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

How Fed Rate Hikes Impact US Debt Slaves

Authored by Wolf Richter via WolfStreet.com,

But savers are still getting shafted.

Outstanding “revolving credit” owed by consumers – such as bank-issued and private-label credit cards – jumped 6.1% year-over-year to $977 billion in the third quarter, according to the Fed’s Board of Governors. When the holiday shopping season is over, it will exceed $1 trillion. At the same time, the Fed has set out to make this type of debt a lot more expensive.

The Fed’s four hikes of its target range for the federal funds rate in this cycle cost consumers with credit card balances an additional $6 billion in interest in 2017, according to WalletHub. The Fed’s widely expected quarter-percentage-point hike on December 13 will cost consumers with credit card balances an additional $1.5 billion in 2018. This would bring the incremental costs of five rates hikes so far to $7.5 billion next year.

Short-term yields have shot up since the rate-hike cycle started. For example, the three-month US Treasury yield rose from near 0% in October 2015 to 1.33% today. Credit card rates move with short-term rates.

Mortgage rates move in near-parallel with the 10-year Treasury yield, which, at 2.39%, has declined from about 2.6% a year ago. Hence, 30-year fixed-rate mortgages are still quoted with rates below 4%, and for now, homebuyers have been spared the impact of the rate hikes.

Auto loans, in line with mid-range Treasury yields, have wavered a lot and moved up only a little. The average APR on a 48-month new-car loan rose only 40 basis points over the past two years to 4.4% in August 2017, according to WalletHub, citing the most recent data available. Note that the offers of “0% financing” are usually in lieu of rebates or other incentives and are therefore rarely free.

The chart below shows the increase in the Fed’s target for the federal funds rate, from 0-0.25% to 1-1.25% (not including a hike on December 13), so an increase of 100-basis points. Credit card rates have increased in lockstep by 101 basis points. But bank deposits rates have lagged woefully behind, on the logic that credit-card borrowers and savers, both, are going to get shafted:

So how do these rate hikes translate for households with credit card balances?

Revolving credit outstanding of $1 trillion, spread over 117.72 million households, would amount to $8,300 per household. But many households do not carry interest-bearing credit card debt; they pay their cards off in full every month. Finance charges are concentrated on households that use this form of debt to finance their spending and that cannot pay off their balances every month. Many of these households are already strung out and are among the least able to afford higher interest payments.

Consumer credit bureau TransUnion shed some light on this in its Q3 2017 Industry Insights Report, according to which 195.9 million consumers had a revolving credit balance at the end of Q3, with total account balances of $1.35 trillion. This equals $6,892 per person with revolving credit balances. If there are two people with balances in a household, this would amount to nearly $14,000 of this high-cost debt. If the average interest rate on this debt is 20%, credit-cart interest payments alone add $233 a month to their household expenditures.

What is next for these folks?

For now, the Fed has penciled in, and economists expect, three hikes next year. But recent developments – particularly the expected tax cuts and what the Fed calls “elevated asset prices” – suggest that the Fed might “surprise” the markets with its hawkishness in 2018.

The Fed is currently pegging the “neutral” rate – the rate at which the federal funds rate is neither stimulating nor slowing the economy – at somewhere near 2.5% to 2.75%, so about five or six more rates hikes from today’s target range.

Interest rates on credit cards would follow in lockstep. These rate hikes to “neutral” would extract another $8 billion or so a year, on top of the additional $7.5 billion from the prior rate hikes.

But that’s not all. Credit card balances continue to rise as our brave consumers are trying to prop up US consumer spending and thus the global economy by borrowing more and more. Thus, rising credit card balances combined with rising interest rates on those balances conspire to produce sharply higher interest costs.

Since consumers with high-interest credit-card balances already don’t have enough money to pay off their costly debt, these additional interest payments will further curtail their efforts at making principal payments and thus inflate their credit card balances further.

For many consumers whose credit is already challenged, this scheme eventually ends in default. Credit card delinquencies have started to tick up, from 2.16% in Q1 2016 to 2.53% in Q3. While still soothingly low overall, the damage is always concentrated in the subprime segment – and on lenders that specialize in subprime lending. And there, delinquency rates are jumping. Yet these are still the best of times, with the lowest unemployment rate since the year 2000.

