Friday Haymaker
Courtesy of Charles & Louis-Vincent Gave!
“The central bank of the United States will intervene—it was born with the buttinsky gene—and not always to a constructive end.” -Jim Grant
“The Fed has practiced an unappreciated form of government control over the economy since the Greenspan era that is antithetical to capitalism. We should hardly be surprised, then, that socialist concepts such as Modern Monetary Theory (MMT) or guaranteed income are treated seriously despite their intellectual bankruptcy.” -Michael Lewitt, author of The Credit Strategist.
The Most Important Merger Ever?
Deal making is what Wall Street does best. That is arguably only surpassed by its proficiency at supplying gullible investors with ill-conceived innovative products created to play the fad du jour. Could it be, however, that the greatest Mergers and Acquisition (M&A) event of all-time happened in Washington, D.C., and not New York City?
Today’s Gavekal Research-authored Haymaker contains a provocative quote from one of my favorite Street (ironically) strategists: BofA Merrill’s Michael Hartnett. As you will soon read, the deal of the century, in his view, might be the de facto merger between the Fed and the U.S. Treasury. In case you weren’t aware of the historically significant separation of powers, those two immensely powerful U.S. government institutions are supposed to operate completely independently. Well, maybe that hasn’t been as complete as originally envisioned but, until lately, this has largely been the case.
Many pundits have noted that Treasury Secretary Janet Yellen seems to be increasingly encroaching on turf that once was the exclusive purview of Jay Powell. Whether intentional or not (I’ll go with the former), she has made moves that have potentially infringed upon the Fed’s areas of operation.
For example, her running up and down of the balances in the Treasury General Account (TGA), her department’s effective checking account, can weaken or intensify the Fed’s monetary management efforts. Another is her ability to direct government financing to the short-end of the maturity spectrum (i.e., heavily relying on T-bills versus longer-term debt). Because the Treasury’s issuance has been so skewed toward short maturities, it has had the effect of accentuating and extending the yield curve inversion (short rates higher than long rates). Perhaps that’s one reason this upside-down yield situation is the longest on record.
Personally, I think the greatest merger of all-time did, in fact, occur but I would argue that not-so-felicitous union (at least for U.S. consumers) happened in the summer of 2020. That was when the U.S. government stumbled into the economic paradigm known as Modern Monetary Theory (MMT). As a reminder, this school of thought holds that the federal government need not worry about antiquated considerations like spending limits. Rather, if there is a need — and with U.S. policymakers there always is — just spend the required money. These days, of course, the quantity of that is consistently measured in the trillions.
MMT theory also contends that should there not be enough demand for U.S. Treasurys (USTs), then the Fed simply buys them with its Magical Money Machine. This was formerly known as Quantitative Easing and I strongly suspect we haven’t heard the last of that alchemy. As I’ve often written, including as far back as the spring of 2019, the Achilles heel of MMT was almost certain to be inflation. As we saw in 2021 and 2022, it certainly was.
For whatever reason, unlike most of the private sector, Ms. Yellen elected not to finance those multi-trillion-dollar deficits with a copious quantity of long-term bonds. Instead, she kept the government’s overall maturities very short. Now, the wages of that decision are biting with Jaws-like force. The Treasury’s interest expenses are rising as fast as Donald Trump’s legal bills, as all that short-term debt rolls over at massively increased rates (like 5% vs 0.5%).
The repeated CNBC flash headline as I write this introduction on Thursday, April 25th, is “Rate Fear Rock Markets”. Most of that anxiety centers on the longer-term portion of the UST market where the 10-year and 30-year maturity are threatening to hit 5%.
As today’s Gavekal report describes, this is rendering stocks even more expensive relative to bonds than they were at the 2000 peak, the apex of the biggest stock market bubble in U.S. history. Normally, this would be a signal to sell stocks and buy bonds. Yet, if the U.S. is becoming Turkey with U.S. characteristics (meaning we aren’t going to see 60% type inflation), that traditional reallocation might be very costly in the long run. Inflation is kryptonite to bonds but it can help stocks, especially those in natural resource sectors. (Interestingly, gold stocks were up yesterday in a nasty overall tape.)
Actually, for holders of extended maturity USTs it already has been an expensive few years. In gold terms (i.e. based on real money), they’ve lost almost 50% of their value since the start of 2020. Fortunately, for those who have allocated their yield-seeking capital to emerging bond markets, an asset class the Haymaker has long favored, returns have been superior
If Louis and Charles are right, the beatings will continue until the bond market’s morale improves. Yet, with higher interest rates boosting the spending power of the private sector’s wealthiest segments, a dramatic attitude adjustment may not be nearly as imminent as the bond market bulls hope. Even never-say-sell stock market players might see more days like yesterday when most stocks and bonds head in the same southerly direction. For market geeks, that’s a positive correlation with very negative implications
David “The Haymaker” Hay
Turning Turkish II
Charles Gave & Louis-Vincent Gave
In our April 17 webinar, we touched on the outlook for global currencies during an inflationary boom. However, the webinar format prevented us from going into any great depth about the risks facing developed-economy currencies. This paper aims to make good the deficiency.
Elon Musk has likened money to the operating system of the economy. This is a parallel we have made many times, arguing that the US dollar has been the Microsoft Windows of the global trading system, while China hoped to use the renminbi to mount an Apple-style insurgency against the US dollar’s monopoly.