TikTok, Will The Fed's Liquidity Bubble Implode?

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Jeanna Smialek of the New York Times reports Fed Chair Jerome Powell sets the stage for longer periods of lower rates:

Jerome H. Powell, the chair of the Federal Reserve, announced a major shift in how the central bank guides the economy, signaling it will make job growth preeminent and will not raise interest rates to guard against coming inflation just because the unemployment rate is low.

In emphasizing the importance of a strong labor market and saying the Fed will tolerate slightly faster price gains, Mr. Powell and his colleagues laid the groundwork for years of low interest rates. That could translate into long periods of cheap mortgages and business loans that foster strong demand and a solid job market.

The changes, which Mr. Powell detailed at the Kansas City Fed’s annual Jackson Hole policy symposium, follow a year-and-a-half long review of the central bank’s monetary policy strategy. In conjunction with his remarks, the Fed released an outline of its long-run policy plan.

“Our revised statement emphasizes that maximum employment is a broad-based and inclusive goal,” Mr. Powell said in the remarks. “This change reflects our appreciation for the benefits of a strong labor market, particularly for many in low- and moderate-income communities.”

Market reaction to Mr. Powell’s announcement was mixed. Investors had already penciled in years of rock-bottom interest rates and analysts will be watching for more concrete rate guidance at the Fed’s upcoming meetings.

Still, Mr. Powell’s announcement could mark a defining moment in his tenure as chair, which began in early 2018 in the midst of the longest economic expansion on record and has run straight into the sharpest downturn since the Great Depression. The Fed raised rates nine times between 2015 and late 2018, with four of those increases under Mr. Powell’s watch, as it tried to guard against inflation. Price increases instead stagnated, making the Fed’s moves seem like overkill and helping to inspire and inform the policy review.

The central bank is facing major long run challenges as price gains prove tepid and as interest rates have slipped lower across advanced economies including the United States, leaving Fed officials with less room to cut borrowing costs and coax higher growth following recessions. Those slow-burn problems are what prompted Mr. Powell and his colleagues to revamp their policy framework. At the same time, the coronavirus pandemic has created a significant short-run threat, shuttering businesses and costing millions of people their jobs.

Mr. Powell’s announcement codifies a critical change in how the central bank tries to achieve its twin goals of maximum employment and stable inflation — one that could inform how the Fed sets monetary policy in the wake of the pandemic-induced recession.

The Fed had long raised rates as joblessness fell to avoid an economic overheating that might result in breakaway inflation — the boogeyman that has haunted monetary policy ever since price gains hit double-digit levels in the 1970s. But the Fed’s updated framework recognizes that too low inflation is now the problem, rather than too high.

“It seems like a pretty subtle shift to most normal human beings,” said Janet L. Yellen, the former Fed Chair. But “most of the Fed’s history has revolved around keeping inflation under control. This really does reflect a decisive recognition that we're in a very different environment.”


The Fed’s revised statement says that its policies will be informed by “shortfalls” of employment from its maximum level, rather than by “deviations” — suggesting that the central bank is no longer planning to raise rates to cool off the economy simply because unemployment has dipped to low levels.

The central bank is also formally shifting its inflation approach, aiming to average 2 percent inflation over time, rather than as an absolute goal. In doing so, the Fed is trying to convince the public and investors that it will allow prices to rise a little bit faster. If public inflation expectations slip, it can lock in slow increases. Those feed directly into the level of interest rates, and leave the central bank with even less room to cut them during times of crisis.

“If inflation expectations fall below our 2 percent objective, interest rates would decline in tandem,” Mr. Powell said. “In turn, we would have less scope to cut interest rates to boost employment during an economic downturn.”


Higher inflation may seem like an odd goal to anyone who buys milk or pays rent, but excessively weak price gains can actually have damaging effects on the economy. A circle of stagnation has played out in countries including Japan, in which lower price gains leave less room to cut rates, limiting policymakers’ ability to stimulate the economy and resurrect inflation.

“We are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes,” Mr. Powell said. “However, inflation that is persistently too low can pose serious risks to the economy.”

In a question-and-answer session after the speech, Mr. Powell said the Fed was “talking about inflation moving moderately.”

If the Fed can achieve slightly higher price gains, it will translate into more room for future rate cuts — and buying that extra headroom is a crucial goal in 2020. Long-running economic changes, such as an aging population with different saving habits and weaker productivity gains, have weighed on the interest rate setting that neither stokes nor slows the economy. That has left the central bank with less recession-fighting wiggle room.

