The American Speculative Innovation And Great Onshoring Myths Are Morality Tales Of Mission Creep To Zombie Nation Status
Macro, behavioral finance, emotional finance, central banks,
Seeking Alpha Analyst Since 2015
Over thirty years of taking the volatility out of uncertainty, by taking the uncertainty out of volatility, for proprietary trading desks, commodity trading advisors, sovereign wealth funds and private offices.
Summary
- American economic and health indicators are diverging.
- American employment indicators are diverging.
- The date of economic and health indicator convergence is anybody’s guess.
- Employment Indicators are highly likely to converge, basis the August Employment Situation report.
- A new Fed false-narrative about Speculative Innovation masks the realities of Creative Destruction and Zombie Creation.
(Source: Gallup, caption by the Author)
The official COVID-19 plague diary narrative is being spun to hide several worrying divergent trends in the economic and health performance of the US economy. These divergent trends must however converge to reflect reality at some point in the future. The Fed’s monetary policy seeks to lengthen the duration of this convergence process, in the hope that the negative trends eventually converge on the positive ones. The Fed’s buying of time comes with a great economic cost, in return for the unquantified consideration of future onshore supply chains.
Perceptions of the US economy are now collapsing into two frames of reference for the main risks identified by two Fed speakers in the last report. Atlanta Fed president Raphael Bostic was worried about a growing economic headwind from expiring Federal support programs blowing during the summer. Kansas City Fed president Esther George worried about the inability of state and local governments to sustain their economies in the face of pandemic-eroded tax bases.
As the re-opening gets off to a very shaky start, in which some governors are reconsidering new lockdowns, the two risks identified by Bostic and George have combined with the underlying healthcare headwind.
(Source: Bloomberg, caption by the Author)
The influence of new healthcare protocols, at the state and local level, has had an immediate negative impact on employment.
(Source: Bloomberg)
State and local governments are now grappling with the funding and liquidity difficulties that George previously opined.
This confluence of headwinds provides the context for the Fed’s current flirtation with Yield Curve Control (YCC). It is highly likely that the Fed will use its balance sheet to target state and local government borrowers in the near future. The Fed’s balance sheet is, however, already reaching proportions at which any spikes in yield create serious capital losses for the central bank, which in turn hinders its ability to continue with its qualitative and quantitative easing. The Fed, therefore, needs a backstop from the US Treasury before it requests a more politically embarrassing bailout. In short, the Fed is Too Big To Fail (TBTF) and its plight may crowd out the economic recovery.
(Source: New York Fed, caption by the Author)
Signaling the Fed’s intentions and capabilities, to focus on the state and local government sector, the New York Fed has hastily prepared some research. The researchers have found that whilst Muni-spreads, in general, have recovered, the weakest fiscal authorities in the areas hardest hit by the pandemic are still experiencing credit stress.
Always keen to do the Fed’s easing in advance of monetary policy decisions, that may not then occur, Mr. Market continued to pile into junk municipal bonds. It was looking like enhanced guidance was truly allowing the Fed to get away with not having to buy anything. Unfortunately, this was also creating a bubble in muni bond prices that the Fed would have to sustain, eventually, through buying at higher prices than when it initially guided it was going to buy. The whole exercise, thus, proved that the Fed audibly creates bubbles which it then has to maintain, with buying, because of its prior commitment to allowing economic overshooting.
Having bought, at higher prices, the Fed will then have to sustain the bubble in order for it not to sustain unrealized losses that require a taxpayer bailout. Ironically, the Fed was supposed to be helping the taxpayer with its buying in the first place. Now its buying makes it reliant on a bailout from the taxpayer who it was supposed to be helping. The road to moral hazard is paved with good intentions and comes at great cost to the economy, which cannot be kicked into the future indefinitely without strong economic growth. So far, there is no strong economic growth on the immediate horizon.
(Source: Bloomberg, caption by the Author)
This author also notes that the Fed’s charade, of appearing not to be monetizing public and private debt, is wearing a bit thin. As of June 16th, the Fed became the third-largest holder of the iShares iBoxx $ Investment Grade Corporate Bond exchange-traded fund (LQD). Even standing at arms-length from the assets, via an external asset manager, doesn’t obscure the problem when the size of the purchases is so large.
