve got a combined $1.1 TRILLION in Central Bank liquidity hitting the system next year…. when inflation data is already spiking up around the globe.

Why does this matter?

As I explain in my bestselling book The Everything Bubble: the Endgame For Central Bank Policy, sovereign bonds trade based on inflation expectations.

Put simply, when inflation spikes higher, so do bond yields.

When bond yields rise, bond prices fall.

When bond prices fall, the Bond Bubble bursts.

When the Bond Bubble bursts, the EVERYTHING bubble follows.

Well, guess what? The yield on numerous sovereign bonds are already spiking, and this is BEFORE inflation has even really hit!

Put simply, the bond yields for countries representing over 60% of global GDP are already warning that the bond bubble is in major trouble.

What"s coming will take time for this to unfold, but as I recently told clients, we"re currently in "late 2007" for the coming crisis. The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Warning: Real Inflation is Already 3%... and the Fed Wants More!

While the Fed Board of Governors continues with its “we don’t see inflation anywhere” shtick, one of its own in-house measures (the underlying inflation gauge or UIG) is about to hit 3%.

The UIG estimated on the “full data set” increased from a revised 2.91% in October to 2.95% in November.

Source: the NY Fed.

Yes, one of the Fed’s OWN inflation measures (and one that leads the CPI) is about to hit 3%. And by the way, the UIG is from the NY-Fed: the regional Fed bank involved in daily market operations with the best understanding of how the financial system actually works.

Why does this matter?

Because, as I outlined in my bestselling book The Everything Bubble: the Endgame For Central Bank Policy, since the mid-1990s, the Fed has embarked on a policy of intentionally creating asset bubbles to keep the financial system afloat.

In the late ‘90s we had the Tech Bubble or bubble in Technology stocks.

When that bubble burst in 2000, the Fed dealt with it by intentionally creating a bubble in housing: a more senior asset class that was more systemically important.

When that bubble burst in 2008, triggering the Great Financial Crisis, the Fed dealt with it by intentionally creating yet another bubble…

… this time in US sovereign bonds, also called Treasuries.

By the way, these bonds are THE most senior asset class in the US financial system. The yields on these bonds represent the “risk-free” rate against which EVERY asset class in the financial system is priced.

So when these bonds went into a bubble, EVERYTHING followed.

This is THE endgame for Central Bank policy. And the bad news is that inflation is what will lead to this bubble bursting.

You see, bond yields track inflation (as well as economic growth). So as inflation rises (again, the UIG is clocking in at 3% already, bond yields will rise.

When bond yields rise, bond prices fall.

When bond prices fall, the Bond Bubble bursts.

When the Bond Bubble bursts, the EVERYTHING bubble follows.

The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Bubble Watch: Warning Signs That The Everything Bubble Will Burst in 2018

I believe 2018 will be the year inflation arrives.

The reason, as I’ve noted throughout mid-2017, is that multiple Central Banks, particularly the European Central Bank (ECB), Bank of Japan (BoJ) and Swiss National Bank (SNB) have maintained emergency levels of QE and money printing, despite the fact that globally the economy is performing relatively well.

All told, in 2017 alone, these Central Banks will printed over a $1.5 trillion in new money and funneled it into the financial system. This is an all-time record, representing even more money printing than what took place in 2008 when the whole world was in the grips of the worst crisis in 80 years!

And it has finally unleashed the much sought after inflation. Around the world, inflationary data are breaking out to the upside. Producer prices are soaring in the EU, Japan, China and the US.

H/T Jeroen Blokland

Why does this matter?

Because the $199 TRILLION Bond Bubble trades based on inflation.

When inflation rises, so do bond yields to compensate.

When bond yields rise, bond prices FALL..

And when bond prices fall, this massive bubble, which I call The Everything Bubble bursts.

This process has already begun. Around the world, bond yields are spiking to the upside as the bond market adjusts to the threat of future inflation.

The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Asset Prices Are "Prices" Too...

Authored by Thorstein Polleit via The Mises Institute,

We live in inflationary times.

Some people might consider this statement controversial. This is because these days inflation is widely understood as a rise in the consumer price index (CPI) of more than 2 percent per year. However, there are convincing reasons to question this viewpoint. On the one hand, the CPI does not include “assets” such as, for instance, stocks, housing, real estate, etc. As a result, the price developments of these goods are not accounted for by the changes in the CPI.

On the other hand, and even more essential, price changes of goods and services are associated with changes in the quantity of money. This is why economists used to understand a rise in the quantity of money as inflationary (and a decline in the quantity of money as deflationary): Without money sloshing around, there could not be a phenomenon like inflation — that is an ongoing upward trend in all prices of goods and services over time. The truth is that rising prices across the board is inextricably linked to money.

Asset Prices Are Prices

One indicator of an inflationary monetary development is the link between the US money stock M2 and nominal GDP. This ratio can be referred to as a measure of "excess liquidity." Since the outbreak of the crisis 2008/2009, excess liquidity has been growing strongly — as GDP growth lagged behind the increase in the quantity of money. Why? Well, a great deal of the monetary expansion has been driving asset prices upwards — most notably in the stock and housing market.

The Federal Reserve (Fed) has created yet another “inflationary boom." The US economy is fueled by extremely low interest rates, accompanied by additional credit and money growth created out of thin air. The monetary expansion leads to an artificial rise in consumption and investment spending, resulting in production and employment gains. Furthermore, the newly created liquidity finds its way into financial (asset) markets, driving up asset prices and even valuation levels.

How To Keep the Boom Going: More Inflation

To keep the inflationary boom going - and prevent the “bust,” - the Fed has to make sure that credit and money supply keep increasing and that, by no means less important, borrowing and capital costs remain at fairly low levels. That said, the ongoing inflationary policy must - and for political reasons most likely will - go on. Higher interest rates and a slowdown of credit and money creation would take away the punch bowl - and the party would come to a shrieking halt. The economic boom would turn into bust.

Inflation only works if it comes unnoticed, if there is “surprise inflation.” However, as soon as people find out that the purchasing power of money goes down more than they had expected, the chickens come home to roost: People factor in higher inflation into their contracts for wages, leases and credit. If this happens, there is no longer surprise inflation, and inflation loses its power to stimulate the economy (through misleading price signals, that is).

A central bank that wants to keep the boom going and prevent the bust is left with just one option: it has to create a higher dose of surprise inflation. The reader may already know what such an “inflation game” is leading to. It puts the economy on a high-inflation road or, in the extreme case, a super-inflation road or even a hyper-inflation road that will ultimately destroy the purchasing power of the currency.

Why There Is No Perceived Crisis

So far, financial markets have remained fairly relaxed. Inflation is not seen as a major problem as proven by, for instance, inflation expectations. How come? There might be two reasons for this. First, the majority of people derive their inflation expectations from experienced CPI inflation (we can speak of “adaptive inflation expectations”). As the latter has been relatively low for many years, people do not expect inflation to edge up in the years to come.

Second, many people still do not seem to realize that “asset price inflation” ruins the purchasing power of money in the same way as CPI inflation does: If you want to buy stocks, houses or land with your money, you will get less for your money if prices for these goods go up. However, as long as asset price inflation is not understood as a form of "true inflation," inflation expectations are tamed, and central banks can continue their inflationary scheme. 

