Gordon T Long

Gordon T Long

Global Macro Research | Macro-Technical Analysis 





The US Federal Reserve operates in an independent fashion to a large degree, separated from the turmoils of political pressures.
There are however a few exceptions, the most notable being:
  1. During the Renomination Cycle of an incumbent Fed Chair,
  2. When Fed policy traditionally attempts to be supportive of the in-power administration during an election year,
  3. Pressures stemming from a new Executive Branch administration with clearly differing views from the prior administration, particularly in the area of Fiscal Policy.
All three have recently came together! It is our estimation that these pressures had a material impact on recent Fed communications and policy, specifically the abrupt and startling removal of inflation being “Transitory” from Fed Speak.
Prior to this the Federal Reserve had placed itself in a very tenuous position of its own making. Many in fact felt the Fed was “Trapped” as a result of its policy decisions! This is bad enough, but additionally when politics influences Monetary Policy it normally contributes to a major monetary blunder!
The degree to which President Biden’s approval polls have fallen is a major concern for the congressional candidates seeking re-election in this mid-term election year. What is most alarming is that 69% of voters don’t approve of the Biden Administration handling of Inflation. It is the number one concern that the incumbent Democrats up for election have with this new President and his administration’s policies.
This problem is something that the administration perceives the Fed can fix, and as a result prior to Biden re-nominating Chairman Jerome Powell for another term he called him to the White House for consultation. The timing of Powell’s major pivot on Inflation not being “Transitory” is likely not just a coincidence.
The result has been what appears to be a planned sequence of moves that will take Fed Policy from a Covid Recovery Focus to an Inflation Fighting Focus as quickly as possible. The biggest impediment is not to create yet another “Taper Tantrum” which the markets endured earlier in this decade. A tricky amount of “stick handling” is required which even the Great Wayne Gretzky in his prime may not have been able to pull-off.
Here is the likely roadmap with the stages outlined below:
The four charts to the right are what the Biden Regime sees and politically wants to believe (and promote) to both improve Biden’s Poll results and the Democratic platform for those up for re-election next November.
CHART 1: GDP has recovered from the Covid shock.
CHART 2: In Biden’s first year, the US Economy has surpassed the Pre-Covid highs.
CHART 3: Payrolls are back near Pre-Covid highs with Job Openings far surpassing the unemployment rolls.
CHART 4: Coming Fiscal spending will further propel economic growth to new highs.
Biden Regime’s Conclusion; Job Well Done!
However, it’s all false reality which Powell must not distract from!
The economic recovery from the Covid shock is built on historic injections of liquidity and the growth in the Federal Reserve’s Balance Sheet. Little of this massive fiscal deficit spending actually went into productive investment to support growth. At best it was short term “triage” for a failing economy; at worst – political desperation in front of a looming debt crisis.
The reality is that the huge deficit growth was most fundamentally used for unprecedented transfer payments to desperately maintain consumption spending. Consumption is not investment!
CHART 1: The chart (BELOW LEFT) illustrates that US GDP growth has been, and still is, a major problem. The US economy is close to the end of an unprecedented decade long business expansion cycle fabricated on endless versions of Quantitative Easing (QE).
CHART 2: The second chart (BELOW RIGHT) shows that short term GDP growth is only the result of massive deficit spending to provide government transfer payments. This has resulted in greatly distorted GDP reporting and an illusion of economic growth.
CHART 3: The story board’s political narrative also fails to lay out the devastating damage that has been done to real earnings, because of actual inflation resulting from interest rates being held too low for too long (chart to right).
Chairman Powell’s first Pivot is best labeled as the “Inflation IS NOT Transitory” shift, which shocked many to hear a Federal Reserve Chairman acknowledge such a major error underpinning monetary policy formation. Powell had little choice if he was to attempt to get ahead of what is such a publicly visible inflation explosion in food, gas, shelter and goods that most Americans are experiencing first hand.
The Fed’s credibility has been seriously damaged! We will wait to see if it comes back to haunt the Fed down the road.
The Cycle below suggests we have entered its second rotation. As such the Fed now expects slower economic growth ahead as well as a flattening yield curve. To be reducing stimulus and possibly tightening is not the normal course of action for established Monetary Policy when an economy is slowing. It signals a possible major monetary blunder if the Fed does not prove to be sufficiently nimble.
Powell however has little choice as he will attempt to appease the financial markets with the appearance of a gradual Taper to avoid another “Taper Tantrum”, But the Fed isn’t fooling anyone – especially the old school ‘bond vigilantes’!
What the Federal Reserve is desperately hoping to buy is a little time.
The Fed believes that a slowing economy will put downward pressure on bond yields which will counter balance fighting the rising pressures on yields due to rising inflation.
As the charts to the right suggest, there is a lot of analysis that this is actually a real possibility.
CHART 1: DEFLATIONARY PRESSURES due to reduced money stock are expected. Many countries (especially in Emerging Markets are already aggressively tightening).
CHART 2: PEAKING INFLATION: Though inflation will stay high it is likely to abate slightly in the near term.
CHART 3: DEMOGRAPHICS: With more workers both retiring and joining the approximately 100 thousand eligible US workers who have left the labor pool, It is expected that this will create further deflationary pressures as their spending is forced to moderate.
Time will tell if these factors assist the Fed in managing rates such that it still allows the government’s financial deficits to be funded, without surging interest expense.
The second Pivot will be towards a greatly accelerated fight against inflation via rapidly rising Fed Funds Rate.
Unfortunately, the Fed is way behind the curve and needs to catch up quickly for two reasons:
  1. Contain Inflation and Inflation Expectations,
  2. Create room to reduce rates to combat possible financial fallout which historically always occurs when the Federal Reserve raises rates.
The Fed has only so much room to move within before causing another Financial Crisis. As the chart to the right illustrates the boundary condition the Fed has is keeping the Fed Funds Rate positive while having a negative Real Fed’s Rate.
Over the four decades since price rises peaked under Paul Volcker, inflation has quite often exceeded the fed funds rate (meaning that the real fed funds rate is negative). But all hiking cycles have ended with the Fed Funds rate above inflation.
Inflation is as much about INFLATION EXPECTATIONS as it is about the mechanics of money supply and monetary policy. This is not commonly fully appreciated.
Once Inflation takes hold of public sentiment it has proven historically to be a monster to contain. The chart to the right suggests the monster may already be larger than the Fed has the flexibility to fight? In the latest survey, the public’s short-term expectations for inflation surged to 6% – a new record high.
The problem that the Fed must address are two competing forces:
  1. Falling Economic Growth
  2. Rising Inflation
The Fed doesn’t have the tools to fight both concurrently! The 1970s proved this to be the case. It took Chairman Volckers dramatic policies to pull the US Economy back from the abyss.
Stagflation is likely going to be the problem the Fed faces predominately over the remainder of this decade.
We have long argued that we are experiencing both Inflation and Deflation at ever increasing and destabilizing levels.
This is what the Fed currently faces and now they seem to be panicking!


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