(Source: and caption by the Author)
As noted in a previous report the subcontracting out of QE, to “Masters of the Asset Class Universe”, had created the misleading appearance that debt is not being monetized; by the simple construction of a Wall Street interface between the Fed’s balance sheet and the debt. This sleight of hand is, however, no longer big enough to cover the sheer volume of the Fed’s indirect securities buying. The systemic risk, from the TBTF Fed, is now leaching back into the asset management sector via the Masters. The Masters and the Fed are both TBTF. The Masters also need a US Treasury backstop and or a future bailout.
(Source: and caption the Author)
The Fed’s interest in YCC is borne out of observations of its application by the BOJ. The BOJ has been able to mitigate its risk of capital losses to a limited extent by the application of YCC. In addition, the enhanced forward guidance to apply YCC has been so successful that the BOJ has not had to follow through fully on its promises to buy. Clearly, not having to buy more securities greatly reduces the interest rate risk to the BOJ’s balance sheet. YCC should, thus, be seen as a kind of stop-gap before the Fed goes for the US Treasury backstop and/or the bailout. YCC is also the “Masters of the Asset Class Universe’s” best friend.
(Source: New York Fed)
Evidently, at least the New York Fed is coming to the conclusion that the Fed creates bubbles, and that the current one that it is creating maybe the one that bites it and the US economy in the proverbial. New York Fed staffers have empirically determined that, as participation in the equity market has grown since Paul Volcker began the greatest bull market in history, monetary policy has had a greater tendency to get channeled into stocks at the expense of the real economy over time. In layman’s language, this means that the Fed creates asset bubbles de facto larger in size than the real economy’s potential to sustain them.
Clearly, going forward, to prevent the current equity bubble from bursting painfully the Fed will have to be far more focused and targeted about who it stimulates. It will be interesting to see if the Community Reinvestment Act (CRA) monetary policy tool, that the Fed is using for its informal Inclusivity Mandate, can meet these focusing requirements. Alternatively, if it fails, the Fed can simply provide ethnic minorities with brokerage accounts and cheap leverage so that they can join the party! Given that the US is facing a jobless recovery the latter suggestion is quite logical if policymakers are seeking to redistribute wealth without direct fiscal transfers.
Chairman Powell’s prepared transcript, released before his testimony, for the House Financial Services Committee, set an underlying tone of guarded optimism that framed perceptions of the Fed’s guidance and actions going forward. He noted, positively, that the re-opening had occurred faster than originally anticipated. He then warned of the healthcare risks associated with this premature reopening.
San Francisco Fed president Mary Daly characterizes her perspective on the economic recovery as “curious” rather than cautious. In her opinion, it is simply too early to say with any degree of certainty how the economic recovery is progressing.
Atlanta Fed president Raphael Bostic and Minneapolis Fed president Neel Kashkari are now both nudging the Fed’s adopted, rather than Congressionally mandated, Inclusivity Mandate into the policymaking milieu. Bostic’s latest commentary nudged this moral imperative into a structural policymaking reform to eradicate racism at all levels of the executive. Kashkari would like a more granular analysis of the employment situation to target outlying demographics that have below trend dynamics.
New York Fed president John Williams doesn’t want the Fed to lose sight of the healthcare challenges to the economic recovery. Citing the current sporadic pandemic outbreaks, as evidence for his thesis, he theorized that a return to a normal functioning economy is years away. By inference, the normalization of monetary policy is even further away, as the Fed intends to allow the economy to overshoot.
The release of the minutes of the June FOMC meeting opened a hind-sighted window on the Fed’s current posturing.
The minutes clearly showed that Esther George’s fears for state and local governments becoming overwhelmed resonated with ger colleagues.
On the subject of YCC, which the FOMC calls YCT (T for Targeting), the minutes showed that enhanced forward guidance is the next step on the road to massaging the term structure of interest rates. Evidently, the Fed still believes that talking the talk means that it doesn’t have to physically walk the walk with bond purchases.
Whilst enhanced forward guidance was accepted as necessary, there remains considerable debate about how to frame this guidance with relevant context. This context is known as “state dependency”. Some members would like it framed in relation to inflation. Others would like it framed in relation to employment. There are also others who want it framed in relation to the signaling of a commitment to let the economy overheat a little. A failure, to agree on the appropriate context, will create the kind of dissonance that undermines the impact of the guidance. The Fed needs to get its guidance act together.
