September 15, 2023
By Steve Blumenthal
“I know that it is fashionable to talk about a ‘dual mandate’ – that policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory: operationally confusing in breeding incessant debate in the Fed and the markets about which way should policy lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic; illusory in the sense it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel prize winners but by experience.
The Federal Reserve, after all, has only one basic instrument as far as economic management is concerned – managing the supply of money and liquidity. Asked to do too much – for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously hypothetical circles of stability, growth, and full employment – it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.”
– Paul Volcker, Former Federal Reserve Chairman, 2013
I’m off today and looking forward to a long weekend. I’ll continue to mull over an excellent article about the Federal Reserve and the future by Dr. John Hussman this week. Perhaps you will too when you read it. Trying to discern how the future will unfold is a combination of understanding the players in the system, the rules imposed on them, and human behavioral tendencies—and, of course, some luck.
On Monday, March 23, 2020, for the first time in its history, the Federal Reserve and the Department of the Treasury created a facility to buy corporate securities, including high-yield junk bonds. Being a high-yield guy for most of my career, I was not only shocked but also angered, and my anger was evident in an email exchange with a handful of friends in the industry—names you’ll know. Like Dr. Lacy Hunt. “Steve, stop….Call me,” he wrote. No one knows the Federal Reserve Act better than Lacy. His message to me was simple: “Of course it’s illegal, but do you know anyone who’s going to stop them?”
Remember, this was the beginning of the Covid crisis. The key word is crisis, and the important takeaway here is that the Fed’s response in 2020 set a precedent that may be used and expanded upon in the next crisis. In fact, we already saw it used again with the collapse of Silicon Valley Bank and others earlier this year. I’m not arguing whether that response is right or wrong. I’m simply trying to ascertain the probabilities of certain behavioral responses we are likely to see from policymakers in the next crisis.
Judging by the Fed’s responses in 2020 and this year, I believe the next great societal disruption will be followed with more rescue money, which will have similar, but possibly even greater, inflationary consequences as the ones we’ve experienced in the last few years. As a result, I believe we are on a road leading to “stagflation” for the rest of the decade.
There’s no way to know anything for sure, and I could be wrong—I hope I am. But we’ll need to watch the signs to understand better which way to turn as we travel further down the road. Look at the problem, look at the players, have a good sense of human behavior, and intently track what happens on the ground. I’ve long said that inflation is kryptonite to Fed policy. Thus, stay super zeroed-in on the 10-year and 30-year Treasury yields.
Hussman’s article is a master class in understanding the Fed. I get a lot of feedback from readers every time I mention Hussman’s name. “He was wrong… He’s always bearish…”—I hear you. But he’s also been right plenty of times in his many years on the job. My humble request is that you read his latest piece from the perspective of understanding the Fed, money, and its impact on the economic and financial system. And note the word “shall.” Hang your head, shake it off, and move forward. This is the arena we find ourselves in. Ever forward…
Grab your coffee and find your favorite chair. Below, you’ll also find a quick chart on the 10-year Treasury Note. It’s flirting with an important threshold.
Here are the sections in this week’s On My Radar:
- Central Bankers Wandering in the Woods
- Watch the Ten-year Treasury Note Yield
- Personal Note: The 2023 Women’s Mid-Am Conclusion
- Trade Signals: CPI Inflation 3.70%
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
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Central Bankers Wandering in the Woods
“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
– Federal Reserve Act, Section 2A, Monetary policy objectives
Following is a teaser from Dr. John P. Hussman’s piece titled, Central Bankers Wandering in the Woods
While the monetary policy objectives set by Congress identify several goals the Fed is expected to promote, the Fed is given only one mandate, and it is the phrase that follows the word “shall”: Maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production.
Fed officials like to gloss over the “shall” part of their mandate, preferring to fabricate what they call the “dual mandate” of balancing unemployment versus inflation. As I detailed in Fabricated Fairly Tales and Section 2A, there is actually no such “tradeoff” in the data, and even the popular concept of the “Phillips Curve” is a misinterpretation of Phillips’ work, which is actually a relationship between unemployment and (real) wage inflation. The whole idea of a “dual mandate” is actually a constructive interpretation of 2A, evidently invented to divert attention from that pesky “shall.”
I know that it is fashionable to talk about a ‘dual mandate’ – that policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory: operationally confusing in breeding incessant debate in the Fed and the markets about which way should policy lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic; illusory in the sense it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel prize winners but by experience.
The Federal Reserve, after all, has only one basic instrument as far as economic management is concerned – managing the supply of money and liquidity. Asked to do too much – for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously hypothetical circles of stability, growth, and full employment – it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.”
– Paul Volcker, Former Federal Reserve Chairman, 2013
Historically, the liquidity created by the Fed has earned zero interest. As the Fed created more base money, relative to the size of the economy, savers became more eager to chase close alternatives such as Treasury bills. Of course, someone still had to hold the base money, but eventually T-bill yields would decline to a point where savers were indifferent between holding zero-interest bank balances or holding low-yielding Treasury bills. For the entire history of the Federal Reserve until 2008, the Fed conducted monetary policy and pursued its short-term interest rate targets strictly by changing the quantity of base money. The amount of base money never exceeded 16% of GDP.