This parallels the delinquencies in auto loans. The 90+ day delinquency rate for loans originated by auto finance companies has hit 9.7% in Q3 2017, the highest since Q1 of 2010, when it was on the way down from the Financial Crisis. Delinquencies first hit that rate on the way up in Q3 2008, during the Lehman moment. But now, there is no Financial Crisis. These are the boom times.

Read…  Auto-Loan Subprime Blows Up Lehman-Moment-Like

Trump Will Own The Next Fed But "All Their Models Are In Ruins"

Authored by James Rickards via The Daily Reckoning,

President Trump is expected to nominate the next Federal Reserve chair within a matter of days.

As I’ve explained before, Donald Trump has the opportunity to appoint a higher percentage of the Board of Governors of the Federal Reserve system at one time than any president since Woodrow Wilson.

President Wilson signed the Federal Reserve Act during the creation of the Fed in 1913 when they had a vacant board. At that time, the law said the secretary of the Treasury and the comptroller of the currency were automatically on the Fed’s board of governors. But besides that, President Wilson selected all of the other participating members.

Due to vacancies he inherited and key resignations, Trump now has the opportunity to fill more seats on the Fed’s Board of Governors than any president since then.

That’s pretty amazing when you think about it.

To review, the Federal Reserve’s Board of Governors is made up of seven appointees. That means that they can make a majority decision with four votes. If you’re reading about the Fed, you might also see reference to “regional reserve bank presidents.” These are roles within the Federal Reserve System, but the real power is found on seven-member Board of Governors.

Trump will own the Fed.

Meaning, whatever the president wants monetary policy to be, he’ll get. In other words, Donald Trump will be able to shape the Fed’s majority. But the tricky part is figuring out how he plans to shape it...

During the campaign season, Trump called China and other nations currency manipulators. That signaled he believed the dollar was too strong and wanted it to weaken. But then the North Korean nuclear crisis rose to the fore.

Trump backed off his threats against China because China has the most economic influence over North Korea, and Trump wanted China to use that leverage to convince the North to back off its nuclear program.

But China didn’t deliver as Trump had hoped, and a trade war with China is now likely. That’s especially true now. Chinese president Xi Jinping has solidified his hold on power after the Chinese Politburo re-appointed him yesterday. Xi had avoided rocking the boat in recent months while his position was uncertain. But now that his lock on power is secure, Xi can afford to be much more confrontational with Trump.

Trump’s trade policy has led many to believe that Trump will appoint a lot of “doves” to the Board. But don’t be surprised if Trump goes with a hard-money board. In fact, that’s what I expect. These will be hard-money, strong-dollar people, contrary to a lot of expectations.

Trump advisers include hard-money advocates like Dr. Judy Shelton, David Malpass, Steve Moore and Larry Kudlow. I expect Trump to heed their advice.

Which brings us to Janet Yellen and the next Federal Reserve Chair…

Janet Yellen’s term as chair is up at the end of January - just over three months from now. Whoever President Trump appoints to replace her will be subject to Senate confirmation.

Because that process takes time, that means the president has to name Yellen’s successor around November or December.

And again, he’s expected to make that announcement by Nov. 3, before he heads to China.

The market is tightly focused on President Trump’s pick. As of now, betting markets had the approximate probabilities as follows:

Powell’s main qualification seems to be that he’s just like Yellen except he’s a Republican. So, if we combine their votes, that a 68% chance that policy will continue unchanged, which means more rate hikes ahead.

The next in line is John Taylor, who is considered the most hawkish of the group. If we add his votes to the Powell + Yellen pool, that an 85% probability that policy will either be the same or tighter.

No relief for gold in the Fed sweepstakes.

Now, as I’ve been saying for months, my money’s on Kevin Warsh. Warsh is the likely next chair of the Fed.

Warsh has previously served on the board. After being nominated by President George W. Bush he was a Fed governor where he served from 2006 until he resigned early in 2011.

Kevin Warsh is a pragmatist, not an ideologue like Yellen. He’s not beholden to obsolete Fed models like Phillips curve that says low unemployment means higher inflation. Warsh understands that disinflation is a serious problem for a country with a 105% debt-to-GDP ratio, like the U.S.

