Is the Bond Market About to Call the Fed"s Inflationary Bluff?

Perhaps the single biggest development this year, as far as the markets were concerned, was the Fed admitting on the record that it has no idea what is going on with inflation.

This represents a kind of endgame for the Fed. Since the early ‘80s, the Fed has been actively understating inflation via a variety of gimmicks.

It first removed home prices and replaced them with “owner’s equivalent rent.” Doing that removed any sharp rise in home prices from affecting inflation data, thereby downplaying the official inflation rate.

Then in 1998, the Fed started playing around with “hedonics” (think food and energy prices). The Fed claimed that the goal was to somehow balance the deflationary forces of technology vs. the inflationary forces of hedonics items… but the reality was that this was just another gimmick to understate inflation.

Then, finally in 1999, the Fed introduced the idea of “substitutions.” Here again the Fed claimed it was trying to get an accurate read on inflation (the Fed argues here that if a consumer cannot afford steak anymore, the fact he or she can substitute hamburger indicates his or her quality of life is roughly the same as before).

And once again the goal was to understate inflation.

I realize this is getting a bit complicated, so let’s put this in simple terms…

1)   Since the early ‘80s, the Fed has been employing various gimmicks to hide the real rate of inflation.

2)   Doing this allowed the Fed to overstate GDP growth while understating the true decline in incomes/ quality of life for most Americans.

This game worked for a while, but this year the whole scheme crashed into a wall when the various gimmicks resulted in data that made no sense what-so-ever.

At a time when the NY Fed’s UIG inflation measure and the Atlanta Fed’s “sticky inflation” measure, showed inflation at 2.8% and 2.1% respectively, the Fed’s official inflation measures (CPI and trimmed PCE) were clocking in at 1.7% and 1.4%,

The Fed’s Board of Governors had a choice here:

1)   Admit the official inflation numbers were garbage

Or…

2)   Act surprised by the official rate being so low and claim it’s an anomaly.

The Fed went with #2 in what was one of the most insane Fed statements ever. According to the Fed’s July FOMC statement…

• Most participants expect inflation to pick up over the next couple years.


• Many Fed participants think inflation will remain below 2% longer than expected.


• Many Fed participants believe that inflation measures dropped recently due to “idiosyncratic factors.”


• A few Fed participants believe the Fed’s framework for forecasting inflation is no longer valid.


• Some Fed participants noted their increase uncertainty about the outlook for inflation.

Put simply: the Fed admitted that it no longer had a clue what was going on with inflation. It has since maintained this “who knows!” shtick (I note that Fed Chair Janet Yellen, in last week’s conference stated that the Fed’s understanding of inflation is “imperfect.”)

Why does this matter?

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

Put simply, when inflation spikes higher, so do Treasury 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 10-Year US Treasuries is spiking, having broken above its 20-year trendline.

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

FX Weekly Preview: Dollar Squeeze A Growing Concern, But Longer Term Bears Likely To Temper It

Submitted by Shant Movsesian and Rajan Dhall MSTA

from fxdailyterminal.com

Over the past week, the argument that the tax reform aimed at corporates specifically could prompt a period of USD repatriation - much like an amnesty - has been growing in sentiment, and whether one believes in this, remains an upside risk we shouldn"t ignore.  Since the Fed"s much anticipated rate hike, we have seen a moderate hit on the USD reversed in full, but put in perspective, the overall ranges traded so far have been modest to say the least.  We also shouldn"t ignore the time of year, where liquidity is not at its best, though has been enough to send the major indices on Wall Street to new record highs.  There was a time this would have sent USD/JPY soaring, but it hasn"t, but times have changed and most of us can see that global growth reflected in the stock markets is a far cry from that seen through wage growth and inflation. 

There has also been some focus on cross currency basis, turning negative to further signal year end USD demand and into early 2018, which can be tied-in in part to the repatriation story above.  Some will attribute it to regulatory pressures in Europe (derivatives market) as well as Japan, and although immeasurable for the most part, is a risk worth noting given our focus for the week ahead. 

As such, we look for concurrent moves in EUR/USD and USD/JPY, with a move in the former through 1.1700 likely to correspond with a USD/JPY push for 113.50-114.00 again.  Once again, in light of the illiquid period ahead, these are merely risks we are highlighting, and given where the respective spot rates ended up on Friday night, it is noteworthy risk at this stage. 

