Tuesday, June 11, 2019

Hey, Kids, That's A Wall Street Trap Door You're Standing On!

By David Stockman
Zero Hedge got that right. It described the latest melt-up spasm in the casino as the Nike Market---just buy it!

The last few days have seen the re-emergence of the Nike market - just buy it... buy the rumor, buy the news, buy the good news, buy the bad news. As long as Powell keeps his promises, everything will be awesome and stocks will go to the moon, Alice. 
Yet, ain't them promised rate cuts pathetic?

After all, whatever ails the US economy at this moment or threatens worse down the road, it sure as hell isn't interest rates. As a practical matter, we don't even have any---- let alone rates so "high" they are biting into economic growth, jobs and incomes.

In fact, at last night's low point, the 10-year UST swooned to 2.12%, thereby crossing back under the inflation rate---at least as measured by the 16% trimmed mean CPI, which posted at 2.27% Y/Y in April. And that 2%+ inflation level has been consistently posted for 13 straight months now.

So how in the world can anyone in their right mind be talking about cutting interest rates---3.5 times before year end, no less---when the yield on even long term money is so low that it is negative after inflation? 

In other words, the Keynesian fools domiciled in the Eccles Building have gotten so tangled-up in their own groupthink and puzzle palace macro-models that they have made themselves hostage to the most aggressive, reckless gamblers in the entire casino. 

Yes, our cowardly central bankers keep insisting that levitating the stock market is not their "third" mandate, and, apparently, most of them actually believe that. Sort of. 

But they also falsely believe they can deftly calibrate short-run inflation and economic growth rates. So any sign of even tiny, temporary shortfalls in the latter become the next excuse for another round of placating the stock market via deferring rate increases, open mouth easing or actual rate cuts---even as they pretend to ignore the stock averages or find valuations to be (always) in the normal range. 

But let's get right to it. That's complete wishful thinking and overweening institutional arrogance. 

The Fed does not have a magic economic wand that can make a billion prices salute to the second decimal place or trillions of GDP to spring to the next rung on the growth ladder. 

The only tool of macroeconomic control they actually have is indirect: That is, the interest rate channel of monetary policy transmission to the real main street economy that ostensibly induces households, businesses and governments to borrow and spend more than they would otherwise. 

That point is essential. Capitalism actually generates an amount of aggregate output and inflation at any point in time that is the mere and unplanned sum of contributions made by millions of workers, businessmen, investors, savers, speculators, inventors etc. in pursuit their own self-interest across the warp and woof of the economic system. 

Stated differently, the naturally occurring macro which presents itself to would be policy makers--central bankers, Congressman, Presidents and bureaucrats alike---is merely the sum of capitalism's manifold (and splendiferous) micros. 
If policy makers want more macro than the market produces, therefore, they have to induce households and businesses to steal from their own futures by swapping balance sheet encumbrances tomorrow for more borrowing and spending today. 
That's not only the sum and substance of Keynesian policy; it's the heart of the Low Interest Man's take on how business works and how he got (ostensibly) rich. 

But here's the skunk in the woodpile: The Fed's crude interest rate tool has been so over- used and has been ground to such a thin, miniaturized remnant that it just doesn't work anymore. We have called that condition Peak Debt, and it simply means that when balance sheets get saturated, interest rate cutting produces only marginal increments of the hallowed "borrow and spend" effect. 
In the case of households, Peak Debt was reached on the eve of the Great Financial Crisis, when the total debt to wage and salary income ratio reached 220% compared to the pre-Greenspan norm of about 80%. 

And the chart below proves that point in spades. In response to Greenspan's panicked slashing of the Fed funds rate from 6.5% at the time of the 2000 dotcom crash to the theretofore unheard of rate of 1.0% by the spring of 2003, household borrowing soared---especially for adjustable rate mortgages in the midst of the subprime fueled housing boom. 