Warsh and the pragmatists understand that inflation is needed for the U.S. to have any hope of getting the debt problem under control.

Warsh believed that the Federal Reserve should have raised interest rates a long time ago. But with disinflation a much more pressing concern than inflation right now, being a pragmatist means he won’t commit to tightening if conditions don’t warrant it.

We’ll see how this all plays out probably late this week or early next before Trump leaves for China.

But it’s important to realize that institutions boil down to people. And there’s going to be a lot of turnover at the Fed under Trump. It’s not just limited to his choice of Fed chair.

Yes, Yellen will likely be out. But so are Fed officials that align with her, like Vice President Stanley Fischer, who announced his resignation in September.

As I indicated, the new, emerging Fed will have less faith in traditional models. For example, in September, Fed governor Lael Brainard delivered one of the most significant Fed speeches ever. Translating from Fed-speak to plain English, she more or less admitted the Fed has no idea how inflation works.

Brainard pointed out that the Fed began its current monetary policy tightening cycle in the belief that tight labor markets implied inflation was coming with a lag. The Fed raised rates in December 2015, December 2016, March 2017 and June 2017 in part to get out ahead of this coming inflation.

Instead the opposite happened.

The Fed’s favorite measure of inflation plunged from 1.9% to 1.3% between January and August 2017 even as job creation continued and the unemployment rate fell. In other words, the relationship between tight labor markets and inflation turned out to be the exact opposite of what the Fed believed.

Their models are in ruins.

Of course, this is what I’ve been telling my readers to expect all year. The Fed was tightening into weakness, not strength, and would soon have to flip back to ease in order to avoid an outright U.S. recession. And ease is exactly what Brainard called for in her speech.

In the meantime, a lot of uncertainty over the Fed’s direction will hover over the market, as if there wasn’t enough uncertainty in the market already.

But one thing is certain:

The next Fed head will have a lot on his (or her) plate.

The biggest winner will be gold. The time to enter your gold position, if you don’t already have one, is now.

Commodities Bust Hits Farm Lenders, Delinquencies Surge 225%

Submitted by Wolf Richter via WolfStreet.com,

Just as the deflating Farmland bubble leaves its marks.

When it comes to agricultural debt, the numbers aren’t huge enough to take down the global financial system. But this shows how much pain the commodities rout is producing in the farm belt just when the farmland asset bubble that took three decades to create is deflating, and what specialized lenders and the agricultural enterprises they serve – some of them quite large – are currently struggling with in terms of delinquencies.

This is what delinquencies on loans for agricultural production – not including loans for farmland, which we’ll get to in a moment – look like:

From Q4 2014 to Q1 2017, delinquencies have soared by 225% to $1.4 billion, according to the Board of Governors of the Federal Reserve, which just released its report on delinquencies and charge-offs at all banks. This is the highest amount since Q1 2011, as delinquencies were falling after the Financial Crisis. That amount was first breached in Q4 2009.

The delinquency rate rose to 1.5%, the highest since Q3 2012. On the way up, going into the Financial Crisis, delinquencies breached that rate in Q1 2009.

These were the loans associated with agricultural production. In terms of loans associated with farmland, delinquencies have soared by 80% from Q3 2015 to Q1 2017, reaching $2.15 billion:

Farmland values have surged for three decades but are now in decline in many parts of the US. For example in the district of the Federal Reserve of Chicago (Illinois, Indiana, Iowa, Michigan, and Wisconsin), prices soared since 1986, in some years skyrocketing well into the double-digits, including 22% in 2011, and nearly tripling since 2004. It was the Great Farmland Bubble that had become favorite playground for hedge funds. But starting in 2014, prices have headed south.

This chart from the Chicago Fed’s AgLetter shows farmland prices in its district in two forms, adjusted for inflation (green line) and not adjusted for inflation (blue line):

Adjusted for inflation, farmland prices in the district fell 9.5% over the past three years. The exception is Wisconsin:

• Illinois -11%


• Indiana -7%


• Michigan -12%


• Iowa (since their 2012 peak) -15%


• Wisconsin +4%

The Chicago Fed adds this about the deflating farmland asset bubble, in inflation-adjusted terms:

Even after three annual declines, the index of inflation-adjusted farmland values for the District was nearly 60% higher in 2016 than its previous peak in 1979.

