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On My Radar: Inside the Fed – Richard Fisher

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June 11, 2021
By Steve Blumenthal

“If it is not transitory, and I hope it is,
then the weed of inflation grows and kills the garden.”

– Richard Fisher,
Former President and CEO of the Federal Reserve Bank of Dallas

“The weed of inflation.” Love the analogy. And the topic of inflation was at the heart of most discussions at the Mauldin Economics SIC2021. Grateful for the talent, insights, depth of thinking, and debates I watched live and replayed… But I have to admit, I’m replayed out. It’s time, after today, to move on.

What I’ve been after is a better understanding of how we get out of the debt and underfunded pension mess and probable government and Fed policy responses.

Because we sit at zero-bound interest rates and high valuations, inflation plays the biggest role in determining what the future holds. It is the weed that kills the garden. Or in this case, calls the Fed to task. Depending on how you are positioned, the outcome matters to your wealth — to the good and to the bad.

Don’t Fight the Fed is a truism. The data supports this view. Each week, I look at Ned Davis Research’s “Don’t Fight the Tape or the Fed” chart. Essentially, it looks at the trend in the equity market and the direction of Fed policy. The current reading is a neutral score of zero. When it hits a positive max score of +2, the S&P 500 Index has gained 33.66% per year. That has happened 11.17% of the time since 1980. The market did well when readings were +1. Neutral readings produced a 6.87% gain per annum. Not awful. Such readings occurred 31.86% of the time since 1980. It’s the -2 we’ve got to watch out for: -32.04% per annum. The good news is occurrences are infrequent, happening just 5.75% of the time since 1980.

Understanding the players at the table is helpful in shaping forward probabilities and that is why I’m following last week’s OMR William White notes with Danielle DiMartino Booth’s conversation with Richard Fisher this week.

Why Richard Fisher Matters

Richard Fisher is the former president and CEO of the Federal Reserve Bank of Dallas, having served in that post from April 2005 to 2015. He is a senior advisor to Barclays Plc, a British bank holding company, a director of PepsiCo, and a senior contributing editor for CNBC. From 2011 to 2017, he served on the Harvard Board of Overseers.

In his earlier years, he worked for Brown Brothers Harriman & Co., a New York City investment bank specializing in fixed income and foreign exchange markets. From 1978 to 1979, he served as Special Assistant to Secretary W. Michael Blumenthal at the United States Department of the Treasury, where he worked on issues related to the dollar crisis. Returning to Brown Brothers, he established and managed the bank’s Dallas-based Texas operations. He then left in 1987 and established Fisher Capital Management, and a separate funds-management firm, Fisher Ewing Partners, and managed both firms until 1997.

Grab that coffee and find your favorite chair. Let’s do one last dive into the conference as I share my high-level notes from Danielle DiMartino Booth’s interview with her former boss and mentor Richard Fisher.

  • Richard Fisher
  • SIC2021 Concluding Thoughts
  • Trade Signals – Inflation Concerns Persist; S&P 500 Approaches Record High
  • Personal Section – Golf at Whistling Straits and New York City

Richard Fisher

I’m going to do my best to focus just on what I found to be the most helpful insights. If you’d like to access the replay (and all of the conference presentation replays) you can do so here. I would replay the session on my way to and from work, while taking a walk, while hitting golf balls on the range, and again while sitting in my office.

John introduced both Danielle and Richard saying, “Richard Fisher is my favorite central banker of all time.” No small statement.

Danielle sat right next to him for a decade. She is author of an outstanding book titled Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America. It’s well worth the read.

My takeaways are in bullet-point format below. They include my comments, as well as quotes from the interview. My goal is to understand the players, their environment, and how they are likely to respond. It’s getting dicey… the Fed is “stuck between a rock and a hard place.” Any bold emphasis is mine… Here we go:

  • Fisher told Danielle a number of years ago, “Danielle, I want you to follow one person who remains. One man, one man who’s pushing to stop reinvestment. One man who is dead set on normalizing the Fed funds rate. One man who is equally resolute about shrinking the balance sheet. He’s the last man standing. His name is Jay Powell.” He said, “Take me for my word, pay attention to Powell.”
  • Booth: In October of 2012, Powell famously said, “Quantitative easing has the risk of inflating a duration bubble across the entire credit spectrum.” At that same meeting, you raised the issue that the Fed owned almost 40% of the mortgage-backed securities market, that triple-C bonds were flashing a big, big red light. And that inflation targeting the verbiage that was being used at the time was going to box in the Fed.
  • Powell was worried that by having done what we did: we took rates to zero in ’08, we hammered down the yield curve, that we were continuing the process with rounds of QE.

