Swan Song Of The Central Bankers, Part 1: Last Week Wasn’t An Error

By David Stockman

Last week’s twin 1,000 point plunges on the Dow were not errors. Instead, these close-coupled massacres, which wiped out $4 trillion of global market cap in two days, marked the beginning of a bear market that will be generational, not a temporary cyclical downleg.

What hit the casino wasn’t an air pocket; it was a fundamental change of direction, signaling that the three decade long central bank experiment with Bubble Finance has now run its course.

Moreover, this epochal pivot is not tentative or reversible in any near-term time frame that matters. That’s because the arrogant but clueless Keynesian academics and apparatchiks who run the Fed think they have succeeded splendidly and that the US economy is on the cusp of full-employment.

So they’re now hell-bent on positioning the central bank for the next downturn. That is, they are reloading their recession-fighting “dry powder” thru interest rate normalization and a second giant experiment—-this time in shrinking their balance sheet by huge annual amounts under a regime called quantitative tightening (QT).

Needless to say, both the magnitude and the automaticity of this impending monetary shock are being completely ignored by Wall Street in favor of bromides like “the market knows” QT is coming because the Fed has been transparent in its forward guidance.

So what? Knowing the steamroller is coming doesn’t stop you from getting crushed if you remain in its path. In fact, the $600 billion annualized bond dumping rate incepting in October is a fearsome number; it’s larger than the entire $500 billion Fed balance sheet as recently as the year 2000.

By your way, that had taken 86 years to accumulate through two world wars, the Great Depression and 9 lesser recessions. Yet that monumental change of dimension has faded from the working knowledge of Wall Street punters and commentators alike only be virtue of the insane 9X expansion to $4.5 trillion that occurred over the subsequent 14 years.

Moreover, you can count on the Fed’s impending bond selling spree to get a turbo-charge from the bond pits.

As we insisted on Fox Business this AM, the fast money will soon figure out that the best way to print profits is to pivot with the Fed. That is, just as they were buying what the Fed announced it would be buying in the tens of billions per month during the era of QE, leveraged traders will start selling what the Fed has announced it will be selling during the new ball game of QT.

That will cause the impending bond market yield reset, in turn, to overshoot to the upside. Accordingly, the 10-year yield, which touched another new high at 2.88% early this AM, will be ripping through 3.0% shortly; and then be on its way to 4.0% and beyond.

Indeed, that’s virtually inevitable. With the ECB, BOE, PBOC and BOJ all moving toward tightening in one fashion or another, the US bond market will have to clear $1.8 trillion of supply during FY 2019, but with little prospect of uptake from foreign central banks or their local bond markets.

That’s right. The GOP fiscal geniuses now running the government, who inherited $700 billion of red ink for the upcoming year as a bipartisan legacy of decades past, have promptly layered on another $500 billion. That stems from the unfunded tax cut at $280 billion and from $220 billion more flowing from last week’s spend-a-thon and the associated rise in interest payments.

Indeed, since Congress so dramatically front-loaded the tax-cut, the argument that “growth” will close the gap has been reduced to a bad joke. Even if it boosted GDP growth by a full 1.0 percentage point next year, the gain to GDP would be $200 billion and the associated revenue uptake would be less than $40 billion.

In the context of a $4.6 trillion annual spending level, call that a 0.9% rounding error and be done with it. And don’t expect that the s0-called growth dividend will catch-up a few years down the road, either.

The fact is, FY 2019 will end in month #124 of the current business expansion (incepting in June 2009). That would make it the longest business expansion in recorded history and more than double the average cycle.

As we also argued on Fox this AM, if we even reach that point before the next recession hits, it should be considered a minor miracle. After all, the “yield shock” directly ahead is going to throw everything “priced-in” down there on Wall Street into a cocked-hat—including the likelihood that rising rates will rip $20 per share out of S&P 500 earnings (see below).

But to think you can go another 3-4 years without a recession is surely delusional; and to expect to get all the way through 2027 without a downturn (a putative 219 month expansion), as do both the current Trump budget and CBO baseline, would be downright inconceivable.

In this context, the Fed’s resolve to dump $600 billion per year back into the bond pits should not be underestimated. As our colleague Lee Adler pointed out recently, the Fed has so determinedly adverted to auto-pilot with respect to it bond selling campaign that it not only announced it would refrain from commenting about it in its meeting minutes, but has now even stopped publishing the monthly runoff schedule.

That get’s us to the market’s misplaced confidence that after a moderate-sized hissy fit on Wall Street, the Fed and other fellow-traveling central banks will back-off from normalization and QT. The fact that the head of the New York Fed and Goldman plenipotentiary at the central bank, Bill Dudley, pointedly referred to last week’s two-day $4 trillion stock plunge as “small potatoes” is perhaps a hint of things to come.

In that vein, the next chairman of the ECB in waiting, also left little to the imagination.

German Bundesbank President Jens Weidmann called on the European Central Bank Thursday to wind down its giant bond-buying program after September, urging officials not to be distracted by a stronger euro currency or volatility in global financial markets.

Here’s the thing, however. Wall Street’s complacent belief that the auto-pilot shift toward QT will be turned-off and reversed in the event of a recession is badly misplaced. That’s because the era of Bubble Finance has turned business cycle causation upside-down.

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