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November
18
2023

Investors Are Running Back into a Building While the Fire Alarms are Still Sounding
David Haggith

The inflation battle is about to get weird and chaotic.

The fire alarm sounded, and everyone fled out the exits, practically trampling each other to death in order to save their lives. Then they all came running back into the flaming building, practically tripping over each other due to the thick the smoke in order to get in first. What on earth happened?

The savage sell-off that hit Treasuries in prior months was driven by concerns a buyers’ strike had hit the $26 trillion bond market. It’s now confirmed: at least one set of investors headed for the exits back in September.

Foreign investors sold $1.7 billion more worth of Treasuries than they bought during that month, data from the US Treasury department shows. This marked the first net outflows since May 2021 and capped the weakest three months for foreign demand since the period ending May 2020….

A sale of 30-year US bonds last week was one of the worst auctions of the past decade.

In other words, you have to go back to the manmade lunacy of the Covid lockdowns to find a period as upsetting in the bond market. Only this time it is years of porky politics that have spent the nation deep into debt now facing a wall of real interest rates that caused foreign investors to flee and credit agencies to issue stark warnings and even domestic money to run over to stocks and caused the one of the worst Treasury auctions in many years.

Then it all reversed, even without the foreign investors, and everyone ran into both markets with buckets of money. Treasuries made a comeback this month based solely on phantom inflation doing a head fake that has tricked, it would appear, nearly all of those who are willingly deceived in stocks and bonds to believe the inflation battle is over! At long last, everyone breathed a sigh of relief.

“Not so,” say two more inflationista Fedheads today. The market, they say, is overly optimistic (to put it nicely):

Despite recent encouraging signs on inflation, Boston Federal Reserve President Susan Collins said Friday that more interest rate hikes could yet be needed.

“I understand the tendency to really enjoy good news, and there was some good news in some of the numbers [emphasize “some”— and I think that we need to appreciate that. But I don’t see additional firming off the table,” the central bank official told CNBC’s Steve Liesman during a “Squawk on the Street” interview. “I think the key point is we need to really stay the course.”

Ah well, the market has wrongly ignored everything the Fed has said since it started tightening the economy; so, why start listening now that the battle is clearly over? That is, in part, because the Fed has lost trust. Plain and simple. It said it would tighten till the cows come home back in 2018 then suddenly did a faceplant and promised to turn 180 degrees on interest rates when stocks hit trouble. Then it said that it would keep on with reducing its balance sheet even after it stopped raising interest but did an about face on that as soon as we entered a repo crisis, going right back to rapidly increasing its balance sheet. It said inflation in 2021 would be transitory, then eventually had to leap into tightening at a faster rate of increases than it ever has because it was dead wrong. So, both stock and bond markets have been fantasizing about the “Fed pivot,” as a result of all previous pivots that came whenever the market crashed; and the Fed wonders why investors don’t believe them.

The Fed has trained investors like Pavlov’s dogs to slobber on bad news because the dogs have learned it means the Fed-red meat is coming. However, this time they slobbered on fake good news. Anything will do, I guess. Meanwhile, the pivot has never come and was never even remotely about to come, but the Pavlovian dogs just cannot stop themselves from believing in fantasy finance. Regardless, the pivot is not happening still:

Policymakers are leery over repeating the mistakes of the past, where the Fed quit too early in efforts to bring down inflation and ended up paying for it.

The Fed, as I’ve said all along, will keep right on tightening … even into a severe recession because they have to; inflation is still burning up their backside, in spite of a highly fabricated positive inflation report. The market’s delusional eagerness led it to swallow the report in large gulps with a smile on every dog’s face, not knowing the Fed’s red meat has been poisoned. It’s sudden laxative effect on markets will be the very thing that forces the Fed to tighten even harder.

What I liked in one of the articles from today’s news that I’m quoting here is the following comment:

Inflation reports this week showed a slowing pace in both consumer and producer prices. However, Collins said recent data has been “noisy.”

“Noisy.” That’s what they are now calling it when inflation runs the wrong direction for three full months and then holds steady for one month. Well, at least, one of the Fedheads is now acknowledging that those past inflation reports presented a little “noise” that they didn’t want to hear. “Nothing to hear here, Folks. It’s just noise.”

Markets think there’s virtually no chance the Fed will hike any more during this cycle.

Yeah, well, the market is dumb like that. It’s been dumb like that since Zero Hedge and others started pumping the pivot a year and a half ago — the pivot that never came and never had a chance that it would. I kept saying that endlessly on ZH, but they didn’t listen. Now, the market, of course, was going there with or without ZH’s approbation because it thrives on denial of reality, but the problem is reality just kept happening and pounded the market down and down some more throughout the first year of pivothead mania.

As for how close the elusive pivot is that the market now believes will bring four rate cuts in 2024, Fedhead Collins gives the following dose of reality:

It’s important for us to be patient and recognize that [we’re] far from declaring victory.

“Far” from victory!

In fact, the last report, while it went down a nudge in some respects, rather than up as I expected it would if it were honest (which it was not, as I’ll lay out in my “Deeper Dive” for the week), came in far from looking like the inflation battle was over. So desperate were investors for something to feed their fantasies that they all leaped on it in a feeding frenzy. They went from looking like Pavlov’s starving dogs to piranhas hitting a cow that just fell into the Amazon. All you could see was blood and bubbles.