Fisher: I voted against QE3 and was silently supported by Jeremy Stein (because Fed Governors don’t vote and don’t dissent). Our message was, basically, be aware because you’re painting yourself into a corner that’ll be very difficult to get out of.

  • Then we had the taper tantrum of 2013, which I think still is a deep scar infecting the methodologies of the existing Open Market Committee, because that was very painful, but it just underscored the point that we had inflated the markets.
  • We had this great debate in early 2009, before Jay Powell got there (to the Fed), which was, the math is simple: We took rates to zero, but we started QE1. We expanded the balance sheet to a trillion one quarter billion [dollars] and the market bottomed it’s 666 on the S&P (March 6, 2009). What I called at the table, the Book of Revelations moment, the devil’s number.

Ben Bernanke summarized it well by saying, “Richard, the math is simple. You do what we did and an investor can discount the present value of future cash flows literally to infinity, that’s the math.” 

  • And what happened, we reached that balance sheet number that I just gave you, I believe on the last week in February 26th or 28th [2009], and then on the first week of March, the market turned and there was a lot of, “This is great stuff.”
  • We kept reminding them that there would be a by-product here and the by-product would be, the rich and the quick would benefit, people like the attendees at this conference, people like us would be able to benefit from this.
  • That firms would take advantage and rebalance their balance sheets, buy in their shares, earnings were not increasing at the rate people wanted, so their earnings per share because revenue wasn’t growing, they could manipulate this and profit from it, that would be good.
  • And corporation could push out their debt durations, et cetera.

But it would also lead to political actions because the hardworking men and women who make money off the sweat of their brow would not see the returns that the rich and the quick would see.

That’s where we are now, that’s the big argument that’s taking place. Now, Congress is deeply involved after taking away all our 13-3 powers after 2008, 2009, because the extreme right and Bernie Sanders on the left wanted to take away our powers.

  • Now, they’ve added even more powers to the Fed to help monetize their fiscal largesse.
  • Talking about painting yourself into the corner, how do you get out now without bringing a downfall in markets at this delicate moment of the economy screamingly roaring back?

How long does this go on? That’s the question.

  • Jay Powell understands credit markets. He started out that way in his early career, he does not have a Ph.D. in economics, which Fisher believes is a positive.
  • The only Fed chairman that didn’t have a Ph.D. in economics was Paul Volcker, who also came up through the credit markets. He understands the credit markets. He’s not an academic, but…
  • Powell is surrounded by the Board of Governors, who are well-educated deep thinkers with MIT Ph.D.s. Fisher believes Powell or anyone in that position can be taken in by the staff.
  • It is important to have someone to encourage him to trust his instincts, given his strengths. Fisher is not sure Powell has that right now.

The key official at the table is the person running the New York Fed: John Williams.

  • Fisher doesn’t believe he informs the Chair to the degree that Powell needs on what’s actually happening in the marketplace.
  • Because of the market’s reaction to the taper tantrum and COVID-19 last March, Fisher said he can understand the hesitation of the Fed to pull back on policy and the Fed’s belief that we do need to accomplish a full recovery before doing so.

However, Fisher believes the staff and people like Charlie Evans and John Williams have set a trap for the FOMC by waiting until they are sure inflation is non-transitory (above 2.5%).

  • Monetary policy can affect markets instantaneously—right or wrong. They can be volatile and react. And there is a long-lag in the feedback. It takes months and even years.
  • The real economy—businesses—are run by women and men, big and small, public and private and they adjust their capex programs, to whatever they need to in a new monetary regime, let’s say raising rates or cutting back on the balance sheet, it takes months and years to do so.

So, there’s a lag as to when monetary policy affects the real economy.

  • Let’s say now under the new decision rule that you decide, “Oh my gosh, this is not transitory.” It’s not just coming off a low base, it has now become part of the psyche of consumers and investors.

And then the Fed decides to start gently reducing its expansive monetary policy (such as bond purchases at $120 billion per month) and/or by tightening (raising) interest rates.

  • By going slow, you might just make the (inflation) problem even worse because you’re late.
  • It takes time to work its way into the economy.
  • “If it is not transitory, and I hope it is, then the weed of inflation grows and kills the garden.”

That is the risk position the Fed has put themselves in. This is what Jay Powell must deal with now. Powell and the Fed are in a different position.