Still, Mr. Powell pointed out that he and his colleagues “are not tying ourselves to a particular mathematical formula that defines the average.”

Some economists questioned whether the Fed will actually manage to achieve its new inflation target.

“The Fed is announcing this policy framework in part to push up inflation expectations,” said Seth Carpenter, a former Fed research official now at UBS. “In practice, however, getting above 2 percent is a long way off.”

Many of the changes the Fed announced Thursday formalize an approach it has edged toward over the past decade. The Fed was patient in beginning to lift interest rates following the recession from 2007 to 2009, even as unemployment fell.

When it did start to raise borrowing costs in late 2015, under Ms. Yellen, it did so slowly.

Under Mr. Powell’s leadership, the Fed has increasingly emphasized the benefits of that strong labor market, which pulled long-sidelined workers into jobs and helped to foster strong wage growth for those who earn the least.

Ms. Yellen, who has long argued that a strong labor market could boost marginalized groups, said the Fed’s shift is “great” and “a recognition that tight labor markets are beneficial.”

The long-run document promises that the central bank will continue to hold reviews, roughly every five years, and will continue to consult the public as it has done over the past year through its “Fed Listens” events.

“Public faith in large institutions around the world is under pressure,” Mr. Powell said in a question-and-answer session following his speech. “Institutions like the Fed have to aggressively seek transparency and accountability to preserve our democratic legitimacy.”

The Fed also explicitly noted in its statement that financial stability ranks among its key goals. In recent decades, expansions have ended when asset price bubbles — like the mid-2000s housing boom — got out of control, rather than at the hands of too-high inflation.

“Sustainably achieving maximum employment and price stability depends on a stable financial system,” the Fed said in its statement. “Therefore, the committee’s policy decisions reflect its longer-run goals, its medium-term outlook, and its assessments of the balance of risks, including risks to the financial system that could impede the attainment of the committee’s goals.”

Mr. Powell’s remarks, and the Fed’s shift, are set against an unhappy backdrop that has highlighted the central bank’s limits.

Fed officials have taken action to support the economy as the pandemic-induced downturn drags on — cutting interest rates to near-zero, buying government-backed bonds in vast sums, and rolling out emergency lending programs. Still, more than one million people filed initial state jobless claims last week, data released Thursday morning showed.

The Fed has repeatedly emphasized that a strong job market and economy is an imperative goal, but that Congress will need to help achieve it.

“It is hard to overstate the benefits of sustaining a strong labor market, a key national goal that will require a range of policies in addition to supportive monetary policy,” Mr. Powell said.

He added that there was a strong economy under the surface of the ongoing weakness.

“We will get through this period, maybe with some starts and stops,” he said. Still, “we’re looking at a long tail” as people who work in industries heavily impacted, like travel and service, struggle to find new work in a process that could take years.

“We need to support them,” Mr. Powell said.

It's Friday and this week was a big one for Fed watchers looking forward to the most anticipated Fed speech in decades.

Here's my reading of the Fed's momentous shift in policy:

  • Fed Chair Powell basically admitted the Fed cannot attain its 2% inflation target so the focus will be on its maximum employment mandate.
  • No surprise to me. Long time readers of this blog know I've been worrying about deflation forever and even wrote a comment three years ago about how deflation is headed for the US outlining several structural factors behind my reasoning: the global jobs crisis, the demographic time bomb, the global pension crisis, excessive private and public market debt, rising inequality, and technological shifts placing downward pressure on prices and wages.
  • The global pandemic has only exacerbated this long-term deflationary trend I've been warning of.
  • And now, the Fed's policy response and that of other global central banks will only intensify the deflationary trend and augur in an era of record low rates and growth.

Why? Last week, I discussed top funds' activity in Q2 and shared this:

