As Fed Chair Jerome Powell took center stage yesterday, even if virtually not able to feel the anger and frustration of the investing community as they wonder what the end goal of the Federal Reserve is. After printing billions to save the market as a crisis emerged to now printing trillions every time there is a hiccup, how much further can this go on? We have printed $4 trillion plus since last March when the pandemic induced lockdowns took hold. Today with markets above March 2020 highs, the Fed still needs to buy $120 billion of Treasury assets on a monthly basis and with the balance sheet constantly growing. Why still, one may ask? They keep claiming that they intend to "support" the economy (i.e., markets) till they reach full employment or inflation reaches consistently above their 2% average inflation goal. The thing with hard limits like that is that these goal posts keep moving which means no end in sight to this money printing. New money is printed to pay off old debt and the cycle goes on, never leading to any productivity, the system getting more and more indebted as the years go by. How can the Fed and central banks ever get out of this mess?
In short, the answer is deflate away the debt. Print so much and for so long that the debt is essentially inflated away. They need this inflation and are just hoping that there is enough GDP growth in time to support the economy so they can raise rates at some point. It is all wishful thinking for now as one year on and they are still not even able to cut back on monetary support let alone raise rates by 25 bps! The big issue in the market right now is that U.S. bonds are down 20% over the past few months as 10 year yields are testing highs of 1.75% from lows of 0.5%. The Fed claims this is "normal" as the bond market prices in the current economic growth backdrop. True as that may be, but it is not the level of yields that is concerning, but the pace at which it moves. Recently, the moves have been disorderly and the world cannot take high levels of rates so quickly as there is just too much debt. The growth is not enough to offset these higher yields, for now.
If one were to look at commodity prices from soya, milk, corn, and copper, there is rampant inflation. The Fed claims this is "transitory" due to year over year base effects, but they fail to see the fact that so much money supply growth is adding fuel to the inflation theory. They cannot desire inflation and then dismiss it as transitory because it is not in the right places. They cannot raise rates as the economy is too weak recovering from post pandemic lows. The fiscal stimulus has been passed which should help but it will take time. The bond market has been testing the Fed's resolve time and again over the past few weeks, to see what tools the Fed has and if they embark on some sort of yield curve control. Looking at broader economic indicators, it seems the US 10 year can drift towards 2% or the copper/gold ratio falls.
The Fed still needs to decide what to do with the SLR ratio. The deadline is March 31 and the Fed said they would be making an announcement in the next few days. The bond market does not think they will extend it. If that is the case banks will be required to sell Treasuries and release deposits. If this gets messy, it will surely lean over risk assets and equities. There is an influx of liquidity coming into the money markets and T-bills are now trading at a negative yield. Things do not look pretty for now, so let's see what the Fed decides to do. They are stuck between a rock and a hard place, and at some point this liquidity train will have to stop. But for now keep riding it, hoping nothing goes wrong.