On political pressure:

  • We all know monetary policy is a very blunt tool. I do see Powell resisting that, but the politics now have gotten a lot tougher, that they don’t just want full employment, they want to make sure that certain ethnic groups, racial groups, et cetera, are specifically targeted.
  • There’s very little that monetary policy can or should do to affect that outcome.
  • Right now, the politics are severe. We know how harsh Washington, DC is.

And people are coming to view them as doing two things. One is providing a Powell Put, which I would hope is not the case, and the other is monetizing the debt.

  • And we did buy all the Obama period debt that was put out there.
  • So, now the question is, does this broach the Modern Monetary Theory, which to me is not modern nor theory, or actually monetary, but it puts the Fed in a very difficult position.

One last comment here, Jay is different than his immediate two predecessors. Ben was a shy, deep-thinking man. He was very uncomfortable going to Capitol Hill. And remember he was under criticism of what we were doing in ’08, ’09. You could just see him sweat bullets when he had to go up to testify. A sweet, shy man. Janet is a labor economist. She was comfortable probably with six or seven Democrat leaders on the Hill. She very rarely visited with Republicans.

  • Powell is comfortable on both sides of the aisle. He has a good background from when he was at the think tank from when he was working with them, advising them. And I think sometimes he’s viewed as being too politically savvy and therefore compliant.
  • I don’t think that’s the case, but I do think he gets a bad rap because both sides of the aisle feel comfortable with him.

With Janet Yellen now the head of the Treasury, Fisher said to be careful not to tie Yellen and Powell together. He believes that is a false impression.

  • However, he does think there is an expectation in the marketplace for a “Powell put.” [SB here: the Fed preventing the market from declining more than. Say, 20%.]
  • And how you get away from that? The answer is very slowly and over time.

Market operators, many of whom weren’t in the markets in 2008—certainly not in 1987, certainly not in 1974—think it is a one-way street. That leads to excess:

  • Look at the narrow spreads right now, on junk versus quality.
  • Look at the multiples being paid for equities.
  • So, this expectation is there.

Once you build it into the system, it’s very hard to undo. There is pressure within the FOMC to start thinking-about how it articulates the need to eventually slow down the growth in the Fed’s balance sheet, and to cut back on its accommodation.

  • But there is a little rebellion taking place within the FOMC as we speak. I know that for a fact.

Notable comments:

On mortgage purchases:

  • Stepping into the mortgage backs was supposed to be a temporary phenomenon. That’s how it was sold to us by Bill Dudley. Now it’s a third of all mortgage backs are held at the Federal Reserve.
  • It takes a while for academics, I think, to fully grasp what happens in markets.
  • And I worry that there are very few supply-side economists in the Fed.
  • There are very few people at the FOMC who’ve ever been in a company who understand how long it takes to land capex or to react to inflationary pressures on the tin market, or the wheat markets or labor markets or whatever it may be.

And that lack of how businesses actually operate, I think is a drawback as to how monetary policy is played. [SB here: There it is!]

Booth asked, “Do you think that we see negative interest rates?”

  • They’ve been a miserable failure in the European community, and they haven’t worked in Japan or other places.
  • The destruction that would be done to the money market funds alone would be enormous.
  • Fisher said, “We have talked about this, I think in my 10 years there, it came up for no more than 10 minutes. Ben threw it out as an academic exercise.”
  • So, the Fed knows it hasn’t worked. First of all, it’s done enormous damage to the European banking system, not just the big guys who did the Landes Banks in Germany and so on. It’s been horribly destructive and they don’t have the sophisticated markets that we do.
  • So, if you add onto that our money market funds and other funds, this won’t work in the United States. It doesn’t do the job and it’s hyper-destructive. Look at the bank index for the European banks. It’s still trading at levels around 2008, 2009, if my memory serves. So, no, I don’t believe they’ll go that way.

Booth asked Fisher about Bitcoin… Do you think we’ll see Fed Coin?

  • We could talk about this for quite a while. The whole effort is to speed up payments. It is a matter of having instantaneous payments. However, if you were to go all the way—the direction that Xi Jinping is going now—all the way to having the equivalent of a crypto Yuan or crypto Renminbi, I don’t believe that’s acceptable in our society.
  • I was talking to John (Mauldin) the other day, just reminding him he knew this, blockchain is just a ledger. It’s a hyper-sophisticated ledger. We’ve gone from double-entry accounting to blockchain. It just allows you to track every transaction.