Through 1.1700, EUR/USD will test the band of support seen in the 1.1650-1.1550 area, where the longer term interest based on the Euro zone recovery continues to carry favour.   Based on the rising PMIs in Germany and other leading states, notably France, few can argue that there is momentum here, but this is largely priced in for now as we can see in some of the relative performance in the cross rates.  Even a supported EUR/CHF rate is struggling at 1.1700. 

In the final week into Christmas, we should see the EU wide inflation reading for Nov confirmed at 1.5% while the German IFO survey will likely continue with a healthy business climate.  Italian industrial production and orders later in the week will give us some insight into whether the rest of Europe is keeping up pace, but all of the above - as we have already alluded to - will do little to materially better the EUR position for now.

USD/JPY in the meantime survived the short lived post FOMC sell off, in a move which was seemingly pre-empted as "dovish hike fade", but that lasted for all of a day at best.  We held 112.00 on the downside, with 111.50-60 the strong base lower down, and despite the longer term bias for USD weakness and a return through 110.00 at some stage, the consolidation phase looks set to continue with 114.00-115.00 yet to be retested in any substantial way. 

The BoJ meeting towards the end of the week will again maintain current policy stance aimed at getting inflation back to 2.0% target, so the only interesting potential is of any dissenters to the persistent asset purchasing and an eventual unwind.  Domestic data is improving, albeit slowly, but the central bank have their mandate - the markets have their own take, and it is one which looks likely to test the BoJ"s tolerance for JPY strength at some point down the line.  When rather than if!

In the UK, GBP looks capped now that the EU-UK passage to the round of talks on trade have been secured.  Once again, the agreements made to facilitate this are nothing more than a "statement of intent" - as David Davis put it - so we are now at the crux of the negotiation, and this should start to weigh on some of the (blind) optimism which has driven GBP to better levels across the board.  To temper this, we are not advocating a return to the doom and gloom scenario, rather some moderation which would put Cable back to levels closer to 1.3000-1.3100 rather than creating a platform for a move through 1.3500-1.3600 for 1.4000 as some have suggested.  It is all sentiment here for now.

EUR/GBP has found good support in the mid 0.8700"s, but we also see limited scope for an aggressive push through 0.9000 unless Brexit cordiality breaks down completely.  On the UK economy, notable was the lack of positive response to the bumper spending results seen for Nov.  Naturally there will be a discounting factor in pre Xmas buying incorporating the Back Friday sales, and next year"s numbers will make for a far better reading on consumer appetite and more importantly disposable income.  The final Q3 GDP print is the only notable data point next week including business investment numbers. 

We also saw some reprieve for the AUD and NZD last week, with both consistently getting hammered into their recent lows with very little breathing space.  NZD had recovered first, again, largely down to over-exhaustion and traders throwing the towel in, so suggestions that the market have eased up on their bearish sentiment on the new coalition government look a little premature, not to say "convenient" at this stage.   This is not to say that the recovery does not have a little more to run, and could be generated through the EUR and GBP crosses, with over-extensions here - much in the same way as we have seen in EUR/AUD and GBP/AUD - redressed into year end at least. 

Lots of data in NZ next week, with more business confidence surveys (ANZ), current account and trade all leading up to Friday"s Q3 GDP number. 

Little in the way of stats to consider in Australia, so markets will focus on the RBA minutes and what the central bank take is on the economy.  With bearish sentiment emanating on low wage growth, low inflation and high household debt, the AUD got a welcome boost from a 60k+ rise in jobs, which keeps hopes alive for the Phillips Curve kicking in.  Little evidence of that in the US, but hope is hope and the AUD has weakened enough for now, with 0.7500 proving a strong base.  AUD/NZD is now the one to watch, where we took out pre 1.0900 demand, but the late Sep lows ahead of 1.0800 remain intact as yet.

CAD traders have some hard data to feed on rather than hang on every speech and reported rhetoric from the BoC.  Accused of a hard turnaround from the post rate hike hawkishness, the market was once again wrong-footed on governor Poloz"s statements this week, who stated that he saw the need for less stimulus going forward.  The CAD push up was brief however, and found fresh buyers looking for an eventual push through 1.2900 based on the retrenchment in CAD rates.  The jobs report for Nov was strong however, and if CPI, retail sales and ultimately GBP can can improve on the moderate expectations (0.2% growth seen for Oct), then perhaps USD/CAD can survive a push on the heavily offered 1.2900-1.3000 area.  Fear of long(s) liquidation by some banks suggest this could facilitate a move through the above mentioned area, but this assumes intent, which again, is immeasurable.  We could also say this about strong positioning in the market for (long) EUR"s!