At the meeting, there were also staff presentations made to the FOMC on the specific subject of YCC/YCT. The general conclusion was that it can be helpful. There was, however, one significant caveat. For YCC/YCT to be successful, it was found that it must be credibly reinforced by significant asset purchases. If the Fed, therefore, thinks that it can talk the talk without walking the walk it is deluded. This will be even more the case if the Fed fluffs its guidance frame and context as noted in the previous paragraph. Indeed, this author foresees that the Fed may have to overcompensate, with asset purchases, as a consequence of its failed enhanced forward guidance.
The minutes also showed that, despite the premature economic re-opening and attendant bounce in GDP, the Fed was even more vigilant to the healthcare risks that could unravel the whole story at any moment.
The dissonant contextual tones, in the Fed minutes, could clearly be heard in the ensuing guidance from San Francisco Fed president Mary Daly. She opined that even assuming that the healthcare strategy and tactics are executed perfectly, a best-case scenario is a four-to-five year economic recovery period back to pre-pandemic levels. She refused to speculate on how long a worst-case botched healthcare plan scenario would take, but one may assume that it could at least be a decade at best.
Faced with the uncontrollable vicissitudes of the reopening, St. Louis Fed president James Bullard signaled that he has gone into risk management mode. This involves watching closely for signs of tightening liquidity, in sectors and sub-sectors of the economy, that may turn into economic headwinds. Such potential headwinds can, then, be unconventionally targeted in a focussed manner without about the blunt tools of gross asset buying and/or interest rate cuts.
(Source: Atlanta Fed)
Atlanta Fed president Raphael Bostic is in advanced risk management mode. The high-frequency data, that he watches, currently tell him that economic activity is “leveling off”.
(Source: Atlanta Fed, caption by the Author)
One of the indicators referred to by Bostic is the Richmond and Atlanta Fed’s CFO Survey. The latest survey shows that CFO’s do not expect the US economy and/or their respective businesses to return to pre-pandemic levels before 2021.
(Source and caption by the Author)
What the CFO’s are signaling is what this author has called the “To Hell and Back To Purgatory Shaped US Recovery”.
(Source: Boston Fed, caption by the Author)
If Bostic is correct, the newly arrived Fed Main Street Lending Programme has arrived just in time to head off the second wave.
Bostic’s caution resonates with that of Vice-Chair Clarida and Cleveland Fed president Loretta Mester. Clarida simultaneously opined that strong guidance and possibly further balance sheet action will be needed, if the recovery stalls and inflation expectations remain depressed. Mester was clear that a failure by Congress, to get another fiscal stimulus into the game, will require remedial action from the Fed.
(Source: Cleveland Fed, original caption by John Maynard Keynes)
Mester’s caution may be due to some new research into the Phillips Curve, from two of her staffers, that is just percolating through to the monetary policymaker level. The staffers have found that COVID-19 has destroyed tight capacity, to such an extent, that the Phillips Curve now needs a new parameter input to produce intelligible outputs. For the Phillips Curve to work, economic growth must now be plugged into its calculations instead of economic slack. The staffers have, thus, curve-fitted with hindsight something that they could not predict a priori with the theory as it existed. Only economists would try and save a sacred cow, like the Phillips Curve, from the altar of new data. Scientists would slaughter it and move on to a new theory.
The alarming new conclusion, drawn by Mester’s Cleveland Fed, is that the Phillips Curve, even with its new backward-fitted parameters, is a harbinger of deflation these days.
A layman would observe that the Phillips Curve has become a victim of COVID-19. Mester has invested a great deal of her time (and guidance) in theories pertaining to tight economic capacity. This prior investment has always made her guidance and behavior sound and look Hawkish. Suddenly, COVID-19 has killed her golden guidance goose. Rather than fess up, she has simply tried to modulate her guidance and rhetoric to accommodate this new development. Perhaps, she is hoping that one day the Phillips Curve will return the old normal that made her a Hawk. In the meantime, she needs to frame perceptions, of her ongoing metamorphosis, from Hawk to Dove, and its empirical cause, so as not to lose face and the credibility of her guidance.
(Source: St. Louis Fed, caption by the Author)
The St. Louis Fed research on the Phillips Curve unequivocally finds that, since it is not robust enough to deal with shocks, it must be dead. It’s going to be amusing watching, the fun-and-games as James Bullard debunks Loretta Mester’s references to the Phillips Curve going forward. The impact on Fed enhanced forward guidance, of this fun-and-games, will not be as amusing to behold.