Does it mean to say that there is a lot more air to deflate out of the farmland bubble and a lot more pain to come and that this is just the beginning? Or is it saying that this is no big deal?

These falling farmland prices are making the debt much more precarious. So on a nationwide basis, the delinquency rate of farmland loans, according the Fed’s Board of Governors, jumped from 1.46% in Q3 2015 to 2.0% in Q1 2017.

In terms of magnitude of the dollars involved, agricultural and farmland loans pale compared to consumer or commercial loans. So the problems in the farm belt won’t cause the next Global Financial Crisis, and it progresses on its own terms. But it is putting strain on agricultural lenders, growers, and their communities.

Another asset bubble, a global one, is quietly but persistently experiencing a downturn that parallels and in some aspects already exceeds the one during the Financial Crisis. What the slow crash of classic cars says about the future of other asset classes. Read…  This Is How an Asset Bubble Gets Unwound these Days

Bankers To Fed: Stop Riding The Asset Bubble And Raise Rates Already

Submitted by Patrick Watson via MauldinEconomics.com,

The stakes were high at last September’s Federal Open Market Committee (FOMC) meeting. Federal Reserve officials had hinted all year that a rate hike was coming. Traders assumed it would come at a quarter-end meeting, coinciding with one of Janet Yellen’s news conferences. If so, it would be the Fed’s last chance until December.

After much suspense, the FOMC again sat on their hands.

But the September vote to do nothing wasn’t unanimous. Three hawkish committee members dissented—a first in Yellen’s term as Fed chair.

What no one outside the Fed knew at the time: Two weeks earlier, the Fed’s Board of Governors had held an unannounced, closed-door meeting with top US bankers, including the heads of Citigroup (C), Wells Fargo (WFC), BB&T Corp (BBT), and Northern Trust (NTRS).

Echoing the FOMC dissents later that month, the bank CEOs asked the board to normalize rates and stop “riding the asset bubble being generated by the easy-money policies around the globe.”

That’s unusually direct language by Fed standards, but the way it stayed hidden ahead of the FOMC meeting is stranger still. It raises serious questions about the Yellen Fed’s commitment to transparency as well as its struggle to reach policy consensus.

Federal Reserve Board meeting, June 3, 2016. Photo: Federal Reserve

The Forgotten Council

The 1913 Federal Reserve Act created a system of regional reserve banks balanced by a politically appointed Board of Governors in Washington.

It also mandated a link between the two, called the Federal Advisory Council (FAC). Each of the 12 Fed districts appoints a representative to the council, which then meets with the Board of Governors four times a year.

Those meetings have been happening for over a century, yet few people outside the Fed knew about them. For decades, the Fed disclosed very little.

In 2013, Bloomberg News used the Freedom of Information Act (FOIA) to obtain official records of Federal Advisory Council meetings. Now you can read them on the Fed’s web site.

Note that this was not a voluntary disclosure. If not for FOIA, we would all still be in the dark, as the Fed evidently wants. Even now, the public records omit important details, like who are the group’s officers, attendees of each meeting, votes taken, and future meeting dates.

They are still useful, though. I’ve been reading the FAC summaries since 2013 and find them much more informative than the better-known Beige Book reports.

The September 7 meeting record was especially interesting. Consider this from a section on persistently low interest rates and their impact on bank profitability.

It may be a prudent time to adjust policy thinking to shift the balance from stimulus through lower rates to encouraging investment activity through investment returns. Shifting the policy stance to a normalization posture that steadily moves to higher rates could increase confidence and reestablish the normal relationship among savers and borrowers.

If rate normalization happens in a steady and more predictable approach, the economy can incorporate this change in rates and psychology and make investment decisions based on the best allocation of capital to productive sources versus riding the asset bubble being generated by the easy-money policies around the globe.

Remember who said this: Top bankers, talking to the Fed’s Board of Governors, two weeks before a key FOMC meeting. The bankers clearly wanted higher rates as soon as possible.