One Trader Reflects On A Bad Trade - The Never-Ending Grain Pain (And Whose Fault It Was)

Authored by Kevin Muir via The Macro Tourist blog,

I have had some bad trades in my day. But lately, one call has been especially atrocious.

For the past couple of years, I have taken stabs on the long side of the grain market. At different times, I have held various positions for different lengths of time, but make no mistake - grains have done nothing but cost me money. Sure, I might have a decent sounding argument, The Last Remaining Cheap Asset, but the market is indisputably telling me that I am dead wrong.

And it’s hard to sit and watch the grains go down. Day after day. Week after week. Month after month. Like the slow drip of a leaky faucet that no one can fix, it can drive you insane.

Have a look at the 5-year chart for front month Wheat.

Tough to make money writing any blue tickets with that sort of action. All rallies have been opportunities to sell, not the start of any sustainable uptrend.

This recent grain bear market has pushed the big three contracts (wheat, corn and soybeans) down to near all time lows when measured in real terms.

I don’t want to bother with another forecast about why this time will be different, and how the low will be made in the coming weeks. After a certain number posts, I begin to more closely resemble a degenerate gambler than a cool calculating macro trader (I think that number might be three, which means it’s too late for me, and I do in fact resemble Richard Dreyfuss a whole lot more than George Soros).

And although I poke fun at myself, it’s no laughing matter. The amount of economic pain in farming is downright scary. According to an article in The Guardian, Why are America’s farmers killing themselves in record numbers?, the stress from low grain prices is causing an epidemic amongst the agricultural community.

Once upon a time, I was a vegetable farmer in Arizona. And I, too, called Rosmann. I was depressed, unhappily married, a new mom, overwhelmed by the kind of large debt typical for a farm operation.

 

We were growing food, but couldn’t afford to buy it. We worked 80 hours a week, but we couldn’t afford to see a dentist, let alone a therapist. I remember panic when a late freeze threatened our crop, the constant fights about money, the way light swept across the walls on the days I could not force myself to get out of bed.

 

“Farming has always been a stressful occupation because many of the factors that affect agricultural production are largely beyond the control of the producers,” wrote Rosmann in the journal Behavioral Healthcare. “The emotional wellbeing of family farmers and ranchers is intimately intertwined with these changes.”

 

Last year, a study by the Centers for Disease Control and Prevention (CDC) found that people working in agriculture - including farmers, farm laborers, ranchers, fishers, and lumber harvesters - take their lives at a rate higher than any other occupation. The data suggested that the suicide rate for agricultural workers in 17 states was nearly five times higher compared with that in the general population.

 

After the study was released, Newsweek reported that the suicide death rate for farmers was more than double that of military veterans. This, however, could be an underestimate, as the data collected skipped several major agricultural states, including Iowa. Rosmann and other experts add that the farmer suicide rate might be higher, because an unknown number of farmers disguise their suicides as farm accidents.

 

The US farmer suicide crisis echoes a much larger farmer suicide crisis happening globally: an Australian farmer dies by suicide every four days; in the UK, one farmer a week takes his or her own life; in France, one farmer dies by suicide every two days; in India, more than 270,000 farmers have died by suicide since 1995.

The lightbulb

For the longest time, I had no idea why grain prices were so low. It perplexed me. Central Banks around the globe were printing money at an unprecedented pace. All else being equal, you would expect a real asset, like grains, to have rallied in these circumstances. Yeah sure the advances in farming technology might keep the price of grains pressured, but at the same time, demand has also never been higher, so you would expect the debasement of money to eventually win out and send grains prices skyward.

But more importantly, these situations are usually self correcting. Nothing solves the problem of oversupply like low prices. Except this time. Even with the state of farming littered with heartbreaking stories of ruined families, not enough farmers are giving up planting crops to allow the price to rise.

This conundrum would still be a mystery to me, if it wasn’t for one of my sharp readers, who sent me a note last week. It was actually a response to a post I made about Grandma’s Bond Portfolio is in Trouble, but Shaeffer Steward from Nesvick Trading Group, related it back to the grain market in such a unique original way, I felt it was too important not to share.