As shown in the purple line, year-over-year household debt grew by 8-11% annually during most of that period in response to the plunging interest rates (brown line) engineered by the Fed. In just 7 years (2000-2007), outstanding household debt soared from $6.5 trillion to $14.2 trillion or by 120%. 
Yet after partially normalizing rates in 2004-2006, the next spasm of Fed rate-cutting didn't work. Notwithstanding zero money markets rates and correspondingly rock- bottom mortgage rates (both fixed and adjustable), household debt levels changed in a negative direction for several years after the crisis; and even after tepid positive gains returned in 2013, annual growth never broke out of the 2-3% range. 

For the nearly 12 year period between Q4 2007 and Q1 2019, in fact, total household debt grew by only 10%; and in the most recent LTM period ending in Q1 2019, the growth rate clocked in at just 2.8% per annum or marginally above the 2.27% inflation rate posted during the same period. 

In summary, then, household debt grew by 10.2% per annum during the 2000-2007 cycle, but by only 0.8% per annum during the 2007-2019 cycle. The fact of that radical deceleration is alone far more significant for the future than all the rubbish the Fed heads scribble into their monthly meeting statements. 
Once upon a time, a real central banker or even a dopey member of the House banking committee would have readily seen the chart below as evidence that ultra-low interest rates did not stimulate household borrowing and spending during the current so-called recovery; and that whatever the causes of the tepid 1.5% per annum peak-to-peak real GDP growth rate recorded since Q4 2007, interest rate barriers are not remotely one of them. 

Of course, what has changed is the household balance sheet: For 90% of US households, balance sheets are now saturated with Peak Debt or are not even credit-worthy in the first place. In the old days they had a phrase about the Fed "pushing on a string" and when it comes to the household sector, which accounts for 70% of GDP and its therefore the engine of Keynesian central banking, the aforementioned string is apparently made of jello.

The American people are tapped out and broke! Is that really so hard to see?
And is it any less obvious that the so-called deleveraging of the past decade was modest indeed, and did not begin to return household balance sheets to their healthy pre-1987 starting point? So why would cutting rates at this late stage of the business cycle accomplish anything at all by way of Keynesian borrow and spend stimulus? What it would actually do is only further defer the household balance sheet repair that would be needed to re-establish a healthy foundation for sustainable prosperity.
Household Leverage Went From Historic 80% of Wages And Salaries To 180%
Indeed, that's the real insanity---if not downright evil---of cutting interest rates at this late stage (month #119) of the business/credit cycle.
What has obviously happened is that anyone who can fog a mirror has already gotten a car loan; any student who can stay sober at least two days a week has racked up maximum student debt; anyone with a set of power tools has gotten back into the debt- funded house flipping business, which is at record levels; and people have gotten so tapped out that they again are using their credit cards to buy daily necessities like food, fuels and rent.
What we are saying is that under the Fed's quasi-free money regime, the inherent result as the cycle ages is that credit quality systematically deteriorates. And you don't have to look far under the hood to spot it if you apply even a modicum of common sense----the kind that the talking heads of Wall Street have long ago abandoned.

They are always chirping that default rates are low, so what's to worry?
Well, of course they are low during an Easy Money expansion cycle because they whole scam is an exercise in extend and pretend. Car loans don't default if you can refi 130% on a new vehicle and pay off the balance on the old one, which is exactly what they have been doing. Likewise, credit cards don't default if you can get a so called P2P loan consolidation from Lending Club et. al. to pay off old card balances; and student loans never default---so long as you keep being a student.

Extend and pretend in the mortgage refi game was exactly what happened in the run-up to the 2008 financial crisis--until the music stopped; and the time-bombs out there this time are of like and similar character----just in new sectors and venues.

But the credit cycle is like Earnest Hemmingway's character who described how he ended up in bankruptcy: Slowly at first, and then of a sudden!
So the single thing at this late hour of the cycle that rate cuts could do on main street, as opposed to Wall Street, is to draw in the remaining credit dregs and thereby make the eventual credit bust all the more extensive and destructive to borrowers and lenders alike.

There is already plenty of incipient evidence that the next credit bust is well on its way to implosion. For instance, seriously delinquent (90-day) auto debt is now nearly double its peak 2008-2010 level; and loss rates are already approaching recession level highs.