The Federal Reserve Act specifically empowers the council to make recommendations to the board, but why say it so forcefully? This is the Fed, where everything is slow, measured, and deliberate. Terms like “asset bubble” and “easy money” aren’t in their normal vocabulary.

I asked a former Federal Reserve official, familiar with internal deliberations, what to make of this language.

The answer: This is not normal. Whoever said it wanted to make a point.

So, it looks like the Federal Advisory Council was trying to shake up the Board of Governors. The council wanted higher rates and said so in plain, unmistakable terms.

The board doesn’t have to agree, and it didn’t. All five governors, including Yellen, voted not to raise rates at the September 21 FOMC meeting.

Convenient Delay

All this stayed unknown to the media or public due to an unusual deviation from Federal Reserve practice. The FAC normally posts records of its meetings a week after they occur. As of September 7, it even said so on its web page.

You can see it in this screen shot taken that day.

But as we know, this meeting wasn’t typical.

Instead of posting the September 7 meeting record a week later (on September 14), the Fed released nothing until September 23. Here’s what the page looked like then.

The Fed staff added a line linking to the September 7 record. They also removed the line that had previously said, “Records are typically posted within a week after the FAC meeting.”

Through another source, I confirmed that this text disappeared from federalreserve.gov sometime between noon on September 7 and 5:00 PM on September 8—right after the FAC meeting occurred.

This suggests someone decided to delay the September 7 record release beyond the “typical” one week.

Who made that decision is unclear, but here’s what we know.

• Instead of the usual one week, the FAC record didn’t appear until 16 days after the September 7 meeting.

• Someone removed language that would have highlighted this delay on September 7 or September 8.

Photo: Getty Images

A Fed spokeswoman told me they try to get the FAC records out within a week but don’t always make it. She could not comment on September’s unusual delay or the web site changes.

Since the Fed won’t explain, we can only speculate. Combine what we know these with two other facts:

1. The delayed record revealed major disagreement between the FAC members and the Board of Governors on interest rate policy.

1. The delay hid this disagreement from the public until after the FOMC decided not to raise rates.

Strange, yes? Here’s the sequence of events again.

• Sept. 7: FAC meets, asks FOMC to raise interest rates

• Sept. 8: One-week publication note disappears from FAC web page

• Sept. 14: FAC meeting record not released on schedule

• Sept. 21: FOMC announces no change to interest rates

• Sept. 23: FAC releases FAC meeting record 11 days later than normal

By the way, the “within a week” sentence is still missing from the web site now, three months later. That suggests the delay was more than a one-time exception.

More mysteries could be hiding in the 20-page September meeting record. I invite you to review the document and contact me with other ideas.

A Question for Mrs. Yellen

On one level, this is just normal bureaucratic behavior. Government officials don’t like being questioned. Neither do bank CEOs.

But this is not simply another alphabet agency. It’s the Federal Reserve, the world’s most important central bank, whose chair has promised greater transparency on matters of public interest.

What else are they hiding?

Well, if the FAC followed custom, it met on the first Friday of this month, December 2. But as of now, they won’t even confirm a meeting occurred.

On December 1, I called the Fed’s Public Affairs Office and asked if the FAC was meeting the next day.

The answer, after a brief pause: “It’s not on our public schedule.” Nicely vague.

I called again on Monday, December 12, and asked the same question: Has the FAC met this month? Again, they would not confirm whether the FAC had met and advised me to watch the web site. 

So, it looks like we won’t know any more until the Fed feels like telling us. Will the FAC record again appear after the FOMC meeting?

As I said last week, the Federal Reserve Board has two vacancies that President Trump can fill as soon as he takes office. Maybe they can help Yellen pull back the curtain.

Riding the Asset Bubble

One more thing…

We know the bankers on the Federal Advisory Council saw an “asset bubble” as of September 7. Yet their own stocks have skyrocketed since then.

For example, Comerica (CMA) shot up 46.4% and Regions Financial (RF) jumped 44.2% through December 12, including dividends. Most of the others were up 25% or more.

If the bank leaders saw an asset bubble even before this rally, what do they call it now?

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