I suggest that while Kevin’s assessment for the economy in general might be eerily accurate, it is ENTIRELY BACKWARDS for agriculture.

 

Before you dismiss my hypothesis, hear me out.

 

I hypothesize that the farm economy is in dire circumstances (recall article I sent you the other day: https://www.dtnpf.com/agriculture/web/ag/news/article/2017/11/20/bankers-gearing-difficult?referrer=twitter#.WhLWFmNMPIE.twitter&DCMP=Todd )

 

Primarily because commodity prices skyrocketed during the 2004-2008 super-cycle triggered by the ethanol buildout combined with huge demand growth out of China and when the GFC occurred in 2007-2008, many sectors of the economy literally collapsed under their own weight but agriculture actually thrived because the QE provided the accelerant to keep things going. You see, agriculture did exactly what you would’ve expected - lower cost of money & greater availability of credit (greater supply) - commodity prices remained rather high so farmers levered up, borrowed money and banks were glad to loan it to them as many were using land as collateralization on loans and after all, the land values were based off of what people were willing to pay (rent) to farm it or what sort of return they needed to make it a worthwhile investment.

 

What we’ve seen happen is massive leveraging, steadily increasing cost of production (seed, chemical, fertilizer, equipment, insurance, land rents, etc) and now as prices come under pressure due to massive global oversupplies, margins have quickly collapsed and the cost structure hasn’t responded. Instead, farmers have levered up further by refinancing land and/or selling off some land to keep their bankers going along with them and the cycle has continued.

 

Why would the banks lend to farmers when they didn’t lend to normal citizens? Why would farmers be willing to borrow money when normal citizens weren’t willing to borrow money? Glad you asked.

 

CROP INSURANCE

 

Specifically, federally subsidized crop insurance.

 

Farmers take extraordinary risks doing what they do BUT they now have access (and have had access) to crop insurance that protects a portion of their historical production and/or projected revenue. When I say “a portion” I mean upwards of 75-85%. When I say “federally subsidized crop insurance” I mean that the federal govt pays upwards of 65% of the premium on behalf of the farmer on some crop insurance policies. WHOA.

 

Let me put figures to it for you. Imagine that you were a farmer and your history showed that your 5 year avg yield (actual production history) on your farm was 55 bu/ac and at planting time the insurance price for soybeans was $10.19/bu. Let’s say that it was going to cost you $550/ac to grow soybeans, so a breakeven type situation if you make ordinary yields at ordinary prices. Imagine that you could guarantee yourself $420.00/ac in revenue ($10.19/bu x 55 bu/ac = $560 bu/ac revenue x 75% coverage = $420 /ac) and it only cost you $3.70/ac. You’re paying $3.70/ac to guarantee yourself $420.00/ac in revenue. Pretty cheap, right? Yes, but the REAL cost of that insurance is more like $8.23/ac with the govt paying $4.53/ac and the farmer paying $3.70.

 

Granted, there are some situations in which you can lose more and some causes of loss, such as hail are not covered by basic crop insurance and require a separate policy but in the grand scheme of things, the cost of protecting 75% of revenue is reasonable enough that farmers buy it and banks make loans that they might not otherwise make sans crop insurance policies. There is also increased risks because the loss calculations are based on futures prices at planting and harvest time and do not address the cash markets which might have wide, unfavorable basis so it isn’t anywhere near a complete failsafe but enough to keep the borrowed money flowing.

 

Now we need to put it all together. The relatively “cheap” cost of subsidized crop insurance encourages the farmer to take risks he wouldn’t take otherwise. The balance sheet equity he has goes a lot further if you consider that he “really” only has $130/ac at risk instead of the full $550/ac so he’s willing to a) stay in the game and b) expand his acreage because if he hits a homerun on larger yields and/or higher prices, then JACKPOT!!. If it goes bad, he’s out $130/ac and it doesn’t completely wipe him out - plus he’s using the bank’s money at very low interest rates.

 

The farmer not only wants to stay in the game but he wants to grow so he’s bidding up inputs and more importantly land rents because if you don’t have the land, then you’re out of the game. Revenues continue to be good, in general so the farm cash flow has meat on the bone and where there is meat on the bone, the dogs come chewing. Seed costs are higher every year and sometimes much higher. Equipment costs have gone FREAKIN’ PARABOLIC. Land rents have skyrocketed. Since many farmers are self-insured, health insurance prices have… well you know what they’ve done. Much of this expansion has been done with debt financing on equipment meaning that while the interest rates are low, interest costs are accumulating. You see, there HAS been demand for debt from agriculture and the lenders have seen positive cash flows and the revenue safety net of crop insurance as courage to continue to lend to farmers.