Against this backdrop we can draw two conclusions. First, inflation is alive and kicking, it is currently raging in asset price increases. Second, an inflationary boom runs the risk of turning into a bust at some point — a scenario which would hit the economy, the financial system, and asset prices hard. Unfortunately, one cannot forecast (with any scientific precision) when the boom will turn into bust; it really depends on certain conditions.

That said, the current boom may go on for quite a while — with the economies keeping expanding and asset prices rushing from one record level to the next. However, we do know from sound economics that the current inflationary boom — which is presumably welcomed by many as it provides more jobs and additional incomes — is actually sowing the seeds of a bust.

The investor should keep in mind that central banks do not only set into motion an inflationary boom in the first place (which will end in tears), but that they will fight an approaching bust with even more inflation (by increasing the quantity of money even further). That said, investors are well-advised to live up to a rather uncomfortable truth: We"ve had inflation, and there will be more of it. Money will continue to lose its purchasing power.

 

 

Finally, An Honest Inflation Index – Guess What It Shows

Posted with permission and written by John Rubino, Dollar Collapse 

 

 

Central bankers keep lamenting the fact that record low interest rates and record high currency creation haven’t generated enough inflation (because remember, for these guys inflation is a good thing rather than a dangerous disease).

 

To which the sound money community keeps responding, “You’re looking in the wrong place! Include the prices of stocks, bonds and real estate in your models and you’ll see that inflation is high and rising.”

 

Well it appears that someone at the Fed has finally decided to see what would happen if the CPI included those assets, and surprise! the result is inflation of 3%, or half again as high as the Fed’s target rate.

 

New York Fed Inflation Gauge is Bad News for Bulls

 

(Bloomberg) – More than 20 years ago, former Fed Chairman Alan Greenspan asked an important question “what prices are important for the conduct of monetary policy?” The query was directly related to asset prices and whether their stability was essential for economic stability and good performance. No one has ever offered a coherent answer even though the recessions of 2001 and 2008-2009 were primarily due to a sharp correction in asset prices.

A new underlying inflation gauge, or UIG, created by the staff of the New York Fed may finally provide the answer. Its broad-based measure of inflation includes consumer and producer prices, commodity prices and real and financial asset prices. The New York Fed staff concluded that the new inflation gauge detects cyclical turning points in underlying inflation and has a better track record than the consumer price series.

The latest reading shows inflation of almost 3 percent for the past 12 months, compared with 1.8 percent for the consumer price index and 1.8 percent for core consumer prices, which exclude food and energy. Since the broad-based UIG is advancing 100 basis points above CPI, it indicates that asset prices are large, persistent and reflect too easy monetary policy.

The UIG carries three important messages to policy makers: the obsessive fears of economy-wide inflation being too low is misguided; monetary stimulus in recent years was not needed; and, the path to normalizing official rates is too slow and the intended level is too low.

Harvard University professor Martin Feldstein stated in a recent Wall Street Journal commentary that “The combination of overpriced real estate and equities has left financial sector fragile and has put the entire economy at risk.” If policy makers do not heed his advice odds of another boom and bust asset cycle will be high — and this time they will not have the defense mechanisms they had after the equity and housing bubbles burst.

To summarize, a true measure of inflation – one that is highly correlated with the business cycle – is not only above the Fed’s target but accelerating.

 

Note on the above chart that both times this happened in the past a recession and bear market followed shortly.

 

The really frustrating part of this story is that had central banks viewed stocks, bonds and real estate as part of the “cost of living” all along, the past three decades’ booms and busts might have been avoided because monetary policy would have tightened several years earlier, moderating each cycle’s volatility.

 

But it’s too late to moderate anything this time around. Asset prices have been allowed to soar to levels that put huge air pockets under them in the next downturn. Here’s a chart that illustrates both the repeating nature of today’s bubble and its immensity.

 

 

In other words, it is different this time — it’s much worse.

 

 

Questions or comments about this article? Leave your thoughts HERE.

 

 

 

 

 

Finally, An Honest Inflation Index – Guess What It Shows

Posted with permission and written by John Rubino, Dollar Collapse 

 

 

 

Check out these other articles by our contributors:

 

Jason Liosatos via Rory Hall - Dr. Paul Craig Roberts – Why is England, Germany and France Ruled by Washington? 

Craig Hemke - Another Tradable Low Coming

Jeff Thomas - Tilt! Game Over

You"re Just Not Prepared For What"s Coming

Authored by Chris Martenson via PeakProsperity.com,

I hate to break it to you, but chances are you"re just not prepared for what’s coming. Not even close. 

Don"t take it personally. I"m simply playing the odds.

After spending more than a decade warning people all over the world about the futility of pursuing infinite exponential economic growth on a finite planet, I can tell you this: very few are even aware of the nature of our predicament.

An even smaller subset is either physically or financially ready for the sort of future barreling down on us. Even fewer are mentally prepared for it. 

And make no mistake: it"s the mental and emotional preparation that matters the most. If you can"t cope with adversity and uncertainty, you"re going to be toast in the coming years.

Those of us intending to persevere need to start by looking unflinchingly at the data, and then allowing time to let it sink in.  Change is coming – which isn"t a problem in and of itself. But it"s pace is likely to be. Rapid change is difficult for humans to process. 

Those frightened by today"s over-inflated asset prices fear how quickly the current bubbles throughout our financial markets will deflate/implode. Who knows when they"ll pop?  What will the eventual trigger(s) be? All we know for sure is that every bubble in history inevitably found its pin.

These bubbles – blown by central bankers serially addicted to creating them (and then riding to the rescue to fix them) – are the largest in all of history. That means they"re going to be the most destructive in history when they finally let go.

Millions of households will lose trillions of dollars in net worth. Jobs will evaporate, causing the tens of millions of families living paycheck to paycheck serious harm.

These are the kind of painful consequences central bank follies result in. They"re particularly regrettable because they could have been completely avoided if only we’d taken our medicine during the last crisis back in 2008.  But we didn"t. We let the Federal Reserve --the instiution largely responsible for creating the Great Financial Crisis -- conspire with its brethern central banks to "paper over" our problems.

So now we are at the apex of the most incredible nest of financial bubbles in all of human history.

One of my favorite charts is below, which shows that even the smartest minds among us (Sir Isaac Newton, in this case) can succumb to the mania of a bubble:

It"s enormously difficult to resist the social pressure to become involved.

But all bubbles burst -- painfully of course. That’s their very nature.

Mathematically, it"s impossible for half or more of a bubble"s participants to close out their positions for a gain. But in reality, it"s even worse. Being generous, maybe 10% manage to get out in time.

That means the remaining 90% don’t. For these bagholders, the losses will range from "painful" to "financially fatal".

Which brings us to the conclusion that a similar proportion of people will be emotionally unprepared for the bursting of these bubbles.  Again, playing the odds, I"m talking about you.    

How Exponentials Work Against You

Bubbles are destructive in the same manner as ocean waves. Their force is not linear, but exponential. 

That means that a wave"s energy increases as the square of its height. A 4-foot wave has 16 times the force of a 1-foot wave; something any surfer knows from experience.  A 1-foot wave will nudge you.  A 4-foot wave will smash you, filling your bathing suit and various body orifices with sand and shells.  A 10-foot wave has 100 times more destructive power. It can kill you if it manages to pin you against something solid. 

A small, localized bubble -- such as one only affecting tulip investors in Holland, or a relatively small number of speculators caught up in buying swampland in Florida -- will have a small impact.  Consider those 1-foot waves.

