via pentoport:
Investors are experiencing huge moves in commodities, currencies, equities and in sovereign debt across the globe. And now the fall has arrived. Expect the volatility currently witnessed in markets to only surge.
This is because global central banks have overwhelmingly turned hawkish in a vain attempt to gradually let the air out of the massive bubbles they have spent the last decade recreating. Unfortunately, that is not the nature of asset bubbles—they don’t end with a whimper–and they are about to burst in violent fashion.
First off, our central bank hiked rates for the 8th time since December 2015 at the September FOMC meeting. While the Fed did remove the word accommodative from its policy statement, it also raised the neutral rate to 3%, from 2.9% on the Fed Funds Rate. And, most importantly, predicted it would stay above that neutral rate for two years—keeping it at the 3.4% level. It also indicated that December would be the next rate hike and that three more hikes are on the agenda for 2019.
Nevertheless, the Fed is now caught in a hydraulic press of its own making; and is completely unaware of the predicament it is in. An inflation rate of 2% has been its goal for the past decade. And now inflation, when measured by core CPI, is up 2.2% y/y and is up 2.7% y/y on the headline rate. Even though the Fed emphasizes the Personal Consumption Expenditure inflation rate rather than Consumer Price Inflation, it is still aware that inflation is rising above its target.
Therefore, its own inflation models—however irrelevant and useless they may be—are compelling the Fed to keep on raising rates. But because inflation is a lagging indicator, the Fed will keep on hiking rates until the next economic downturn is well underway. However, since asset bubbles and debt levels have never been more disconnected from reality, the next economic downturn should quickly morph into a depression rather than just a normal recession.
The sad truth is that the global economy has become so unstable due to a humongous level of debt (up over 40% since 2008) that there is no R*, or neutral rate for the Fed to reach. One of the fatuous goals of central banks is to place interest rates at a level that is neither stimulative to inflation or a depressant to job growth—the real interest rate where the economy is at an equilibrium. The only problem with this exercise is that the Fed has no idea what level this R* rate should be. Only a free-floating and market-based interest rate can accomplish this task. For a central bank to usurp this process is both futile and dangerous.
But the Fed has already hiked to the point in which the global economy has started to falter. The discrepancy between U.S. interest rates and those of foreign markets has put upward pressure on the dollar and is putting debt service payments on the $11 trillion of dollar-based foreign loans under extreme pressure.
The current chaos in Emerging Markets would have started years ago if it were not for the Bank of Japan and the European Central bank’s massive ventures into money printing. The Fed’s ending of QE back in October of 2014 was merely offset by those other central banks’ purchases. Thus, delaying the deflationary impact of reverse QE.
However, the pace of global QE is crashing from a peak of $180 billion per month during 2017, to $0 by the end of this year. Also, 14 of the most important global central banks are in a rate hiking mode, while only 5 currently hold a dovish monetary policy stance. This means the gargantuan pile of $250 trillion worth of global debt, which is up $70 trillion since 2007, along with the surging level of annual deficits, to a great degree must now stand on its own. In other words, the private sector must step in to supplant government purchases or interest rates will simply skyrocket.
The amount of Publicly Traded Debt in the U.S. at the start of the Great Recession in December 2007 was $5.1 trillion dollars; and the Fed’s balance sheet totaled around $800 billion. That amount of Treasury issuance has now surged to $15.8 trillion today (not counting intra-governmental debt). And yet, the Fed’s balance sheet now totals $4.2 trillion. Therefore, that $4.2 trillion worth of Fed assets—an increase of $3.4 trillion–is trying to support nearly $16 trillion of publicly traded debt–an increase of 10.7 trillion!
Not only this, but the fed is no longer buying any of our deficits, which have surged 33% y/y. And in fiscal 2019 (starting this October) will total well over $1 trillion per year. Indeed, rather than buying all of the annual deficits, as it did during the QE periods, the Fed is adding to the deficit by selling $600 billion of debt per year as part of its reverse QE process. When you add $50 billion per month of QT to the four rates hikes per annum you end up with an extremely hawkish Federal Reserve.
Meanwhile, central banks will keep on hiking rates until asset prices and economic growth come crashing down around the globe. The truth is the global economy has become one giant central bank shell game; consisting of perpetually rising asset prices that have been supported by consistently falling interest rates. Interest rates that hover around zero percent have become mandatory to support surging debt loads. Now that QE is ending and interest rates are rising, the whole artificial construct has started to implode.
It is now very likely that the NYSE will suffer through one or more of what is known as circuit breaker days. The NYSE rule 80B, stipulates that there will be a 15 minute pause if the market falls by 7%. It will then reopen until the market drops by a total of 13%; in that case it will shut down for another 15 minutes. And then, if the market drops by a total of 20% intraday, it will close for the remainder of that day.
With trillions of investment dollars being moved from the active management style of investing to the passive and indexed ETF variety over the past few years, there is virtually nothing to offset the avalanche of sell orders and plunging stock prices once the panic begins. Time is running out to garner an active strategy that hedges your investments and seeks to protect your wealth from the coming deflationary wipeout.
Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”, is Host of The Pentonomics Program and Author of the book “The Coming Bond Market Collapse”.
Lessons from Lehman 10 Years After Failing
September 24th, 2018
Global financial services firm Lehman Brother’s stock was in free-fall during the first week of September 2008. After making huge bets in the mortgage securities space, Lehman’s President Dick Fuld feared bankruptcy and frantically sought out a buyer. The company was hopeful to strike a weekend deal with either Barclays PLC or Bank of America.