  • Starting in late March, the Fed cranked up its balance by $3 trillion to backstop credit and equity markets. By doing this, it infected the bears with monetary coronavirus and unleashed the mother of all liquidity orgies on Wall Street. 
  • Speculators which include top hedge funds and bank prop trading desks used all that excess liquidity to buy risk assets, everything from junk bonds to tech stocks, to highly speculative vaccine stocks, some of which ran up as much as 3,000 or 4,000 percent year-to-date (before cooling off recently). 
  • This is entirely rational behavior but make no mistake, we are in the midst of a massive liquidity bubble and even George Soros has publicly warned it's a liquidity bubble.
  • Anyone who thinks stocks would be up more than 50% since March lows and making new record highs without such massive Fed intervention is either a fool or completely delusional. 
  • It's the Fed, stupid. The Fed took out the big bazooka and prayed it would work. It did, asset prices are all up all over the world, including in emerging markets, but the problem is the Fed has sown the seeds of the next crisis.
  • Why? Because a handful of mega cap tech names -- Apple, Amazon, Microsoft, Google, Facebook, Netflix, NVIDIA, Tesla -- are melting up to bubble territory while the rest of the market is still depressed. This concentration risk is unprecedented as a handful of stocks represent almost 40% of the S&P 500.
  • Top hedge funds knew all this, they used the "Ackman bottom" when Bill Ackman went on CNBC in late March to scare the living daylights out of investors, to front-run the Fed and take super concentrated positions in a few tech names.
  • But most investors got caught flat footed, sold out of the market and didn't participate in this parabolic liquidity bubble over the last six months. Value investors, in particular, are underperforming once again relative to growth investors and some of them are jumping into this market to try to make some gains going into year-end for fear of missing out (FOMO).
  • On top of this, you have commodity trading advisors (CTAs) with trillions under management buying every breakout on the S&P and Nasdaq because that's what their systematic models tell them to do, driving stocks even higher.
  • Moreover, you have the passive investor craze where everyone is giving BlackRock, Vanguard, Fidelity and State Street money to invest in passive indexes which also exacerbates concentration risk and forces a handful of mega cap tech shares to fly to the stratosphere.
  • Of course, you also have the dumb day traders like Dave Portnoy who used this liquidity bubble to speculate on stocks, delusionally proclaiming "it's the easiest game ever". 
  • And now, the final clincher, Wall Street strategists throwing in the towel, toppling over each other to raise their S&P 500 targets for the year based on the fact that record low rates warrant these forecast adjustments because there is no alternative (TINA).

It's enough to make any investor shake their head in disbelief. 

I'm not a conspiracy theorist but given the vast fortunes Wall Street and a handful of tech gurus made since the pandemic erupted while many people have permanently lost their job, it makes you wonder.

Importantly, once again, the Fed has bailed out Wall Street and extremely high net worth individuals who invest in stocks and left everyone else to collect the crumbs Uncle Sam is sending them every month.

This is what capitalism has been reduced to, a charade that keeps benefiting the power elite and being a student of C. Wright Mills, I should have seen it all coming. 

The late comic genius and social commentator George Carlin was dead right: "It's called the American Dream because you have to be asleep to believe it."

In his book, The Myth of Capitalism, Jonathan Tepper argues persuasively that regulators and competition bureaus are to blame, effectively killing competition to ensure monopsonies thrive.

He has many good points but the truth is capitalism is a system which thrives on massive inequality, that's its endemic engine and its ultimate demise because when this massive inequality becomes unsustainable, it will implode the system (we are seeing it every year with rising social tensions).

Why am I sharing all this with you? Because you have to think a lot bigger when looking at the stock market and ask yourself who is benefiting the most from this pandemic and what are the long-term consequences.

Top hedge funds invest on behalf of endowments, large global pensions and sovereign wealth funds but they also invest on behalf of ultra high net worth clients at Blackstone, Goldman, UBS Asset Management, and other big banks and their wealth management divisions.

The Fed has bailed them all out, at least so far, but when the next major crisis hits, even the Bezos and Gates of this world will get hit and hit hard.

What is critically important to remember is while the Fed can't influence consumer price inflation which typically comes from wage inflation which is non-existent, it can create asset inflation.

But too much asset inflation causes speculative bubbles and history has taught us that financial manias never end well.

Worse still, the Fed is knowingly exacerbating income inequality. It doesn't really care about maximum employment for minorities as long as big banks, big hedge funds and private equity funds and their high net worth clients make off like bandits.

This is great for Bezos, Gates, Musk and other plutocrats but it does nothing to materially stimulate aggregate demand (only higher wages will but capitalists and Wall Street speculators don't like that):

Meanwhile, Main Street is in a world of hurt and it will only get worse as fiscal stimulus tapers off: 

All this to say, the Fed is in a major pickle, damned if it does, damned if it doesn't, so it opted for its only real recourse, increase its balance sheet up to wazoo and inflate asset prices all over the world. 

Great, fantastic, we know this, we've seen this movie play out back in 1999-2000 and 2008-2009 and somehow we've always managed to come through all these episodes.

This time isn't different, right? 