A larger bubble inflating an entire nation’s real estate market will be far more destructive. Like the US in 2007. Or like Australia and Canada today.  Those bubbles were (or will be when they burst) 4-foot waves. 

The current nest of global bubbles in nearly every financial asset (stocks, bonds, real estate, fine art, collectibles, etc) is entirely without precedent. How big are these in wave terms? Are they a series of 8-foot waves? Or more like 12-footers? 

At this magnitude level, it doesn"t really matter. They"re going to be very, very destructive when they break.

Our focus now needs to be figuring out how to avoid getting pinned to the coral reef below when they do.

Understanding "Real" Wealth

In order to fully understand this story, we have to start right at the beginning and ask “What is wealth?”

Most would answer this by saying “money”, and then maybe add “stocks and bonds”. But those aren"t actually wealth. 

All financial assets are just claims on real wealth, not actually wealth itself.  A pile of money has use and utility because you can buy stuff with it.  But real wealth is the "stuff" -- food, clothes, land, oil, and so forth.  If you couldn"t buy anything with your money/stocks/bonds, their worth would revert to the value of the paper they"re printed on (if you"re lucky enough to hold an actual certificate). It’s that simple. 

Which means that keeping a tight relationship between "real wealth" and the claims on it should be job #1 of any central bank. But not the Fed, apparently. It"s has increased the number of claims by a mind-boggling amount over the past several years. Same with the BoJ, the ECB, and the other major central banks around the world. They"ve embarked on a very different course, one that has disrupted the long-standing relationship between the markers of wealth and real wealth itself. 

They are aided and abetted by both the media and our educational institutions, which reinforce the idea that the claims on wealth are the same as real wealth itself.  It’s a handy system, of course, as long as everyone believes it. It has proved a great system for keeping the poor people poor and the rich people rich.

But trouble begins when the system gets seriously out of whack. People begin to question why their money has any value at all if the central banks can just print up as much as they want. Any time they want. And hand it out for free in unlimited quantities to the banks. Who have their own mechanism (i.e., fractional reserve banking) for creating even more money out of thin air.

Pretty slick, right?  Convince everyone that something you literally make in unlimited quantities out of thin air has value. So much so that, if you lack it, you end up living under a bridge, starving. 

Let"s express this visually.

“GDP” is a measure of the amount of goods and services available and financial asset prices represent the claims (it"s not a very accurate measure of real wealth, but it"s the best one we’ve got, so we’ll use it). Look at how divergent asset prices get from GDP as bubbles develop: 

(Source)

What we see in the above chart is that the claims on the economy should, quite intuitively, track the economy itself.  Bubbles occurred whenever the claims on the economy, the so-called financial assets (stocks, bonds and derivatives), get too far ahead of the economy itself.

This is a very important point. The claims on the economy are just that: claims.  They are not the economy itself!

Yes the Dot-Com crash hurt.  But that was the equivalent of a 1-foot wave.  Yes, the housing bubble hurt, and that was a 2-foot wave.  The current bubble is vastly larger than the prior two, and is the 4-foot wave in our analogy -- if we’re lucky.  It might turn out to be a 10-footer.

The mystery to me is how people have forgotten the lessons of prior bubbles so rapidly.  How they cannot see the current bubbles even as the data is right there, and so easy to come by.  I suppose the mania of a bubble, the "high" of easy returns, just makes people blind to reality.

It used to take a generation or longer to forget the painful lessons of a bubble. The victims had to age and die off before a future generation could repeat the mistakes anew. 

But now, we have the same generation repeating the same mistakes three times in less than 20 years. Go figure.

In this story, wishful thinking and self-delusion have harmful consequences. It"s no different than taking up a lifelong habit of chain-smoking as a young teen.  Sure, you may be one of the few who lives a long full life in spite of the risks, but the odds are definitely not in your favor.

The inevitable destruction caused by the current froth of bubbles is going to hurt a lot of people, institutions, pensions, industries and countries.  Nobody will be spared when these burst.  The only question left to be answered is: Who’s going to eat the losses?

This is not a future question for a future time; it"s one that"s being answered daily already.  Pensioners are already taking cuts.  Puerto Rico will not be fully rebuilt.  Shale wells drilled when oil was $100/barrel, but being drained empty at $50/barrel, represent capital already hopelessly betrayed. Young graduates with $100,000 of student debt face lost decades of capital building. The losers are already emerging.

And there’s many more to follow.  This story is much closer to the beginning than the end.

The bubbles have yet to burst. We’re just seeing the water at the shore’s edge beginning to retreat, wondering how large the wave will be when it arrives. Hoping that it’s not a monster tsunami.

The End Is Nigh

History"s largest bubbles have had the exact same root cause: an expansion of credit that causes leverage to go up faster than the income available to service it.

Simply put: bubbles exist when asset price inflation rises beyond what incomes can sustain. They are everywhere and always a credit-fueled phenomenon.

(Source @hussmanjp )

Look at the ridiculous trajectory of the S&P 500, especially since Trump got elected. I don’t know about you, but pretty much everything that has happened in the US over the past year has been either a diplomatic clown show or a financial cruelty to the average citizen. And yet prices have risen at their highest pace in two decades?

My view is that the Trump election was a totally unexpected black swan shock for the global central banking cartel, and it freaked out.  With the Dow down -1,000 points in the late night hours following Trump"s surprise win, the central banks dumped gobs and oodles of money into the equity markets to prevent carnage.

All that money calmed investors and sent prices roaring higher over the following months. The resulting 80-degree rocket launch will hurt a lot when it comes back to earth. Good going central banks!

This is all happening when we’re as close as ever to a military (if not nuclear) confrontation with North Korea, Russia is busy beefing up its war machine, Saudi Arabia has pivoted away from the US towards China and Russia, and most of our European allies are inching away from us.

Meanwhile, the FCC is about to rule against the vast majority of the public and allow US corporations to turn the internet into a pay-for-play toll road -- completely undermining the core principle of the most transformative and useful invention of the millennium. By eliminating net neutrality the FCC has ruled "against" you, and "for" the continued usurious profits of the cable companies. 

Worse, heath care premiums continue to increase by double-digits each year. They"re going up by a horrifying 45% in Florida and 57% in Georgia, to name just two unfortunate states out of many.

And to really rub salt in the wounds of the nation, the DC swamp is busy passing a tax change that will further drive an enormous gap between the 0.1% and everybody else by lowering taxes on corporate profits (already the lowest in the world if you measure both tax on profits and value-added taxes). 

How to pay for the massive cost of this deficit-exploding bill?  Easy, just eliminate deductions for average people (such as the state and local tax deductions) and begin taxing the waived tuition of graduate students. That’s right, the government helped to massively bloat tuition fees via massive lending to students and then wants to squeeze the poorest and hardest-working among them.

I wish I were kidding here. But like a cruel joke re-told at the wrong moment, the GOP is busy destroying the meager and precarious financial situation of our citizens just so it can toss a few more dollars into the already-bloated wallets of the richest people in the country. 

The long rise of the ultra-wealthy is not some mystery.  It arose as a predictable consequence of the financialization of, well…everything that began in the 1980’s:

The above chart speaks to a deeply unfair system that punishes hard working people in order to give more to those who merely shuffle financial instruments around or own financial assets.

This is the system that the Fed is working so hard to preserve. This is the system that Washington DC is working so hard to sustain. 