This is part of the reason I use the word “deranged” to describe the Fed’s experimental “ample reserves regime.” It is wholly outside of the range in which monetary policy has historically operated. It ignores the Fed’s 2A mandate. It breaks the link between open market operations and interest rates, to the extent that it is now impossible to hold interest rates at any level above zero without transferring public funds to the private sector in the form of interest on reserve balances, or accruing small but daily balance sheet losses through “reverse repurchases” with money market funds.
Click on the photo to read the photo to the full piece.
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Watch the Ten-year Treasury Note Yield
This is one of the most important charts to keep on your radar.
Here is how to read the chart:
- Note the red circle in the upper right-hand corner of the chart. The current yield is 4.324%.
- The red line shows the prior high made last October at 4.33%.
- The lower section plots something called a MACD. It is a trend-based indicator.
- Green arrows signal bullish changes in trend (lower interest rates). Red arrows are bearish signals (higher interest rates).
- A breakout above that line looks imminent.
- Higher interest rates are bearish for fixed-income investors and most all capital market assets in general.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
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Personal Note: 2023 Women’s Mid-Am Conclusion
Last week, I gave you the wrong television schedule for the U.S. Women’s Mid-Amateur being hosted at Stonewall. I hope you found your way to the right one. It’s really quite an event. All the players are so good! The tournament concluded yesterday. Here’s how Julia Pine described some of the exciting events from the championship for the USGA:
The victory also earned Dinh a place in the 2024 U.S. Women’s Open at Lancaster (Pa.) Country Club.
Chugg, who was playing in her third U.S. Women’s Mid-Am championship match in the last six iterations, looked like she would become the first since 2016 to earn multiple titles, jumping out to a 3-up advantage through the first seven holes. […] She would win four holes on the front side, two with birdies, and lose only one when Dinh hit her approach shot on the 319-yard, par-4 fourth hole to just three feet. The result? A 3-up lead for the former champion through seven holes, and after tying the next four holes with her opponent, a 3-up lead through 11, with just seven holes to play.
But that’s when things would take a turn. The two competitors would not tie a hole the rest of the way, with Dinh remarkably winning six of the last seven (Chugg would momentarily stop the bleeding by taking the 15th hole), ultimately resulting in a Dinh 2-up victory. It was the first time a competitor came back from a deficit as large as 3 in the championship match since 2003.
For Chugg, the tale of two nines [was] really a tale of putting. After playing steady for the first part of the match, her putter betrayed her starting on the 11th hole, and while she was able to tie the hole and keep her 3-up lead, she missed a six-footer for birdie that would have pushed the lead to 4.
The Fed finds itself down five with seven holes to play, and Chairman Powell is struggling with his putting. Along the way, he is learning an important lesson: You can’t decelerate your putting stroke and expect to make the putt. Can he win this match? Not impossible. Improbable? Yes.
Speaking of sports, it was a rough week for Coach Sue and her Malvern Prep Fryers. They had a heartbreaking, last-second 2-1 loss on Tuesday and a 3-1 loss on Thursday to a strong Philadelphia high school team. I shouldered the outcome as well. My “opposition analyst” role is quite fun, and I enjoy getting to know the boys. The next game is on Sunday, and we need a W.
My big win of the week was a reunion with my old Penn State teammate. He was the assistant coach on that Phila team. What a nice surprise.
Call an old friend and tell them how much you miss them. Oddsmakers say it will lift you both.
Wishing you a great week!
Trade Signals: CPI Inflation 3.70%
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
“The August Consumer Price Index (CPI) report showed that overall inflation increased by 0.6%. In line with estimates. Year over year, inflation increased from 3.2% to 3.7%, which was a tenth hotter than estimates….” This is from my good friend and interest rate/mortgage/housing market expert, Barry Habib (and his team at MBS Highway). The bottom line: Oil prices hurt inflation while shelter costs helped.
We looked at the oil chart last week when Brent crude topped $90. It closed at $91.98 today (Wednesday, Sept 13, 2023). Note the MACD trend buy signal in late June. (I’ve updated the chart through yesterday’s close – now $93.70.)
The yield on the 10-year Treasury note was little changed on the inflation news, closing the day at 4.25%. The Zweig Bond Model improved from a – 3 sell reading to a –2 sell reading. The ZBM and the Weekly MACD point to higher interest rates. (Charts in the fixed income section below) I believe a nice trade is nearing in the Treasury bond market, but not yet. I’m watching for the ZBM to move to a +1 or better signal. Positive readings are bullish (signaling declining interest rates). Negative readings are bearish (signaling rising interest rates).
The dashboard of indicators follows. Subscribers can find the updated charts with the explanations section below.
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