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The Fed’s Head Fake

Posted May 05, 2022

Jeffrey Tucker

Anyone paying close attention could have seen this ahead of time. The supposedly massive crack down on inflation, with the unleashing of the hawks, turned into a non-event. Rates are now in historically low territory, once you factor inflation, which is running at 11% according to real-time data. That means that the Fed has done almost nothing so far. 

Fed chairman Jerome Powell said as much in his post-crackdown press conference. He believes that inflation is going away on its own. The economy is healing and he doesn’t expect that the GDP numbers are going to be worse; quite the contrary. Which is to say that the Fed has decided not to go full Volcker, despite months of signaling that they would do so. 

All of which is to say that the Fed has already made a specific policy choice. It favors inflation over recession. Period. This is why President Biden laughed so uproariously at the joke made at the White House Correspondents Dinner. It’s become quite the fashion in the highest circles to regard anyone who complains about inflation to be a member of the mouth-breathing MAGA tribe and unworthy of any policy influence in Washington. 

An almost identical situation is taking place in the U.K. The central bank is only pretending to fight inflation. These tiny efforts are nearly pointless compared with the scale of the problem. And yet bond markets are reacting very strongly to them. It’s like taking away a bit of heroin: for the addict, it’s a moment of panic. 

Already we have strong increases in 30-year mortgage rates. 

chart

But compared with the previous bout of high inflation in the late 1970s, 5.25% is rock bottom. There was a moment back then when buyers were paying +16%. 

chart

The conclusion is that we have a very long way to travel before we get anywhere close to reality. To live in a world of dramatically negative interest rates reveals that the Fed hasn’t even begun seriously to fight inflation. 

Buy or Sell?

The reaction of the financial markets was as wild as election night 2020. The initial response was elation, based on the view that Powell was not serious and would keep the monetary drugs flowing so as to avoid recession. After a good night’s sleep, the fear emotion came back: what if the recession happens anyway? Prices collapsed. 

The Wall Street Journal cobbled together a story. 

By Thursday, investor optimism had begun to wane. Even with a larger interest-rate increase off the table in the coming months, investors are still facing the most aggressive tightening of U.S. monetary policy since 2000—the last time the central bank last raised rates by a half-point. Many investors are now questioning how high the Fed might raise rates over the next two years amid soaring inflation and how that might ripple across the economy and corporate profits.

Translation: even a slight change in monetary policy could cause what is called a hard landing. Interesting, Powell’s reassurances that inflation is going away on its own and the economy will avoid a recession came to mean next to nothing. 

This really is a situation we’ve not seen in generations: the Chairman of the Fed has about as much credibility as the head of the CDC. No one trusts authority anymore, not even the fanciest of the fancy. Gone are the days of worshipful adoration of Greenspan. Now these guys are ever more seen as nothing but propagandists. 

Back to the Housing Boom! 

Friends have lately begun asking huge philosophical questions, like: “why don’t humans learn from history?” I suppose the answer is that we haven’t yet invented a technology to upload the lessons of the past to the current generation. That’s the greatest failing of the human experience. It means that we keep having to learn the same lessons over again, along with all the attendant pain that the process implies. 

That brief foray into the philosophy of history is the headway to this extremely weird announcement from the Biden administration that followed directly on the heels of the alleged Fed tightening: 

The latest proposal to modernize rules for the 1977 Community Reinvestment Act is set to be announced Thursday and aims to ensure lending to lower-income individuals and small businesses is distributed more evenly where banks do business. Existing rules focus on bank activities around their physical branches. Those rules are outdated in a world in which much financial activity happens online, both bankers and community advocates say.

Historically astute readers know exactly what this means. This very system of forcibly forgoing rational lending standards, in the name of serving the poor, made a mighty contribution to the wild housing bubble that exploded back in 2008. After the collapse, lending standards were tightened by simply reducing the mandates that banks take on vast numbers of high risk borrowers. 

Now we have the Biden administration attempting to reproduce the SAME CONDITIONS that led to that disaster and do it at the very same time that the Fed is pretending to tighten money and credit. This change in the regulations will mean exactly the opposite. It’s their way of responding to grave warnings from the National Association of Homebuilders, that a crisis is just around the corner. Regulators are responding by saying: don’t worry, we are going to force banks to grant millions of weak-credit borrowers vast new debt, so that the markets will be sustained. 

The damage of such small changes will become obvious a few years from now. It will be a repeat of exactly where we were before. The crash will once again enlist the Fed in a massive quantitative easing to rescue the overleveraged financial and banking systems to keep them from going belly up. 

When will rationality return? Not anytime soon. 

The saving grace of the 2008 crash was that we didn’t have to deal with high price inflation on either the consumer or the producer side. The great worry of the time was the opposite: deflation. This time will be different. Imagine a combination of every crisis of the past (1929, 1979, 1985, 2000, 2008, 2020) all rolled into one. 

The new normal includes sporadic and seemingly random shortages in essential goods. New moms are complaining all over the country that they simply cannot get baby formula, not at the local grocery store or even at Amazon. You can order it but it will likely be canceled. As for the chip shortage that was supposed to end 18 months ago, it is still with us. 

The worst thing about all of this: we have all been conditioned to be used to it. 

Regards,

Jeffrey Tucker

Jeffrey Tucker

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