It’s flat out unfair and punitive.  It both punishes and rewards the wrong folks, respectively.  Debtors are provided relief while savers are punished.  The young are saddled with debts and face impossible costs of living mainly to preserve the illusion of wealth for a little longer for the generation in front of them.

For so many reasons, folks, none of this is sustainable. If the system doesn"t crash first under the weight of its excessive debts or the puncturing of its many asset price bubbles, the brewing class and generational wars will boil over if the status quo trajectory continues for much longer.

In Part 2: When The Bubbles Burst... we detail what to expect as the unraveling starts. When these bubbles burst, as they inevitably must, the aftermath is going to be especially ugly.

Understand the likely path the carnage is going to take and position yourself wisely ahead of the crisis -- so that you and those you care about can weather the turmoil as safely as possible.

Remember: the role of bubble markets is to injure as many people as badly as possible when they burst. Don"t be one of the victims.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

 

What is The Everything Bubble? And how can you prepare for it?

What do formerly successful hedge funds going out of business, wacky economic data points, and the election of populists like Donald Trump all have in common?

All of them are the product of The Everything Bubble.

In the aftermath of the 2008 Crisis, Central Banks attempted to corner the sovereign bond market via low interest rates and massive QE programs.

Doing this represented the End Game for Central Bank policy. In a fiat-based monetary system, (meaning the currencies are not backed by anything) sovereign bonds represent the ultimate backstop of the financial system.

Remember, because currencies are not backed by anything, they can be depreciated via money printing. So they are not immune to inflation. Sovereign bonds on the other hand pay yields based on inflation and so hedge (at least partially) against this risk.

So when Central Banks attempted to create a bubble in the sovereign bond market, they were literally creating a bubble in EVERYTHING because every other asset in the system trades based on where sovereign bonds are trading.

This screwed up EVERYTHING. It screwed up economic data, it screwed up traditional investment analysis, and it screwed the average citizen hence why people like Donald Trump have been elected to positions of power.

Put simply, Central Banks have attempted to rig the entire system. Nothing is real anymore. Everything is trading based on a false risk profile induced by Central Banks cornering sovereign bonds.

This is why I coined the term The Everything Bubble in 2014. It’s also why I wrote a book on this issue as well as what’s coming down the pike: because when this bubble bursts (as all bubbles do) the policies Central Banks employ will make those from 2008-2015 look like a cakewalk.

We are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards
Graham Summers

Chief Market Strategist

Phoenix Capital Research

 

 

 

Who Are You Going to Trust, the Fed or $76 Trillion in "Smart Money"?

Let’s talk about inflation.

There are two types of inflation in the world… the “inflation” that you and I experience in the form of a rising cost of living induced by Central Banks devaluing our currencies…

...and the inflation that Central Banks are “targeting” in the bizarre claim that somehow hitting said targets will unleash economic growth.

Inflation #1 is depicted in the chart below. This is the reason why everything "costs" more today than it used to.

Inflation #2 is some kind of nebulous concept that Central Bankers talk about without ever admitting that they themselves change how they define “inflation” to suit their political purposes.

Indeed, hearing a Central Banker talk about how we need to target inflation in light of the above chart is like hearing a raging drunk talk about targeting an appropriate level of drinking.

Jokes aside, inflation is a painful reality for the world. And the bad news is that it’s about to worsen dramatically.

Why does this matter?

Because the Bond Bubble trades based on inflation.

When inflation rises, so do bond yields to compensate.

When bond yields rise, bond prices FALL..

And when bond prices fall, the Everything Bubble bursts.

The sovereign bond market is over $76 trillion in size. It"s the "smart" money in the financial system. So when it starts to "speak" it"s smart to listen.

With that in mind, take a look at the chart for the 10-Year US Treasury. We’ve already taken out the bull market begun in 2007. The single most important bond in the world is tracking lower just as housing prices did in 2006 before the housing bubble burst.

Put simply, BIG INFLATION is THE BIG MONEY trend today. And smart investors will use it to generate literal fortunes.

Imagine if you"d prepared your portfolio for a collapse in Tech Stocks in 2000... or a collapse in banks in 2008? Imagine just how much money you could have made with the right investments.

THAT is the kind of potential we have today. And if you"re not already taking steps to prepare for this, it"s time to get a move on.

We just published a Special Investment Report concerning FIVE secret investments you can use to make inflation pay ou as it rips through the financial system in the months ahead

The report is titled Survive the Inflationary Storm. And it explains in very simply terms how to make inflation PAY YOU.

We are making just 100 copies available to the public.

To pick up yours, swing by:

https://www.phoenixcapitalmarketing.com/inflationstorm.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Two Charts That Signal a Major Warning For 2018

Inflation is going to annihilate the stock market.

The reason, in fact the BIG reason, that stocks have been soaring since November 2016 is because of the coming inflationary storm. Stocks LOVE inflation at first as it results in asset prices rising.

However, stocks absolutely HATE inflation once it starts eating into profit margins. When this happens, companies begin to lose money as higher operating costs eat into their profits.

On that note, take a look at the following chart of corporate profits pre-tax.

What you are looking at, is an “end of cycle” situation in which corporate profits begin to roll over in a bit way.

Why are corporate profits rolling over?

Profit margins are shrinking as inflation begins eating away at profits. And this is just the beginning.

What happens when inflation REALLY starts to bite into stocks?

Put simply, BIG INFLATION is the THE BIG MONEY trend today. And smart investors will use it to generate literal fortunes.

We just published a Special Investment Report concerning FIVE secret investments you can use to make inflation pay ou as it rips through the financial system in the months ahead

The report is titled Survive the Inflationary Storm. And it explains in very simply terms how to make inflation PAY YOU.

We are making just 100 copies available to the public.

To pick up yours, swing by:

https://www.phoenixcapitalmarketing.com/inflationstorm.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Andy Xie Warns "The Bubble Economy Is Set To Burst" As Political Tension Soars

Authored by Andy Xie via The South China Morning Post

Central banks continue to focus on consumption inflation, not asset inflation, in their decisions. Their attitude has supported one bubble after another. These bubbles have led to rising ­inequality and made mass consumer inflation less likely.

Since the 2008 financial crisis, asset inflation has fully recovered, and then some. The US household net worth is 34 per cent above the peak in 2007, versus 30 per cent for nominal GDP. China’s property ­value may have surpassed the total in the rest of the world combined. The world is stuck in a vicious cycle of asset bubbles, low consumer ­inflation, stagnant productivity and low wage growth.

The US Federal Reserve has indicated that it will begin to ­unwind its QE (quantitative easing) assets this month and raise the ­interest rate by another 25 basis points to 1.5 per cent. China has been clipping the debt wings of grey rhinos and pouring cold water on property speculation. They are ­worried about asset bubbles.

But, if recent history is any guide, when asset markets begin to tumble, they will reverse their actions and ­encourage debt binges again.

Recently, some central bankers have been puzzled by the breakdown of the Philipps Curve: that falling unemployment rates would lead to wage inflation first and consumer price inflation next. This shows how some of the most powerful people in the world operate on flimsy ­assumptions.

Despite low unemployment and widespread labour shortages, wage increases and inflation in Japan have been around zero for a quarter of a century. Western central bankers assumed that the same wouldn’t happen to them without understanding the underlying reasons.

The loss of competitiveness changes how macro policy works. Japan has been losing competitiveness against its Asian neighbours. As its population is small, relative to the regional total, lower wages in the region have exerted gravity on its ­labour market. This is the fundamental reason for the decoupling between the unemployment rate and wage trend.