The cautious contagion is spreading quickly through the Fed. San Francisco Fed president Mary Daly has made it clear that, through the lens of the employment mandate, the Fed will have to act in some way going forward.
Richmond Fed president Thomas Barkin is with Daly. Even if the unemployment rate recovers to 11%, he still believes that the Fed will have to act. As he noted, “unemployment is 11%, so yes.”
Fed Governor Randal Quarles has provided a cautious look at how the banking sector is performing in the current situation. He noted that the economy is not out of the woods yet and that a full recovery is still some way off. Against this uncertain outlook, he then discussed how the banking sector is performing from a systemically important institutional risk perspective.
Progress made on systemic risk, since the GFC, means that the banking sector went into the COVID-19 pandemic on a much stronger capital and liquidity footing. The banks are, thus, in a better position to weather the current storm, but the magnitude of this crisis will test them. One important takeaway, from Quarles’ discourse, is that the global contagion risk from the continuing inability to have a consistent set of rules on liquidation and unwinding, across international borders, has still not been comprehensively addressed. The risk of another global financial crisis, triggered by the COVID-19 pandemic, thus, remains a clear and present danger reading between the lines of Quarles’ presentation.
(Source: and caption by the Author)
The caution evinced by Mester et al is totally dissonant with the confidence on St. Louis Fed president James Bullard. Bullard is on a roll. He initially called the self-mandated recession, with the acronym NPAP, as the pandemic response and, also, the swift recovery and re-opening that has ensued. Ostensibly, maintaining his current hot streak, he recently made the call that unemployment will swiftly fall to 8%, even though masks and social distancing hurdles will remain “ubiquitous” features of American working life.
Bullard’s potentially over-confident, premature, self-confirming bias should be compared and contrasted with the caution of Boston Fed president Eric Rosengren. The reader will remember that Rosengren was a principal architect of, and spokesman for, the Main Street Lending Programme (MSLP). Bullard, thus, flips the economy’s on-off switch, whilst Rosengren is responsible for the wiring and plumbing that kicked in when the economy was switched off. Both have unique and contrasting perspectives.
(Source and caption by the Author)
Rosengren’s recent guidance is much more measured than Bullard’s. It is his expectation that Main Street will now start to avail itself of the MSLP. He also expects a slower economic recovery from here.
It could be that both commentators are looking at different parts of the same beast. Bullard’s swift recovery may be predicated on Furlough swiftly running out and employers tapping into the MSLP to sustain their businesses. It is critical to see how Bullard and Rosengren’s forecasts intersect because this point will essentially govern what the Fed then does. Currently, there is a wide convergence basis between the two.
The reality is that neither of the two esteemed Fed presidents has a clue how the future will unfold. This fact alone should engender caution.
(Source and caption the Author)
Rosengren’s caution may be triggered by specific microeconomic conditions in his district that may not be as acute as the same ones in Bullard’s. A previous report credited Kansas City Fed president Esther George with noting the fiscal stress at state and local government level building into s strong economic headwind. The Boston Fed has gone micro with George’s macro thesis. New Boston Fed research shows that, despite all the current pandemic emergency programs out there, New England state and local government will need fiscal transfers from the Federal budget.
Dallas Fed president Robert Kaplan is basing his next move on the results of the healthcare protocols that are accompanying the re-opening. Based on the chaos that is appearing, his balance of risks is presumably heavily-weighted to the downside at present.
(Source: ING, caption by the Author)
The cognitive and guidance dissonance within the Fed may also be, in part, due to some curious divergence in the reported labor market data. The Department of Labour (DOL) has unemployment benefit claims reaching new highs, whilst, the official Bureau for Labour Statistics (BLS) shows the situation improving. Both cannot be right, once the reporting and counting obstacles created by the pandemic are cleared. The two are expected to converge, basis the August Employment Situation report. This should make for more fun-and-games if the DOL is correct since the current working assumption and price action are based on the BLS being on the money.
(Source: Philadelphia Fed, caption by the Author with immense thanks and gratitude to Dame Vera Lynn RIP)
The unemployment basis risk, between the DOL and BLS, can also be found in the high-frequency data being followed by the Philadelphia Fed as part of its weekly Tracking the COVID-19 Economy series of reports. The report clearly shows that, whilst Initial and Continuous Unemployment Insurance (UI) claims are slowly falling, the Pandemic Unemployment Assistance (PUA) and Pandemic Emergency Unemployment Compensation claims (PEUC) have risen and plateaued. Plateauing is occurring for the Initial component, whilst claims are still rising for the Continuous components of the PUA and PEUC data. The disruptive August day of reckoning data convergence point thus beckons in this data-set set also.
