Of Hamster Wheels, Zombies And Spiraling Bubbles!

Just in case “more cowbell” is needed when it comes to “hot takes” on the Fed, we’re going to go ahead and round out our wall-to-wall coverage of the March meeting/”impossible”-dovish-surprise with one last glorious missive while it’s still “fresh”.

On Wednesday evening, we brought you some excerpts and other various soundbites from a handful of desks, and it’s only natural that we close the loop (and the cynical among you will appreciate the sense in which “close the loop” can be taken literally here) by summarizing Goldman’s take.

Generally speaking, the bank was spot-on in their dot prediction, but they do note that “the 11-6 majority expecting no hikes in 2019 was slightly stronger than we expected.”

They’ve pushed out their call for the next hike to Q1 2020 and, somewhat amusingly, the bank still sees “a strong possibility” of another hike in 2021 assuming “the economy sticks to its usual pattern during expansions of above-trend growth and a falling unemployment rate, assuming core inflation is somewhat above 2%.”

Goldman’s call on what the Fed would announce on the balance sheet was similarly spot-on, but they do note (as did we on Wednesday) that the taper announcement was something of a surprise. As far as the actual ramifications, the bank writes that “the effect of the taper will be fairly limited”, adding that they “estimate that lowering the UST cap from $30bn to $15bn for the five months from May to September will reduce total UST runoff by about $43bn.”

Although the operational details on the balance sheet plan (and Powell’s remarks during the presser) stopped short of tipping an all-out effort to shorten WAM (in the interest of freeing up room for another Operation Twist later), Goldman notes that mechanically, investing maturing MBS in proportion to Treasury securities outstanding (as detailed in the “plan”) “instead of in proportion to new auctions excluding bills implies a somewhat shorter average maturity for the Fed’s future Treasury security purchases (69 months vs. 83 months currently), and likely hints at a further and more material shortening down the road.” Don’t sleep on that, it’s important.

While Goldman has reduced its subjective probabilities for a rate hike in 2019, they have not increased their probabilities around a rate cut. “Our high-frequency US and global growth tracking estimates have firmed up, and [Wednesday’s] meeting reinforced our sense that Fed officials share our view that downside risks have receded somewhat and are less severe than market pricing suggests”, the bank swears.

(Goldman)

This is another one of those times when we would implore you to temper your cynicism by asking yourself this: “What did you expect?” Sure, there will be some disagreements about where things go from here and some desks will be more prone to bearish takes and witty sarcasm than others, but generally speaking, you can’t expect anyone to say something like: “Well, it looks like rate cuts are coming in H2 because the White House’s economic projections are hopelessly optimistic and if you torture the data enough, you can surely conjure a scenario where the US economy tips over and careens into a recession sooner than anyone expects.”

As “honest” a take as something along those lines might be, making a habit of acting surprised that the Street doesn’t offer up dour projections for the sake of conjuring dour projections serves no purpose. These takes just are what they are – read them, take them with a grain of salt, and go on about your business.

That said, Nomura’s Charlie McElligott isn’t one to shy away from telling you what he really thinks, which perhaps explains why he’s developed a dedicated, loyal “cult following” (to quote Bloomberg).

Earlier, we brought you the “rant” section from his Fed postmortem, but lest you should think he didn’t channel his inner “philosopher / pseudo-economist” (apparently, Charlie has a philosophizing economist doppelgänger who, quote, resides “deep inside of him”), we thought it was well worth highlighting a couple of additional points from his Thursday note, which contains a variety of hashtags and “Wu-Tang references”.

Following his “rant”, McElligott gets down to what he calls some “#REALTALK” and again, this emanates “from philosopher / pseudo-economist” Charlie.

“Low interest rates are (ultimately) deflationary, sustaining zombie-firms in a ‘liquidity-trap’ which weigh on overall economic performance while also weakening investment”, he writes, adding that low interest rates and QE are also deflationary “as you incentivize mal-investment and blow perpetual speculative-asset bubbles, which (ultimately) correct and drive deleveraging–thus the ‘balance sheet recession'”.

All of that is of course true and we’ve covered the whole “why QE is paradoxically deflationary” story in multiple “zombie” posts over the years. Here’s a tantalizing visual, for instance:

(BofAML)

That should tempt to you read more in the linked posts below.

Read more on “zombies”

‘Superfirms’ And ‘The Rise Of The Zombies’

‘After A Decade’: With Central Banks At The Crossroads, A Look Back And Ahead

Rise And Fall Of The ‘Zombies’

As far as the perpetual bubble dynamic, that too is something we’ve spent a ton of time on, most poignantly in “The Spiral: ‘History Repeats Itself And The Price Is Higher Each Time’”. Here’s an excerpt from that post:

The vestiges of crises past always linger — creative destruction isn’t a viable option in the modern world. Again, that means that by definition, future crises will be i) inextricably linked to their predecessors, and ii) more spectacular than those that came before. That second point (i.e. the idea of rolling boom-bust cycles that snowball with each turn) means that policy responses will need to grow in magnitude over time to keep pace with ever larger busts. Eventually, the busts become so large that the policy responses required to combat them become caricatures of themselves that border on absurdity.

And here’s the “spiral” visual:

(Deutsche Bank)

Getting back to McElligott, he writes that now, the Fed is “stuck on this hamster wheel because neither markets nor the economy apparently can withstand a rising interest rate environment.”

He then drives the point home by referencing Europe and, of course, Japan, before delivering a rather harsh assessment on the Fed’s inflation rethink, again channeling “philosopher / pseudo-economist” Charlie towards the end. To wit (hashtags and all-caps verbatim):

Realistically in the near-term, the Fed’s now singular “inflation” mandate will allow them to posture in pursuit of reflationary policies, which should then provide near-term upside for inflation-sensitive assets, especially as policy-rate cuts and bond purchases are now implicitly the next move from here.  Powell yesterday: “If inflation expectations are below 2 percent, they’re always going to be pulling inflation down and we’re going to be paddling upstream…’’ (to keep prices up).

But I’ve got news for you, Chair Powell.  The Fed hasn’t hit 2 percent inflation on a sustained basis since formally adopting that objective in 2012.  IT AIN’T COMIN’ IF YOU ‘PRICE-TARGET’ OR ‘AVERAGE’ TO ATTEMPT AND ‘RUN HOT’ EITHER, CHIEF.

Long-term ‘inflation expectations’ will never truly be move higher without full-scale fiscal stimulus (or the future-state of outright ‘helicopter drops,’ shudder)…because debt, disruption and demographic forces are too strong.  #BUYBONDS and #PASSOUT

All of that said, greed is a powerful thing, especially as it manifests in markets via FOMO, which is why, at least in the near-term, any softness in equities (due to, for instance, all of the flows-based/supply-demand-based dynamics that comprise McElligott’s “March surprise” thesis or else due to the dreaded “dovishness confirmed the slowdown” theme) could prove fleeting.

And on that note, we’ll just leave you with Charlie’s “however” caveat…

HOWEVER, I personally don’t think this current softness in the Equities response will last beyond a patch (ex some disastrous BREXIT / China Trade outcomes), because investors are greedy and will always be lured by the Siren Song of easy liquidity / low vol / carry environments.  As repeatedly stated, many in the leveraged space have significantly lagged on this YTD Equities move and will look to “take up nets / grosses” and deploy into this.