Nevertheless, Lehman’s outsized investments in the mortgage market ultimately proved them too risky a partner for anyone; and the giant investment bank went belly-up on September 15th. Prior to this event, Lehman had reported record earnings every year from 2005 to 2007. The Street believed the company to be infallible. Analysts held on to hope until the bitter end. Their mantra went something like this, “nothing to see here, this is a small correction in a small section of the housing market that has little effect on the overall economy.”
But it wasn’t the first time that year that analysts got it wrong. The Wall Street perma-bulls also missed the eleventh-hour fire sale of Bear Sterns to JP Morgan for $2 a share. Five days before the sale, a CNBC host who loves to play with buttons fervently advised a viewer to leave his money in the firm, insisting it would be silly to make a sale at current values. However, less than a week later it lost $60 per share!
The Lehman case became the largest bankruptcy filing in history, surpassing other bankrupt giants such as WorldCom and Enron. Markets were panicked. The following day, September 16th, AIG called then-Fed Chairman Ben Bernanke asking for an $85 billion dollar bailout. For years AIG had collected premiums on Credit Default Swaps (CDS), which are basically insurance policies on debt. All three credit rating agencies, which had rubber stamped all new debt issuances as AAA for years, finally downgraded AIG to AA-, immediately triggering a collateral call of $32 billion dollars. In just one day AIG was basically insolvent. AIG had written CDS contracts on $500 billion in assets, $78 billion of these were on residential and commercial mortgages and home equity loans. Remember, the same types of loans Wall Street and the Fed assured investors were rock solid.
And this was Tuesday; the week had just begun…
September of 2008 was perhaps the most eventful month in Wall Street’s history. On September 21st Goldman Sachs and Morgan Stanley, the last two independent investment banks, become bank holding companies, so they could compete for deposits with commercial banks and better ensure their solvency.
On September 25th a group of Washington Mutual Bank executives boarded a plane to Seattle. Upon de-boarded, they discovered that the Fed had seized their bank assets and sold them to JPMorgan Chase; marking it the biggest U.S. bank failure in history.
And then, of course, Congress got in on the fun rejecting a $700 billion Wall Street financial rescue package known as the Troubled Asset Relief Program, or TARP, on September 29th ; before accepting it on October 3rd.
Also occurring in that infamous month of September 2008 was the placing into conservatorship of both Fannie Mae and Freddie Mac; those two giant government sponsored enterprises that would have gone bankrupt without a taxpayer bailout.
The problems didn’t end with September. October saw Wells Fargo, the biggest U.S. bank on the West Coast, squeeze out Citi Group to buy floundering Wachovia for about $14.8 billion dollars. And it was a good thing Citi wasn’t successful in their acquisition because in November the Treasury Department, Federal Reserve, and Federal Deposit Insurance Corp., all had to come up with a plan to rescue Citigroup. Citi issued preferred shares to the Treasury and FDIC in exchange for protection against losses on $306 billion of securities it held.
When the dust settled, the government exited the mergers and acquisitions business and did what it does best–namely, create a scheme to monetize debt and re-inflate asset prices. The first round of Quantitative Easing–a form of government-sponsored counterfeiting–was announced on November 25, 2008.
It’s important to remember that while this major crisis was brewing the Fed saw nothing on the horizon. Then Fed Chair Ben Bernanke saw no bubbles or risk for the broader economy, even as subprime mortgages started to collapse. Janet Yellen, Bernanke’s successor as Fed Chair, made this infamous quote regarding the real estate sector in September 2006, “Of course, housing is a relatively small sector of the economy, and its decline should be self-correcting.”
Fast forward to today, Wall Street and the Fed are busy assuring us there are no bubbles out there at all. And, even if one does exists, it poses no threat to the overall economy whatsoever. They want you to ignore the doubing of the National Debt since Lehman failed. Don’t worry about an annual deficit of $1 trillion either; which is projected to only surge “big league” from its current level of over 5% of GDP. Never mind stock prices that are 1.5x the underlying economy—a valuation so high that it has never been witnessed before. A doubling of corporate debt to a record 45% of GDP isn’t a concern either—even when considering the quality of that debt is at a record low. And, having trillions of dollars worth of sovereing debt with a negative yield is just par for the course…or so they insist.
At least that is their public spin. However, the Fed recently found it necessary to telegraph to certain insiders within the Main Stream Financial Media what it would do during the next financial crisis. Here is the plan: It has pledged to act early and forcefully once the next crisis becomes manifest. The Fed will also publicly promise to do whatever it takes to fight deflation and tumbling asset prices and rising unemployment rates immediately—there will be no scaling into the next fight. Finally, our government will not delay or tinker around the edges when it comes to passing the next fiscal stimulus. It seems both parties have agreed that a massive tax cutting and infrastructure package would need to be enacted very quickly once the next recession arrives.
Of course, our government will have to recognize a crisis exists in the first place, which given the historical record, won’t be until the markets are in absolute free fall. But assuming they do eventually arrive on the scene, those are the things it would try to do “better”. This is crucial to understand if you want to make the most prudent investment decisions going forward. This is because the changes to economic growth and with the inflation/deflation dynamic are going to be unprecedented in scope and in magnitude. If investors are not modeling those changes they will be blindsided. Prepare now while you still have a chance!
Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check”, is Host of The Pentonomics Program and Author of the book “The Coming Bond Market Collapse”.