 

Let’s take a detour for a moment here - banks have wanted to lend money but “conservatively” and if the average consumer really hasn’t had the appetite for borrowing money, that makes it a difficult task. If you’re a regional bank or small town bank and you can lend out money on 10-12 month agricultural operating notes to the tune of $500k-2.5 mil each isn’t it much easier to put $10-20 mil to work than if you were dealing with making retail loans for cars, houses, etc particularly since those loans are longer maturity loans? What if you could effectively put $20 mil out in annual operating loans with 12 month or less maturities at 4.5-5.5% via 25-30 loans PLUS the person borrowing it has 75% revenue protection bought via crop insurance as well as land & equipment collateralizing the notes at a time that equipment and land prices are zooming into the stratosphere?!?!?!?!?!

 

You see, the ag community kept growing and the appetite for debt was there from the start but encouraged by federally subsidized crop insurance. Lenders needed to put money to work and they found it too easy NOT to make large operating notes that renewed annually at decent interest rates to individuals/businesses that were a) looking at positive cash flows, b) partially protected by federally subsidized crop revenue protection in the form of crop insurance and c) collateralized by rapidly appreciating assets (equipment & land). Farmers get to expand, rural America gets a hand, bankers put money to work and everyone lives happily ever after…

 

Until commodity prices come under pressure because the supply side gets overstimulated, revenue side drops dramatically while the cost side remains sticky and then we get the massive transfer of equity from the farmer to a variety of beneficiaries including a) banks in the form of interest, b) landlords in the form of higher rent and higher asset(land) values, c) equipment companies in the form of inflated revenues due to inflated equipment prices, d) input providers in the form of higher prices for seed, chemical and fertilizer… all being transferred from the farmer’s balance sheet.

 

Then you add in the intangible side to the equation: what is the farmer going to do if he decides to quit because he doesn’t want to take all of these risks? If he decides NOT to farm because he sees what is happening in terms of greater and greater risks to his equity what is he going to do to put food on his table? If he doesn’t pay the extra $25/ac land rent to keep a neighbor from renting it out from under him he’ll lose the land and then what will he do? There are only so many jobs “in town” to get and rural America is drying up so what will he do? You see, here is the hard part. He made the decision to get in or stay in the rat race even when he knew that the numbers didn’t make sense because he didn’t see a viable “plan B” and there was a banker standing there able and willing to continue to give him more and more rope until he finally hanged himself when the mouse trap flipped on him.

 

THAT, fine sir, is where we are today in US agriculture.

 

I apologize that this turned out as lengthy as it did BUT I felt that it was a worthwhile exercise to put these thoughts into email and share them with you because you are a student of the markets and also because you will hopefully be joining us for our Commodity Roundtable in January so a better framing of the situation might help you understand the circumstances they are facing.

 

As a macroeconomist, how do we work out from under this situation? What is the roadmap for the US farmer? Higher commodity prices are a temporary fix as we’ve seen because as long as the money is available (available credit) and affordable (low interest rates) the inflationary explosion continues on the cost/input side of the equation. Currently we’re shrinking farmer balance sheets until banks won’t be able to lend to them any longer at which time the decisions will be made FOR the farmer not BY the farmer.

Brilliant! I mean, f’ng brilliant. Shaeffer completely nailed it. The government’s subsidies have created a situation where far too much credit has been extended to an industry. This has caused inflation in prices of the inputs that go into farming, but not the output.

Want another example? Have a look at Student Loans versus tuition inflation.

Tuition inflation has greatly outpaced regular CPI, but it has gone hand in hand with the growth of student debt. Over allocations of credit have peculiar effects on the pricing of both the inputs and the outputs of the affected area.

What to do about it?

Now I am not sure what to do about Shaeffer’s deduction. As long as subsidies exist, it seems that too much money will be allocated to agriculture loans, and will therefore, keep grain prices lower.

But here’s a thought. Over the past half dozen years, there has been little demand for loans in the regular economy. This has encouraged bankers to lend to farmers with their government backstop.