Well, folks, that's the trillion dollar question, but if you ask me, positioning is so extreme in various risk assets (tech shares, high yield bonds, emerging markets bonds and equities, etc.) that the entire financial system is one major carry trade away from blowing up, seizing and having massive convulsions.

When will it happen? No clue but when I hear some CNBC commentator state "...the Nasdaq 100 (NDX) is only 20% above it 200-day moving average, at the height of the tech bubble, it was 60% above it," I get nervous:


I kid you not, it was Carl Quintanilla who uttered this yesterday but to be fair, he was saying it in the context of how things have become overly stretched.

Right now, these markets have become so lopsided that you'd have to be nuts to keep playing the one-sided tech momentum game:

And yet, this madness will likely continue until the Nasdaq hits 15,000 or 20,000 or more as Jerome Powell and company sit idly by for years (yeah right). 

What are value investors suppose to do in this environment? Jump on the tech trend and join all those hedge funds and Robin Hoodies making a killing buying tech shares? 

My best advice to those suffering FOMO and TINA here is you have a lot to fear, especially all you newbies who have never lived through a real bear market:

On that note, enjoy your weekend, let me leave you with some more food for thought.

Here were the top performing large cap stocks this week:

Interestingly, shares of Salesforce (CRM) took off 26% on Wednesday after the company reported great earnings and after it was known it will be a new Dow component along with Honeywell and Amgen.

26% in one day and 30% for the week, all very rational in a bubble market where everyone is trying to pick the next big tech stock to break out (crazy!):


Not surprisingly, the S&P Tech sector (XLK) is outperforming all other sectors, up 34% YTD followed by Consumer Discretionary (XLY) which is up 27% YTD (Amazon is 23% of that ETF):

And what's underperforming? What else? Energy (XLE) which is down a whopping 40% YTD and Financials (XLF) down 18%, both cyclical value sectors.

The dichotomy between value and growth is so bad that everyone is waiting for a major rotation (not just mini ones).

In fact, in his weekly market wrap-up, Up, Up, and Away!, Martin Roberge of Cannacord Genuity notes the following:

Our focus this week is on the persistent outperformance of technology stocks YTD. As we show in our Chart of the Week, the relative price line of the S&P 500 technology sector is back to levels set on February 23, 2000. The ultimate relative price peak occurred on March 10, 2000, or 12 business days later. Valuations, using a PEG ratio (i.e. P/E ratio divided by long-term EPS growth expectations), tell a similar story considering the technology index peaked at a ratio of 2.16 in March 2000 vs. 2.10 currently. As for earnings, other sectors are bouncing from cyclical lows with the reopening of the US economy. Hence, despite strong earnings in Q2, technology forward earnings estimates are no longer rising but falling, relatively speaking. In short, a negative divergence is opening between relative price and earnings strength. It remains to be seen if this divergence will last past the first leg of the cyclical recovery in S&P 500 earnings. Assuming it will, we recommend investors tred carefully and keep benchmark weights in tech. With the inflation trade back on the table, we favour energy, materials and industrials.


Very interesting chart, I think he's right but my fear is tech shares will keep melting up and then I see a massive tech selloff coming out of nowhere (like last September) and the entire market will crap out and stay down (in other words, no major rotation). 

Don't worry, if that happens, I'm sure the Fed stands ready to pump more liquidity into the system at a moment's notice: 

Japanification, here we come!!

Alright, that's enough, I'm sounding like a cynical jerk, enjoy your weekend. 

Below, Federal Reserve Chairman Jerome Powell delivers remarks at the virtual Jackson Hole Economic Policy Symposium, hosted by the Federal Reserve Bank of Kansas City. Powell discussed the Fed’s policy framework and specifically how it will alter its posture on inflation. The Fed has had a 2% inflation target, but in the decade since the financial crisis it has more often than not seen inflation fall below its target. 

And CNBC's Kelly Evans discusses the Federal Reserve's new average inflation targeting with Greg Ip, chief economics commentator at the Wall Street Journal. 

CNBC's Steve Liesman and Kelly Evans also talk with Robert Kaplan, Dallas Fed president, about the Federal Reserve's historic approach to inflation. 

Fourth, Jim Bianco, Bianco Research, breaks down the Fed's historic policy shift. With CNBC's Melissa Lee and the Fast Money traders, Guy Adami, Tim Seymour, Karen Finerman and Steve Grasso.

Lastly, Anastasia Amoroso, J.P. Morgan Private Bank head of cross asset thematic strategy, joins 'Fast Money Halftime Report' to discuss the state of the market and why she thinks the rally could continue.

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