(Source: New York Fed, caption by the Author)
Despite Bullard’s optimism, the dissonance in the Fed’s guidance and the unemployment basis risk imply a growing sense that the Fed is preparing to ease again. It may be forced to go in August when all the diverging data-sets converge. Evidently, this gut-feeling is shared by the New York Fed’s Daleep Singh.
Issuing a big disclaimer, that his thesis and comments are his own, Mr. Singh has recently written an exculpatory report explaining how the Fed has learned from the mistakes of its earlier actions. Mr. Singh, thus, explains how the Fed will be successful next time it acts. He, therefore, signals that the Fed is already prepared to act and is drumming up the courage and reasoning to do so.
The last report discussed the rising probability of President Trump being impeached as he repeats his previously successful “Helter Skelter” re-election campaign. John Bolton’s explosive book release was noted as part of this process. Since then, the momentum has escalated, with a new revelation that the President was aware that Russian military intelligence personnel paid Taliban fighters bounties to kill American soldiers. Leveraging off this allegation, the 43 Ronin from the W. Bush administration have formed a breakaway Alumni for Biden Super PAC group. This latest expose raises the moral standing and political leverage of the Pentagon further; in order for its mission creep into executive foreign policymaking to gain further traction.
As it grows in moral stature, so the Pentagon grows in executive power. Mission creep now extends from supply chain onshoring governance to foreign policy. A recent flexing of muscles by the Pentagon prevented Intel from shipping components to a Chinese server manufacturer allegedly controlled by the Chinese military. On the logistics and supply side, the Pentagon has seen to it that its main heavy lifter Yellow Roadway (O:YRCW) receives CARES Act support.
(Source: Richmond Fed, caption by the Author)
The Fed is a key enabler of the Pentagon’s mission creep, that must be well camouflaged in order to avoid detection and possible disruption from America’s foes. The Richmond Fed has recently camouflaged the Fed, in some empirical DPM’s, in order to tactically support the enabling mission.
The Richmond Fed’s researchers have published a subjective empirical piece of propaganda, to refute the growing criticism that the Fed is supporting Wall Street to the exclusion of Main Street.
The research empirically determines that financial speculation is a key driver, and also a key-sustainer, of innovation. This innovation is the basis of economic value. The reader of this propaganda is, therefore, being encouraged to infer that the current alleged speculative new highs in US technology stocks are nothing more than this process of Speculative Innovation at work.
Unfortunately, nothing is said by the Richmond Fed researchers of Schumpeter’s Creative Destruction that this Speculative Innovation must, by default, be doing to companies that can be identified with the Old Economy. If said Old Economy is located in China and the Eurozone, then so much the better for Speculative Innovation and mission creep for that matter!
(Source: Bloomberg, caption by the Author)
It will be interesting to see if, how, and when the Speculative Innovation narrative is woven into the narratives of how the Fed is saving Main Street and ethnic minorities simultaneously. The reality makes this monetary policy morality tale look like a fairy tale in practice.
The latest data on the Fed’s asset-buying shows that there are no Main Street borrowers, ethnic minority or otherwise, currently availing themselves of the Fed’s magnanimous offer to lend directly to them. The current rate of attrition, in the small business sector, shows that 46% of firms expect to need further emergency support, whilst, 20% expect to close down when the current PPP round ends. Presumably, those who are not borrowing prefer to subsist on Federal gifts rather than loans. When the gifts end, they will stop subsisting and will then struggle to exist further.
To hide the embarrassing reality behind a convenient fiction the Fed is, therefore, increasing its purchases of corporate bonds and fixed income ETF’s. Consequently, those with a credit rating, that is undoubtedly under duress from COVID-19, will still be able to borrow. Emerging innovators, with a poor credit rating by default, will not get to borrow.
(Source: the Author)
Speculative Zombie Creation is, thus, the reality despite the Richmond Fed’s classification of the process as Speculative Innovation. Mission creep and the “Great Onshoring” of supply chains, enabled by the FOMC and a few good men, are, therefore, creating a structurally weak industrial base that is anything but competitive in global terms.
(Source: redubble.com, caption by the Author)
Blue Horseshoe, in fact, loves Zombie Nation.
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