R** And The Funniest Thing You’ll Read All Week
The topic du jour across markets and macro in October is the "breakage" discussion. Posed as a question, it's: "How long before Fed hikes break something?"
The answer, I've suggested, is that they've already broken something. Several things, in fact. The yen, to name one. And gilts to name another. There will be more casualties before this tightening cycle is complete. The US economy may be among the wounded, if not the deceased.
Everyone is talking about this, and I don't just mean sell-side
At the risk of sounding too pedestrian, “that is not how this works; that’s not how any of this works!”
Maybe economists should spend more time with the risk people in banks, market makers, pension funds, insurers, bond shops, options traders, hedge funds, asking “what actually happens to your book if rates go to X? to Y? And why, how, when?” Would likely be more productive than inventing stylized models of a household-and-widget economy that only exists in their heads.
More generally, as the economy that economists are supposed to understand becomes increasingly financialized, the critical mechanisms and linkages are less about households and widgets and more about leverage and derivatives, which most economists don’t seem to know much about.
jyl: Hear, hear. I risk some credibility when I say this, but I have never met an economist that understood the real world, how people and businesses actually behave. The thing is an economist can now earn a Nobel Prize, therefore economics is a science, therefore it must have quantitative models it can use in research, therefore … Real life can’t really fit these models because they aggregate the behavior of billions of individuals and businesses, small and large. The models just don’t get the “color” aspect of the game. I get the same feeling when I hear Powell and his cronies talk about us and what will happen to millions of us, as I had when I listened to generals talking about the daily details of the Korean War and the Vietnam War and they told us how many deaths were “acceptable.” Acceptable to whom? None of those guys was on the front lines seeing which actual guys were part of the acceptable loss group. I get my house cleaned by individuals who may well not have a job soon because they fall into that “acceptable pain” group that will arise as Powell attempts to channel Volcker. There won’t even be a memorial for these people. I provide support to my local food bank that distributed 50 mil pounds of food last year in its service area, 25 pounds for every man, woman, and child in the area … you know, part of the collateral damage the economists just can’t worry about. I’ll keep sending them as much as I can afford.
Yes, I fear that too much academic economics is of the “let us define the behavioral sets of X sub i and Y sub j such that the transitive property of their intersections blah blah” variety, which seems profound and rigorous to economists but looks infantile to the mathematicians that they are pretending to be and utterly addled to the business operators, traders, bankers, etc who they need to understand.
Ask a mathematician “What does two plus two equal” and the mathematician will say “Four.”
Then ask an accountant the same question and they will say “On average, four – give or take ten percent, but on average, four.”
Then ask an economist the same question and they will say “What would you like it to equal?”
Anyway, back to the topic of breakage – I remain convinced that the Fed will not stop to avoid breaking something they can’t easily fix, they will stop when they break something they can’t easily fix.
I don’t have an opinion about whether that happens before they slow the economy “enough”. Economic slowdown may be another of those “first gradually, then suddenly” things.
For now, best to assume tightening continues unrelenting, and not get excited by “pivot” talk. That ain’t happening.
Look at Brainard’s comments today – despite all her dovish-tinged caution, she still says she’d keep tightening (to her target level) until problems emerge (and she’ll watch carefully for those problems), which is different from saying she would try to predict the tightening level that will trigger problems (and stop short of that).
In other worlds, another variant of “tighten until something starts to break” (or reach target FF, or inflation caves).
The interesting thing is, I have to think that the Fed is in fact watching spreads and liquidity and CDS and other financial datapoints, in addition to real economy data points, very very carefully. The FOMC has a small army of analysts, who can get access to most data including internal and confidential (I’ve mentioned this before, but when I covered UPS they were sharing their internal shipment data with the Fed).
The British pension funds were telling the BOE weeks before the crisis that they were going to blow up (which gave the BOE time to prepare), and large US institutions should have similar channels to communicate with the Fed. Surely Jamie Dimon can pick up the phone and reach some New York Fed staffer within minutes.
If that is true, tough Fedspeak could indicate that there are in fact not yet major cracks starting to appear in places that we don’t see. (And, of course, that the Fed is just not that moved by crises in other countries, so long as they are manageable by the local CB.)
While I realize this isn’t the type of report that “sells,” it’s absolutely my favorite.
In 2020 we learned that supply chain robustness was actually a desirable thing–and we had allowed the global system to move away from it. Even earlier, we had learned (but didn’t act on) the idea that the banking system, and the financial system as a whole, needed to be robust–and that what we have is not robust. We should not need to make policy decisions based on “unknown unknown” financial derivative landmines that might be out there. Privatized reward based on socialized risk does not make for a good society. Elizabeth Warren gets mocked these days, but she was on the right path when she campaigned for making banking boring again.
+1
joey. Wow, great comment. “streamlining the supply chain made money in the short run, but exposed us all to enormous risks arising from disruptions. We watched Lehman die and never put two and two together there, either.
“The objective of the bank is to make money and exit without going to jail.”
Might be the most succinct quote on what Wall Street does that I’ve ever read.
Applies to politics as well.
Most conversation these days appears to focus on the final destination, as in interest rates. My takeaway from reading H for quite awhile is that the rate of travel is every bit as important. It appears that Powell is hell bent on getting to his approximately 2% target as quickly as possible and therein lies a big problem for financial markets.
Great article, great commentary. There are many secret societies in America, and finance is one of them. I am more interested in knowing what is, and maybe even what will be, than I am in exhausting arguments about what should be with folks who don’t know what they don’t know…
How do you pronounce r**?
Every’s last sentence got my attention.
“ The post-80s experiment of one central bank rate to allocate capital where markets most want it to go is as much as an aberration to long-run norms as free trade is to the mercantilism that preceded it, and will likely succeed it.”
Math guys and economists tend to say R* is r-star and R** is r-double star
Every’s grasp of history is routinely / reliably impressive, but what stood out about his critique here is the craftsmanship of the satire, and the hilarity of the subtle punchlines. “I don’t own any banks myself…” is the best example. To me (i.e., someone who loves subtle humor) that’s just pure gold.