Yet what will happen if economic activity picks up? Loan demand across all sectors will increase, decreasing the amount of credit that will be extended to farmers. This will occur at a terrible time as grain prices are near rock bottom levels. Unfortunately, without as much credit, many of these farmers might be forced to quit. However, that will cause the price of the grains to rally. Maybe to a more sustainable level where farmers can once again make a living. Ironically, rising interest rates, might be the best thing for both farmers, and grain prices.

Wait! Did I just make another bullish argument for buying grains?

Yeah, yeah, I did. As Richard Dreyfuss taught me so well, let it ride…

---

Market On Close in December

What’s that famous Wall Street saying? The dumb money trades in the morning, the smart money trades at the close. Well, astute market watcher Helene Meisler recently highlighted that the Market on Close (MOC) imbalances have consistently been to the sell side lately.

In fact, every single day in December has seen MOC sell imbalances.

Institutions often trade at the close, while the public is more prone to trading closer to the open. There has even been an indicator created to measure this phenomenon.

If we look at the SMART Index, the late day selling shows up clearly with a big retreat from the highs.

So far, the stock market has not followed the SMART Index lower in any meaningful way. But don’t worry, I am sure this distribution by institutions is somehow bullish. After all, don’t you know? Stocks only go higher.

A Perfect Forecast

While I am on the topic of the stock market, earlier in the week Meb Faber noted that Barrons reported:

These strategists are usually bullish, so it’s not terribly surprising. But it does smack of another period when universal optimism also reigned. At the end of 2007, the S&P 500 stood at 1468 and Wall Street’s smartest had the following forecasts:

And where did it close? Down 38.5% to 903. Ooops. Just a little off.

Thanks for reading and have a great weekend,

2 Charts That Might Define The Fed"s Jerome Powell Era

Authored by Daniel Nevins via FFWiley.com,

In September, we proposed a theory of the Fed and suggested that the FOMC will soon worry mostly about financial imbalances without much concern for recession risks. We reached that conclusion by simply weighing the reputational pitfalls faced by the economists on the committee, but now we’ll add more meat to our argument, using financial flows data released last week.

We’ve created two charts, beginning with a look at cumulative, inflation-adjusted asset gains during the last seven business cycles:

According to the way that the Fed defines its policy approach, our first chart stamps a giant “Mission Accomplished” on the unconventional policies of recent years. Recall that policy makers explained their actions with reference to the portfolio balance channel, meaning they were deliberately enticing investors to buy riskier assets than they would otherwise hold. Policy makers hoped to push asset prices higher, and they seem to have succeeded, notwithstanding the usual debates about how much of the price gains should be attributed to central bankers. (See one of our contributions here and a couple of other papers here and here.) But whatever the impetus for assets to rise, it’s obvious that they responded. In fact, judging by the data shown in the chart, policy makers could have checked the higher-asset-prices box long ago, and with a King Size Sharpie.

Consider the measure on the vertical axis, percent of personal income. From the risky asset trough in Q1 2009 through Q3 2017, households accumulated asset gains, in real terms, equivalent to 139% of personal income. (Nominal gains were much greater, but we used the CPI to deduct the amount of purchasing power that households lost on their asset holdings. Also, we defined asset holdings as the four biggest categories that the Fed computes gains for—equities, mutual funds, real estate, and pensions.)

In other words, households are enjoying an investment windfall that amounts to nearly sixteen months of personal income, which is larger than the windfalls accrued in any other business cycle since the Fed began tracking asset gains in 1947. Not only that but the gap continues to widen—as of this writing, we’re likely approaching 145% of personal income and well clear of the previous peak of 128% from the 1991–2001 expansion.

Getting back to policy priorities, the chart seems to tell us that asset prices no longer need boosting. The Fed’s pooh-bahs proved they could boss the investment markets, and they’ve almost certainly moved on to new endeavors.

Bull, bear, or donkey?

But record asset gains are just one of the reasons the Fed’s priorities are likely to be changing. To describe another reason, we’ll first show that policy makers may wield a King Size Sharpie but that it’s not a Permanent Marker:

As you can see, our second chart looks like the first, except that we pinned the tails on the asset price donkeys.

We tacked on the down halves of each cycle, showing that the portfolio balance channel has a reverse mode.

So what should we make of the result that asset price cycles, adjusted for inflation, have ended with busts that reverse a large portion and often the entirety of the prior booms?