The mistaken stimulus has the unintended consequences of dissipating real wealth and increasing inequality. American household net worth is at an all-time high of five times GDP, significantly higher than the bubble peaks of 4.1 times in 2000 and 4.7 in 2007, and far higher than the historical norm of three times GDP. On the ­other hand, US capital formation has stagnated for decades. The outlandish paper wealth is just the same asset at ever higher prices.

The inflation of paper wealth has a serious impact on inequality. The top 1 per cent in the US owns one-third of the wealth and the top 10 per cent owns three-quarters . Half of the people don’t even own stocks. Asset inflation will increase inequality by definition. Moreover, 90 per cent of the income growth since 2008 has gone to the top 1 per cent, partly due to their ability to cash out in the ­inflated asset market. An economy that depends on asset inflation always disproportionately benefits the asset-rich top 1 per cent.

There have been so many theories on why inequality has risen. The misguided monetary policy may be the culprit. Germany and Japan do not have significant asset bubbles. Their inequality is far less than in the Anglo-Saxon economies that have succumbed to the allure of financial speculation.

While Western central bankers can stop making things worse, only China can restore stability in the global economy. Consider that 800 million Chinese workers have ­become as productive as their Western counterparts, but are not even close in terms of consumption. This is the fundamental reason for the global imbalance.

China’s model is to subsidise ­investment. The resulting overcapacity inevitably devalues whatever its workers produce. That slows down wage rises and prolongs the ­deflationary pull. This is the reason that the Chinese currency has had a tendency to depreciate during its four decades of rapid growth, while other East Asian economies experienced currency appreciation during a similar period.

Overinvestment means destroying capital. The model can only be sustained through taxing the household sector to fill the gap. In addition to taking nearly half of the business labour outlay, China has invented the unique model of taxing the household sector through asset bubbles. The stock market was started with the explicit intention to subsidise state-owned enterprises. The most important asset bubble is the property market. It redistributes about 10 per cent of GDP to the government sector from the household sector.

The levies for subsidising investment keep consumption down and make the economy more dependent on investment and export. The government finds an ever-increasing need to raise levies and, hence, make the property bubble bigger. In tier-one cities, property costs are likely to be between 50 and 100 years of household income. At the peak of Japan’s property bubble, it was about 20 in Tokyo. China’s residential property value may have surpassed the total in the rest of the world combined.

How is this all going to end? Rising interest rates are usually the trigger. But we know the current bubble economy tends to keep inflation low through suppressing mass consumption and increasing overcapacity. It gives central bankers the excuse to keep the printing press on.

In 1929, Joseph Kennedy thought that, when a shoeshine boy was giving stock tips, the market had run out of fools. Today, that shoeshine boy would be a genius. In today’s bubble, central bankers and governments are fools. They can mobilise more resources to become bigger fools.

In 2000, the dotcom bubble burst because some firms were caught making up numbers. Today, you don’t need to make up numbers. What one needs is stories.

Hot stocks or property are sold like Hollywood stars. Rumour and ­innuendo will do the job. Nothing real is necessary.

In 2007, structured mortgage products exposed cash-short borrowers. The defaults snowballed. But, in China, leverage is always rolled over. Default is usually considered a political act. And it never snowballs: the government makes sure of it. In the US, the leverage is mostly in the government. It won’t default, because it can print money.

The most likely cause for the bubble to burst would be the rising political tension in the West. The bubble economy keeps squeezing the middle class, with more debt and less wages. The festering political tension could boil over. Radical politicians aiming for class struggle may rise to the top. The US midterm elections in 2018 and presidential election in 2020 are the events that could upend the applecart.

What Few Expect: Inflation Will Surge, Destabilizing The Status Quo

Authored by Charles Hugh Smith via OfTwoMinds blog,

Few seem to ponder what global shortages in key commodities might do to prices.

If there is any economic truism that is accepted by virtually everyone, it"s that inflation is low and will stay low into the foreseeable future. The reasons are numerous: technology is deflationary, globalization is deflationary, central banks will keep interest rates near-zero essentially forever, and so on.

Just for laughs, let"s look at healthcare, almost 20% of America"s entire economy, as an example of low inflation forever. If being up over 200% in the 21st century is low inflation, I"d hate to see high inflation.

Here"s the official Consumer Price Index (CPI), which as many have noted, severely distorts real-world inflation by claiming big-ticket items such as college tuition and healthcare are mere slivers in household budgets.

Note the remarkably stable trend line in CPI over the past 40 years. This certainly doesn"t shout "inflation is near-zero and will stay low indefinitely."

Here"s the PCE, Personal Consumption Expenditures, the Federal Reserve"s favored measure of core inflation. Let"s put it this way: either the PCE is real and the CPI is false, or vice versa; they can"t both be accurate measures of real-world inflation.

Here"s a look at the annual rate of inflation. The go-go years prior to the Global Financial Meltdown of 2008-09 and the years of "recovery" 2010 to 2014 look very similar: some modest volatility between 1.7% and 2.5% annually.

But something changed in 2015-2017. The wheels fell off and then inflation turned up. Maybe it was nothing, maybe not. Let"s turn to a chart of asset inflation for a different perspective.

Courtesy of Goldman Sachs, here is a chart comparing asset inflation with real-world inflation. Note how assets have soared while real-economy measures have barely edged higher--commodities actually fell in price.

Now let"s look at where the gains of the "recovery" were concentrated: in the hands of the few in the top .5%. This chart depicts the unprecedented concentration of income gains in the very apex of the wealth-power pyramid. Needless to say, very little trickled down to the bottom 90%, and even the top 9.5% received mere crumbs.

So what do these charts tell us about future inflation prospects? To the conventional punditry, they suggest more of the same: higher asset valuations, low real-world inflation and near-zero interest rates (courtesy of central bank purchases of bonds and other financial assets).

I beg to differ. To me, these charts suggest real-world inflation is about to take off in the next 5 years, surprising everyone who expected more of the same. My reasoning is simple:

The leadership of the Status Quo has a simple choice: continue with more of the same, enriching the top .5% at the expense of everyone else, and face a political firestorm of upheaval, instability and insurrection, or start funneling the trillions of dollars, yen, yuan and euros that have been channeled into the hands of the few into the hands of the many.

The policy of funneling fresh cash into the hands of households has a number of variations: negative tax rates (lower income households get a hefty tax rebate annually), Universal Basic Income (UBI--every adult gets a monthly cash stipend), QE for the people (the central bank buys special government bonds that eliminate all student loan debt), and so on.

Where virtually all central bank monetary stimulus over the past 8 years went into assets, QE for the people would go right into household bank accounts where most of it will be spent in the real economy.

The incomes of the bottom 90% have gone nowhere for 8 long years. No wonder real world inflation has been capped outside of housing, healthcare and higher education. (Never mind these are the dominant expenses for the majority of households.)

So what happens when fresh trillions start flowing into the real world economy instead of into assets? If history is any guide, inflation picks up. Toss in some global shortages in key commodities and the fuel for inflation will be ready to ignite.

One part of the inflation will stay low indefinitely story is there"s an abundance of everything: grain, oil, natural gas, copper, bat guano--you name it, the world is awash in the stuff.

Few seem to ponder the possibility that this surplus of everything might be temporary, a brief run of extraordinary luck rather than a permanent abundance. Few seem to ponder what global shortages in key commodities might do to prices.

