To pivot or not to pivot, or not to pivot quickly

Will the Fed pivot slowly, quickly or not at all? This post is not saying anything very new. Its basic point is that to keep hiking is to crash the economy, but that not to pivot might not be any better. This explains what might happen if the Fed pivots quickly:

It is difficult (but not impossible) to imagine a scenario where the Fed capitulates on current policy direction within (say) a year or so of today. However, monetary policy over the past 25 years or so has been about lower lows and lower highs. So, what conditions might see such a scenario?

This would likely see an apocalyptic scenario, where asset markets crash following a Fed interest rate hike, the US economy entering a deep recession, and some form of credit crisis. All of which would be reflective of an economy which is far more sensitive to higher interest rates than the Fed might currently believe, based on their narrative. And the Fed was quick to respond to asset market crises in 2009 and 2020.

This time around, however, the fed would know that falling short of arresting current inflation rates would lead to persistently higher inflation. This would most likely lead to a “stop-start” economy, where the Fed is continually raising and easing interest rates. This of course would lead to a more volatile GDP.

Such economic uncertainty would mean higher risk premia, higher credit spreads and lower price/earnings ratios. With this higher tolerance of inflation, wages pressure would also likely increase, further compounding the Fed’s dilemma. Additionally, any market skepticism of the Fed’s commitment to arresting inflation might also see a form of bond market revolt.

I think this is the most likely scenario. The Fed believes that it’s status rests on its ability to tame inflation. On the other hand, it is a creature of politics, and crashing the stockmarket would be intolerable to whichever US government is in power. It’s a difficult call, certainly more difficult than in 2018.

China

Everyone thinks that China is the enemy, but nobody thinks it’s a good idea to provoke it. With the exception of Nancy Pelosi, who visited Taiwan yesterday (actually it was the third, nearly a week ago). The USA leadership cannot afford to be positive about China and still get elected. The Chinese leadership cannot disclaim their position on Taiwan. It’s hard to see anything good coming out of this. As China slides into recession, the natural response of Xi will be to amp up the rhetoric against the USA, the classic fascistic strategy. Although I doubt if Xi wants a shooting war, sometimes these things happen by accident.

The fact that Xi is dictator for life increases the chance of a kinetic war enormously, in my view. Maybe not now, be eventually Xi will decide that in order to keep the people behind him, he will have to announce that China is at war, and that is the reason they have to make economic sacrifices. Given the precarious state of the construction market, which accounts for 30% of China’s GDP, this might be sooner rather than later.

Other articles

Playing chicken with the Fed

Published: Fri 05 August 2022
Updated: Fri 05 August 2022
By steve

In markets.

The Fed and the BoE

Central Banks

Everyone (well, someone) keeps asking me “Why is the Bank of England raising rates so much when everyone is forecasting that we’re about to go into a recession?” To be honest

170 years of Bank of England policy rates:

<blockquote class="twitter-tweet …continue
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Not so sunny now

Published: Thu 04 August 2022
Updated: Fri 05 August 2022
By steve

In markets.

Sunrun inc

Sunrun: “ESG” is for Everybody Screws the Government (RUN US)

Muddy Waters is short Sunrun Inc. (RUN) because we see it as an uneconomic business built on three shaky pillars: The equity story of exaggerated “Subscriber Values” and “Gross / Net Earning Assets”, funding growth through abusing tax incentives …
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Another dull day in the markets

Published: Wed 03 August 2022
Updated: Thu 04 August 2022
By steve

In markets.

Distracting agenda

Wrap

MARKET SNAPSHOT AS OF 0430 GMT 4 Aug :

S&P 500 Index Mini Futures: 4,153.00; down 0.08%; 3.25 points
DJIA Mini Futures: 32,764.00; down 0.02%; 6 points
Nikkei: 27,902.26; up 0.58%; 160.36 points
MSCI Asia, Ex- …continue
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The cost of money is lower than ever

Published: Tue 02 August 2022
Updated: Tue 02 August 2022
By steve

In markets.

Tuesday 2, August 2022

Real interest rates

The Real Fed Funds rate says the #Fed remains historically behind #inflation. Why discuss 75 bp hikes when the real question is when will they be doing 100bp hikes? pic.twitter.com/NQxlwlxoCX
— Richard Bernstein Advisors (@RBAdvisors) July 13, 2022

When and how …continue
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Russia has become a fascist regime

Published: Mon 01 August 2022
Updated: Mon 01 August 2022
By steve

In markets.

Monday 1, August 2022

Wrap

Oil was a big loser today. The nearby month of the WTI future dropped by 4.7% to $93.9. Presumably, this was a delayed reaction to the negative GDP print last Friday. Whether or not the US is in recession is an arcane topic …continue
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Little Dishy Rishi is a loser

Published: Sun 31 July 2022
Updated: Sun 31 July 2022
By steve

In markets.

tags: politics

Weekending 31 July

Conservative leadership contest

Things are looking bad for Rishi. The master of detail and the straight-A student has failed to learn that to get elected you must promise the undeliverable. Truss, who has on several occasions embraced policies that even Milton Friedman would have approved of, understood …continue
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Cakeism risks inflation

Published: Thu 28 July 2022
Updated: Thu 28 July 2022
By steve

In markets.

Thursday 28, July 2022

Recession or not?

Will we have a recession? If inflation hits 10%, it seems almost impossible to avoid. We’d have to increase nominal GDP by more than 10% to avoid real GDP going down, for two quarters. The BLS (or some quango in the USA …continue
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Suprise Fed Hike. Risk assets surge

Published: Wed 27 July 2022
Updated: Wed 27 July 2022
By steve

In markets.

Wednesday 27, July 2022

Wrap

Markets showed once again how unpredictable they are. The Fed announced (at 6pm, after markets closed) that it would hike by 75bp. This was not a surprise. Powell threw a bone (bucket of hay?) to the bulls by saying that the Fed would adjust its …continue
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Is the dollar strength going to derail the US stock market

Published: Mon 25 July 2022
Updated: Mon 25 July 2022
By steve

In markets.

Monday 25, July 2022

Dollar strength

The dollar has been rising a lot. It has paused over the last week, but it is still maybe 7% higher than it was a few weeks ago. This is going to hurt US producers, whether exporters or not. Finally, equity markets where the …continue
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Other articles

The Fed and the BoE

Central Banks

Sunrun inc

Sunrun: “ESG” is for Everybody Screws the Government (RUN US)

Distracting agenda

Wrap

Tuesday 2, August 2022

Real interest rates

When and how …continue

Monday 1, August 2022

Wrap

Weekending 31 July

Conservative leadership contest

Thursday 28, July 2022

Recession or not?

Wednesday 27, July 2022

Wrap

Monday 25, July 2022

Dollar strength

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