According to our beliefs about how investment markets work, the up and down phases of asset cycles are closely connected. Also, monetary stimulus influences both phases at the same time. It helped fuel the giant gains of recent expansions, but it also helped create the imbalances that led to giant losses. And after the accelerated advances of 2016-17, it’s fair to wonder if today’s imbalances are approaching the extremes of 2000 and 2007. Even some FOMC members are gently acknowledging that risk.

But we think the committee members are even more concerned than you would know by just reading their meeting minutes. We expect financial imbalances to become their biggest worry, bigger than the risk of recession, which should matter less and less to the central bankers’ reputations as the business cycle expansion continues to lengthen. In fact, a garden variety recession would barely affect their legacies at all by mid-2019, when the expansion, if still intact, would become the longest ever. By that time, the FOMC’s greatest reputational threat would be another financial market debacle, which would suggest that manipulating asset prices maybe wasn’t such a good idea, after all. In other words, the committee’s reputational calculus will change significantly during Jerome Powell’s first few years as chairperson.

All that said, Powell probably wants a recession-free economy in, say, his first year or two in the position. Moreover, he’ll certainly stress continuity with his predecessors’ policies. But once he becomes comfortable in the job, the Fed’s priorities will look nothing like they did under Janet Yellen and Ben Bernanke. Instead of fueling asset gains, Powell’s biggest challenge will be containing imbalances connected to prior gains. He and his peers will aim to avoid pinning another oversized tail on the donkey—or at least to manage the fallout from said tail—and that’s a challenge that could very well define his regime.

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.

Bond Bears Beware As Ag Prices Hit Record Low

Long-end bond yields are lower and the front-end higher once again this morning as the US Treasury yield curve continues to confound by flattening. Bloomberg macro strategist Mark Cudmore suspects there is more to come... for one simple reason, so often overlooked...

Via Bloomberg,

Cheaper eats are great, but maybe not if you’re one of the many expecting a sustainable bump in bond yields next year.

Falling food prices risk wrecking the forecasts -- seen pretty much every December for years now -- for yields to climb in the new year. Ten-year Treasury rates haven’t closed a year above 2.45 percent since 2013.

 

Bond bears seem to struggle to incorporate structural disinflationary pressures that have come from technology and globalization.

 

The Bloomberg Agriculture Subindex on Monday hit its lowest level since the series began in 1991. Technology and science are making the agriculture industry increasingly efficient, and there are still plenty of production gains to be made globally.

 

 

Combined with the overhang of energy supply that’s capping oil prices -- and therefore processing, transport and distribution costs -- that means the long-term trend remains one of cheaper food prices.

 

And food prices are a key component of consumer price index baskets around the world.

 

The impact is global, real and seems to be constantly underestimated.

 

Since Saturday, China, Denmark, Norway and the Czech Republic have all released CPI prints where the annual rate was both decelerating and below expectations. Food prices were specifically cited in China’s case.

None of this is to argue that bond yields can’t spike higher for short periods, notes Cudmore, but it’s just an argument to highlight that structural disinflationary pressures from technology remain strong and shouldn’t be dismissed.

With several major central banks indicating that the marginal bias is to tighten policy, that will further crimp price rises. And that doesn’t bode well for a sustainable broad rise in developed-market yields.

David Stockman Lashes Out At Mainstream Media"s "Peak Fantasy Time"

Authored by David Stockman via Contra Corner blog,

If you want to know why both Wall Street and Washington are so delusional about America"s baleful economic predicament, just consider this morsel from yesterday"s Wall Street Journal on the purportedly awesome November jobs report.

Wages rose just 2.5% from a year earlier in November - near the same lackluster pace maintained since late 2015, despite a much lower unemployment rate. But in a positive sign for Americans’ incomes, the average work week increased by about 6 minutes to 34.5 hours in November.... November marked the 86th straight month employers added to payrolls.

Whoopee!

Six whole minutes added to a work week that has been shrinking for decades owing to the relentlessly deteriorating quality mix of the "jobs" counted by the BLS establishment survey. In fact, even by that dubious measure, the work week is still shorter than it was at the December 2007 pre-crisis peak (33.8) and well below its 2000 peak level.

The reason isn"t hard to figure: The US economy is generating fewer and fewer goods producing jobs where the work week averages 40.5 hours and weekly pay equates to $58,400 annually and far more bar, hotel and restaurant jobs, where the work week averages just 26.1 hours and weekly pay equates to only $21,000 annually.