In the case of credit card delinquencies, smaller banks, which have generally lower credit score customers, are already at nearly peak recession charge-off rates; and for larger banks, it's only a matter of time.
To summarize with respect to the household sector, rate cuts from the current pint-sized levels will not extend the cycle; they will only generate more credit losses just around the bend. 

But on Wall Street they will keep the day-traders and algos in business for a few more days or weeks. And that's about as pathetic as it gets. 

 The Keynesian wizards domiciled in the Eccles Building have been reduced to the role of croupiers on the casino's graveyard shift. As our friend Bill King noted in his recap of Friday's idiotic response to a jobs report, which actually did say that recession is around the corner, we are dealing with pure madness: 

 The rate cut/QE madness intensified after the NYSE opened. Bonds surged over one point; gold rallied modestly while the dollar sank. Oil rallied almost 2%. Lemmings and momos poured into FANGs and other trading sardines. The world economy is teetering; but - Hallelujah! - Central banks will cut rates.

But we will leave it to the estimable Sven Henrich to remind just how far the madness has gone:

Game over. The grand central bank experiment of the last 10 years has ended in utter and complete failure. The games of cheap money and constant intervention that have brought you record global debt to the tune of $250 trillion and record wealth inequality are about to embark on a new round of peddling blue meth again. 
Australia has already cut, so has India. The ECB is talking about it, markets are already pricing in multiple Fed cuts. The new global rate cutting cycle begins anew before the last one ever ended. Brace yourselves as no one, absolutely no one, can know how this will turn out. 
Absolutely staggering. We are witnessing a historic unraveling here. Everything every central banker has uttered last year was completely wrong. Every projection they made over the last 10 years has been wrong. No wonder Jay Powell wants to toss the dot plot. It’s a public record of failure. 
Why place confidence in people who are staring at the ruins of the policies they unleashed on the world and are about to unleash again? 
All the distortions of 10 years of cheap money, debt, wealth inequality, zombie companies, negative debt, TINA, you name it, will all be further exacerbated by hapless and scared central bankers whose only solution to failure is to embark on the same cheap money train again. All under the banner to “extend the business cycle” at all costs. Never asking whether they should nor considering the consequences. But since they are not elected by the people and face zero consequences for failure they don’t have to consider the collateral damage they inflict.
 I repeat: Structural bears who have predicted that central bankers would never be able to normalize the construct they created and has produced the world’s greatest debt explosion ever were 100% correct. We’re all staring at a colossal policy failure with no accountability. 

Yet, there is more.

Despite all of the pathetic begging for rate cuts on Wall Street, the Donald went fully over the deep end this AM when he called into bubblevision to unload some purported monetary and economic wisdom.

Needless to say, he insisted that the Fed has been raising rates too fast, and that America would be swamped in unicorns and rainbows if the Fed had only "listened" to his sage advice:
Without the rate increases, “the stock market would be up 10,000 points more.... President Donald Trump renewed his attack on the Federal Reserve, complaining it doesn’t “listen” to him and contrasting that lack of obedience with the control that China’s leader wields over its central bank. “The head of the Fed in China is President Xi,” Trump told CNBC television in a telephone interview Monday. “He can do whatever he wants. They devalue. They loosen” monetary policy to help offset the burden of tariffs, he said. Refreshing other familiar themes of frustration, Trump said the Fed “certainly didn’t listen to me because they made a big mistake. They raised interest rates far too fast,” and he went on to chide them for hiking “the day before a bond issue goes out so we have to pay more money.”
 And then came the clincher:
“They devalue their currency. They have for years. It’s put them at a tremendous advantage,” Trump said of the Chinese. “We don’t have that advantage because we have a Fed that doesn’t lower interest rates.” 
Holy Moly!

With talk like that coming out of the Oval Office, by all means, kids, buy-buy-buy-the- dip.

After all, when the trap door opens, you won't even know what hit you!

David Stockman was Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.

The above originally appeared at David Stockman's Contra Corner.

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