Whether you call soaring prices inflation or not, the result is the same: the purchasing power of currency declines. Every unit of currency buys less of whatever is no longer in surplus.

The funny thing about inflation is that it"s not a problem that can be solved by creating trillions more dollars, yuan, yen and euros out of thin air. Issuing mountains of new currency actually increases inflation.

Oops. Our only "fix" is to issue trillions more in new currency and credit. If that doesn"t fix the problem, the toolbox is empty.

*  *  *

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. Check out both of my new books, Inequality and the Collapse of Privilege ($3.95 Kindle, $8.95 print) and Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle, $8.95 print, $5.95 audiobook) For more, please visit the OTM essentials website.

Gold Drops, USD Pops As Yellen Warns "Fed Should Be Wary Of Moving Too Gradually"

On the heels of Fed chair Janet Yellen warning of looming inflation and the need for The Fed to perhaps not move as slowly as they have suggested, gold has snapped back below $1300 (erasing North Korean risks) and the dollar is extending gains...

As Citi notes, for those hoping for hawkish comments, Yellen has certainly delivered.

“It would be imprudent to keep monetary policy on hold until inflation is back to 2 percent,”

The Fed “should also be wary of moving too gradually.”

“My colleagues and I must be ready to adjust our assessments of economic conditions and the outlook when new data warrant it”

“My colleagues and I may have misjudged the strength of the labor market, the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation”

And that has sent Dec rate hike odds to 78%...

And banged gold lower...

Stocks, bonds, and bullion are all sliding...

Notably so is the 5s30s yield curve...

Stupidity Well Anchored: Exposing The Absurdity Of Inflation Expectations

Authored by Mike Shedlock via MishTalk.com,

The amount of sheer nonsense written about inflation expectations is staggering.

Let’s take a look at some recent articles before making a mockery of them with a single picture.

Expectations Problem

On July 17, 2017, Rich Miller writing for Bloomberg proclaimed The Fed Has an Inflation Expectations Problem.

Expectations matter because they shape how households and companies act and thus can go a long way in determining where inflation actually ends up. Consumers accustomed to meager inflation will resist paying up for goods and services.

“Lower inflation expectations make it all the more difficult for the central bank to achieve its inflation objective,” Charles Evans, president of the Chicago Fed, said in remarks posted on the bank’s website on July 14.

Key Element

The Business Insider says The Fed is missing a key sign of economic weakness coming from American consumers.

Andrew Levin, a career Fed economist who was a special adviser to Fed Chairman Ben Bernanke, told Business Insider he was worried by a noticeable decline in inflation expectations, both as reflected in consumer surveys and bond-market rates.

“The reality is that the longer-term inflation expectations of consumers and investors have shifted downward by about a half percentage point. Thus, even with the economy moving towards full employment, it’s not surprising that core PCE inflation remains about a half percentage point below the Fed’s inflation target,” he said, referring to a closely watched reading indicator that excludes food and energy costs.

“If the FOMC continues to ignore the downward drift in inflation expectations and simply proceeds with its intended path of policy tightening, actual inflation is likely to keep falling short of the Fed’s target and might well decline even further,” he said.

Janet Yellen On Wednesday

In a brief speech following yesterday’s FOMC announcement Janet Yellen made these statements.

Turning to inflation, the 12-month change in the price index for personal consumption expenditures was 1.4 percent in July, down noticeably from earlier in the year.

For quite some time, inflation has been running below the committee’s 2 percent longer-run objective.

One-off reductions earlier this year in certain categories of prices such as wireless telephone services are currently holding down inflation, but these effects should be transitory.

Such developments are not uncommon, and as long as inflation expectations remain reasonably well anchored, are not of great concern from a policy perspective because their effects fade away.

Complete Nonsense

One can find thousands of such references, all of them idiotic.

Let’s prove that with a single picture and a few comments.

CPI Percentage Weights

The idea behind inflation expectations is that if consumers think prices will go down, they will hold off purchases and the economy will collapse.

The corollary is that is consumers think inflation will rise, they will rush out and buy things causing the economy to overheat.

With that backdrop, let’s have a Q&A. I believe the answers are obvious in all cases.

Inflation Expectations Q&A

Q: If consumers think the price of food will drop, will they stop eating out?
Q: If consumers think the price of food will drop, will they stop eating at home?
Q: If consumers think the price of natural gas will drop, will they stop heating their homes and stop cooking to wait for the event.
Q: If consumers think the price of gas will drop, will they stop driving or not fill up their car if it is running on empty?
Q: If consumers think the price of gas will rise, can they do anything about it other than fill up their tank more frequently?
Q: If consumers think the price of rent will drop, will they hold off renting until that happens?
Q: If consumers think the price of rent will rise, will they rent two apartments to take advantage?
Q: If consumers think the price of plane tickets, taxis, and bus tickets will drop, will they hold off taking the plane the train or the bus?
Q: If consumers think the price of plane tickets, taxis, and bus tickets will rise, will they rush out and buy multiple tickets driving the prices even higher up?
Q: If people need an operation, will they hold off if they think prices might drop next month?
Q: If people need an operation, will they have two operations if they expect the price will go up?

All of the above questions represent inelastic items. Those constitute 80.254% of the CPI. Commodities other than food and energy constitute the remaining 19.746% of the CPI. Let’s hone in on that portion with additional Q&A.

Q. If someone needs a refrigerator, toaster, stove or a toilet because it broke, will they wait two months if for some reason they think prices will decline?
Q. If someone does not need a refrigerator, toaster, stove or a toilet will they buy one anyway if they think prices will jump?
Q. The prices of TVs and electronics drop consistently. Better deals are always around the corner. Does that stop people from buying TVs and electronics?
Q. If people thought the price of TVs was about to jump, would they buy multiple TVs to take advantage?

For sure, some people will wait for year-end clearances to buy cars, but most don’t. And if a car breaks down, consumers will fix it immediately, they will not wait for specials.

Stupidity Well Anchored

The only thing that’s “well anchored” is the stupidity of the belief that inflation expectations matter.

Asset Irony

People will rush to buy stocks in a bubble if they think prices will rise. They will hold off buying stocks if they expect prices will go down.

People will buy houses to rent or fix up if they think home prices will rise. They will hold off housing speculation if they expect prices will drop.

The very things where expectations do matter are the very things the Fed and mainstream media ignore.

No Reliable Measures

“There is no single highly reliable measure” of longer-run inflation expectations, Fed Governor Lael Brainard told The Economic Club of New York on Sept. 5.

Lovely. She’s also correct. Yet, she proposes to know what to do about it! How idiotic is that?

Economic Challenge to Keynesians

Of all the widely believed but patently false economic beliefs is the absurd notion that falling consumer prices are bad for the economy and something must be done about them.

I have commented on this many times and have been vindicated not only by sound economic theory but also by actual historical examples.

1. My article Deflation Bonanza! (And the Fool’s Mission to Stop It) has a good synopsis.


2. My Challenge to Keynesians “Prove Rising Prices Provide an Overall Economic Benefit” has gone unanswered.

There is no answer because history and logic both show that concerns over consumer price deflation are seriously misplaced.

BIS Deflation Study

The BIS did a historical study and found routine deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the study.

It’s asset bubble deflation that is damaging. When asset bubbles burst, debt deflation results.