Peter Schiff’s take is the same as mine, which is that, even if you take the report at face value, it was a meatless burger, a Sunday without the chocolate sauce, whipped cream or cherry; but it was talked about everywhere like it was all of that and more. It was talked about like it was a gourmet burger, the whole bag of chips, the whole enchilada and the Sunday with a cherry on top because EVERYONE talked about it as if it were proof that the Fed’s inflation fight was over.

The good news was as simple and flat and uninteresting as this, according to Schiff:

The consensus was for a 0.1% increase in prices last month. The actual number was flat at zero. Peter wasn’t impressed.

Neither was I.

Yet, 

Cooling [bond] prices reinforced the belief that the Federal Reserve won the inflation fight and the rate hiking cycle is over.

Nope. Not happening.

It’s one month. Who cares? And it’s a government index, so it’s meaningless anyway.”

Exactly. The data doctors were hard at work on this one. They managed doing their best to get it to where inflation didn’t rise like it should have, but they couldn’t get it to go down. That didn’t matter. A final stall was all they needed for the inebriated markets.

“Inflation is over,” the market mavens sang with glee, choosing to willfully ignore the warnings of the Fed that this wasn’t true at all in their eyes, and you’d think how the Fed views the report might mean something about whether or not THEY are done fighting inflation. It’s their call to make, but they have lost trust. They are not believed. Ah, well, the market’s ebullient response virtually guarantees the Fed will have to go back to tightening some more just to get rid of all the loosening the market just added.

Says Schiff, who I admit never saw a market that didn’t merit stocking up on lots of gold that he’s happy to sell you,

The annual rise in CPI was 3.1%, slightly below the 3.2% projection. Core inflation also came in just a tick below expectations. Peter reiterated that this hardly seems like a cause for celebration. Nevertheless, Wall Street reacted with glee, sparking an immediate rally.

“As a result of these numbers, which were almost exactly what everybody thought they were going to be, the expectations for a rate hike have plunged. And the expectations for 2024 rate cuts have moved up quite a bit. So, as a result of this supposedly great news on inflation, the markets believe the Fed is pretty much done, that the war on inflation has been won, the Fed has been victorious, and now it can start taking its troops off the battlefield by cutting rates.”

Pure fantasy fanaticism for sure, and I couldn’t have said it better myself. In fact, I did say the same thing, almost verbatim, myself.

Just because we’re at four now doesn’t mean we’re going to two. We could just as easily double and go back up to eight. There’s no reason to just conclude that that’s where we’re headed. But even at four, we’re still way above the Fed’s target of 2%.

In fact, inflation had been going back up through most of the summer, and we just stalled on the path back up, year-on-year results not withstanding because they benefit from months far before summer’s turn back to rising month-on-month CPI reports.

Peter emphasized that the CPI data doesn’t prove the Fed is winning anything. He said we’re really just in the process of bottoming.

“This is trough inflation. These numbers are banging around the bottom and we’re getting ready to start to move higher. And so we’re going to start to move further and further away from the Fed’s 2% target, not closer to it.”

Even the Fed doesn’t believe it proves anything, as four Fedheads have now stated. In fact, we already put in that turn, albeit not yet in the YoY figures that will take a little longer to show the turn. So, a brief pause after we curved back up is typical enough of any turn. There is often some chop, although this appears to have been manufactured chop, as the reality I will lay out this weekend much looked worse than the numbers indicated.

This, of course, feeds into why Pope Powell made it clear that the Fed is nowhere near done with taking down its balance sheet (quantitative tightening to reduce money flowing through the system). QT is what gives you things like an interbank lending crisis called “the repo crisis” or the “Repocalypse,” if you want my kind of colorization thrown in.

Schiff believes, as do I, that we’re entering a staglfationary recession where the Fed’s efforts to curb economic growth and cut jobs will result in less production and the amount that production moves down will be greater than the amount that demand moves down so that the Fed’s tightening (counterintuitively to almost everyone, especially at the Fed or who reports on the Fed) will be inflationary. We’ll have a stagflationary recession. Whether inflation rises just from the increased shortages or because the Fed also dumps more fuel on the fire with an eventual return sometime down the road back to easing, will determine how hot the new inflation gets. I’m not talking a pivot that saves the market. I’m talking a return to easing AFTER everything breaks, including stock, bond, and real-estate markets.

Peter went on to explain that contrary to conventional wisdom, a weakening economy will not tame price inflation. Remember, inflation is caused by too much money chasing too few goods – not economic strength. A recession will lower production, but consumption typically remains supported by government handouts and fiscal stimulus.

My thesis from day one has been this same thing — that this recession will lower production even more, which is likely to be inflationary in an environment were we have already been struggling with shortage issues all over the world. 

(Note to paid subscribers: I may also include some discussion in this weekend’s “Deeper Dive” on the way Treasury buyers are drying up, which is highly predictive of a return to rising bond yields (falling bond prices.) That, too, will knock the denial out of the bond market. For today, however, I’m going to leave off with the inflation coverage.)

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