Theoretically, if the central bank were to adopt a blockchain cryptocurrency, there’d be no need for banks.

  • You could direct credit to any one sector, any one demographic, any single individual you wished. That’s why it is attractive to Xi Jinping. It’s a method of control.
  • The crypto movement was started by libertarians. Conceived as a way to get away from banks and authorities.
  • If a central authority adopts—as Xi Jinping doing in China—a cryptocurrency, that defeats the whole purpose of cryptocurrencies, the original intent, which is an anonymity.

So, I would think the bank lobby would be lobbying strongly against this, ultimately having a central bank cryptocurrency, unless it’s just a form of settlement. And then secondly, the libertarians here, and certainly the conservatives would rebel against it because the way to track who buys a gun, who needs to be penalized, who is at the center, who’s not at the center, who you should give credit to, who you should not give credit to.

  • So, I don’t think there’s much prospect for it, but I do think we’re going to have to figure out a way to accelerate the payment system.

Booth: I have one last question for you. So, Halloween 2018 the debt of General Electric is downgraded on November the 14th, the high yield bond market closed, nothing was issued for 41 record days, the year ended with a bloodbath in the stock market.

  • And a few days after the start of the year, January 4th, we had the Powell Pivot on interest rates (and I got condolence cards from all over the nation and sat there with Kleenex and cried because I had founded the Jay Powell fan club). Fast forward to the end of 2019, having no QE is clearly not working. The banking system is starved for real reserves, for real QE, but you can’t acknowledge that as a central bank because you’re in a healthy economy… but you need a black swan and then they got a black swan.
  • If you had been at the Federal Reserve at the time, would you have advocated for bailing out the corporate bond market?

Fisher: I’ve always been an advocate for price discovery, and I believe the current regime, which started with our emergency actions in ’08, ’09,

  • That not having cut back on them, although Janet tried a little bit, has just completely blocked price discovery.
  • And I also believe it’s the business of risk managers, all of us here in this audience, to assume risk and not to be given a guarantee for a one-way street as I mentioned earlier.
  • So yeah, I would have probably made myself very unpopular.
  • There’s a risk-reward system. We are risk takers as investors and as bankers and as those that push money around. And we have to recognize the fact that there are going to be reversals.
  • If you assume there’s never a reversal, you’re completely quashing price discovery. I would’ve probably been the least popular man, once again, at the table yet at FOMC.

Booth asked, “Do you foresee the Fed canceling for giving a portion of the Treasury debt that it owns?”

  • Fisher answered: No!

How does quantitative easing differ from Modern Monetary Theory, which you have mentioned is not modern or monetary?

Richard Fisher: Yeah. MMT is a complex matter, probably not as simplistic as it’s presented, but still the basic concept here is you can issue all the debt you want and people will take it down.

  • And the central bank could be a central figure in taking down that debt.
  • The ongoing QE of expanding the balance sheet now to approach $8 trillion.
  • Remember it was $800 billion when I came in 2005.
  • Here’s the thing that I worry about again, you have to remember Modern Monetary Theory comes out of an academic in Staten Island and is embraced by some, particularly by the progressives on the political side.
  • And one question is, “How far can you push this? How much can you actually expect the central bank to expand?”
  • I do think we’re in a trap.
  • I shuddered when I heard my dear friend Janet Yellen say the other day, “Well, rates are low, and we just have to finance all we can.” That’s true until you have to refinance it or until the maturities run off.
  • And again, they’re still not issuing the kind of long duration stuff that we all wish they would, a 100-year bond, century bonds for 50-year bonds. The dealers won’t encourage them and they’re just not doing it.
  • And they’re still doing fairly short financings here. Although the 10-year auction was okay, the 30-year auction was a little weak, but still pretty healthy.
  • It’s a trap, because eventually you’re going to end up, as we all know, being stuck with the cost to carry interest payments, as rates rise, that will swamp everything else in the budget, including defense spending—we’ve seen the numbers.
  • So, I think it’s a very dangerous argument to make, unless you go way, way out. I would be in favor of issuing century bonds here. Everybody else has done century bonds, even Mexico. Why can’t we? If I were still in the Fed and we had any power over the treasury, I would be strongly arguing for that because you better do it now, otherwise this will evaporate as we go through time.

Booth: How high of interest rates—and I’m talking about market set—do you think the stock market can tolerate?