Central banks’ seriously misguided attempts to defeat routine consumer price deflation is what fuels the destructive asset bubbles that eventually collapse.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Finally, and as a measure of insurance against the Fed’s clueless tactics, please consider How Much Gold Should the Common Man Own?

How BofA Learned To "Stop Fighting Central Banks" And Love Shorting The Euro

In a new report that may come as music to the ears of Mario Draghi, who has been valiantly hoping to show the European economy recovering while keeping the EURUSD below the "red line" of 1.20, BofA FX strategist Athanasios Vamvakidis is out with a new note today urging currency traders to "stop fighting the central banks", in other words stop selling the USD and buying the EUR, and recommends shorting the EURUSD to 1.15 with a 1.21 stop loss. 

His thesis is simple: markets have been fighting the major central banks, and BofA argues that they will be proven wrong, "leading to lower EUR/USD in the months ahead following the recent rally." Such a contrary posture by markets is unusual as markets usually follow the simple rule not to fight the G10 central banks, particularly the major ones. However, as Vamvakidis writes, "the market expects very little from the Fed in the rest of this year and next year, despite the unexpected two Fed hikes so far this year and the dot plot having four more hikes by end-2018. The market also seems to expects too much from the ECB-fast QE tapering-despite inflation being well below the target and room for slow QE tapering. The consensus is also that the two central banks will respond differently to low inflation this year, with the Fed staying on hold and the ECB giving up. We disagree and see EUR/USD weakening by the end of this year, following the strong rally so far."

He lays out the market"s explicit "expectations" as follows:

Markets expect too little from the Fed: The consensus is that the Fed will focus more on low inflation and stay on hold. "We argue that the Fed will focus more on loose financial and monetary conditions, as well as risks to financial stability from asset price bubbles, and will continue normalizing policies gradually. We also argue that US inflation could start surprising to the upside."

The current dilemma for the Fed in our view is whether to focus on inflation or financial conditions. The two have diverged this year (Chart 1). Despite Fed tightening, financial conditions have been loosening (Chart 2). However, both price inflation and labor costs have dropped (Chart 3) and credit growth has slowed (Chart 4). Overall, US data has been mixed and data surprises have been negative, although less so recently (Chart 5)

The FX strategist then contends that the market seems to be focusing on the low inflation dynamics in the US. Indeed, the market is pricing only a 30% probability for a December hike this year and less than one hike next year. If inflation is so low and has actually fallen this year, what"s the rush? As a result, risk assets have performed strongly, with equities at historic highs and volatility at historic lows.

Here BofA disagrees with this consensus for the following reasons:

• US inflation is surprisingly low given the position of the economy in the business cycle, but this may not last. The Phillips curve is not dead yet.


• The Fed is already behind the curve. Based on historical correlations, the Fed policy rate is too low to begin with compared with core inflation (Chart 11) and the output gap.


• The market is priced for perfection. Our Global Fund Manager Survey shows a record consensus for strong growth and low inflation. The risks are asymmetric if there is an inflation surprise.


• Even if inflation remains low, the Fed may focus more on financial conditions. Indeed, this is what the Fed has been doing so far this year, and for a good reason. We do not expect gradual Fed tightening to lead to even lower inflation, given that overall financial conditions are loosening and the Fed is already behind the curve. However, keeping policies too loose for too long could lead to asset price bubbles, which will eventually burst, leading to deflation risks. A forward looking Fed should take this into account, in our view. Why not take advantage of the good times to normalize policies, from a historically loose stance, to avoid risks from bubbles bursting down the road? Wasn"t one of the key lessons from the Greenspan years that monetary policies should not focus only on inflation, but also on financial stability? Don"t we know now that the Greenspan put was a policy mistake that led to moral hazard? Why repeat the same mistake twice, after having payed such a high price the first time?


• We note that the last time when inflation and financial conditions diverted was in 2013-14 (Chart 1). At that point, despite low inflation, the Fed announced and then started QE tapering, taking advantage of the market euphoria to normalize policies-and triggering the so called tapering tantrum. We expect their policy reaction function to be similar this time.

And at the same time as expecting too little from the Fed, "markets expect too much from the ECB"

ECB QE has an expiration date. For a number of reasons, the ECB does not seem willing or capable to increase the issue limit or relax the capital key in its QE purchases. QE will have to end next year. However, investors expect a relatively fast pace for QE tapering. Indeed, our Rates and FX Sentiment survey shows that most investors expect ECB QE to be over by mid-2018. Moreover, the market is pricing faster hikes by the ECB than by the Fed for the next three years (Chart 13).

Here the biggest bet by Bank of America is a simple one, and one which Yellen and most of her peers at the Fed recently warned against: the threat, and realization, that the Fed is stoking a bubble:

• We strongly disagree with the argument that central banks should ignore asset price bubbles. Eventual correction of bubbles could lead to a crisis and deflation, as we very painfully experienced in the last ten years. The Fed"s credibility will suffer if a new bubble is formed, leading to another crisis down the road. Uncertainty on what is a bubble is not an excuse to do nothing.


• Micro-prudential measures can also help to address such concerns. However, the right and the left hands of a central bank should be coordinated, to avoid offsetting each other.


• We also disagree with the argument that the policy rate is too broad a measure to target asset price bubbles. After all, the policy rate is also too broad to micromanage labor market outcomes, but major central banks have been doing it anyway, particularly after the global crisis.


• At a minimum, a central bank needs to avoid forming a bubble in the first place. Unconventional monetary policies were a way to support risk assets after the global crisis and through this channel support the economy. There was strong justification back then. However, more recently markets have been over-relying on central bank policy support, to the extent that bad news (weak data) is good news (strong equities) because they keep monetary policy loose. This is an indication of market addiction to central bank support, which the central banks have been trying to slowly address and they will continue doing so, in our view.


• Asymmetric central bank policy response to asset price bubbles-doing nothing as they are formed and easing policies aggressively when the burst-will inevitably lead to moral hazard and more bubbles.

The key conclusion for BofA is that the market may be underappreciating the concerns of major central banks, and particularly the Fed, for being responsible for the next asset price bubble and a possible crisis after it bursts. Gradual policy normalization can take place despite low inflation under the current conditions.

In FX terms, assuming BofA is right, the FX implications is simple: weaker EURUSD.

The bottom line of the above discussion is a weaker EUR/USD. We believe that given what the market is pricing today for the Fed and the ECB and by how much the Euro has appreciated this year, the risks are asymmetric for a hawkish Fed surprise and a dovish ECB surprise this fall, leading to weaker EUR/USD by the end of the year. We understand that this is a contrarian call, given the EUR/USD performance this year and particularly in recent weeks.

And the recommendation:

We introduce a new trade recommendation to short EUR/USD spot based on our above analysis. Our target for EUR/USD is 1.15, which is also our year-end projection, with stop loss at 1.21, which is above the latest peak. Spot reference is 1.1891. Risks to this trade are the Fed not hiking again this year, the ECB announcing fast QE tapering and the Eurozone economy continuing to decouple from the US.

What are the trade downsides? First, here are the good, bad and ugly scenarios:

Considering alternative scenarios and the implications for the USD:

• In a good scenario, US and global data improves and market euphoria continues. In this case, we would expect the Fed to continue normalizing policies, supporting the USD. Monetary policy divergence and risk-on should support USD/JPY in particular, but EUR/USD could also weaken. The USD could also do well against GBP if Brexit negotiations are slow-as we expect, despite a more pragmatic UK government after the elections this year.