In other words, the ballyhooed headline averages are essentially meaningless noise because the BLS counts all jobs equal----that is, a 10-hour per week gig at the minimum wage at McDonald"s weighs the same as a 45 hour per week (with overtime) job at the Caterpillar plant in Peoria that pays $80,000 annually in wages and benefits.

When the line is trending inexorably from the upper left to the lower right, of course, it means there are more of the former and fewer of the latter. Six more minutes of continuing worse----is still bad.

 

As a matter of fact, the November report showed 20.199 million goods-producing jobs in manufacturing, construction and energy/mining, which did represent about a 2% improvement from prior year.

The real story, however is not about the short-term monthly or annual deltas being generating by an economy barely crawling forward. Rather, at 102 months, the current business cycle is exceedingly long in the tooth by historic standards (the longest expansion was just 118 months under the far more propitious circumstances of the 1990s).

In fact, what has been the weakest expansion in history by far may now be finally running out of gas.

During the last several weeks the pace of US treasury payroll tax collections has actually dropped sharply---and it is ultimately Uncle Sam"s collection box which gives the most accurate, concurrent reading on the state of the US economy. Some 20 million employers do not tend to send in withholding receipts for the kind of phantom seasonally maladjusted, imputed and trend-modeled jobs which populate the BLS reports.

Yet we we are not close to having recovered the 4.3 million goods producing jobs lost in the Great Recession; 40% of them are still AWOL---meaning they are not likely to be recovered before the next recession hits.

Stated differently, the US economy has been shedding high paying goods producing jobs ever since they peaked at 25 million way back in 1980. Indeed,  we are still not even close to the  24.6 million figure which was posted  at the turn of the century.

By contrast, the count of leisure and hospitality jobs( bars, hotels and restaurants), or what we have dubbed the "Bread and Circuses Economy" keeps growing steadily, thereby filling up the empty space where good jobs have vacated the BLS headline total.

Thus, when goods-producing jobs peaked at 25 million back in 1980, there were only 6.7 million jobs in leisure and hospitality. Today that sector employs 16.0 million part-time, low-pay workers or 2.4X the four decade ago level.

Yes, there is nothing wrong with these jobs or the workers who hold them, but the fact that they constitute a rapidly increasing share of the mix is powerful proof that the job market is not nearly as awesome as it is cracked up to be; and that the monthly BLS report is surely no measure at all of a rising standard of living in Flyover America.

The larger point is that the monthly jobs report is really neither a report on true labor market conditions or a proxy for genuine economic growth. The fact is, without sustained growth of  full-time, full-pay "breadwinner" jobs there is no real economic recovery or progress.

And we literally mean, no progress. With an update for November"s results, the chart below would show 72.8 million "breadwinner jobs" in goods production, the white collar professions, business management and support, transportation and distribution, FIRE (finance insurance and real estate) and full-time government jobs outside of schools.

As it happens, that is virtually the same number posted by the BLS back in January 2001 when Bill Clinton was packing his bags to vacate the Oval office. In short, three presidents later---all of whom have claimed undying devotion to good jobs and rising living standards---and there is hardly a single new breadwinner job.

The above chart does not bring the concept of awesome to mind. In fact, it reminds of the same kind of stagnation that is evident in all the key metrics for real economic progress. For instance, an economy flat-out can not grow without steady gains in industrial production, which includes energy extraction and all facets of goods manufacturing from automobiles to furniture clothes, shoes and canned soup.

But like in the case of "breadwinner jobs", this so-called recovery has generated none of it. The index of industrial production stands at exactly the level of the pre-crisis peak a full decade ago.

There is a whole raft of these statistics,  but the following graph leaves little to the imagination.

Notwithstanding the Fed"s whacko claim that it hasn"t generated enough inflation in recent years, the truth is that even by the BLS" faulty measuring stick every single dollar of median household income gain has been eaten up by CPI inflation. Accordingly, there has been zero gain in real median household income for the entirety of this century!

What does our latest Oval Office occupant plan to do about this? Why nothing less than borrow $1.8 trillion from future taxpayers in order to enable corporations and other business to crank-out even bigger financial engineering distributions to shareholders in the form of dividends, stock buybacks and M&A deals.

This isn"t even "disruption" as per the Donald"s real job. It"s just dumb and fiscally irresponsible beyond measure - a message we have once again taken to the mainstream media in recent days.

 

 

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