  • Fisher: I don’t have the answer but look, for every basis point that I have said the 10-year rises, and recently it settled down a little bit, pops up to 170 then settles down, but remember, it was below 50 basis points in March of 2020.
  • Theoretically and practically, for every basis point, there is an increase on a key marker bond and like that it changes the way you discount the present value of future cash flows.
  • If it’s gradual, it’s like a frog in warm water, you just go to sleep. If it’s sharp and radical, then you have a reaction. So, I don’t think it’s the number itself. I think it’s the speed and the direction and the speed of going in that direction.

Booth: At what point could we see yield curve control?

  • Fisher: Lael Brainard said she believes the Fed does not have most power here to control the yield curve.
  • Markets can shove the 10-year rate around probably to a greater degree than the central bank can control.
  • So question, how big would the balance sheet have to be in order to have your curve control and where would it have the control? How far out on duration would it have control?
  • I don’t think the balance sheet is large enough to achieve control to a degree that the markets can’t tug on their tail and set the rate.

Booth: What are the FOMC views on cryptocurrencies?

  • Fisher: I don’t know if it’s viewing cryptocurrencies other than as a sign of speculation. We’ve seen some bank presidents talk about that.
  • It’s going to be interesting to watch how the regulators—whether it’s the Fed or anybody else—come down on cryptocurrencies.
  • Certainly interesting to watch how the IRS goes after cryptos. Just today, they were able to shut down the bad guys in Russia and have them pledge. If you saw the news recently, a couple of hours ago to give the money back on the pipeline and to others that they had been holding a ransom. How did they get all that information on that hacker? We know, to me that undermines confidence and the confidentiality in the process. And I would imagine there are some on the FOMC like me who consider it an interesting speculative tool, but probably worry about it because of that and the excess price and volatility that we’ve seen.
  • So, I don’t know how they’re thinking about it. I do want to repeat that you’re always looking for a way to speed up the settlement system and to move payments faster. So, they’re talking probably in that sense about this.

Booth: Lot of questions coming in about your view on the dollar.

  • Richard Fisher: Compared to what?
  • Look, the only other deep pool of capital is a Euro. You have to remember Germany was going into recession before the pandemic. They’ve now gotten rid of what was a sacred German ethic, which was running budget surpluses. Europe has done a miserable job in terms of vaccination. Their banking system is in terrible shape, undermined by negative interest rates.
  • So, compared to what? The only other alternative in size, you can play the Australian dollar, the Canadian dollar, and Japanese Yen on a trade basis. But in terms of fundamental holdings?
  • We learned a lesson. In March of 2020, I had just landed in Australia on behalf of Barclays to meet with the big banks down there and the big miners on the first week of March. And I remember the driver who picked us up said, “Mr. Fisher, there are two things that are being hoarded right now: toilet paper and US Treasurys.”
  • Then I went into the meetings and it was clear the banks and the mining companies out west that I met with C-suites were trying to get every Treasury, whatever duration they could get their hands on.
  • You have to ask yourself compared to what we’re getting away with—bad budgetary policy, excess monetary accommodation—and yet the dollar hasn’t weakened dramatically except from that artificial high, in my view in March of 2020, keeps pumping on testing 90 on the DXY and then pops a little bit back up. And that’s where it is today, I think as I speak.

[SB here: Druckenmiller has a different view, as I wrote a few weeks ago and share again below. Keep an eye on the technical.]

Booth: So, the final subject is China.

  • Fisher: Ahh, China.
  • You know that I’ve been there since 1948, even though I was born in 1949. I was conceived in Shanghai and fortunately delivered six months later in Los Angeles after my family was kicked out of Shanghai.
  • And when I was negotiating with Madam Wu Yi and Charlene Barshefsky and I was negotiating, she’d always say she was the deputy premier by the way, “I want Ambassador Fisher to sit to my right because he was manufactured in China.” So, that became the big joke, I was made in China.

This is the battle of our time, two diametrically opposed systems. One is control and definitely Chinese communism. The other is our spastic, free, oddball, market-driven, capitalism of democratic society that we have. And the real issue is, who’s going to win?