• In a bad scenario, something triggers a sharp sell-off in risk assets. In this case, we would expect the Fed to slow policy normalization, but the ECB would still have to announce QE tapering. EUR/USD would likely appreciate, although not by much, as markets are already pricing a very slow Fed. USD/JPY would suffer the most, but we would expect the USD to still do well against high beta G10 currencies, such as AUD, CAD and NZD, and against EM.


• In an ugly scenario, the sell-off in risk assets is much stronger, risking a global recession/crisis. We would expect in this scenario JPY and CHF, followed by USD and EUR to do well, against everything else. The EUR/USD implications would depend on the specific trigger and the details, and are hard to determine in advance.

Therefore, we believe the USD would do well in most scenarios, although one would have to be selective depending on the scenario. The USD could do particularly well against high beta currencies and EM FX.

All these scenarios also point to higher FX vol. This is easy to argue for the bad and ugly scenarios, starting from a point of low volatility. In the good case scenario, our expectation for higher vol is based on our thesis for Fed monetary policy normalization.

Finally, what is BofA is wrong about central banks?

• The biggest risk we see to our view is if Yellen is replaced by the end of this year-her term as a Fed Chair ends in February-and who would replace her. It is too early to have a view on who the next Fed Chair will be and whether and how the Fed"s policy reaction function could change. We are assuming policy continuity, but we may be proven wrong.


• The second concern we have is that the Fed"s message on how its policy reaction function takes financial conditions into account, particularly when inflation is low, has been mixed. The Fed"s priorities were very clear to us under Bernanke, but Yellen has been flip-flopping, particularly this year. At times, she comes across as not having decided to respond to low inflation or to loosening financial conditions. Although we believe that the Fed will eventually do the right thing and try to prevent another bubble in assert prices, mixed messages this fall could keep markets guessing.


• We are more confident about the ECB. Their credibility is directly in question, as they are missing their inflation target and are forced to end QE next year because of technical constraints. Giving up is not an option. We expect them to use everything within their mandate to persuade markets that they will do whatever it takes to reach their inflation target. The inevitable QE tapering next year makes their work very challenging, but they could try using other tools. Otherwise, an even stronger Euro will bring them even further away from their target.


• Draghi will be faced with a very difficult communication challenge this fall. He has to announce a plan for QE tapering, despite the deteriorating inflation outlook, while persuading markets that the ECB remains committed to its inflation target. This will be tough. However, given market expectations, we see asymmetric risks from a dovish surprise.

"It's The Economy, Stupid... Not Drugs & Demographics"

Authored by Jeffrey Snyder via Alhambra Investment Partners,

The mainstream media is about to be presented with another (small) gift. In its quest to discredit populism, the condition of inflation has become paramount for largely the right reasons (accidents do happen). In the context of the macro economy of 2017, inflation isn’t really about consumer prices except as a broad gauge of hidden monetary conditions.

Therefore, if inflation behaves as it is supposed to after so many years of “stimulus”, then the political opposition to the status quo really is about racism and xenophobia. If, however, inflation underwhelms for now the sixth year and counting, there just might be something to this economic anxiety element of grand and growing political discord.

In many ways this isn’t a point of contention at all, merely a misreading of what policymakers are actually doing and why. The global economy really has suffered some horrible fate, but what? Inflation underwhelms because the economy does and has, but policymakers in 2017 are trying to figure out why in a way that leaves them blameless.

Any long-term GDP chart for any place shows clearly that it is small wonder political and social devastation took so long to start manifesting. That speaks to the power of Economics and the tremendous benefit of the doubt it began with, and then squandered. People largely believed Ben Bernanke when he said he knew what he was doing with QE2 (without ever accounting why he felt there needed to be a second) or Mario Draghi when he made his promise. The public did so because they wanted to believe such a big awful thing was fixable.

The media is still stuck on the idea of the economy being fixed, however, though policymakers have more than a year ago shifted to figuring out why it won’t ever be. Inflation for them is now the measure of who’s to blame, not what will happen.

Again, if inflation continues to underperform the 2% target here and elsewhere, even textbook Economics makes it a monetary reason. If it gets back to and above 2%, drug addicts and Baby Boomers would have been a legitimate structural drag, meaning QE failed because it stood no chance of ever working. You can see the stakes for central bankers as they have this year practically resorted to outright pleading, as if saying the thing over and over will increase the chances of it happening.

So it must have been some relief when earlier this year oil price base effects raised the CPI to above 2% for three months starting last December (and the HICP for only one month in Europe). It would stay above 2% for a total of five, but those last two were on the way back down again, clearly showing that it was oil not the opioid epidemic the public should turn to for answers.

Given the nature of its annual comparison, WTI was this July on an upswing whereas in July 2016 falling again. Crude oil’s contribution to consumer price inflation last month is once more significantly positive, meaning that in all likelihood on Friday when the BLS reports the CPI for July it will be accelerated from four straight months of “unexpected” weakness. There will certainly be much crowing and rejoicing.

But it won’t matter for more than just a single news cycle, not the least of which because of the bond market that policymakers and especially economists (therefore the media) just can’t (or refuse) seem to understand.

“The market has paid a lot more attention to inflation than in recent years, simply because that has the potential to be what changes the Fed’s mind on further rate hikes,” [said Gennadiy Goldberg, an interest-rate strategist at TD Securities]. This week’s report “has a pretty substantial amount of power to push rates to annual lows or getting us off those lows and pushing rates higher.”

Once again, no, no, and no. The bond market takes no cues from monetary policy except if it views that policy to be effective. Interest rates rise because of opportunity, not because the Fed attempts to command it with the federal funds rate as in 2016, 2004, or even 1994. There is no “hawkishness” or “dovishness” by itself, instead the interpretation of “hawkishness” if things are actually getting better or “dovishness” if they aren’t. This other convention where the Fed is at the center of everything just doesn’t wash.

It presupposes infallibility which has been proven not to exist. Presumably the Fed’s “hawkishness” derives from its proficiency in economic interpretation. Therefore, bond rates would rise not based on monetary policy action per se, but rather agreeing with the Fed’s interpretation of what “hawkishness” means as far as economic opportunity. To claim that the bond market must follow monetary policy is to simultaneously claim that the FOMC is always right; and further that bonds must always defer in that judgment to these economists.

The bond market does not do this, though it does take into consideration central bank judgment as part of its stream of information. Before the summer of 2011, the bond market largely agreed with FOMC assessments. By and large, though, ever since 2011 the bond market which is always free to disagree with them about the economy or even the state of monetary function has exercised that freedom and in convincing fashion. From 2013 forward, nominal rates should have risen and curves steepened as economists and policymakers declared QE3 a resounding success, with particular emphasis on the unemployment rate. The bond market was correct, not economists.

What drives UST yields or eurodollar futures prices is therefore not “hawkishness” or “dovishness”, but rather perceptions about whether “hawkishness”, “dovishness”, Trump, or even Paul Krugman’s fake alien invasion scenario will amount to anything positive and the significance of it. It is the translation of current conditions into considerations about the future, captured in prices and yields – the actual discounting of information, of which monetary policy is only a (variable) part.

And oil prices factor to a much higher degree than Janet Yellen for these reasons. It is oil that moves the CPI (or PCE Deflator) which is a very negative commentary on the economy tomorrow as well as today. Unless oil prices really break higher, then the bond market gives far more weight to what the FOMC members would all rather never consider – the problem really is money and economy rather than drugs and demographics.