  • Obviously cyber tools have given potential to perfect Xi Jinping’s vision. You can allocate credit, you can use that to have enormous influence around the world.
  • The average state-owned company (state-owned enterprise) the SOE and China now has on average 15,000 subsidiaries all across the world.
  • Some of them we don’t even know they’re subsidiaries until you dig deeply into them. This allows them to penetrate the system.
  • They’re still working to escape the middle-income trap.
  • Don’t get caught up that we’re their number one enemy, we’re not.
  • The ones they want to show they can outperform are Japan and South Korea. They escaped the middle income trap in the old days pre-technology and China has yet to do that. They’re on the verge of doing it. They will use artificial intelligence, 5G, 6G, IP, AI, all the initials I can throw out at you to get that done.
  • And they get to skip a whole generation. They’re not stuck with copper wires and they’re not stuck with credit cards and they’re skipping a generation of infrastructure.
  • Then Xi Jinping, who’s a brilliant, ruthless leader with a vision for his people has come to realize this. First it was a threat and now it’s a tool and they will continue to press that envelope.

We have to outperform them. And the only way to do it, by the way, is to let our private companies develop the 5G, and the 6G, and AI, and remote operating, and communications and all the things that can be done to add to productivity and encourage them rather than penalize them through tax policy or government intervention.

  • Theirs is a purely communist government-driven solution.
  • We represent the opposite and, Danielle, your brilliant little children, and my grandchildren will be dealing with this as far as the eye can see.
  • But, in my lifetime, we will not see this resolved, whether it’s a Democrat in the White House or a Republican on the White House.
  • This is the battle of our time.
  • And on that note, I’m just going to say have a nice day. John, thank you, Danielle, thank you.

That concludes Richard Fisher discussion. Let me just say this, the bond market is bigger than the Fed. I believe most investors today believe the Fed has our backs. The biggest takeaway from today’s note is they don’t. For a period of time, yes. After that, no. I think we are within a few years of another great learning. This through the eyes of three great insiders: William White, Richard Fisher, and Danielle DiMartino Booth.

In the Personal Section below, you’ll find more links to the conference. Mauldin shared his thoughts and I provide a link to a select few past OMR letters.

SIC2021 Concluding Thoughts

A client asked me about “debt monetization” in response to last weeks On My Radar (William White section). Following is my answer. I then expand my response, attempting to pull together what I believe are the probabilities (“tickets in a fish bowl”) when it comes to what the period head may look like. Of course, I could be wrong.

What Monetize the Debt Means

Debt monetization is the financing of government by the central bank. The Fed prints and buys up the bonds (like we are doing now) and holds them forever and forgives the debt when it matures. The difference now is the Fed says they will sell the bonds and take the money or keep the money when it matures as assets on their books. We are likely headed toward a period in which they buy and buy and buy.

If the Fed buys your bond, you get cash and you do something with it. If the Fed prints money out of the blue and buys your bond, new money is inserted into the system. If the Fed prints and buys government bonds from the Treasury to cover government deficits, more money is going into the system.

What do they do when the bonds mature? Collect money from the Treasury? No, they’ll forgive it. Print, buy, let it evaporate away. They will be the only buyers of U.S. Treasurys.

Debt is a deflationary drag on growth. The question is the balance of all of the newly created money via printing—how it gets into the system, into whose hands within the system, and then the rate of velocity in which it moves within the system. Balancing that is tricky and perhaps impossible. They most likely overshoot (way too much printing, new money pumped into the system) and inflation gets out of the bag.

Today, they own the assets on their books. In the future they will wash the assets off their books. It is for this reason that, in the end (a few years out), we will have inflation. White said that in the near term we have inflation, in the medium term, deflation, in the long term, inflation, and the risk is we jump from first to third (long term) in a blink. Not saying it is probable; just saying it could happen. I think White is right…

My Two Cents

Nothing is perfect, because the system is complex with constantly moving parts (elections and new players here in the U.S. and globally). A big challenge is the gap between the haves and have nots. This flows into our politics and has the potential to affect the macro-economic system, i.e.: the Biden administration’s game plan today. More taxes, regulation, free money, and wealth redistribution. (Not a judgment, just a likelihood—our job is to figure out how this plays out in markets given current starting conditions and properly positioned.)

People who voted for this sort of government were/are pissed. People who voted for Trump-type leadership were/are pissed. The division that exists between us is big. Far right, far left. Less in the center. Economically, I believe higher taxes (we likely get them) and higher regulation will further suppress/depress the heavily indebted system. Thus, the hard landing in 2023–25. People don’t understand macro-economic system dynamics, but they do understand they are disenfranchised.

Politicians don’t understand business or economics; many have never signed a paycheck. Same with Fed Ph.Ds. I think I understand how to coach and teach soccer because I played in college. Once I try to do it, fail, fix, fail, fix, etc. Then I begin to know how much I really don’t know. Insert Fed MIT educated Ph.Ds. They don’t know how businesses work, but they think they do. Books teach you one thing; experience teaches you another. Thus the system is dynamic and ever moving.

I believe ahead of us is a severe recession. Our starting conditions are far worse than those prior to the last recession—or pretty much any recession on record. I believe we are headed to a painful outcome. Debt is the problem; underfunded pensions are the problem. The Fed is trapped. Bad for cash, bad for bonds, bad for overvalued stocks.

My best guess is we have a hard market sell-off (20% worst case). V-market patterns—sharp down and quick up as Fed comes to the rescue—for a period of time. Buy the 20% dips. I think Bill White is right: Inflation over the short term, then deflation returns in the intermediate term (as debt and demographics dynamics again take hold), then inflation long-term as Biden/Treasury/Fed ultimately go all-in (as do other central banks).

This V-market trading playbook works until confidence in the Fed is lost. We’re not there yet. At some point, people will realize that printing money and massive spending plans have consequences. Inflation is the trigger. And it’s maybe a year or two away. Best guess is for a severe recession in 2023–25 window. I believe one must be a market trader (timer) to survive. Risk management. All of this is bullish on gold and especially gold miners. Felix Zulauf sees gold going to $7,000 per ounce in a few years. He could be right.

Stanley Druckenmiller is one of the greatest investors of our time. I wrote about him several weeks ago. His view on this very subject. In case you missed it, here is a brief summary:

Druckenmiller Comments (June 2021)

  • Why is the Fed buying $40 billion in mortgages a month, when we are clearly running out of housing supply?
  • Not only is the Fed still providing record amounts of accommodation; it is promising not to raise rates until after 2023—even when the recession is already over.
  • If the Fed raised rates in the first quarter of 2024, as indicated, it will be 41 months after recovering 70% of the drawdown and unemployment.
  • What do you think the average number of months is before the Fed’s first hike after a 70% employment recovery in the post-war period? Chairman Powell is predicting 41 months before Fed’s first rate hike. What do you think the average after that kind of recovery has been since World War II? Four months. Four!
  • And according to the Chair (Powell), they are not even thinking about ending $120 billion a month in bond purchases. Simply put, the fastest and strongest recovery from any post-war recession is being met with the Fed’s easiest response on record… by a mile.
  • Policymakers say, “We need to go big to avoid downside risks and avoid this stagnation experienced after the great financial crisis.”
  • But as I have shown, comparisons with the great financial crisis are completely inappropriate.

Get ready to feel Druckenmiller’s emotions as you read this next section:

  • The worst economic periods of the last century have followed the bursting of asset bubbles––think the 1930s after the 1929 bubble burst and think about the great financial crisis after the housing bubble burst.
  • Foreigners not buying US Treasury’s. Always a go to asset. Always a big increase in purchases after great financial crisis. Big exit this time. This has never happened before. Foreigners are saying, “No más.”
  • There is no way yields would not have gone up without the Fed financing, all the things that I’ve been showing the last five or 10 minutes.
  • The CBO projects that the new debt level, despite drastic cuts in growth and non-entitlement spending—that’s the gray line—will result in an interest expense of 27% per year if the 10-year was to normalize to 4.9%.
  • Simply put, the system cannot handle it, so the Fed will be forced to monetize the debt.
  • Think about that 27% of GDP just in interest costs alone. That’s basically all the money we’ve spent in COVID relief in the last 12 months.
  • And this is the only solution (the Fed forced to monetize the debt)? For this unnecessary and self-inflicted situation from this radical monetary and fiscal policy.
  • Currently, 85% of the world’s transactions are done in dollars. I think we have crossed the Rubicon, as I’ve said, and for the first time in my career, I believe we will lose this reserve currency status, and all the benefits that come with it within 15 years.

I’ve never said this before, I’ve never even thought of it before. At present, there’s no alternative because of the lack of the trust in the communist dictatorship in China, and the message here apparently is, I don’t know who’s gonna replace us…

  • But my best guess is the biggest threat is a crypto-derived ledger system that will be invented by a group from an army of engineers leading universities like USC.

I will conclude my remarks with how my family office is positioned given this background. This comes with a huge word of caution. For those who don’t know, I mean, my immediate view is very flexible, and I do change my mind. Let me just say that, for obvious reasons we are positioning ourselves for the dollar (short dollar). I think you’ll understand that from what I presented in the presentation.

  • We’ve recently had a bounce (in the dollar) that I think it’s unsustainable, frankly because the US growth outlook has picked up relative to others because of our vaccine rollout. But as soon as the vaccine rollout catches up in Europe and Asia, which I don’t think will be far behind. I think the downtrend of the dollar will resume.
  • We are short global fixed income, the booming economy I’ve outlined. I just think 1.6% on 10-year Treasurys is a ridiculous price, particularly relative to history that has traded right on top of nominal GDP, which is running at 10%.
  • The other way we positioned ourselves for this inflationary outcome, is we’re long all sorts of commodities; long oil, long copper, and we are long grains. Pretty much if it moves, we are long it in the commodity world.
  • And finally, equities. We are long, but I will be very surprised if we don’t make the exit by the end of this year.

SB here: Take in the information as data. Don’t get emotional. The bond market is broken right now. Yet there are opportunities to generate income and achieve returns similar to the days when bonds were attractive. It’s a question of adapting your game plan based on the set of probabilities that you believe exist. We may or may not have a severe recession. I think it’s coming. 2023–25 is a good guess. Could be sooner, could be later, may not be severe. But I sure want to be prepared.

I wish I had a solution for fixing the debt problem. I believe we in the U.S. and the bulk of the developed world will monetize the debts and the side effect will be inflation and higher interest rates. There are things we investors can do. I continue to like well-collateralized short-term private credit-earning yields in the mid- to high single digits and trading strategies with bond like reward/risk profiles (high single digits with low drawdown) for CORE bucket. Short term because if rates move higher, I want to roll to higher rates or have investments that do that for me.

I was on a call with my mentor and friend Mark Finn this week. He said, “I believe the only edge in investing is in innovation.” Find innovative/disruptive ideas that make our world a better place. And put those in your EXPLORE bucket. I’m really excited about the future, about creating every day and about being with the people I love most. That’s the real win.

Trade Signals – Inflation Concerns Persist; S&P 500 Approaches Record High

June 9, 2021

Posted each Wednesday, Trade Signals looks at several of my favorite equity market, investor sentiment, fixed income, economic, recession, and gold market indicators.

For new readers – Trade Signals is organized into three sections:

  • Market Commentary
  • Trade Signals — Dashboard of Indicators
  • Charts with Explanations

Market Commentary

Notable this week:

No significant changes to the trade signals this week, but we note that the Ned Davis Research Daily Trading Sentiment Composite increased since last week, indicating “excessive optimism,” a short-term bearish signal.

At this writing, the equity markets are generally flat, awaiting some directional catalyst. While inflation concerns persist, the S&P 500 Index approaches a record high.

From today’s Politico Playbook:

Former President HARRY TRUMAN once asked for a one-handed economist because he was sick of them answering his questions by saying, “on the one hand … but on the other.” The issue of how seriously to take inflation risks, which has recently become a major partisan issue, has divided the field in a way that would have infuriated Truman.

A new survey released Tuesday by the Initiative on Global Markets at the University of Chicago’s Booth School of Business asked its panel of 43 top economists for their views on the following statement: “The current combination of U.S. fiscal and monetary policy poses a serious risk of prolonged higher inflation.”

On the one hand 26% of the panel agreed, but on the other 21% of them disagreed. The biggest group (40%) was uncertain.

Trade Signals – Dashboard of Indicators follows next. Green continues to dominate the dashboard. Click HERE to go to the balance of Wednesday’s Trade Signals post.

Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon and risk tolerances.

Personal Note – Golf at Whistling Straits and New York City

I’m checking in happy and excited. On my wish list for some time has been playing golf at Whistling Straits. I fly to Wisconsin on Sunday and golf is planned for Monday and Tuesday.  From there I’m going to drive, with big smile on face, to Chicago to have dinner with my business partner Kevin Malone.

Travel is picking up. The following week I’m having dinner with John Mauldin and good friend Rory in New York City. Really looking forward to that.

Here are a few links if you’d like to track some of the writings from SIC2020.

  1. On My Radar: Howard Marks’s “A Bowl Full of Tickets,” and William White on Inflation
  2. Deflation Talk, by John Mauldin – Thoughts from the Frontline (May 28, 2021)
  3. Expecting Inflation, by John Mauldin – Thoughts from the Frontline (May 21, 2021)
  4. Cold War or Not – China Panel, by John Mauldin (May 14, 2021)
  5. On My Radar: Stan Druckenmiller at His Best
  6. On My Radar: SIC2021 – Deflation? Inflation? Transitory? Define It?

I do hope you have some fun plans in your immediate future. Have a great week!

Steve

Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.

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